Foreign seller has to set a zero upfront cost

Foreign Currency Forward
contract

A forward contract is
defined as an agreements made between two parties that have the consent of
exchanging two designed currencies at a fixed period in the future. Foreign
Currency Forward Contracts are normally used to hedge a foreign currency at the
time the investor has an obligation in either making or taking a foreign
currency payment at some periods in the future. For instance, if the duration
of the payment for foreign currency is successfully matched up with the last
trading period of the foreign currency forward contracts then the investor has
to take an action of ‘locked-in’ the amount of exchange rate payment. In order
to ‘lock-in’ a forward contract to sell the currency, the seller has to set a
zero upfront cost of future exchange rate. For the Foreign Currency Forward
Contract, it will state the exact contract sizes, time periods and settlement
process after consideration. The transaction of foreign currency forwards contracts is being taken place over-the-counter
(OTC) because there is no centralization of trading location.

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In Digi Com
Berhad, the company has adopted foreign currency forward contracts in the notes
of derivative financial instruments. The foreign currency forward
contracts of Digi Com Berhad were entered into by the Group in order to
lessen the risk exposure to foreign exchange risks as the transactions
denominated in currency other than its functional currency which occurred from
the company’s normal business activities. The foreign currency forward
contracts are used to hedge certain payables which denominated in USD for the
firm commitments that existed at the reporting date which extend the durations
between January and March 2017.The foreign currency risk will affected the
business activities as the company had managed the business in foreign
currencies and the currencies arise are primarily the USD, SDR (Special
drawing rights) and NOK (Norwegian Krone).
The foreign currency forward contracts are not designated as fair value hedges
and are entered into periods in line with the currency transaction exposure and
changes of fair value exposure. The foreign currency forward contracts of Digi
Com Berhad of totaling RM 4,034,000 and USD 24, 400, 000 is used to reduce
uncertainties in short term inter-company receivables. In 2016, the company’s
trade receivables balances included exposure to foreign currency denominated in
United States Dollar (USD) and Special Drawing Rights (SDR) amounting to RM5.2
million and RM31.6 million respectively. The company also holds cash and cash
equivalents denominated in USD for working capital purposes.

Recommendations
for Digi Com Berhad

1) Interest
Rate Swaps

XiaofengYang
et al. (2009) defined that interest rate swaps as two parties exchanging their
cash flows arising from an agreed notional principal amount in a specific
period of time. The interest rate swaps act as one of the most popular and
highly liquid instruments of the international capital market and played some
important roles such as price discovery, risk aversion and asset allocation. The
interest rate swap helped the company to decrease the costs of borrowing in the
floating-rate or the fixed rate markets in order to strengthen the comparative advantage
among competitors. The interest rate swaps also played a prior role of hedging
against changes in the interest rate. The interest rate swaps
usually involve the fixed interest rate exchange for a floating rate, or vice
versa, to reduce or increase exposure to fluctuations in interest rates or to
obtain a marginally lower interest rate than would have been possible without
the swap. For Digi Com Berhad, the interest rate risk is the risk that the fair
value or future cash flows of the company’s financial instruments will
fluctuate due to changes in market interest rates. The company’s income and
operating cash flows are substantially independent of changes in market
interest rates. The company is exposed to interest rate risk primarily from the
deposit placements and interest-bearing financial liabilities. The company will
manage its interest rate risk for the interest-earning deposit placements by
placing such balances on varying maturities and interest rate terms. The
company’s policy in dealing with interest-bearing financial liabilities is to minimize
the interest expense by obtaining the most favorable interest rates available.

2)Foreign Currency Options

S.Choi et al. (2003)
indicates that an option on a foreign currency represents an option on a
foreign treasury bond. When the option denominated in domestic currency through
the spot exchange rate, such instruments may be considered as exotic domestic
securities. A foreign currency option is a contract that allowed
the option purchaser the rights, but not the obligation, to buy or sell a
specified currency at a specified exchange rate on or before a specified date.
The foreign currency option is similar to the common option which the option
purchasers pay the premium to the seller. The seller will profit from the premium
received and option purchasers will have unlimited potential profit from the future
exchange rate in foreign currency options. The use of foreign currency options is
to help the companies to hedge against the uncertainty of being loss due to changes
of foreign exchange rate. For Digi Com Berhad, the fluctuations of foreign
exchange rate will indirectly affect the management of the company. Therefore,
the company needs to use foreign currency option to prevent from large
fluctuations of exchange rate.