Question

Every quarter, Bronx Co. ships computer chips to a firm in central Asia. It has not used any trade financing because the importing firm always pays its bill in a timely manner upon receipt of the computer chips. However, Bronx Co. was concerned that the foreign government may impose foreign exchange controls. Bronx Co. reconsidered whether it should use some form of trade financing that would ensure that it would be paid for its exports upon delivery. How could Bronx Co. have achieved its goal?

Answer 1

Bronx Co faces the risk of foreign currency fluctuation as they have trade relations with central Asia and transact in foreign currencies. Bronx Co is therefore exposed to transaction, economic and translation exposure.

1. Translation Exposure: Translation exposure is the exposure that Bronx Company’s balance sheet and income statement items to foreign currency fluctuation.
2. Transaction Exposure: Transaction exposure is the exposure of foreign currency transaction to fluctuation in foreign exchange.
3. Economic Exposure: Economic exposure is the risk that Bronx company’s cash flow and foreign investments may be affected by foreign exchange fluctuations.

Bronx Co can manage its transaction, economic and translation exposure with the help of derivative contracts such as forwards, futures and options.

A forward agreement is an agreement where two parties agree to buy or sell foreign currency at a specified future time. Future contracts are similar to forward contracts except that they are standardized contracts and they are traded on an exchange. They can also use options. Options give the right but not the obligation to trade foreign currency for home currency. They help to convert uncertain foreign currency into a certain amount of home currency.

I hope that was helpful :)