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An Australian-owned business manufactures bicycles in China and sells them to wholesalers in France - HSC - SSCE Business Studies - Question 24 - 2013 - Paper 1
Question 24
An Australian-owned business manufactures bicycles in China and sells them to wholesalers in France. These wholesalers do not pay in advance. (a) Describe ONE metho... show full transcript
Worked Solution & Example Answer:An Australian-owned business manufactures bicycles in China and sells them to wholesalers in France - HSC - SSCE Business Studies - Question 24 - 2013 - Paper 1
Step 1
Describe ONE method of payment the business could use to ensure that it receives payment for the sales.
Answer
One effective method of payment is the use of a letter of credit. This is a financial agreement issued by the French customer's bank that guarantees payment to the Australian business upon the presentation of certain documents that confirm the shipment of bicycles. The characteristics of a letter of credit include:
- Security: It reduces the risk of non-payment, as the bank takes responsibility for the payment once the specific conditions are met.
- Conditions: The Australian business must present shipping documents, invoices, and other relevant paperwork that align with the terms specified in the letter of credit.
This method provides assurance to the seller that payment will be made as specified, given the documents are in order.
Step 2
How could this business protect itself against a change in the value of the Australian dollar relative to another currency?
Answer
To protect against fluctuations in currency value, the business could use derivatives, specifically forward contracts. A forward contract allows the business to lock in an exchange rate for a future date, minimizing the risk associated with currency changes. This strategy works as follows:
- Locking in Rates: The business agrees to sell a specific amount of Australian dollars for a set foreign currency exchange rate on a future date. This ensures predictability in revenue from the contracts.
- Mitigating Risks: By using a forward contract, the business protects itself from unfavorable changes in the exchange rate that could reduce its profits.
In essence, the business secures its income against adverse currency fluctuations, thus stabilizing its financial outlook.