Introduction to foreign trade
• Globalisation → growth in international trade has surpassed all
expectations.
• Trade in the “global village”, where geographical country borders do
not matter anymore, has become a daily occurrence in most
companies.
• Exchange rates facilitate international trade.
• Without exchange rates it would not be possible for companies to
trade across country borders.
• Exchange rates are used to convert from one currency to another.
• Example: For a South African buying in Dollars it is necessary to
take Rands and buy Dollars for payment of the goods
The major currencies
• G8 group of nations = major economies in the world.
• The G8 nations are (G7 now):
• the USA
• Germany
• Japan
• the UK
• Canada
• France
• Italy
• Russia.
• The G8 nations are seen to be the major industrial democracies in the
world. It would be fair to say that these currencies would be the major
currencies of the world.
• From a trading point of view, the US Dollar = most important currency in the
world
• European Union and creation of the Euro = also important
The effect of trading in strong currencies
• Certain currencies are seen to be stronger than others.
• This may be due to a number of reasons, from the political situation in
the country (government and labour) to economic reasons (interest
rate levels and inflation rates).
• Some South African companies = Rand hedge companies
• able to earn strong currencies (for example US Dollars)
• while their home currency or cost structure is in Rand (weaker
currency).
• they benefit from earning (for example) US Dollars and converting these
earnings to Rand, especially knowing that the Rand will weaken against
the US Dollar over the long-term.
• It therefore makes a lot of sense to try to earn strong currencies (for
example by exporting) and therefore boost the performance of the company
by earning currency profits.
• Examples: Richemont, Aspen, Sasol, British American Tobacco
Quotation and conversion of currencies
Direct versus indirect quotes
There are two ways in which exchange rates can be quoted, that is, direct or indirect
quotes.
a) Direct quotes
A direct quote is the number of domestic currency units needed to buy one unit of a
foreign currency. As a South African, the Rand/US Dollar exchange rate quote will be
as follows:
US$1 = R7,663
Therefore one US Dollar will buy R7,663, or R7,663 will buy one US Dollar.
b) Indirect quotes
An indirect quote is simply the reciprocal of the direct quote: It is the number of foreign
currency units needed to buy one unit of the domestic currency. As a South African,
the Rand/US Dollar exchange rate quote will be as follows:
R1 = 1 7,663 = US$0,1305
Therefore, one Rand will buy 13,05 US cents or 13,05 US cents will buy one Rand.
One currency against the rest…
• This reporting method puts one currency against all other major currencies.
• The Rand can, for example, be put against all major currencies.
• The Rand to the US$ and the Rand to the Pound sterling can be read, but
the US$ to the Pound sterling will not be seen on the table (though this rate
can be calculated, as will be illustrated shortly).
1. How to read the table
The rates given in the table refer to the exchange rates of the given currencies
against one specific currency.
2. Direct or indirect?
• When this sort of table is used, it is very important to know which quotation
system is used.
• Most countries→ direct quotation method.
• The source of the table should determine the method used.
• South African report → typically the quote would be direct.
What is the Rand/US Dollar exchange rate?
Being from a South African source, the table is a direct quote table;
therefore we know that the rate given is the amount of Rand necessary to
buy one unit of a foreign currency.
Therefore, US$1 = R8,3655
Cross-rate calculations
Cross-rate calculations
Example 1
Assume USD/ZAR =15.25
And AUD/ZAR = 10.55
What is the USD/AUD rate?
Quoted currency/Quoting currency:
15.25/10.55 = 1.446
Example 2
Example 1
Assume EUR/ZAR =16.25
And ZAR/GBP = 0.054
First convert ZAR/GBP to GBP/ZAR
GBP/ZAR = 18.518
What is the GBP/EUR rate?
Quoted currency/Quoting currency:
18.518/16.25 = 1.14
Conversions
Conversions
