Currency Speculation

Currency speculation is the act of purchasing and holding foreign currency in the hopes of
selling that currency at an appreciated, or higher, rate in future. This is in contrast to those who
buy currencies to finance a foreign investment or to pay for an import.
Slightly in contrast to currency speculation, is currency trading. Both, to some extent or another,
facilitate international transactions. There is nothing preventing a trader from acting as a
speculator or a speculator from acting as a trader. A trader will purchase foreign currency from
importers/exporters and charge a transaction fee for doing so, but there is nothing stopping them
from holding on to that currency, in the hopes of selling it at an appreciated value in future (and
thereby engaging in speculation)
For example, if a speculator believes ABC Company stock is overpriced, they may short the stock, wait
for the price to fall, and make a profit.

Carry Trade

A carry trade is a trading strategy that involves borrowing at a low interest rate and investing in
an asset that provides a higher rate of return. A carry trade is typically based on borrowing in a
low-interest rate currency and converting the borrowed amount into another currency, with
proceeds placed on deposit in the second currency if it offers a higher rate of
interest or deploying proceeds into assets – such as stocks, commodities, bonds, or real estate –
that are denominated in the second currency.
As an example of a currency carry trade, assume that a trader notices that rates in Japan are 0.5
percent, while they are 4 percent in the United States. This means the trader expects to profit 3.5 percent,
which is the difference between the two rates. The first step is to borrow yen and convert them into
dollars. The second step is to invest those dollars into a security paying the U.S. rate. Assume the current
exchange rate is 115 yen per dollar and the trader borrows 50 million yen. Once converted, the amount
that he would have is:
           U.S. dollars = 50 million yen ÷ 115 = $434,782.61

After a year invested at the 4 percent U.S. rate, the trader has:

           Ending balance = $434,782.61 x 1.04 = $452,173.91

Now, the trader owes the 50 million yen principal plus 0.5 percent interest for a total of:

          Amount owed = 50 million yen x 1.005 = 50.25 million yen

If the exchange rate stays the same over the course of the year and ends at 115, the amount owed in U.S.
dollars is:

         Amount owed = 50.25 million yen ÷ 115 = $436,956.52

The trader profits on the difference between the ending balance and the amount owed, which is:
         Profit = $452,173.91 - $436,956.52 = $15,217.39

Notice that this profit is exactly the expected amount: $15,217.39 ÷ $434,782.62 = 3.5%

If the exchange rate moves against the yen, the trader would profit more. If the yen gets stronger, the
trader will earn less than 3.5 percent or may even experience a loss.

Spot Exchange

The spot exchange rate is the rate at which a foreign exchange dealer converts one currency into
another currency on particularly day. Thus, when U.S. tourist in Edinburhg goes to a bank to
convert her dollars into pounds, the exchange rate is the spot rate for that day.
For Example- Spot exchange rates are reported on a real-time basis on many financial websites.
An exchange rate can be quoted in two ways: as the amount of foreign currency one U.S. dollar
will buy or as the value of dollar for one unit of foreign currency. Thus, on March 12, 2013 at
12:11 p.m. Eastern Standard Time, one U.S. dollar bought €0.7655, one euro bought $1.3063.

Forward Exchange

Forward Exchange occurs when two parties agree to exchange currency and execute the deal at
some specific date in the future.
For example-a company expecting to receive €20 million in 90 days, can enter into a forward
contract to deliver the €20 million and receive equivalent US dollars in 90 days at an exchange
rate specified today. This rate is called forward exchange rate

Currency Swap

A Currency swap, also known as a cross-currency swap, is an off-balance sheet transaction in

which two parties exchange principal and interest in different currencies. The parties involved in
currency swap are generally financial institutions that either act on their own or as an agent for a
non-financial corporation. The purpose of a currency swap is to hedge exposure to exchange rate
risk or reduce the cost of borrowing a foreign currency.
For example- Company A wants to transform $100 million USD floating rate debt into a fixed
rate GBP loan. On trade date, Company A exchanges $100 million USD with Company B in
return for 74 million pounds. This is an exchange rate of 0.74 USD/GBP (equivalent to 1.35
GBP/USD).
During the life of the transaction, Company A pays a fixed rate in GBP to Company B in return
for USD six-month LIBOR.
The USD interest is calculated on $100 million USD, while the GBP interest payments are
computed on the 74 million pound amount.
At maturity, the notional dollar amounts are exchanged again. Company A receives their original
$100 million USD and Company B receives 74 million pounds.
Company A and B might engage in such a deal for a number of reasons. One possible reason is
the company with US cash needs British pounds to fund a new operation in Britain, and the
British company needs funds for an operation in the US. The two firms seek each other and come
to an agreement where they both get the cash they want without having to go to a bank to get
loan, which would increase their debt load. As mentioned, currency swaps don't need to appear
on a company's balance sheet, where as taking a loan would. 
Having the exchange rate locked in lets both parties know what they will receive and what they
will pay back at the end of the agreement. While both parties agree to this, one may end up better
off. Assume in the scenario above that shortly after the agreement the USD starts to fall to a rate
of 0.65 USD/GBP. In this case, Company B be would have been able to receive $100 million
USD for only $65 million GBP had they waited a bit longer on making an agreement, but instead
they locked in at $74 million GBP. 
While the notional amounts are locked in are and not subject to exchange rate risk, the parties are
still subject to opportunity costs/gains in that ever changing exchange rates (or interest rates, in
the case of a floating rate) could mean one party is paying or more less than they need to based
on current market rates. 

Transaction Exposure

Transaction exposure is the risk of loss from a change in exchange rates during the course of a
business transaction. This exposure is derived from changes in foreign exchange rates between
the dates when a transaction is booked and when it is settled.
For example, a company in the United States may sell goods to a company in the United
Kingdom, to be paid in pounds having a value at the booking date of $100,000. Later, when the
customer pays the company, the exchange rate has changed, resulting in a payment in pounds
that translates to a $95,000 sale. Thus, the foreign exchange rate change related to a transaction
has created a $5,000 loss for the seller. Transaction exposure is only applicable to the party in a
transaction that has to pay or receive funds in a different currency; the party only dealing in its
home currency is not subject to translation exposure. This can be a significant risk when the
currencies involved in an international transaction have a history of significant fluctuations.

Translation Exposure

The Translation Exposure is the risk of loss suffered when stock, revenue, assets or liabilities
denominated in foreign currency changes with the movement of the foreign exchange rates. In
other words, the translation exposure stems from the requirement of converting the subsidiary’s
assets and liabilities (operating in another country) denominated in foreign currency in the home
currency of the parent company, at the time of preparing the consolidated profit and loss
statement and the balance sheet. Thus, any change in the foreign exchange rate will have a
considerable impact on the financial statements.
For example, assume the domestic division of a multinational company incurs a net operating
loss of $3,000. But at the same time, a foreign subsidiary of the company made of profit of 3,000
units of foreign currency. At the time, the exchange rate between the dollar and the foreign
currency is 1 to 1. So the foreign subsidiary’s profit exactly cancels out the domestic division’s
loss.
Before the parent company consolidates its financial reports, the exchange rate between the
dollar and the foreign currency changes. Now 1 unit of foreign currency is only worth $.50.
Suddenly, the profit of the foreign subsidiary is only worth $1,500, and it no longer cancels out
the domestic division’s loss. Now, the company as a whole must report a loss. This is a
simplified example of translation exposure.

Economic Exposure

Economic exposure is a type of foreign exchange exposure caused by the effect of unexpected
currency fluctuations on a company’s future cash flows, foreign investments, and earnings.
Economic exposure, also known as operating exposure, can have a substantial impact on a
company’s market value since it has far-reaching effects and is long-term in nature. Companies
can hedge against unexpected currency fluctuations by investing in foreign exchange (FX)
trading.
For example, Assume that a large U.S. company that gets about 50% of its revenue from
overseas markets has factored in a gradual decline of the U.S. dollar against major global
currencies—say 2% per annum—into its operating forecasts for the next few years. If the dollar
appreciates instead of weakening gradually in the years ahead, this would represent economic
exposure for the company. The dollar’s strength means that the 50% of revenues and cash flows
the company receives from overseas will be lower when converted back into dollars, which will
have a negative effect on its profitability and valuation.

Lead and Lag strategy

Leads and lags in international business most commonly refers to the alteration of normal
payment or receipts in a foreign exchange transaction based on an expected change in exchange
rates. When a corporation or government entity has the ability to control the schedule of
payments being received or being made, then that organization may opt to pay earlier than
scheduled or delay the payment later than scheduled. These changes would be made in
anticipation of capturing the benefit from a change in currency exchange rates. These dynamics
hold true both for small and large transactions.
If a company in one country were about to acquire a corporate asset in another country, and the
target company's country currency were expected to decrease in value relative to the acquiring
company's country, then delaying the purchase would be in the interest of the acquiring
company.
A strengthening of the currency being paid out would lead to a decreased payout for the entity in
question, while a weakening of the currency would lead to increased costs the longer the
payment were delayed. Because it amounts to a timing strategy, Leading and lagging implies
risks. A lack of proper execution and may result an unfavorable outcome.
For example, if a U.S. company has agreed to buy a Canadian asset it will need to buy Canadian
dollars and sell U.S. dollars to complete the transaction. If the company believes the Canadian
dollar is going to strengthen against the U.S. dollar they will accelerate the transaction (lead)
before the price of the asset increases in U.S. dollar terms.
Conversely, if the company believes the Canadian dollar will weaken, they will hold off payment
(lag) in the hope the asset becomes cheaper in U.S. dollar terms. 
There are risks with leading and lagging in that the move in the currency may not go as expected.
For example, if the company that is buying the Canadian asset chooses to hold off payment
because it believes the Canadian dollar will weaken, and before making the payment the Bank of
Canada (BoC) unexpectedly raises interest rates, the Canadian dollar will strengthen making
their decision to hold off detrimental. For this reason some companies will choose to make part
of the payment at the time of agreement and wait to pay for the remainder.

Sphere cash investment

Sphere cash investment is a triangular and diverse competition where direct cash investor helps
multiple shareholders and attracts the entrepreneurs to make them interested in taking loans with
providing them the guarantee of give back the money with profits.
For example- Us Government issued treasury bill having the par value of 1,000 which is for
$950. Treasury bill is issued with the promise to pay full par value to the investor at the time of
maturity. Now the government at the time of maturity will pay $1000 to the investor being the
full value of treasury bill. This will give a profit $50 ($1000-$950) to the investor. The profit
amount is considered as the interest earned.