Currency exchange rate is a country’s currency expressed in foreign currency’s terms. This is affected by the forces of demand and supply in the currency market. Currency exchange rates are essential whenever making investment decisions. Investors tend to invest in countries where the exchange rate is high as in so doing their returns will be maximized. The investors also use the exchange rate for speculative purposes when carrying out foreign exchange market transactions. For instance in instances where the exchange rate has been increasing the investor will be able to speculate a future increase in the rate. Various factors however are responsible for the variation in the exchange rate, this includes: inflation, political reasons, economic factors and the monetary policy of a country .i.e. interest rates changes.
Exchange rates also affect the international trade. Businesses that are involved in imports and exports can suffer loss or make profit depending on the change in exchange rate. Export companies can find their goods competitive or expensive in the foreign markets depending on the fluctuation in the exchange rate. For instance a decrease in the exchange rate will lead to a loss to the exporting company. The capital and financial markets are also affected by the exchange rate fluctuations. As such businesses in such sectors are greatly affected by variations in the exchange rate.
Bonds though affected by exchange rates, at specific circumstances the rate of exchange cannot affect the transaction not bonds in the market. For instance, if a domestic bond is issued by the government, the rate of exchange will be inapplicable. It is only affected by transactions taking place in the domestic market. Besides, where the fixed exchange rate regime is used the fluctuations in the exchange rate will not affect the bonds valuation.
Multinational corporations play a great role in the global commodity pricing. Commodity pricing has far reaching effects on the MNCs. Though they command a great deal in the market commodity pricing, the prices they set may positively or adversely affect its operations. By setting high prices, a Multinational stands a chance to gain or make a loss. If a multinational operates in a monopoly market, by increasing its prices it will make profits due to the nature of its market. However, if it is operating in a perfectly competitive market, the company will stand a chance to lose as consumers will tend to purchase from its competitors who offer lower prices. If an MNC sets a lower price than its competitors in a perfectly competitive market it will make high profits due to the shift in the demand of its supplies. For instance if Shell BP sets the price of its petroleum products below its competitors, it will stand a chance to increase its profits. However, an MNC operating in a monopoly market may experience minimal changes ion its profit margin as by changes in the price of the commodity will have a minimal impact on the consumption. For example if Shell BP was operating in a purely monopoly market, by reducing its prices does not lead to increase in the quantity of Petrol refilled in the car rather consumers will continue to refill a quantity that will take them to their destination.
International financing suffers from three major market risks. These risks include the transaction risk, Translation risk and economic risk. The translation risk is due to negative fluctuations in the exchange rate where long term assets and obligations are expressed in foreign currency terms. Transaction risks arise as a result of negative fluctuations in the exchange rate from a receivable or payable which is expressed in the foreign currency. Economic risk on the other hand is related to the currency which the business transacts in irrespective of the situation of the customer.
International risk can be mitigated in different ways. These ranges from risk sharing strategies, money market hedging, future contracts, market nettings, currency options and forward contracting. Future contracting is where a standardized contract which involves delivery of a commodity at a stipulated future time and specified price. This enables hedgers to keep the risk of pricing in check. Forward contracting is a cash agreement where the seller agrees to deliver the product at a stipulated future time. This enables hedgers to avoid risks that may arise in future due to exchange rate fluctuations. In risk sharing, the buyer and the seller agree to share the risk caused by the exchange rate fluctuations. Currency options may take the form of call or put option. They are rights to the buying and selling of currency at a specified time and price in the future. As a result this is not affected by fluctuations in the exchange rate.
International finance and domestic finance vary greatly. In domestic finance major concern is on transactions and resource procurement which are localized. Thus, domestic finance is concerned with transactions in a single country. International finance on the other hand deals with transactions which are both local and international. They involve transactions between two or more countries.
The client base in international finance is broad as it deals with both the local and international clients. On the other hand the client base in the domestic finance is not only from a certain locality but also limited.
International finance is greatly affected by the exchange rate fluctuations. This will either have an adverse or positive effect on the transactions of the MNC involved. Where as, in the domestic the fluctuations in the foreign exchange rate have no effect on the financial position of the domestic based company.
The differences in sizes of the companies involved in the financial transactions affect the financial reporting of the domestic and international companies. Due to the high number of transactions involved in the international finance, Multinational corporations have to prepare large books of account to present their transactions. They have to comply with the international financial management standards and reporting. On the other hand domestic based companies are essentially required to comply with the domestic standards of reporting.
