International Bathroom Design Case
The development of the market through the history, along with the evolution of the consumer, transactions and behavior itself has produced different ways to manage international transactions, production chains and distribution channels throughout the world.
The openness of the market nowadays has introduced many aspects that should be taken into account when analyzing the patterns of trade and the economic development of a country. Difference in technology, the impact of the qualified labor in a territory, the quantity of raw materials in an area but in our case, the existence of a main player that may determine success or loss in the transaction and agreement times are the exchange rates.
Many authors simply as follows define these exchange rates… The price of one country's currency expressed in another country's currency. In other words, the rate at which one currency can be exchanged for another1. The appearance of these differential rates in every country has created another opportunity/threat when doing their transactions internationally. It may happen that a firm lose part of its profits when making a contract for future payments, or also may profit from a future agreement of payment. This is why many studies of how to face the exchange rate differentials have increased in the economic science as a “practic” theory on International Business.
The following case of the International Bathroom Design gives us a glance of the opportunities and threats that a differential in exchange rates in production and sales may cause to a company in the international market these days.
IBD Case Short term transaction risk and different hedging alternatives Just as with most firms who trade products internationally, International Bathroom Design (IBD) must deal with payables and receivables in different currencies. As a result, there is considerable transaction exposure involved with these contractual cash flows and in order to minimize the risks of foreign currency fluctuations the firm could take advantage of several options to hedge the risk of potential foreign exchange rate changes that are beyond their control. The firm has payables to suppliers in Europe that must be settled in Euros while their receivables from customers in Arab and Asian countries are settled in USD. To further complicate the situation their head offices in Dubai have expenses that require costs to be settled in UAE Dirhams (AED) and inevitably they must repatriate profits to satisfy taxation requirements. Considering that they must maintain current accounts in several currencies and facilitate the necessary payments, the firm will be exposed to the transaction risks of currency movements in the international spot markets. There are several methods of hedging these risks and the size of the company dictates that they take advantage of one or all of these. The simplest form of negating the risk of fluctuations dictates that they enter into agreements with their financial institutions to manage their staggered receivables through the use of forward currency contracts. Instead of actually tying up funds purchasing Euros and AED to settle their future payables they can contractually purchase forward rate agreements that guarantee the cost of payables, negating the risk but similarly eliminating the upside potential of positive exchange rate fluctuations. If for example, they anticipate monthly revenues of USD $900,000 (10.8 m / 12) and monthly expenses of roughly USD $500,00 (EU 6.5m/12 + USD .681m/12) they can negotiate forward contracts to cover their expenses at fixed rates in both Euros and AED. These monthly contracts guarantee the receivables are readily available at understood valuations to settle their operating costs. If they have a different (non-monthly) schedule of receivables to payables they can set the terms and forward rates based upon the expected dates of these receipts and payments