Covering Clients in an Exchange Contract

The Euro-market now has become an entrepreneurial play­ground. Weak currencies have been borrowed by specula­tors, then liquidated through the exchange markets for a strong currency on a scale that has inevitably caused a dra­matic downturn in the rates. For instance, sterling sold against an undervalued dollar created a pressure on the Lon­don market. The dealers were unable, by exchange control ruling, to hold the resultant shortage of dollars. They were then driven to repurchase them on a thin market. Such an accumulation of pressure through a number of London banks led to a double counting of turnover, which in turn acceler­ated the rate movement against the pound. So, in a floating exchange system, the quoted rates do not necessarily relied economic values. This is where the speculator steps in.

The most important defence against speculation is the For­ward Exchange Contract— a legally binding contract be­tween the bank and its customer. The agreement is that one currency will be exchanged for another at some future date the exchange rate l>eing agreed at the time of the contract. Once a contract is entered into, it does not mailer how much the rale of exchange varies between Ihe lime of enlcring Ihe contract and its maturity. The customer has fixed the rale. A forward exchange conlracl may be for a fixed dale or within oplion to deliver or take delivery wilhin an agreed period. Unlike a slock exchange oplion, where Ihe facilily to deal or not at the price any lime during the period exists, the option period of a forward exchange conlracl-concerns only Ihe lim­ing of Ihe delivery for the exchange of currencies, Ihe cus-lomer having already deal I al a fixed rale.

Forward exchange conlracls are subject to relalively un­complicated exchange control regulations. The first and most important requirement is lhal a forward exchange conlracl can only be entered into when there is a firm commercial contractual commitment expressed and payable (or rcceiv-

able) in a foreign currency. This requirement therefore rules out any exchange or gold clauses which may be incorporated into a commercial conlracl whereby slerling is to he paid away at some future date, the amount of sterling to be paid out depending upon the rale of exchange ruling on thai day. For example, a customer may be importing from Germany and has agreed that he will pay in sterling, b*ut that the ac­tual; amount of slerling to be paid will be dependent upon Ihe rale ruling for Deulschemarks against slerling on Ihe dale of payment. No forward exchange conlracl may he en­tered into for this type of transaction and there is no way in which the banks can protect their customers against fluctuaclions in Ihe rate of exchange.

Forward exchange cover must be in the currency of the commercial conlracl, i.e. if Ihe payment is to be in dollars the customer is not permitted to purchase a stronger currency with a view to converting at a profit into dollars on maturity of the conlract.

Let us look al one or two praclical examples. A customer is importing machinery from West (Germany. He signs a con­lracl lhat he will receive two machines per month, delivery starling in six monlh lime and finishing in one year's lime. He is quile entitled therefore to enler into a forward cont­ract whereby he buys forward Deulschemarks for Ihesc ma­chines for the various periods he requires, namely from six months up to twelve months. In addition, if he so wished he can go further as he is allowed by Exchange Control Regula­tions up to six months after the dale of importation.'All he has to do is to produce to his bank documentary evidence lhat he is importing these goods. In other words thai Ihere is a firm commercial conlracl; that the amount to be paid out is expressed in Deutschemarks and the bank will then provide him with the forward cover.

Another customer may be exporting capital goods. He en­ters inlo his conlracl whereby he is going to export goods and will receive x amount of American dollars. The goods

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will not be exported perhaps for another twelve months, and he is giving credit to his buyer for a further six months. Therefore he may arrange now to sell to his bank dollars delivery eighteen months forward.

It is important to note that whether the customer is buying or selling a foreign currency in the forward market, there must be some documentary evidence that all foreign currency is to be paid or received. There are very heavy penalties for anyone who tries to speculate.

Choose the word or phrase in brackets that would best sub­stitute for the word or phrase in bold print in the following sentences.

1. Weak currencies are liquidatedthrough the exchange
markets for a strong currency by speculators,
(compensated, cleared, honoured)

2. In a floatingexchange system the quoted rates do not
reflecteconomic values.

(fixed, varied, unstable)

(are not related to, do not influence, do not refer to)

3. A forward exchange contract may be with an optionto
deliver within an agreed period.

(condition, choice, requirement)

4. A forward exchange con tract can only be entered intowhen

there is a firmcommercial contractual commitmentex­pressed and payable in a foreign currency, (cancelled, endorsed, signed)

(strong, fixed, rigid)

(promise, desire, pressure)

5. The actualamount of sterling to be paid will be depen­dent upon the rate rulingfor Deutsche-marks against ster­ling on that day. (present, real, true) (fixed, obligatory, confirmed)

6. The amountto be paid ottt is expressedin Deutsche-
marks and the bank will provide him withthe forward

cover. \

\

(sum, debt, rate) ^x

(added, stated, multiplied)

(deal with, acquaint with, supply with)

7. In the forward market there must be some'documentary
evidencethat all foreign currency is to be paid or received.

(letter, signature, proof)

8. There are heavy penaltiesfor anyone who tries to specu­
late.

(punishment, consequences, condemnation) (do business, make bets, play the market)

II

Choose the right miswer:

1. Sales of weak currencies through the exchange markets
on a large scale:

a) help stabilize the economy of the countries concerned,

b) cause a dramatic fall in their/ates of exchange.

2. Under the forward exchange contract the exchange rate:

a) is agreed upon at the time of contract,

b) is fixed at its maturity.

3. The option period of a forward exchange contract:

a) creates the facility to deal or not at the price any time
during the agreed period,

b) concerns only the time of the delivery for the exchange
of currencies.

4. In the forward exchange contract the amount of currency
to be paid out:

a) does not depend upon the rate of exchange ruling on
the day of signing the contract,

b) depends upon the rate of exchange ruling on the day of
signing the contract.

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119

5. As forward exchange cover must be in the currency of the
commercial paper, the customer:

a) is not allowed to purchase a stronger currency and
convert it at a profit,

b) is not forbidden to purchase a stronger currency and
convert it at a profit.

6. To obtain the forward cover from the bank the customer:

a) has to produce to this bank documentary evidence that
he is importing these goods,

b) need not prove that he has a firm commercial contract.

7. There are very heavy penalties for anyone:

a) who deals in the forward market,

b) who buys a foreign currency in the forward market
without firm contractual commitment.

Ill

Say what is true and what is false. Correct the false sen­tences:

1. Accumulated pressure upon a currency at the exchange

markets accelerates its devaluation.

2. In a floating exchange system the rales of exchange re­
flect economic values.

3. It does not mailer how much the rale of exchange
varies belween Ihe lime of entering the forward ex­
change contract and its maturity.

4. A stock exchange option concerns among olhers the
liming of Ihe delivery for the exchange of currencies.

5. The requirement concerning a firm commercial con­
tractual commitment does not exclude Ihe possibility of
incorporaling an exchange or gold clause into a forward
exchange contract.

6. Under the forward exchange contract an exporter
may sell to his bank Ihe currency in question delivery
within the agreed period of lime.

IV \

Answer the following questions:

1. Whal does Ihe sale of weak currencies for a slrong cur-

rency at the exchange market lead to?

2. Whal was the standing of the sterling at the exchange
markets in the early seventies?

3. What does the speculator at exchange markets lake ad-
van lage of?

4. How can a businessman protect himself against losses re­
sulting from rate fluclualions?

5. Whal is the essence of a forward exchange agreement?
H. In what does a slock exchange oplion differ from Ihe op-
lion of a forward exchange contract?

7. What requirements arc forward exchange contracts sub­
ject to?

8. What types of transaction may not be entered under the
forward exchange cover?

9. Whal does it rneanlhal forward exchange cover must be
in Ihe currency of the commercial paper?

10. Whal document must an importer present to its bank if
he wants lo buy a currency forward?

11.Whal arrangemcnls may an exporler make with his bank
when he enlers a forward exchange contract?

12.How are dealings in the forward markcl protected against
speculations?

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aggregate average base year

base-weighted index by word of mouth capitalization

channel (v) commodity

floor

index jobber

marketability

market value pension price index ratio

quote (v) volume

актуарий, служащий страховой, компании, занимающийся рас­четом страховых рисков совокупный средний базовый год базовый средний индекс

- устно

капитализация дохода, структу­рирование капитала направлять

предмет потребления, товар, продукт

1) минимальный уровень цен

2) производственная площадь
индекс, показатель

джоббер, спекулянт на фондовой бирже, профессиональный бир­жевик

товарность, реализуемость, при­годность

- рыночная стоимость

- пенсия
индекс цен

- соотношение, коэффициент, про­
цент, доля

назначать цену, котировать

- объем

122

Stock exchange is a market in which securities are bought and sold. There are stock exchanges in most capital cities, as well as in the largest provincial cities in many countries, and over twenty in Britain. The principal stock exchange in Britain is known as the Stock Exchange, and is located in Throgmorton Street in the City of London; the New York Stock Exchange is located in and is known as Wall Street. Continental European exchanges are often referred to as Bourses. The economic importance of stock exchanges is that they facilitate saving and investment, first, through making it possible for investors to dispose of securities quickly if they wish to do so and, secondly, in channelling savings into productive investments. Ready marketability requires that new issues should be made or backed by reputable borrowers or institutions, that information should be avail­able on existing securities, and that should be both a legal framework and market rules to prevent fraud and sharp practice. Stock exchanges have their own rules and con­ventions, but their functioning depends also on the exist­ence of company and other law and financial intermediar­ies, such as the issuing houses.

The British Stock Exchange, founded in 1773, devel­oped from informal exchanges in coffee houses in the City of London. It is managed by a council of memters. There are some 3,500 members, who alone may deal or even enter the floor of the exchange.

Stock-brokers act as agents for the public and buy from and sell to jobbers. Members are formed into a declining number of companies and there are now only 192 broking firms and ninety-one jobbing firms on the London Ex­change. Business is conducted entirely by word of mouth and although jobbers and brokers keep their own regis­ters and may record details of a "bargain" (as all transac­tions are called) on the official list, they are not obliged to do so. Even today there are no official statistics of the volume of

123

transactions, although prices at the exchange are widely available in the press. The market value of the securities quoted on the exchange is about J120 billion, of which rather more than half are foreign securities.

Index numbers indicating changes in the average prices of shares on the Stock Exchange are called share indices. The indices are constructed by taking a selection of shares and "weighing" the percentage changes in prices together as an indication of aggregate movements in share prices. Roughly speaking, a share index shows percentage changes in the market value of a portfolio compared with its value in the base year of the index. Index numbers are published by several daily papers and weekly journals.

Using the words in brackets as a guide, explain the mean­ing of the following terms:

1. securities (income-yielding papers, traded on, stock,
shares)

2. government securities (fixed-interest paper)

3. ordinary shares (rights to assets and dividends, prefer­
ence shares, paid)

4. actuary (the calculation of risk and premiums, a person
trained in, assurance purposes)

5. equities (a fixed rate of interest, stock and shares, do not

pay)

6. share (a unit of ownership, a proportion of distributed
profits, small denomination)

7. stock (a unit of ownership, a proportion of distributed
profits, units of J100 value)

8. yield or return (outlay, percentage the investor gels on)

9. blue chip (highly priced, slock, valued for, security)

II

Choose the word or phrase in brackets that would best substitute for the word or phrase in bold print in toe follow­ing sentences:

\. The economic importance of stock exchanges is that they facilitate saving and investment, (prominence, significance, necessity) (humpcr, make dificult, make easy)

2. Slock exchanges facilitate investment through channel­
ing savings into productive investments,
(controlling, directing, handling)

(profitable, industrious, industrial)

3. There should he both a legal framework and market rules

to prevent fraud arid sharp practice. (set of laws, body oflaw, arm of the law) (danger, swindling, haste) (trickery, gesticulation, turmoil)

4. Business at stock exchanges is conducted entirely by word
of mouth.

(strictly, completely, originally) (orally, willingly, usually)/

5. There are no official statistics of the volume of concluded

transactions at the London Stock Exchange,, (printed, public, trustworthy) (quantity, quality, size)

6. Prices at the exchange are widely available in the press,
(noticeable, obtainable, profitable)

7. The indices are constructed by taking a selection of shares

and "weighing" the percentage changes in prices to­gether.

(choice, range, sample) (comparing, calculating, evaluating)

N. The percentage changes in prices indicate aggregate move­ment in share prices.

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125

(guide, predict, denote) (total, complete, expected)

9. The equities included in the series account for60 per
cent of the value of all quotedequities.

(explain, amount to, include) (exemplified, listed, announced)

10. The 500 share index consists of equities broken down
into capital goods, consumer goods etc.

(measures, defines, includes) (determined as, subdivided, arranged)

11. There was considerable publicity,when the Financial

Times Industrial Index passed500.

(sufficient, average, great)

(coverage, understanding, ignorance) л

(left, exceeded, possessed)

П1

Choose the right answer:

1. The principal stock exchange in the United States of
America is known as:

a) the Stock Exchange,

b) Wall Street.

2. Ready marketability requires that new issues should be
made or backed by:

a) reputable borrowers or institutions,

b) law and financial intermediaries such as the issuing
houses.

3. Jobbers:

a) act as agents for the public,

b) deal only with brokers and not with the general pub­
lic.

4. Jobbers and brokers:

a) are obliged to keep records of concluded bargains,

b) are not obliged to record concluded transactions.

5. Share indices indicate:

a) percentage changes in the market value of shares as
compared with their value in the base year,s of the in­
dex,

b) percentage changes in share prices within the last three

years.

6. Price indices and averages published in the Financial
Times Actuaries Share Indices/fireЪased on:

a) fixed-interest stocks,

b) equities and fixed interest stocks.

7. Financial Times Actuaries Share Indices provide for fixed-

interest securities:

a) prices and yields,

b) price indices, average earning and dividend yields.

8. The financial group of equities is broken down into:

a) capital goods, consumer goods, industry,

b) sectors, e.g. banks, discount houses etc.

IV

Complete the following sentences on the. basis of the infor­mation given in the text:

1. Stock exchanges facilitate ....

2. Through slock exchanges investors can quickly....

3. The functioning of stock exchange depends on...

4. The British Stock Exchange is managed by.....

5. Members of the Slock Exchange may....

6. The volume of transactions concluded at the Stock Ex­
change is ......

7. The best known stock and share indices are.....

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127

Answer the following questions:

1. What is stock exchange?

2. Where is the British Stock Exchange located?

3. Where is the New York Stock Exchange located?

4. What is the economic importance of stock exchange?

5. What are the requirements of ready marketability?

6. What does Ihe functioning of stock exchanges depend on?

7. Give a brief characteristic of the British Stock Exchange.

8. In what way do the duties of brokers differ from these of
jobbers?

9. What is the volume of transaction concluded on the Brit­
ish Stock Exchange yearly?

10. What do share indices indicate?

11. How are share indices constructed?

12. Where can you find index numbers?

13. What information do the Financial Times Slock Indices
include?

9. stock exchange list

10. smash on the exchange

1 1. stock exchange operations

12. stock exchange value

13. financial news

VII

Collocation. Combine Ihe words listed below into meaning­ful two or three, word expressions as possible:

actuaries

average

base

chain

change

capitalization

commodity

dividend

VI

Vocabulary study. Synonyms. Match the expressions listed in column A willi Иге synonymous ones from column B.

В

1. stock exchange

2. member of the exchange

3. exchange days

4. exchange hours

5. exchange dealings

6. stock exchange securities

7. unlisted securities

8. contract note

a) exchange trading

b) slock listed at Ihe ex­
change

c) sale contract

d) unquoted securities
c) official quotation list

f) trading days

g) slump in exchange
prices

h) dealings in stocks and shares

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129

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