Question

Appraise the functions of the foreign exchange markets that would be useful to an exporting business.

Answer 1

An export business would have numerous transactions in foreign exchange. It may need to convert domestic currency into some foreign currency, or some foreign currency into domestic currency. Foreign exchange markets provide the facilitation and liquidity for these transactions.

An export business is exposed to foreign exchange risk. For example, the exporting business may have a large amount of receivable due in foreign currency. If the domestic currency appreciates relative to the foreign currency, the amount received in domestic currency would decrease. Foreign exchange markets can help reduce this risk by "hedging". Hedging is a type of foreign exchange risk management. It can help one reduce their foreign exchange risk. For example, an exporting business has these kind of hedging options available in the foreign exchange markets :

• Forward hedge - Entering into a forward contract to lock in to the future exchange rate
• Futures hedge - Entering into a futures contract to lock in to the future exchange rate
• Options hedge - Buying/selling call/put options to benefit from a change in exchange rate