Financial Management (Currency Risk Management) Essay

Financial Management (Currency Risk Management) - Essay Example Suppose a U.S tourist flies from New York to London then to Paris then to Munich and finally back to New York. When he arrived at London’s Heathrow Airport, he goes to the bank to check the foreign currency listing. The rate he observed for US dollar is $1; this means that $1 will cost him â‚ ¬ 0.6814. Assume that he changed $2000 for â‚ ¬1362.8 and enjoys a week vacation in London, spending â‚ ¬500 while there are saving â‚ ¬862.8. At the end of the week, he travelled to Dover to catch the Hovercraft to Calais on the coast of France and realizes that he needs to exchange his â‚ ¬862.8 remaining Euro for Swiss francs. However what he sees on the board is the direct quotation between Euro and dollar and indirect quotation between franc and dollars. The exchange rate between any two currencies is called the cross rate. Cross rates are actually calculated on the basis of various currencies relative to the USD$. For example the cross rate between Euro and French fra nc is computed as follows:Therefore for every Euro he would receive 0.009923 Swiss franc and arrives at Czech Koruna, he again needs to determines a cross rate. This time between Swiss franc and Czech Koruna to find the cross rate he must divide the two dollar basis rate.First, we assume that our traveller had to calculate the entire cross rates. For retail transactions it is customary to display the cross rate directly instead of a series of dollar rate. Second, we assume that exchange rate remain constant over time. Actually exchange rates vary every day, often dramatically.