International Finance Essay Example | Topics and Well Written Essays - 2000 words - 3

International Finance - Essay Example This keeps the revenues of the company intact and also caps the amount of its currency outflows. In the event of any adverse movement in the foreign currency receivables, the company can exercise the forwards or the options. If a company having dollar receivables is afraid of strengthening the domestic currency against dollar then by taking the desired position in dollar futures the company can keep the value of its receivables intact. All these financial instruments have their own set of merits and limitations. In the following paragraphs, these instruments have been discussed with various examples that will give an idea about their usefulness. A forward contract on a foreign currency eliminates the risks related to exchange rate fluctuations. In this case the parties entering the contract agree to exchange a specified amount of currency at a future date at a pre-determined exchange rate (Redhead, 2008, pp.730; Von Pfeil, 1988, pp.127). Suppose A Ltd, a British company got $1 million receivable after 3 months. The company is afraid of British pounds appreciating against dollar as this will lower the value of its receivables. To hedge its position the company can enter into a forward contract that will entitle it to sell the receivables after three months at an agreed upon rate irrespective of the rate prevailing in the market. Suppose the spot rate is GBP 0.60/$. In three months time the company expects that the value of pounds will strengthen against dollar due to which the rate will fall to GBP 0.55/$. A Ltd can enter into a 3 month forward contract of GBP 0.62/$ which will freeze the exchange rate of the company. Now suppose after three months the spot rate is GBP 0.56/$, the company will then be able to sell the dollar receivable at GBP 0.62/$. As evident from the above calculations, the amount realized if the position is hedged through forward contract is GBP 620000, whereas the amount realized if the position is