Products Available in the Market and Finance Derivatives - Essay Example

Products available in the market and finance derivatives A financial product is an agreement between two entities about the movement of cash at the current date and in the future. International trade is facilitated by a wide range of financial products available in the financial markets. Trade finance is one of the key products available in international trade. This trade finance can further be divided into two major categories, category one involve those that affects the person exporting before goods are dispatched and those that affects his position after the release of goods to the importer. Options available are; credit extensions, loans, insurance and guarantees. The greatest challenge in international trading is the time taken by goods from an exporter to an importer from the time when an order is placed by an importer (Chisholm & Chisholm, 2009). This delays make both parties operates under uncertainties and risks; the risk that they have paid for some goods that may never be delivered or the risk by the exporter that they have shipped goods that they might never receive payments for the same. Trade finance therefore comes in to mitigate those challenges with the risks by ensuring that exporters have enough money or rather capital so as to ensure that there is efficiency in international market place. Financial products imply the various methods that are employed when it comes to international trade transactions. This refer to use of various money management methodologies different investment and banking service to satisfy both the exporter and the importer that they are secure in terms of recovering the money (Chisholm & Chisholm, 2009). These also boost confidence in trade because the exporter can lent more goods to the importer. In executing these strategies both parties are subject to various laws both the port of export and at the destination port. Pre-shipment and post shipment are the two key points in international trading. Post-shipment is a situation whereby the exporter export the goods and after shipping it waits for payment at a later date either immediately after delivery or after sale. Pre-shipment involve exporter entering global market or importer first showing interest in placing an order. The exporter often needs financial assistance in order to extend the same credits to the importers if at all he is to remain competitive like other exporters. At the same time the exporter needs finance to continue its operations in producing more goods for export and that is the reason why he need the payment of goods dispatched as quickly as possible. Export credit insurance are mostly used in pre-shipment arrangements, during this arrangement also purchase order financing is very vital. Other trading finance preferred during this kind of shipment include, working capital loans, government guarantees and debt discounting. Government guarantee program mainly aims at pushing or encouraging traders to venture into global market place by availing for them capital and capital needed, this is a more kind of public policy that encourage the public to plunge into trading (Chisholm & Chisholm, 2009). Export credit insurance is very important financial product because it allows the exporter to extend credit service to importer through offering security to the exporter against any default by the importer. With this kind of insurance the exporter will be more secure and comfortable to extend credit service to importer which in turn making him remain competitive like any other exporter. Some specialized financial firms take over responsibility to collect amount due to the exporter from the importer after accessing the credit worthiness on the importer.. a move which is further helpful to the exporter as there will be more time to concentrate on other trading activities rather than diverting the attention to debts due from importers. In post shipment the transactions have to be supported by different documentation to be collected from different sources. One of the documentations required is letter from the bank certifying that the importer is credit worthy. Bank letter will act as a means t granting importer goods. Any party that is involved in international trade must make sure that they understand all the methodologies and anything else to be addressed so as that their activity in trading is not futile (Stephens, 2001). These parties look everywhere for experts in international trade to offer them advice on financial products. Some of them are fully employed by the traders. Derivatives have been derived from financial strategies that are more similar to assets and liabilities in a company risk management. These derivates include among others futures and forwards. This derivates are however adopted after all other risk managements have been exhausted and other market transaction alternatives. The key reasons why the derivatives are used is due to high degrees of market volatility and the same circumstances have been in existence since 70’s; less capability to properly manage risk exposure by just using cash markets. Currency risk refers to the risk that currency exchange is exposed to with regard to certain adverse changes that will adversely affect some business that are using foreign currency conversions. Foreign currency is a general term, what is foreign in one country will be home in another country. These changes in currency exchanges are not universal to all kind of businesses because sometimes when exchanges are adversely affecting some business in some countries it is advantageous to some other business in the same country. The degree of effect therefore will depend on the business exposure to foreign currencies. Example is a case whereby a country uses a product in manufacturing process that has a fixed currency prices all over the world i.e. us dollars. If that country’s currency devalues against us dollars the price of that commodity will rise exposing the business to currency risk. The use of derivatives is still seen and treated by many with suspicion and can’t dare to trade on it. Any derivative instrument is destined to create a particular financial risk and this risk are either inherent in the paper or they are as a result of the way they are put together. Currency exchanges of any kind are therefore intended to create currency risk. It is however prudent to know that currency derivative hold risk for the holder. The difficulty in risk management called for derivatives and it was as a result of growing change in modern commerce and trade. Speculation is the key element in derivatives and speculation involves wide range of business sector and one can speculate almost everything but the benchmark for speculation is in profit making. Every asset is a risk carrier in business and in case the price of an asset drops the speculator makes losses. Anyone joining business is a risk taker and therefore what makes the difference is the great art of knowing to balance the gain in profit and the negatives with losses so as to gain positive at the end of the day. The forward foreign exchange agreement is one of the key derivatives. They are in long existence since they came before any other derivative and since banks and other financial institutions were the first in the financial markets they are taking the leading role in using this forward foreign exchange derivative. This forward FX is good in risk management because it can be altered to fit the preferred circumstances of both parties involved. It will be used in such a way that forward looking contract will be agreed upon and there will be direct relationship between spot and forward FX rates. The agreement is entered upon at a current date but payments are expected in the future of a predetermined quantity of certain currency against the step by step delivery of an agreed upon denomination of the other currency. The key thing with it is that one has no alternative but to trade the currencies at the designated date. The obligation to do so is irreversible and cannot be changed. Whereas it leaves no room for flexibility it shield against any uncertainties and major risk emanating from currency exposure. It is also worth nothing that there is no cost encountered in the process. The agents with this benefit from the buying and selling spread that it bases the forward FX on (Folkerts-landau & Cassard, 2000). Currency futures involve the standardized contracts that trade on some exchanges and they are similar with forward currencies because the contracts agreed upon today will be settled upon in the future with currency exchange fixed today. The terms of agreement are well detailed and stipulated and they are highlighted on the exchange on which they are trading. The terms of exchange are however arrived at through bids and offers just like in the auction. When contract expires the transaction between parties will be carried out at an agreed rate as stipulated in the exchanges terms of agreement (Folkerts-landau & Cassard, 2000). Financial derivatives play an important role in helping organization manage risk and it occupies a prominent place at organization that is looking for shelter from world market volatility (Folkerts-landau & Cassard, 2000). There are several derivative instruments that organizations use to manage risk. One is the use of interest-rate risk. This is a risk result from the increase in countries banks interest rates. An example is that if organization expects to sell a division in a certain period of time to get cash and it strongly believes that the interest rates are about to drop, the company can purchase a treasury future contract, with this, the organization will be aiming towards locking in future interest rates. Another tool is through the use of foreign exchange risk. This risk results from the change in currency exchange rates. To manage this, the organizations should have a guarantee contractual foreign currency commitment. Any organization carrying out business activities has a role to see if it is in a position of meeting its contractual goals without facing financial distress. Managing risk by use of this toll may be complicated sometimes but it is cheap and easy, it is seen by many as an advantage that can be easily achieved. Another way is securing advantage of expected transactions. This situation is normally encountered when an organization gives a fixed quote in form of a foreign currency and yet they do not know whether their quote will be accepted or rejected. This takes place when a business organization is trying to investigate foreign business opportunities, but the right market prices are upset continuously by currency volatility in the market. The business organization should first stabilize these price volatilities so that advantages will not be lost once transactions take place. Another way is through commodity input hedge. Many companies rely heavily on raw materials or commodities that are sometimes sensitive to the changes in price. Many companies manufacturing agricultural products such as pesticides uses future contracts to eliminate price increases of maize and soybeans inventory. A country should protect the value of foreign currency from repatriations. This involves the receiving of payments resulting from the sell of goods and services through importation, fees, interest payments from investment, and many others. The companies should protect the value of received payments because it will control the value of local currency resulting from expenses incurred in foreign currency (Folkerts-landau & Cassard, 2000). A substantial change in one of these cash flows can put at risk profitability hence butting the businesses in distress. Transnational risk should be also hedged out. This will protect or fix the local currency value of foreign assets and profits the moment foreign accounting statements are changed to reflect the accounts of business organization at home. References CHISHOLM, A., & CHISHOLM, A. (2009). An introduction to international capital markets products, strategies, participants. Chichester, U.K., John Wiley & Sons. http://www.books24x7.com/marc.asp?bookid=40906 STEPHENS, J. J. (2001). Managing currency risk: using financial derivatives. New York, Wiley HICKS, A. (2000). Managing currency risk using foreign exchange options. Boca Raton, [Fla.], CRC Press FOSTER, T. (2007). Management accounting risk and control strategy. Oxford, Elsevier CASSARD, M., & FOLKERTS-LANDAU, D. F. I. (1997). Risk management of sovereign assets and liabilities. [Washington, D.C.], International Monetary Fund, Research Dept FOLKERTS-LANDAU, D. F. I., & CASSARD, M. (2000). Sovereign assets and liabilities management proceedings of a conference held in Hong Kong SAR. Washington, D.C., International Monetary Fund. http://search.ebscohost.com/login.aspx?direct=true&scope=site&db=nlebk&db=nlabk&AN=449501 Read More