HOW COMPANIES EXCHANGE CURRENCIES AT PRESENT

Case study
A Czech importer of sanitary devices and bathroom equipment imports a new collection of products from Italy for the Czech market. The foreign manufacturer provided the importer a standard 30 day term of payment for reimbursing the outstanding debt in EUR. Due to delayed terms of payment of his/her customers and current lack of CZK funds, the importer is unable to take advantage of the current favourable exchange rate and is forced to wait with an EUR purchase until the term of payment has expired. This expected payment was not secured by the firm, and thus, when the Czech koruna weakened during the 30day period due to negative macroeconomic data, it was forced at the moment of necessary purchase of the EUR sum to accept the current unfavourable exchange rate. This development of the EUR/CZK rate increased the koruna value of already purchased goods and the firm experienced a loss as a result of the rate movement. In order to cover the expenses associated with the import of the goods, it had to increase the volume of necessary financial instruments in CZK.

HOW CAN THEY EXCHANGE THE FOREIGN CURRENCY MORE EFFECTIVELY?

How does one then hedge against a rate risk?
A simple solution exists for the Czech importer to hedge against the rate risk. On the day of receiving the invoice in foreign currency, the firm fixes the exchange rate for the full value of the debt (also possible for individual transaction items), and by hedging itself by these means, it may easily and effectively plan its CZK financial flows. The exchange rate is solidly fixed using a so-called forward transaction for a period of 30 days. Throughout this period, the firm, if necessary, may settle this forward transaction any time earlier, as well as partially. Practically, this means that the firm e.g. receives a part of CZK from the customer in a shorter term than 30 days and decides to reimburse a portion of its obligation prior to the term of payment. In the opposite event, the entire forward transaction is then settled by the firm in the negotiated 30 days deadline.

AN ILLUSTRATION OF HOW A FORWARD TRANSACTION LOOKS - IMPORT

1. ARRANGING A FORWARD TRANSACTION

Invoice amount: 100 000 EUR
Rate on the date of invoice: 25.00 CZK
Debt value in CZK 2 500 000 CZK

Dated: 1. 10. 2009
A Czech firm closes a forward (FWD) for 30 days for the purchase of 100 000 EUR for CZK.

2. REMITTING THE DEPOSIT

If the forward transaction is arranged for a period of less than 10 days, a deposit is not required.

3. THE KORUNA STRENGTHENS

While the client has a closed forward at a rate of 25.00 CZK/EUR, on 15.10 the CZK appreciates to the limit of 24.00 CZK/EUR.
Invoice amount Rate of the koruna Value of goods as of 15.10.

An appreciation of the koruna led to a decrease in the value of the deposit. The deposit value is calculated based on the real-time exchange rate that is momentarily on the foreign currency market.

The value of the deposit decreased by:

Forward is covered (absolute terms) as of 15. 10. 2009:

125 000 - 100 000 = 25 000 CZK

Forward is covered (relative terms) as of 15. 10. 2009:

5% of the forward must be minimally covered, while Citfin requires the deposit to be added if the forward coverage drops below 2.5%.

The deposit must thus be supplemented:

It follows from the above calculations that the absolute value of the deposit increased from 125 000 CZK to 225 000 CZK, however, in relative terms, the amount of the deposit is 5%.

THE KORUNA WEAKENS

While the client has a closed forward at a rate of 25.00 CZK/EUR, on 15.10 the CZK depreciates to the limit of 26.00 CZK/EUR.

Original forward value: 2 500 000 CZK

Forward value as of 15. 10. 2009

Value of deposit:

Forward is covered (in absolute terms) as of 15. 10. 2009:
125 000 - (-100 000) = 225 000 CZK

Forward is covered (in relative terms) as of 15. 10. 2009:

The forward must be covered by a minimum of 5%; hence Citfin in this case does not require that the deposit be supplemented.
It follows from the above calculations that the absolute value of the deposit 125 000 CZK is unchanged, however, in relative terms, the amount is fully sufficient.

4. FORWARD as of 31. 10. 2009
On the transaction settlement date, the Citfin analyst contacts the client by phone and specifies the method of covering the forward transaction. If necessary for the full settlement of the forward on the negotiated date, the net book value of the transaction is billed to the client, and the client sends the remaining coverage to the Citfin Company account. EUR value of the forward transaction is subsequently sent to the client according to the manner of settlement negotiated, i.e. directly to his/her bank account.

Back to Forward transactions

This product is provided by Citfin - Finanční trhy, a.s.