M4D1 Exchange Rate Management During Financial Transactions

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The monetary approach and the balance of payments approach are two theories that are critical in explaining exchange rates. The former focuses on the monetary guidelines or policies of two countries to establish their currency exchange rate. This model incorporates price and interest rate dynamics. In this case, the domestic money supply brings about a change in the level of prices and similarly, a level change in the prices leads to an exchange rate level change. The monetary policies, however, work best in the long-term as the market takes some time to adjust. This is because the monetary policies target money supply, interest rates, and price levels which take time to be fully aligned to achieve the intended objectives. An expansionary monetary policy will lead to a decrease in exchange rate of the local currencies as the country pursues imports, therefore, weakening the nation’s current account.

The balance of payments approach focuses on the implication of the national income to the nation’s current account. As a result, the exchange rate adjusts to a new level so as to attain new balance of payments equilibrium. With the interest rate level stable, a rise in the national income of country will lead to the rise in the demand for imports or foreign goods. This brings about a shift in the new equilibrium when it comes to the current account balance. The exchange rate, in this case, is used to restore the balance of payments equilibrium level. The exchange rate will thus reduce making the imports expensive to restore the balance of payments of the said country. Likewise, if there is a drop of the national income, the imports will reduce, and therefore the exchange rate will rise to restore the equilibrium as observed in the current account balance.

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Cash-flow harmonization is one of the internal exchange risk management tools. It entails the synchronization of revenues in foreign currency to the overheads in foreign currency on the premise of timing and amounts (Rozsa & Darabos, 2015). This ensures that the transactions occur in the same currency avoiding the risks associated with unwarranted fluctuations. A good example is an American company X transacting with a European-based company Y. X makes a quotation for products worth 10,000 USD but opts to pay in EUR to company Y. In the exchange, the company ends up paying 8,500 EUR instead of 8,700 EUR after exchange rate fluctuations linked to the conversion of currencies. Paying in the foreign currency thus brings about meaningful savings by as much as 10 percent. It also ensures that businesses have room to extend their terms of payment without necessarily being exposed to additional loss or risks.

The problem statement as observed in the Attila Rozsa and Eva Darabos 2015 article centers on the possibility of mitigating currency exchange risks through use of an appropriate currency. The authors understand the multiplicity of currencies in business and its relation to the vulnerability of businesses to exchange rate risks. Drawing lessons from the 2008 financial crisis, financial pundits have emphasized insightful scrutiny into the existing exchange rates without the” need of completeness” (Rozsa & Darabos, 2015).

The analysis of the Keraskedo Ltd.’s case is sufficient in that it breaks down expenditures and incomes in HUF and EUR. Through the cumulative balances transactions using HUF rather EUR is fundamental in highlighting the refusal of neglecting the conversion during EUR booking does lead to the decrease in the exchange rate fluctuation ratio. The analysis, however, shows that there are other underlying factors that affect the exchange rate thus the bank exchange rate alone cannot hinder the company from making exchange rate losses.

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