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Foreign exchange transactions for companies
A company in an import / export business, may need to perform currency exchange operations. In a currency exchange operation, an amount of one currency is converted to another currency, within the framework of a calculated foreign exchange rate, which depends on interbank quotations in the foreign exchange market.
We will present you a few principles governing the functioning of the foreign exchange market, as well as the various services that b-Sharpe can offer.
The foreign exchange market, generally called forex (for Foreign Exchange), Is where the foreign exchange rate, also known as the currency exchange rate, is determined by supply and demand. These rates vary continuously from Monday to Friday.
This is a decentralised zone which affects almost all currencies in the world. These currencies are symbolised by a 3 letter ISO code corresponding to a specific logic: the first 2 letters represent the country, the last the currency. For example, the Swiss franc (CHF), “CH” stands for “Swiss Confederation”, and “F” corresponds to “Franc”. For the record, only the euro is an exception because it has replaced many currencies of the European Union.
There are 2 types of currencies:
There are 3 different foreign exchange markets : the cash market (also called “Spot”), the forward exchange market (also called “Forward”) and the options market. These three markets are completely interrelated and changes in one, impacts the other two and vice versa.
The spot market or “spot” is the most common and all futures quotations and options trading are based on the spot market.
In a foreign exchange transaction, made on the spot market, the rate that is used is that which matches the price, at time t of the currency pair, with a two-day working value date opening. That means, if the operation is performed on day Mon, it is to be “delivered” on Mon + 2.
The futures exchange market differs from the spot market by the date of the value transaction. The listing of a forward contract takes the quotation of the spot to which is added what are known as “point forward” or “swap points”. These swap points vary according to the duration of the contract depending on the difference in interest rates between the two currencies. Therefore, the rating of a forward contract in no way is a prediction of what would be expected for a spot trade.
Specifically, if a company buys EUR 100,000 at 1.0850 / selling CHF 108,500 to 3 months and the spot at time t is 1.0803, it means that there is 0.0047 forwards plus points, which implies that interest rates are higher in Switzerland than in the euro area
With this transaction the company is committed to delivering CHF 108,500 and its counter-party agrees to return EUR 100,000, regardless of changes in the price between the date of the order and the expiration of the contract .
What would be the point of such a transaction for a company? A Swiss company could make a quote in EUR for a client based on a given EUR / CHF price. But if at the time of final encashment, which may happen 2 or 3 months later, at a time when the EUR is down against the CHF, the company would lose money if it had to sell EUR to buy CHF in order to pay its expenses. Placing a forward order would have allowed it to fix the exchange rate as many months in advance as it pleased, and at the time of receipt, the operating margin would not have been affected by any variation of price.
The options market differs from the futures market in that the buyer acquires a right to buy or sell a particular currency against a given currency. There is no obligation on the part of the holder of the option to exercise that right. The major parameters of the option are the maturity and the exercised price, called the “strike”. When the strike price is reached, the option is activated. The price of an option is called a prime, and is set as a function of the forward quotation of the maturity of the option, the volatility of the currency pair recorded during the operation, and the strike price and duration. The higher the volatility, the greater the cost of the option. The longer the duration, so too the more expensive the option. And the closer the strike is to the price recorded at the time of purchase, the higher the premium.
A company may be interested in buying an option for the same reasons as the purchase of a forward contract, i.e. to hedge against a currency risk. An advantage of an option is that there is no obligation to exercise it. This means that if at maturity the company does not need to sell or buy foreign currency, it is not committed to conduct the transaction as it would have to, in a forward contract.
b-Sharpe is the Swiss specialist in foreign exchange. We advise you to set up a currency hedging strategy and foreign exchange risk management systems for your import and export operations. Every year, we support hundreds of clients who benefit from our expertise and our rates, which are among the lowest on the market. To start, contact us!