Foreign Currency Exchange Table and Converter

Over the past decades after the war, statistics show that international trade has grown

allocation of resources. One reason for this growth was the reduction in barriers to trade

and investment through the development of free-trade areas such as the European Union,

the North American Free Trade Agreement and the Association of South East Asian

Nations. Another reason was the rapid improvement in transportation and communication

infrastructures. The proportion of Gross Domestic Product exported (export ratio) had

increased dramatically between 1958 and 1990 for countries such as Korea (0.4% to

25.8%), France (8.8% to 18.3%), Canada (from14.5% to 23.1%), Spain (3.5% to 11.4%),

to mention just a few. This rapid growth in international trade has brought with it a similar

increase in the importance of international money market activity and internationally

oriented financial products. Another effect of this growth in international trade was the rise

of MNCs (multi-national corporations). The United Nations estimates that cross-border

corporate investment grew four times faster than world output and three times faster than

international trade itself between 1980 and 1995, resulting in around 40,000 MNCs and

Apart from risks associated with changes in interest rates and commodity prices,

companies with substantial overseas interests encounter a variety of other hazards, which

include political risks and currency fluctuations. Overseas interests may include, amongst

others:

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Since exchange rates between currencies are volatile, these interests all bear currency

risk. The consequences of movements in foreign currency exchange rates can vary from

receiving higher cash flows or paying lower amounts than expected at the date of the

transaction, to receiving lower amounts or paying higher sums due to an appreciation of

the currency of the transaction. Movements in foreign exchange rates can also affect

positively or negatively the value of a company after integrating the results of a foreign

branch.

As we shall analyse below, currency risk or foreign exchange risk is normally distilled into

usually characterised in terms of adverse effects on a firm’s activity. Exposure to risk

arises as a consequence of uncertainty about the future. In as much as risk management

techniques that are being ingrained in operations and methods adopted by companies,

various instruments to hedge against foreign exchange risk.

In the text below we shall be looking at what changes in exchange rates, and the effects

winding down with a discussion about the merits of such derivatives.

The foreign exchange rate is the price of one currency in terms of another. Therefore if the

market-place where one can buy or sell currencies is operated electronically by banks.

USD/GBP 1.8630 – 1.8660, which means that the bank sells at 1.8630 and buys at

1.8660. Therefore, if one customer wishes to pay a bill of USD1,000 and is paying using

USD1,000 to the bank on the same day, then the foreign exchange market will give her

at the higher price. The difference is the profit of the bank. Apart from this profit, the bank

also charges commissions on the transaction.

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Forward FX market. In the example mentioned above, the rate of exchange used on the

day was the Spot rate. The forward market is where one can buy or sell a specific amount

of currency at a specific forward rate of exchange, for exchange on a specific future date.

The spot and forward rates may be given as:

USD/GBP spot 1.5840 – 1.5860 1.5840 – 1.5860

Discounts are added to the spot rate to derive the actual forward rate. In such a case, the

appreciate against the second of the pair. The forward market is used to insure against

loss on exchange rate fluctuations in the case where a person knows that she is going to

pay out or receive foreign currency at some future date. We shall delve deeper into

hedging instruments further down in this report. For the moment, we shall skim through the

determinants of FX rates.

Basic economic theory suggests that exchange rates are determined by the forces of

supply and demand. These forces stem from

One may at this stage be asking a few questions such as:

a) Why are rates of exchange different for different currencies?

b) Why would the forward rate of exchange of a currency be different from the spot

rate?

c) What determines the forward rates?

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countries. Logically, assuming no transaction costs, an economic unit would prefer

borrowing from a country that charges the lower interest rates. Similarly, a firm would be

tempted to buy the currency of that country and invest it in that same country if the interest

rates offered on deposits are higher than those of other countries including its home

country. Inflation and the purchasing power of money also play an important role in the

context of exchange rates in that economic units will probably decide to buy say, silver,

from one country at a price per troy ounce and ship it to a country where the same silver

would fetch a higher price. In both cases described however, the success of the

transaction would still depend on the spot exchange rate on the day when the cash flows

are repatriated to the home country. Differentials in interest rates and inflation rates

possibly attract business units resulting in higher demands for a currency and lower

demand for another currency bringing back on stage the theory of supply and demand in

exchange rate determination.

financial markets are efficient and that a gain from a more favourable interest rate in one

country compared to another is balanced by an adverse movement in exchange rates.

Forward exchange rates are set to bring about parity between interest rates in different

currencies. Therefore an investor, for example should be indifferent as to whether she

should invest an amount of home currency at a certain interest rate, or buy foreign

currency at the spot rate, invest in the foreign currency and at the same time sell forward

the principle plus interest. At the same time, IRPT suggests that if firms actually decide to

invest in a foreign country because of advantageous interest rates, this would affect the

future spot rate through the higher demand for that country’s currency.

or Purchasing Power Parity Theorem. This theorem states that exchange rates move to

effectively bring about parity in the purchasing power of currencies of different countries.

The rational behind this theorem is that the price of a particular good in say GBP is the

same as the price of that same good in another country converted into GBP at the spot

As explained above in the case of silver, if the firm exporting the silver was able to register

gains from the transaction, this opportunity would not last long because of the effect on the

higher demand for silver and the downward force on the currency of the importing country.

In the real world of course, the argument becomes more complex because of other costs

involved such as carriage and freight. Although Big Mac burgers bought in the Philippines

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would think of buying the burgers in the Philippines, shipping them to Switzerland and

selling them there because the costs would be prohibitive.

Forward rates mentioned above on page 5, are determined by IRPT, while actual future

spot rates are determined by PPPT and supply and demand forces at that future point in

time. Therefore, forward rates are not good predictors of future spot rates.

A simple common transaction between firms of different countries will quickly illustrate the

exchange risk involved in international trade. Assume an exporting US company A which

regularly secures contracts of sale which involve substantial delays in payment. It is the

practice of the company to secure payment using Bills of Exchange maturing after 90

days. Assume that at the time of the transaction which involved a sale to a UK company B

invoiced at GBP30,000, the spot rate was USD/GBP 2.0000. Company A therefore

anticipates revenue of USD60,000. Over the 90 days however, the USD appreciates so

that the exchange rate when the funds are paid by company B to company A, is USD/GBP

1.5000. The funds thus transferred were just USD45,000. Company A has just made a

investment such as building a warehouse in a foreign country since such an investment

risks include also risks involved in borrowing or lending money denominated in a foreign

currency since these would involve interest and principle repayments in foreign currency.

establish a UK branch and this branch is expected to earn a profit of GBP500,000

(equivalent to USD1000,000 when translated at the current rate of exchange is USD/GBP

2.000), then company A will only be registering USD750,000, a shortfall of USD250,000, if

the exchange rate changes to 1.5000. As such this type of exposure is only an accounting

one since at this stage it has no cash flow impact. However, related to this is the case

where the investment in the foreign branch was taken on the basis of positive NPV

calculated using, in our case, GBP to project the cash flows and the UK cost of capital so

as to discount the cash flows. The expectations of the shareholders of company A would

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fall should the USD appreciate especially where the branch is expected to repatriate its

This type of risk can be viewed as a longer-term version of transaction risk. One must note

a company even in its own home country as a result of appreciation of the home currency.

Assume that the same company A exports its product for the price of USD1,000 per unit,

which when converted at the spot rate on the date of the transaction (USD/GBP 2.000)

sells in the UK for GBP500. Assume also that a UK company C is competing with

company A in the UK and is also selling similar products for GBP500 each. Assume that

the following year the USD depreciated to USD/GBP 2.5000. This would result in the

product of company A selling in the UK for GBP400 straining the competitiveness of