Introduction to Foreign rates
Introduction to Foreign rates
There is a fundamental difference between making payment in the domestic market and making payment for goods, services, or securities purchased abroad. In a domestic transaction only one currency is used, whereas two or more currencies may be used in a foreign transaction. For example, a U.S. company that exports $100,000 worth of textile machinery to a Zurich textile producer will ask the Swiss buyer to remit payment in dollars unless the U.S. firm has some specific use for Swiss francs. (If the firm has a Swiss subsidiary, for instance, it may wish to make the funds acquired available to this subsidiary and would accept payment in Swiss francs.)
Assume that the situation just described is not the case and that you are a U.S. importer who has agreed to purchase a certain quantity of French perfume and to pay the French exporter 20,000 francs for it. How would you go about paying? First, you would go to the international department of your local bank to buy 20,000 French francs at the going market rate. Let's assume that the dollar/franc exchange rate is FF 5 = $1. Your bank then would debit your demand deposit by $4000 plus transactions costs and give you a special check payable in francs made out to the exporter. The check then would be sent to the exporter, who would deposit it in a Paris bank. The bank in turn would credit the exporter's account with 20,000 francs, and the transaction would be complete.
The special checks and other instruments for making payment abroad are referred to collectively as foreign exchange. It is sometimes difficult to understand and relate to different currencies. As we saw in the opening case, dealing in foreign exchange is almost like using Monopoly money. It is hard to develop a context or feeling for the currency. As illustrated in the opening case, the first step in understanding foreign exchange is to understand the basic terms and key markets.
As an extension to the case, we need to understand the global and national context in which exchange rates are set. Then, we need to see how foreign exchange is used in international transactions and the nature of risks and risk aversion strategies adopted by MNEs. These issues will be developed in several different chapters.
To be effective, MNEs as well as small import and export firms must understand exchange rates. The exchange rate can influence where a wholesaler or retailer buys products from and sells products to an end consumer as well as where a manufacturing firm acquires raw materials or components and produces products. In addition, the rate of exchange affects the location of capital that a firm needs to access in order to expand.
There is a fundamental difference between making payment in the domestic market and making payment for goods, services, or securities purchased abroad. In a domestic transaction only one currency is used, whereas two or more currencies may be used in a foreign transaction. For example, a U.S. company that exports $100,000 worth of textile machinery to a Zurich textile producer will ask the Swiss buyer to remit payment in dollars unless the U.S. firm has some specific use for Swiss francs. (If the firm has a Swiss subsidiary, for instance, it may wish to make the funds acquired available to this subsidiary and would accept payment in Swiss francs.)
Assume that the situation just described is not the case and that you are a U.S. importer who has agreed to purchase a certain quantity of French perfume and to pay the French exporter 20,000 francs for it. How would you go about paying? First, you would go to the international department of your local bank to buy 20,000 French francs at the going market rate. Let's assume that the dollar/franc exchange rate is FF 5 = $1. Your bank then would debit your demand deposit by $4000 plus transactions costs and give you a special check payable in francs made out to the exporter. The check then would be sent to the exporter, who would deposit it in a Paris bank. The bank in turn would credit the exporter's account with 20,000 francs, and the transaction would be complete.
The special checks and other instruments for making payment abroad are referred to collectively as foreign exchange. It is sometimes difficult to understand and relate to different currencies. As we saw in the opening case, dealing in foreign exchange is almost like using Monopoly money. It is hard to develop a context or feeling for the currency. As illustrated in the opening case, the first step in understanding foreign exchange is to understand the basic terms and key markets.
As an extension to the case, we need to understand the global and national context in which exchange rates are set. Then, we need to see how foreign exchange is used in international transactions and the nature of risks and risk aversion strategies adopted by MNEs. These issues will be developed in several different chapters.
To be effective, MNEs as well as small import and export firms must understand exchange rates. The exchange rate can influence where a wholesaler or retailer buys products from and sells products to an end consumer as well as where a manufacturing firm acquires raw materials or components and produces products. In addition, the rate of exchange affects the location of capital that a firm needs to access in order to expand.
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