Currency certificate

From CEOpedia | Management online

Currency certificate helps to reduce risk of changes in exchange rate. It gives the right to exchange certain sum of currency to another currency on pre-determined exchange rate, usually up to certain date. Nowadays, currency is one of the best tools for exchanging one product for another. The certificate does not indicate the owner, so it can be sold.

The currency certificate is usually used in international trade, when the company wants to buy goods in another country, but with minimal exchange rate risk. The organization which wants to use currency certificates for risk management should buy them regularly, when the price is low enough. In such case the certificates may be used in future international trade situations.

This certificate give the holder possibility to exchange one currency to the another, but the holder do not have to do it. This document guarantees that the transaction will be made in accordance with the data on the document, even the rate is higher. The currency is used in a versatile way. Currency certificates are helpful when company must pay invoice in the another country in the certain time. Then company can buy certificate earlier for given amount and secure that invoice. Firms also use foreign currency derivatives for saving their business from exange - rates movements (Hentschel and Kothari, 1997).

According to Hooper and Kohlhagen (1978) we can also said that trade flows are depends to exchange risk. It means that when exchange risk is higher the trade flows are lower. When companies make frequently foreign transactions, use certificates allows to reduce costs. The certificates can be used in case of devaluation of home currency and final goods abroad (Itagaki, 1981). It is also worth noting that changes in the exchange rate affect on the value of companies. The goodwill is changes when value of revenues or value of purchased good changes (Allayannis and Ofek, 1997). It means that certificate with a low and permanent currency is very important for the company.

Propositions of international payments

Nowadays there are many propositions of methods that allows exchanging currencies at a favorable rate. One of them is the possibility of making Internet payments based on the verification of the geographical region. The main task of this type of payment is to integrate electronic payments for the global banking network and accounting infrastructure. During the transaction, the new currency is insured and then currency server creates a key which allows to create and manage currency. Based on this key a financial institution can recognize currency certificate as a legal payment.

Examples of Currency certificate

  • Forward Contract: A forward contract is an agreement between two parties to exchange a certain amount of one currency for another at a fixed exchange rate on a future date. The settlement date is usually within six months.
  • Currency Option: A currency option is a contract that gives the holder the right, but not the obligation, to buy or sell a certain amount of currency at a specific exchange rate on or before a certain date. The holder pays a premium to the seller for the option.
  • Currency Swap: A currency swap is an agreement between two parties to exchange a certain amount of one currency for another at a pre-determined exchange rate. The exchange is usually done on a spot basis, with the parties agreeing to reverse the transaction at a later date.
  • Currency Future: A currency future is a financial contract that gives the holder the right (but not the obligation) to buy or sell a certain amount of a currency at a pre-determined exchange rate on a future date. The contract is standardized and traded on a futures exchange.

Advantages of Currency certificate

A Currency Certificate provides a number of advantages:

  • It offers protection from currency exchange rate fluctuations. By locking in a pre-determined exchange rate, the certificate provides certainty and reduces risk for the holder.
  • It is a convenient and liquid asset. Currency certificates are easily traded and can provide the holder with a fast and easy way to convert their currency.
  • It is a relatively low-risk investment. Currency certificates are often backed by the issuer, meaning that there is less risk involved than when investing in other financial instruments.
  • It allows for diversification. By holding a currency certificate, the holder can diversify their portfolio and gain exposure to a variety of different currencies.
  • It is an efficient way to save. Currency certificates can help the holder to save for future purchases, as the pre-determined exchange rate will not be affected by market volatility.

Limitations of Currency certificate

An introduction to currency certificate limitations: Currency certificates are not without their limitations, and understanding what they are can help investors make more informed decisions. Below are some of the limitations associated with currency certificates:

  • Currency certificates are subject to the same exchange rate risks as other forms of currency trading. This means that if the exchange rate changes, the value of the certificate could decrease.
  • Currency certificates have a limited time frame and can be difficult to convert to cash if the currency rate changes quickly.
  • Currency certificates may also have restrictions on the amount of currency that can be traded, or the type of currency that can be traded.
  • Currency certificates may also have charges associated with them, such as transaction fees or commission charges.
  • Currency certificates may also be subject to tax liabilities, depending on where they are traded.
  • Finally, currency certificates can be difficult to use in some countries, as they may not be accepted by all financial institutions.

Other approaches related to Currency certificate

Introduction: Currency certificates can also be used in conjunction with other approaches to reducing exchange rate risk.

  • Hedging - This is a strategy which involves taking out an offsetting position in a related security in order to reduce the exposure to market volatility. For example, a company may enter into a forward contract to buy a specific currency at a future date in order to hedge against potential exchange rate losses.
  • Currency Swaps - This involves exchanging one currency for another at an agreed upon rate for a certain period of time. This can be used to manage currency risk by exchanging two different currencies at a fixed rate over a certain period of time.
  • Currency Options - This is similar to a forward contract, but with an option to buy or sell a currency at a certain price in the future. This gives the holder the flexibility to buy or sell the currency depending on the exchange rate at the time.
  • Currency Futures - This is a contract between two parties to buy or sell a specified amount of currency at a predetermined price on a future date. This helps to lock in a rate and protect against future exchange rate fluctuations.

Summary: Currency certificates are just one of the many ways to reduce exchange rate risk. Other approaches include hedging, currency swaps, currency options, and currency futures. Each of these strategies offers different levels of flexibility and protection against exchange rate fluctuations.


Currency certificate — recommended articles
Outright Forward — Forward points — Interest Rate Collar — Commodity swap — Alternative futures — Asset swap — Equity derivative — Embedded derivative — Swap Ratio

References

Author: Joanna Kruk

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