Foreign Currency Management

Every external transaction involves problem of payment and pricing.  The price payable to a foreign buyer can be in seller's or buyer’s currency or an international currency such as US $. The advantage to the seller for his own currency is that he knows exactly how much he is going to receive.  However, the seller may prefer another currency in the following cases:

If his own currency is depreciating rapidly in value; or

His government prefers to have some other currency; or

The seller himself wishes to make payment abroad, where another currency is more acceptable

The buyer will also have to purchase the necessary foreign exchange to make payments.  In most cases the rate of exchange between his own currency and the foreign currency is not fixed.  An exchange rate represents the number of currency units of one currency that can be exchanged for another country's currency units.  The currencies of the major countries are traded in an active open market and rates are determined by the prevailing demand and supply forces.  From the interaction of those who supply and demand currencies exchange rates are established for two types of transactions:

Spot Exchange Transactions – they occur when currencies are traded for immediate delivery.

Forward Exchange transactions – they occur when purchasers and sellers contract to buy and sell currencies for delivery at a future date.

Foreign exchange risk or exposure is involved whenever some of the assets of an enterprise are not denominated in the currency of its home country.  The loss due to foreign exchange rate fluctuations arises due to fall in the value of domestic currency in relation to the currency of the country with which business is proposed to be done.  The other type of exchange risk is that a country may block its currency so that it cannot be converted into other currencies.