functional currency

Examples of functional currency in the following topics:

• Dealing with Foreign Currency and Bad Debts

  • To deal with foreign currency and bad debts, we have a "gain or loss" account and methods to measure the net value of accounts receivable.
  • A foreign currency transaction requires settlement in a currency other than the functional currency.
  • A change in exchange rates between the functional currency and the currency in which a transaction is denominated increases or decreases the expected amount of functional currency cash flows upon settlement of the transaction.
  • This change in expected functional currency cash flows is a "foreign currency transaction gain or loss" that typically is included in arriving at earnings in the income statement for the period in which the exchange rate is changed.
  • Explain how the "gain or loss" account is used for foreign currency transactions and bad debts

• Demand and Supply for Foreign Currencies

  • Demand function for a currency originates from international trade between Malaysia and the United States.
  • We always show the currency price in the denominator of the currency exchange rate because a price decrease reflects a currency depreciating while a price increase is an appreciating currency.
  • We show the supply function for Malaysian ringgits in Figure 2.
  • We show the demand and supply functions for ringgits in Figure 3.
  • Thus, the demand function increases and shifts rightward.

• International Exchange of Money

  • The foreign exchange market is a form of exchange for international currencies that determines the relative values of different currencies.
  • It is also regarded as the value of one country's currency in terms of another currency.
  • In a typical foreign exchange transaction, a party purchases a quantity of one currency by paying a quantity of another currency.
  • The foreign exchange market (forex, FX, or currency market) is a form of exchange for the global decentralized trading of international currencies.
  • Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends.

• Exchange Rates

  • The price of one country's currency in units of another country's currency is known as a foreign currency exchange rate.
  • A foreign currency exchange rate between two currencies is the rate at which one currency will be exchanged for another.
  • If they have traveler's checks or a travel card in the local currency, no currency exchange is necessary.
  • A currency pair is the quotation of the relative value of a currency unit against the unit of another currency in the foreign exchange market.
  • As part of this function, it determines the exchange rate regime that will apply to its currency.

• Fixed Exchange Rates

  • For example, Argentina, Bermuda, and Hong Kong pegged their currencies to the U.S. dollar while Bosnia and Herzegovina, Bulgaria, and Estonia fixed their currencies to the euro.
  • Furthermore, a central bank must hold a cache of currency reserves to buy or sell currencies to balance its currency flows that maintain the fixed exchange rate.
  • Thus, a central bank requires a cache of currency reserves.
  • It exchanges U.S. dollars or euros for dirhams, decreasing the supply function and shifting it leftward.
  • A country experiences a continuous outflow of capital, and the central bank does not have the reserves to buy its currency from the currency exchange markets.

• The Exchange Rate Regimes

  • First, we set all currencies equal to one ounce of gold.
  • Consequently, the IMF defines the SDR as a "unit of account," which comprises one function of money, and it establishes exchange rates with the four currencies.
  • Governments specify the rules and limits how people and businesses can exchange its currency for other currencies.
  • Usually, a government maintains either a too strong or a too weak currency relative to the other currencies.
  • Inflation can weaken a currency.

• Factors that Shift Demand and Supply Functions

  • Many factors influence supply and demand functions for foreign exchange rates.
  • First, shift the demand function.
  • Then draw three supply function shifts, where the first one shifts a little, the second shifts a little more, and the third shifts a lot.
  • Consequently, the supply function increases, shifting rightward, decreasing the market price.
  • If a central bank wants to strengthen its currency, it must buy its currency using a foreign currency.

• Global finance: initial considerations

  • Entrepreneurs will find that understanding the functioning of the global financial marketplace is a key element of their knowledge and skill base, and a key aspect of furthering their business.
  • The price of one country's currency in units of another country's currency is known as a foreign currency exchange rate.
  • One way, known as a direct quote, is to state the number of domestic units of currency per one unit of foreign currency.
  • The foreign exchange market is generally divided into five basic currency markets based on pricing procedures ruling the exchange, the time to maturity, the degree of freedom available, the convertibility of currencies, and how the currencies are quoted (Carrada-Bravo, 2003).
  • Common ways of hedging currency risk involve:

• Government Bonds

  • A government bond is a bond issued by a national government denominated in the country's domestic currency.
  • Such bonds are often denominated in the country's domestic currency.
  • Most developed country governments are prohibited by law from printing money directly, that function having been relegated to their central banks.
  • Investors in sovereign bonds denominated in foreign currency have the additional risk that the issuer may be unable to obtain foreign currency to redeem the bonds.
  • There is currency risk for government bondholders.

• Spot Rates, Forward Rates, and Cross Rates

  • Spot & forward rates are settlement prices of spot & forward contracts; cross rates are the exchange rate between two unofficial currencies.
  • where F is the forward price to be paid at time, Tex is the exponential function (used for calculating compounding interests), r is the risk-free interest rate, q is the cost-of-carry, S0 is the spot price of the asset (i.e., what it would sell for at time 0), Di is a dividend which is guaranteed to be paid at time ti where 0< ti< T.
  • A cross rate is the currency exchange rate between two currencies, both of which are not the official currencies of the country in which the exchange rate quote is given in.
  • This phrase is also sometimes used to refer to currency quotes which do not involve the U.S. dollar, regardless of which country the quote is provided in.
  • However, if the exchange rate between the euro and the U.S. dollar were quoted in that same newspaper, it would not be considered a cross rate because the quote involves the U.S. official currency.