INTERNATIONAL TRADE

International Trade



Table of Contents

Determination of Exchange Rate Risk4

Types of Currency Risks4

Exchange Rate Risk6

Forward7

Futures8

Swaps8

Types of Credit11

Advantages of Credit12

The Letter Of Credit: A Simple Principle12

Conclusion15

References17

International Trade

Suggest methods of reducing financial risk in international transactions

After the crumple of the Bretton Woods system of flat exchange rates in the global economy, considerable variations occurred in nominal exchange rates and real exchange rates, leading to deviations in purchasing power parity. Changes in exchange rates affect both the current and future cash flows, and ultimately the value of companies. The impact of exchange rates on firm value depends on the structure of foreign exchange flows and competitive market position. Over the past 30 years, foreign exchange risk management practices in non financial corporations have changed dramatically.

Initially, risk management applied only at the level of individual departments of corporations, and the challenge was to reduce costs caused by exchange rate fluctuations. Today, the corporations carry out both short-and long-term management of currency risks throughout the organisation, applying financial and non-hedging strategy. In this case, the main task is the reduction of risks relating to adverse changes in exchange rates. For corporations exposed to foreign currency risk, the use of derivatives for hedging is to increase its value to a safe, average e.g. above five percent. Cost increases when the corporation begins to carry out foreign exchange hedging, and conversely, the cessation of hedging reduces its value against the value of firms that continue to hedge their risks (Bathory, 1987, pp. 49-55).

Determination of Exchange Rate Risk

Under the currency risk, exchange risk refers to risk caused by uncertainty of the future spot exchange. . The term exchange rate exposure literally refers to as "the degree of exposure to the company to currency risk that indicates how an unexpected change in the exchange rate by one unit affects the cash flows of the company for a certain time. For gauging exposure, the following formula is used:

Exposure; change in firm value in home currency / unexpected changes in the exchange rate of $ per unit. A firm can choose the degree of their exposure to it. For example, after the collapse of the Bretton Woods system of exchange rate, risk has raised sharply. In response, many firms have reduced their exposure at risk.

Types of Currency Risks

Categorically, a firm faces the following types of financial risks:

I. Economic risks: economic exposure that measures the effect of exchange rate changes on the economic value of the firm. In turn, they are divided into two groups.

1. Transaction risks (transaction exposure) are formed as a result of receivables or payable in foreign currency firm, unless the debt appears before the exchange rate, and payment must be made in the period after it. Transactional currency risks arise from unexpected changes in nominal exchange rates and affect the cash flows of corporations. Sometimes they are referred to as contractual risks (Blair &Boal, 2000, pp. 305-344).

2. Operational risks (operating exposure) - indicates risks of changes in real exchange rates that affect the value of future cash flows and ...