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This is Part 2 of our Introduction Into Foreign Currency which covers laws - violations - penalties - risk factors - managing & minimizing risk factors -
There will now be a Part 3 to further explore and inform us about Foreign Exchange Risks and how to Mitigate - Minimize & Manage them -
We sincerely hope you enjoy the added feature of more informative posts directly and indirectly related to our investment
Comments are encouraged and will be available for viewing upon approval - Recaps Team
Foreign Exchange Transaction Laws By Jeffery Keilholtz,
Foreign exchange is a money transfer from one form of currency to another. Foreign exchange transaction laws are a device for keeping foreign currencies accessible and acceptable to nations participating in the world market. Laws determine how rates are "fixed," the differences between bilateral and trade-weighted exchange rates and penalties for law violation.
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Transaction laws maintain that market exchange rates between currencies are settled on by the interaction of both official and private contributors in the foreign exchange market. A rate that is "fixed" is established by a monetary authority, according to laws stated on the official website for the Federal Reserve Bank.
A monetary authority is considered as either a country's national bank or another official body. Monetary authorities in the United States do not intercede in the foreign exchange market on a permanent basis to manipulate the exchange rate.
BILATERAL AND TRADE-WEIGHTED RATES
The dollar remains the currency on which trade rates are based.
Foreign exchange laws state that market exchange rates be cited in bilateral terms. Bilateral means the value of the dollar versus any other single foreign currency (i.e. the pound, franc or yen). As well, modifications in the dollar's average value are to be assessed by using various statistical measurements that have been developed to index the dollar's movements on a trade-weighted basis. According to the Federal Reserve Bank website, while trade-weighted rates are not moved on the open market--where only the principal currencies are exchanged--the law does permit the buying and selling of index-based futures.
VIOLATIONS AND PENALTIES
Individuals can be fined up to $5 million dollars.
Violating foreign exchange laws can result in severe penalties. According to the U.S. Foreign Corrupt Practices Act, any company doing business on the open market (domestic or foreign) that is found guilty of bribery can be criminally penalized up to $2 million per violation. For culpable individuals, fines can also mean up to five years' imprisonment. Any criminal activity on the foreign exchange market can lead to the immediate banning of government licenses and prohibition from federal contracting plans
Read more: Foreign Exchange Transaction Laws LINK
How to Understand Foreign Exchange Control Laws By Walter Johnson,
The purpose of foreign exchange control laws is to protect the integrity of the local currency and the sovereignty of the state and banks that control its value. Understanding exchange control laws is about understanding how states protect their own sovereignty by limiting the amount of transactions one is permitted to hold in a foreign currency.
The dominance of a foreign currency in a particular country is a form of both political and economic control by foreign banks. Therefore, states seek to control the amount of economic activity that uses foreign currency within their borders.
1 Remember that any increase in the number of transactions in a country with a foreign currency means that the local currency is more and more edged out of economic life. If the local currency is not used in the majority of cases in the local economy, inflation will be the result since the locally printed money has nothing to do.
2 Study the extent to which currency is used as a weapon. Russia, for example, owns a great amount of American dollars. This means that the Russian state has some control over the value of the dollar. If Russia were to dump the dollar on the market, the value of the US dollar would fall, possibly with disastrous results for the American economy. Therefore, the state owning a certain amount of a foreign currency is a form of international diplomacy and warfare. On the other hand, the private use of a foreign currency means the irrelevance of the home currency.
3 Seek to understand the economic situation of the specific country under study. Usually, smaller, nationalist states will seek to limit foreign transactions with a great degree of vigilance. An example of this is Vietnam, which permits only “reasonable” foreign currency transactions in the country.
Otherwise, all transactions must be done in the Vietnamese currency. The state reserves the right to force the sale of foreign currency if the Vietnamese currency is threatened. Therefore, the Vietnamese government demands that all "unreasonable" foreign cash accounts must be sold to the state bank.
4 Keep in mind that local currencies demand to be the top currency in the country under study, but that the state should be amassing other currencies to use as foreign exchange. In the Russian case, a large percentage of all foreign currencies amassed in the private sector must be traded in for rubles.
Hence, the state amasses foreign currency for international business, yet the private sector is forced to do business in the home currency. This keeps the home currency strong while weakening the foreign currency. A weak currency is really another word for local inflation and the potential destruction of the economic life of the population.
This can be avoided if the local currency is continually active in the economic life of the society and therefore, currency control laws are enacted to enforce this.
TIPS & WARNINGS
Understanding currency laws is very much about the country in question's place in the global economy. Before working on the nature of currency, make sure that the economic and political context of the state and economy are understood first.
Currencies have little to do with states, and everything to do with banks. With some exceptions such as China, Vietnam, Libya or Belarus, most currencies are under the control of banks, rather than the state. Therefore, the state's role is limited to being a collection agency for private interests. Make certain that when you study a specific country, you figure out first of all who is in control of the value of that currency. Is it the state, or private banks, or some cooperative arrangement between the two?
Read more: How to Understand Foreign Exchange Control Laws | LINK
Definition of Foreign Exchange Risk By Kofi Bofah,
Foreign exchange facilitates global commerce. Foreign exchange risk is associated with fluctuating currency valuations that affect your bottom line. In order to manage foreign exchange risk, investors must familiarize themselves with the factors that influence foreign exchange rates. From there, they may devise an effective strategy to hedge against, or manage, foreign exchange risks.
The foreign exchange market refers to the network of corporations, government officials and private individuals who trade international currencies between themselves. Consumers exchange domestic currency for foreign exchange to purchase international goods. Meanwhile, multinational corporations trade foreign overseas revenue for domestic banknotes to spend at home.
Consumers are susceptible to the financial risks of lower domestic exchange rates, while multinational businesses must guard against higher exchange rates for domestic currency. When domestic exchange rates fall, consumers operate with less buying power for imported goods. Businesses, however, are less competitive when domestic exchange rates increase, because their wares are now more expensive to foreign buyers. Further, profits are lost when the business must convert foreign profits back into expensive domestic currency.
Investors recognize the factors that influence foreign exchange rates so that they may foreshadow foreign exchange risks. Strong currency valuations are associated with countries that feature growing economies and stable politics. The currency is then in high demand, as foreign investors covet that particular nation’s bank notes to buy its stocks, bonds and real estate. Alternatively, weak exchange rates often parallel inflation, economic recession and political instability. Foreign capital then flows outside of the country, and its currency rates fall significantly.
Foreign exchange rate movements introduce political risks, which may lead to reactionary policy that does further harm to the overall economy. For example, citizens may argue that weak exchange rates are evidence that government leaders are mismanaging the domestic economy. Treasury officials may then take measures to support higher exchange rates, such as spending the nation’s foreign exchange reserves to buy back its domestic banknotes. As domestic exchange rates shift higher, the country’s export economy begins to suffer, because exports are now more expensive to foreign buyers. The weak export economy then precedes foreign trade deficits and recession.
Advanced information technology associated with the foreign exchange market fosters contagion risks. Contagion relates to the process of one isolated economic event transitioning into global financial panic. For example, the Mexican government may default on its debt. From there, the Mexican peso would collapse. Foreigners doing business in Mexico would suffer large losses and may be unable to repay domestic loans. A global credit crisis would ensue, as banks and near-bankrupt businesses begin liquidating all assets to finance themselves, and recover debt obligations.
Currency derivatives, such as futures, options and forwards, are used to manage foreign exchange risks. Currency derivatives lock in predetermined exchange rates over set periods of time. Options and futures trade on organized financial exchanges, while forwards are private agreements between two parties to negotiate exchange rates.
Read more: Definition of Foreign Exchange Risk |LINK
What Is Foreign Exchange Risk? By Kofi Bofah,
Foreign exchange risk is related to the pitfalls of transacting international business. Lost buying power for everyday transactions and catastrophic trading losses for big investors and multinational corporations will arise from the failure to understand the risks of foreign exchange. Fluctuating currency values and political fallout are important risks that need to be addressed for both the individual and the corporation, while operating upon a global scale. All segments of international commerce must take care to hedge against foreign exchange risk.
DEVALUATION OF CURRENCY
The devaluation of currency is the most obvious risk in international business transactions. The risk that currency will lose value affects both buyers and sellers for different reasons. Buyers will discover that overseas purchasing power erodes as the home currency loses value. Meanwhile, sellers accepting and holding foreign currency reserves will see their net worth adversely affected by depreciating notes.
STRENGTHENING OF CURRENCY
Strong currency is a hidden risk to foreign exchange and the economic standing of particular nations--especially export and tourism industries. Strong currency values at home make goods more expensive to foreigners. Exporters and tourist destinations are unable to match prices with overseas competitors that benefit from doing business and setting prices in weak currency.
Political fallout from warfare, inflationary schemes to print money, and military coups will place downward pressure upon the home currency, at best. At worst, rogue governments will seize all assets of foreigners and refuse to honor contracts in the name of revolution. Unstable governing regimes will cause the value of their home currency to fall on the world stage.
Conversely, stable governments may see domestic upheaval when citizens feel that treasury officials are not committed to sound foreign exchange policy. Politics often causes competing nations to engage in trade wars.
In trade wars precipitated by unfavorable exchange rates, nations will purposefully devalue the home currency or legislate heavy taxes upon overseas profits. These actions influence the flow of capital back into the domestic country and punish those that trade internationally with losses. The risk to investors is that profits made overseas in foreign currency will be artificially weakened in value or burdened with taxes because of politics.
Although the individual may easily avoid foreign exchange risk by switching his spending habits and refusing to accept anything other than hard currency, the multinational corporation must weigh all risks involving foreign exchange. Further, investors should carefully analyze financial statements to ensure that profits are not skewed dramatically by sales overseas that are converted into the home currency.
HEDGING FOREIGN EXCHANGE RISK
Consumers dismiss losses automatically by refusing to purchase expensive imported goods and traveling overseas when prevailing sentiment indicates that the home currency is decreasing in value. Large investors and multinational corporations hedge against foreign exchange risk through diversification and the use of futures contracts.
Diversification entails transacting business in different countries featuring separate economic profiles, where fluctuating values will largely neutralize each other. Corporate managers avail themselves of futures contracts and repurchase agreements within the currency markets to lock in value. Read more: What Is Foreign Exchange Risk? | LINK
Foreign Exchange Risk Factors By Tim Anderson
While the FOREX (Foreign Exchange Market) is an incredibly lucrative venture for many investors, it is also a risky market that requires some knowledge and skill to navigate. Without the proper foreknowledge, it is possible to lose everything in a single bad venture, or to lose money over time through a series of poor investments. Knowledge is built up over time, and learning how to assess the risks associated with the FOREX can make the difference between losing and earning money.
Scams are one of the easiest ways to lose money on the foreign exchange. While it might seem appealing to go with the first choice when it comes to picking a broker to use on the FOREX, it is always worthwhile to do research on that company before you invest even a single penny. The most reputable companies will always be associated with large banks or financial institutions, as well as associated with the proper authorities and government agencies. All United States brokers will be registered with either the CFTC (Commodities Futures Trading Commission) or the NFA (National Futures Association).
No one can predict the fluctuations of exchange rates around the world with complete accuracy. There are always variables that individuals, as well as companies do not see. Even if an algorithm is used to attempt and predict how the market will swing in a particular direction, prices can often rise or drop far swifter than anticipated. Stop loss measures can help avoid taking too large of a hit on an unexpected exchange rate swing, but it is still a risk that can affect any trader or broker
There is always a risk that one of the parties involved in a foreign exchange transaction could fail to hold up their end of the bargain. This could be due to a lack of funds, bankruptcy, or such as when a bank declares insolvency. It is vitally important to work with organizations that have their credit worthiness regularly monitored in order to keep your credit risk at a minimum; otherwise, you could be left holding the short end of the stick, not to mention empty pockets.
The FOREX is largely about exposure. The more money you have on the market, the more money you stand to gain...or lose. The greater the exposure, the greater the risk, but it is also true that the greater rewards can only be gained by being willing to risk larger sums. Still, given the risky nature of foreign exchange ventures as a whole, it is always wise to limit your exposure unless you are willing to accept the risks associated with putting a large bankroll on the line. Read more: Foreign Exchange Risk Factors | LINK
How to Reduce Foreign Exchange Risk By Dicky Cheungcorp,
The profits of a corporation that operates in more than one country depend very much on the foreign exchange rates. Foreign exchange rates can fluctuate up and down, and thereby positively and negatively affect the actual profits of a company. It is therefore very important that companies know how to minimize their exchange rate risks so as to maximize their profits and increase their equity.
1 Hedge using futures or forwards contracts. This is the most common way of managing foreign exchange risk. A company will offset foreign currency holdings with futures and forward contracts. A futures contract is, according to Investopedia, "a contractual agreement, generally made on the trading floor of a futures exchange, to buy or sell a particular commodity or financial instrument at a predetermined price in the future."
A forward contract is a transaction in which the delivery of the commodity is postponed until the contract has been made. The delivery is often in the future, however, the price is well determined in advance. Hedging is the act of taking an offsetting position in a related security.
A good example would be if you own a currency, you will sell a futures contract stating that you will sell the currency at a set price in the future. A perfect hedge can reduce risk to nothing except the cost of the hedge.
2 Use options trading as a strategy to reduce foreign exchange risks. Just like stocks, currencies have calls and puts that allow buyers to buy or sell the financial asset at a predetermined price during a certain period of time or on a specific date (exercise date). Investopedia considers options the most dependable form of hedge. When traditional positions are used with a forex option they can minimize the risk of loss in a currency trade.
3 Use swaps. As described by Investopedia, "If firms in separate countries have comparative advantages on interest rates, then a swap could benefit both firms. For example, one firm may have a lower fixed interest rate, while another has access to a lower floating interest rate. These firms could swap to take advantage of the lower rates."
For example, company A is based in the United States and company B is based in England. Company A needs to take out a loan denominated in British pounds and company B needs to take out a loan denominated in U.S. dollars. These two companies swap to take advantage of the fact that each company has better rates in its respective country.
When these two companies swap, they will be able to save on interest rates by combining the privilege they have in their own country's market.
Read more: How to Reduce Foreign Exchange Risk |LINK
(Dinar Recaps Note: This post is for informational purposes only. It is not legal, tax or investment advice. Dinar Recaps advises that everyone should do their own due diligence and seek local Professional tax, legal and/or investment advisers.)
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