The Process of Currency Conversion - Assignment Example

The Process of Currency Conversion Introduction Foreign exchange is a market concept that means, converting currency of one country into that of another. Therefore, foreign exchange market is the market that hosts the currency conversion process. The process of currency conversion depends on exchange rates. An exchange rate is the cost charged for converting the value of a country’s currency into the value of another. Therefore, the establishment of foreign exchange market was to create a system that could facilitate the conversion of a country’s currency into another and offer insurance services against adverse consequences of foreign exchange rate fluctuation. A spot exchange rate is the rate used in an instant currency conversion agreement between two or more parties. Spot exchange is carried out in a spot exchange market, which is part of the foreign exchange market. On the other hand, forward exchange rate is the rate agreed on today, to convert currencies at a future date specified in the agreement. Company X, based in Saudi Arabia, plans of purchasing equipment from two suppliers. Considering the location of the sellers, the buyer will have to decide on whether to exchange AED for Euros or the pound. The initial amount set for the purchase is AED 50 million. Both the financial manager and the CEO of Company X plans to take advantage of exchange rate fluctuations and, if the opportunity arises, lowers the cost of the purchase. The equipment is quoted to cost € 1,090,000 and £ 860,000 in Euro and pounds respectively. In order to make informed choices, exchange rate movements will be observed for five days from 24th to 28th December. On that note, this assignment presents a five-day exchange rate in a table format showing the value of AED 50 million, for each day, in both the currencies (Pounds and Euros). For each of the five days, the cost of the purchase and the impact of the decision are presented. Last, a report that provides justifications that the decision made is favourable to the company also is provided. The five-day observed exchange rates Table 1: the exchange rates DATE 24 25 26 27 28 AED 1 1 1 1 1 GBP 0.175106 0.175034 0.175036 0.174997 0.174983 EURO 0.223321 0.22232 0.223595 0.223119 0.223479 The above table 1 represents the cost of exchanging 1 AED for both pound and Euros during the five days of observation (XE Live Exchange Rates, 2014) What is AED 50 million worth? Table 2 below represents what AED 50 million is worth when converted to both Euros and pounds using the observed exchange rates in table 1 above. Table 2: the value of AED 50 million DATE 24 25 26 27 28 AED 50 m 50 m 50 m 50 m 50 m GBP 8755300 8751700 8751800 8749850 8749150 EURO 11166050 11116000 11179750 11155950 11173950 Source: adopted from XE Live Exchange Rates, 2014 The transactions (Euros) For the purpose of purchasing the equipment, the currency used for the transaction is Euros. The equipment has been quoted to cost € 1,090,000. The table 3 below shows the cost of the equipment in AED based on the exchange rates observations presented in table 1 above. Table 3: the cost of purchasing the equipment in AED (New cost) DATE 24 25 26 27 28 Quoted price 1,090,000 1,090,000 1,090,000 1,090,000 1,090,000 Exchange rate 0.223321 0.22232 0.223595 0.223119 0.223479 New cost 4880867 4902843 4874885 4885285 4877416 Source: adopted from XE Live Exchange Rates, 2014 Table 4: the cost of purchasing the equipment in (Pounds) DATE 24 25 26 27 28 Quoted price 860,000 860,000 860,000 860,000 860,000 Exchange rate 0.175106 0.175034 0.175036 0.174983 0.174983 New cost 4911311 4913331 4913275 4914763 4914763 The first day Based on table 3 above, the company will spend AED 4,880,867 when purchasing the equipment within the seven day period when the offer is still valid. When comparing the new cost with the planned initial outlay, the company will spend less than anticipated. The capital expenditure will be reduced by (50,000,000 – 4,880,867) = AED 45,119,133. The decision will help lower the company’s expenses and enhance its liquidity level, thus creating a competitive advantage. However, the decision is not favourable when comparing the equipment’s cost on this day with the others like day three and five. For example, on day one, the equipment costs AED 5,982 more than the cost on day three. On the same note, the equipment cost on day one is AED 3,451 more than the cost on day five (XE Live Exchange Rates, 2014). The second day Based on table 3 above, the company will spend AED 4,902,843 when purchasing the equipment within the seven-day period when the offer is still valid. When comparing the new cost with the planned initial outlay, the company will spend less than anticipated. The capital expenditure will be reduced by (50,000,000 – 4,902,843) = AED 45,097,157. The decision will help lower the company’s expenses and enhance its liquidity level, thus creating a competitive advantage. Despite the amount of money saved, the decision to purchase the equipment on this day is the worst for the reason that the equipment’s price at this point is the highest as compared to other days. For example, the company would spend AED 27,958 more on day 2 than would be spent on day 3. From another point of view, the company would spend AED 25,427 more on day 2 than it would on day 5 (XE Live Exchange Rates, 2014). The third day Based on table 3 above, the company will spend AED 4,874,885 when purchasing the equipment within the seven-day period when the offer is still valid. When comparing the new cost with the planned initial outlay, the company will spend less than anticipated. The capital expenditure will be reduced by (50,000,000 – 4,874,885) = AED 45,125,115. The decision will help lower the company’s expenses and enhance its liquidity level, thus creating a competitive advantage. The decision to purchase the equipment on this day is favourable for the reason that the company would spend the least amount of money as compared to all the other days. In addition, the decision at this point would create the maximum competitive advantage since the company would save the more money. For example, the company would spend AED 27,958 less on day three than it would on day 2 (XE Live Exchange Rates, 2014). The fourth day Based on table 3 above, the company will spend AED 4,885,285 when purchasing the equipment within the seven-day period when the offer is still valid. When comparing the new cost with the planned initial outlay, the company will spend less than anticipated. The capital expenditure will be reduced by (50,000,000 – 4,885,285) = AED 45,114,715. The decision will provide value, but at a lower cost and enhance the company’s liquidity level, thus, creating a competitive advantage. Despite the amount of money saved, the decision to purchase the equipment is unfavourable for the reason that the price is second highest on this day. The company will spend more than it would on day three and five. For example, the company will spend AED 10,400 more on the equipment on day four than it would on day three. From another point of view, the company would spend AED 7,869 more on the equipment purchase on day four than it would on day five (XE Live Exchange Rates, 2014). The fifth day Based on table 3 above, the company will spend AED 4,877,416 when purchasing the equipment within the seven-day period when the offer is still valid. When comparing the new cost with the planned initial outlay, the company will spend less than anticipated. The capital expenditure will be reduced by (50,000,000 – 4,877,416) = AED 45,122,584. The decision will provide value, but at a lower cost and enhance the company’s liquidity level, thus, creating a competitive advantage. The decision to purchase the equipment on this day is favourable for the reason that the company would spend the least amount of money as compared to day 1, 2, and 4. For example, the company would spend AED 7,869 less on the equipment purchase on day five than it would on day four (XE Live Exchange Rates, 2014). Recommendation Cost minimization while purchasing the equipment is one of the strategies implemented by the company in order to create a competitive advantage. The currency selected for transactions above is the Euros. Based on the above analyses, the equipment is determined to cost the least on day three. Therefore, that is the suitable period to make the equipment purchase decision for the reason that the company would save the most amount of money. As a result, the company would maximize its goal by purchasing the equipment on day three. Recapture that the company’s goal is to take advantage of the low price thus maximize its competitive advantage over the competitors. Therefore, by purchasing the equipment on day three, the company would spend the least amount of money as compared to other competitors who would not make the purchase on the same day, but obtain high valued equipment. Consequently, the competitive advantage creation goal would have been achieved. Reference XE Live Exchange Rates. (2014). Retrieved from http://www.xe.com/?c=AED Read More