(1) Based on your due diligence, you have identified two international suppliers
ID: 430154 • Letter: #
Question
(1) Based on your due diligence, you have identified two international suppliers to complete your new supply chain network - one in Frankfurt and one in TaiPei. Based on your business plan, you anticipate that you will be conducting a substantial amount of business on a continuous basis with each firm over the next several years. Given this scenario, what method would you specify for handling payments with your new supply chain partners? Why?
(2) Why is it important to manage transaction exposure?
Explanation / Answer
(1) The company can enter into a forward contact with the suppliers in an agreement to exchange a specified amount of the currency in the supplier’s country (in Frankfurt & TaiPei) for the currency of the home country at the time of the contract. If the spot price (current price on the date of payment) is lower than the forward price (cost agreed as on the contract date), the company will gain in the process and will have to pay less. Generally speaking, the firm may sell (buy) its foreign currency receivables (payables) forward to eliminate its exchange risk exposure.
(2) Transaction exposure refers to the risk, faced by companies involved in international trade, that currency exchange rates will change after the companies have already entered into financial obligations. Such exposure to fluctuating exchange rates can lead to major losses for firms.
It is important to manage transactional exposure because the exposure is due to translation of books of accounts into the home currency. Translation activity is carried out on account of reporting the books to the shareholders or legal bodies. It makes sense also as the translated financial statements show the position of the company as on a date in its home currency.
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