A significant issue when dealing with international companies is that transactions occur in more than one currency. A company that collects revenues in a foreign currency will be either long or short in that currency, depending on whether they receive more revenue than they pay out in expenses (long) or less revenue than they pay out (short).
Currency Exchange Rates
Changes in currency exchange rates can have a huge impact on both business profits and on securities prices. These rates are expressed as the ratio of the price of one currency against the price of the other.
When the U.S. dollar weakens against another currency, that currency is worth more dollars. In this case, foreign investment in the U.S. dollar will decline. Imports will also decline as they will be more expensive to U.S. businesses and consumers. On the other hand, a weaker dollar makes importing U.S. goods more attractive to foreign countries. Therefore, exports will increase.
When the U.S. dollar strengthens against another currency, the dollar will buy more of that currency. Foreign investment will increase as foreign investors will be attracted to a strong U.S. dollar. U.S. imports will increase as it is cheaper for U.S. businesses and consumers to purchase foreign goods. Finally, U.S. exports will decrease as U.S. goods will be expensive for consumers in many foreign countries.
Balance of Trade
This is the largest component of a country's balance of payments. (The balance of payments is a record of all transactions made by one particular country during a certain period of time. It compares the amount of economic activity between a country and all other countries.)
Balance of trade is the difference between exports and imports. Debit items include imports, foreign aid, domestic spending abroad and domestic investments abroad. Credit items include exports, foreign spending in the domestic economy and foreign investments in the domestic economy.
The balance of trade is one of the most misunderstood indicators of the U.S. economy. For example, many people believe that a trade deficit is a bad thing. However, whether a trade deficit is bad thing or not is relative to the business cycle and economy. In a recession, countries like to export more, creating jobs and demand. In a strong expansion, countries like to import more, providing price competition, which limits inflation and, without increasing prices, provides goods beyond the economy's ability to meet supply. Thus, a trade deficit is not a good thing during a recession but may help during an expansion.
Find out what it means when more funds are exiting than entering a nation in the article Current Account Deficits.
TradingAn in depth look at out how a currency's relative value reflects a country's economic health and impacts your investment returns.
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TradingThe exchange rate is one of the most important determinants of a country's relative level of economic health and can impact your returns.
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TradingHuge movements in a currency can dictate an economy’s fortunes. In a manner of speaking, the currency becomes the tail that wags the dog.