1.1.1 more serious note, exposures even occur

1.1.1 Foreign Exchange Rate

Foreign
rate exchange system have been a floating since the early 1970’s in most
economies. These economies permitted exchange rates to change in the market
place due to the interaction of demand and supply forces in the market. Prior
to this central banks of nations intervened in the determinations of the exchange
rate, some economies still do. This made international transactions not
subjected to exchange rate movement and as such international transactions were
simple. Since the collapse of the fixed exchange rate system markets forces
have determine the exchange rate of economies. This makes exchange rates
volatile, exposing transactions across borders to exchange fluctuation risks
(Thomas, 2006).

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Exposures
foreign currency is as a result of having an income, expenditure, an asset or
liability denominated in a currency other than that of its balance-sheet. On a
more serious note, exposures even occur with just having currency different
from the balance-sheet currency.  Cash
flows of a business is distorted significantly when it is exposed to a very
volatile exchange rate movements. The table below illustrates the movement of
the USD, Euro, GBP, JPY and SA Rand to the Ghana Cedis exchange rate from
January 2001 to August 2011.

 

1.1.2 Financial Performance (Profitability)

Business
in developing economies also compete for their share of the global market each
day. Unlike their competitors from the developed world developing countries
tend to have very fragile economies with lower per capita income. The financial
performance firms located in this areas is very important for their
development. The volatility of foreign exchange rates is a major risks faced by
any firm doing business with the outside world and any investor holding either
equity or debt instrument of a foreign-based company or an interest in a mutual
fund that invests in foreign companies. The implications on a firm’s earnings,
cash flow, and balance sheet can be significant and detrimental. The major
exchange rate risk to a firm or investor having an operation and/or investment
outside the country is that any gains realized will be reduced or in the worst
case scenario wiped out altogether. Exchange rate risk affect a firm’s price
competitiveness be it product or service also offered by a competitor incurring
his cost in a foreign currency. For instance if the Ghana Cedi appreciates
against the US Dollar our export prices become expensive to US consumers and
our imports from the becomes cheaper. The converse happens when the Ghana Cedi
depreciates against the US Dollar. The weakening of competitor’s currency
improves its relative competitive position since its costs decline, giving the
competitor the opportunity to reduce its price and capturing more market share.

Fluctuations
in exchange rates are translated directly into the import price, producer price
and consumer price, eventually affection consumer price index (CPI) and
inflation. There are three channels through which exchange rate fluctuations
are transmitted to domestic prices that is; through prices of imported
consumption goods (domestic prices), through prices of imported intermediate
goods ( production cost of domestically produced goods) and through prices of
domestic goods denominated in foreign currency.  The share of imports in an economies
consumption basket determines the extent to which those changes in exchange
rates are reflected in the consumer price index (CPI). According to Bailliu and
Bouakez, (2004) if as result of depreciation prices of imported goods rise,
demand for domestic substitutes for imports will increase. As demand keeps
rising, this will translate into an increase in domestic prices and nominal
wages. Rising wages will further push prices upward domestically resulting into
inflation.

 

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