Addressing Transactional Forex Risks for a Tanzanian Tour Operator

As a financial consultant advising a Tanzanian tour operator that organizes safari expeditions for
international tourists, it is crucial to manage the transactional foreign exchange (forex) risks that
come with receiving payments in multiple currencies, such as US dollars (USD), euros (EUR), and
British pounds (GBP). Below is an in-depth analysis of the transactional forex risks and proposed
strategies to mitigate their impact on the company’s revenue.
Transactional Forex Risks
1. Exchange Rate Fluctuations
When payments are received in foreign currencies, fluctuations in exchange rates between the
booking date and the date of revenue conversion to Tanzanian shillings (TZS) can significantly
affect earnings. The primary impacts are:
 Appreciation of TZS: If the value of TZS increases relative to foreign currencies, the
converted revenue will be lower in TZS, reducing overall revenue.
 Depreciation of TZS: If TZS depreciates, the value of foreign currency payments
increases when converted to TZS, benefiting the company. However, this advantage may
be negated if TZS-denominated costs also rise.
2. Timing Mismatches
A common issue is the gap between when a booking is made and when the payment is received
and converted. During this interval, unfavorable exchange rate movements can occur, leading to
potential losses. For example, if a tour is booked now but paid for three months later, the
company is at risk from adverse exchange rate changes during this period.
3. Currency Volatility
Major currencies like USD, EUR, and GBP can experience significant volatility due to factors such
as economic data releases, geopolitical events, and shifts in market sentiment. This volatility can
lead to unpredictability in revenue conversion, complicating financial planning and profit
forecasting.
Practical Risk Management Strategies
1. Natural Hedging
Matching Currency Inflows and Outflows
Natural hedging involves aligning currency-denominated revenues and expenses to minimize
the need for currency conversion. By matching inflows and outflows in the same currency, forex
risk can be mitigated.

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  Implementation: If the tour operator incurs expenses in foreign currencies, such as
advertising costs in USD or supplier payments in EUR, these expenses should be paid
directly from the revenues received in those currencies. For instance, if a significant
portion of revenue is in USD, use USD receipts to cover any USD-denominated expenses.
This strategy reduces the frequency of conversions to TZS, thereby minimizing exchange
rate risks.
2. Forward Contracts
Description
Forward contracts are agreements with banks or financial institutions to exchange a specified
amount of currency at a predetermined rate on a future date. This locks in the exchange rate,
providing certainty for future cash flows.
 Advantages:
o Certainty: By locking in exchange rates, the tour operator gains predictable cash
flows, aiding in financial planning and budgeting. This ensures that revenue
forecasts in TZS are protected against adverse currency movements.
 Disadvantages:
o Obligation: The firm must convert the currency at the agreed rate, even if market
conditions become more favorable. This means potential gains could be missed if
the actual exchange rate at the conversion time is better than the forward
contract rate.
 Implementation: To effectively use forward contracts, the tour operator should analyze
expected inflows over the next 6-12 months, taking into account historical booking
patterns, current market conditions, and anticipated revenue streams in different
currencies. After completing this analysis, the company can enter into forward contracts
to hedge a significant portion of these expected inflows. For example, if substantial USD
inflows are anticipated, the company might hedge 70-80% of these amounts. This
strategy helps protect against the downside risk of TZS appreciation.

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3. Options Contracts
Description: Options contracts are financial instruments giving the holder the right, but not the
obligation, to exchange a specific amount of currency at a predetermined rate by a set date.
There are two types of options: call options, which allow the purchase of currency, and put
options, which allow the sale of currency.
Advantages:
 Flexibility: Options provide the flexibility to benefit from favorable exchange rate
movements. If the market moves in your favor, you can opt not to exercise the option
and instead convert at the more advantageous market rate.
 Protection: While offering potential upside benefits, options also provide a protective
rate, ensuring you are shielded against adverse currency movements beyond a certain
level.
Disadvantages:
 Cost: Options require an upfront premium payment, which can be relatively expensive,
especially in volatile markets. This premium represents the cost of securing the right
without the obligation to transact at a specified rate.
Implementation: Implement options during periods of high uncertainty or anticipated volatility
in exchange rates. For example, if upcoming geopolitical events or significant economic data
releases are expected, options can offer protection and flexibility. Utilize options to cover the
portion of expected foreign currency inflows most exposed to such risks.
4. Currency Swaps
Description: Currency swaps involve agreements between two parties to exchange specified
amounts of currencies and reverse the exchange at a predetermined rate on a set future date.
Exchanges can occur at multiple intervals during the contract's life.
Advantages:
 Predictable Cash Flows: By agreeing on exchange rates and amounts in advance,
currency swaps ensure predictable cash flows, facilitating budgeting and financial
planning.
 Tailored Agreements: Swaps can be customized to meet the company's exact needs,
including specific amounts and durations.
Disadvantages:
 Complexity: Currency swaps are more complex than other hedging tools and require a
thorough understanding of their terms and conditions.

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  Counterparty Risk: There's a risk that the other party might default on the agreement,
potentially leading to financial loss.
Implementation: Currency swaps are appropriate for managing longer-term exposure. For
instance, if the tour operator has long-term contracts with foreign service providers or
substantial ongoing foreign currency payments, a currency swap can effectively manage this risk
over an extended period.
5. Multi-Currency Accounts
Description: Multi-currency accounts allow the company to hold and manage multiple
currencies (such as USD, EUR, and GBP) within a single account. The company can convert these
currencies to TZS as needed, based on favorable exchange rates.
Advantages:
 Reduced Need for Immediate Conversion: This approach minimizes the urgency to
convert foreign currency receipts to TZS, allowing the company to wait for more
favorable rates.
 Rate Flexibility: Provides the opportunity to monitor the market and convert currencies
at the most advantageous times.
Disadvantages:
 Opportunity Cost: There is a potential opportunity cost if the value of the held
currencies declines before conversion, leading to lower-than-expected TZS revenue.
Implementation: Set up multi-currency accounts with a bank offering favorable terms and
services. Regularly monitor exchange rate movements to determine the optimal timing for
currency conversion. By doing so, the company can maximize the value of its foreign currency
revenues.
6. Regular Monitoring and Forecasting
Description: Implement systems and processes to continually monitor exchange rate trends and
forecasts. This ongoing evaluation helps inform timely and effective hedging decisions.
Advantages:
 Informed Decisions: Regular monitoring ensures that hedging activities are based on the
latest market conditions and trends, leading to better timing and effectiveness.
 Proactive Management: Allows the company to proactively manage forex risk rather
than reacting to adverse movements after they occur.

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Disadvantages:
 Resource Intensive: Requires dedicated resources and expertise to effectively track and
analyze currency markets and trends.
Implementation: Designate a financial team or hire external consultants to regularly analyze
forex markets. Use forex forecasting tools and subscribe to financial market updates to aid in
making well-informed hedging decisions.

Advantages
1. Informed Decisions:
o Explanation: Regularly monitoring exchange rate trends ensures that the
company's hedging activities are based on the latest market data and
developments. This ongoing vigilance allows the company to identify optimal
times to enter into hedging contracts, thus maximizing the effectiveness and
timing of these actions.
o Outcome: By staying updated on market conditions and trends, the company can
make well-informed decisions that enhance its forex risk management strategy,
avoiding costly mistakes or missed opportunities.
2. Proactive Management:
o Explanation: With continuous monitoring, the company can adopt a proactive
approach to managing forex risks, rather than simply reacting to adverse
currency movements after they have occurred.
o Outcome: This proactive stance enables the company to anticipate potential risks
and implement hedging measures in advance, thereby protecting its revenue
streams more effectively and reducing exposure to unfavorable currency
fluctuations.
Disadvantages
1. Resource Intensive:
o Explanation: Regular monitoring and forecasting require dedicated resources,
including time, technology, and expertise. The company would need to invest in
specialized personnel or external consultants who understand forex markets and
can provide accurate analyses and forecasts.

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 o Outcome: This can lead to increased operational costs, as maintaining such a
level of dedication and expertise requires continuous financial investment and
potentially expensive forex forecasting tools and subscription services.
Implementation
 Description: To implement a robust monitoring and forecasting system, the company
should designate a financial team or hire external consultants with expertise in forex
markets. This team or consulting firm should be responsible for continually analyzing
market trends, currency fluctuations, and potential risks.
 Actions:
o Assign or Hire Experts: If the company has the internal capability, designate team
members whose primary focus is on forex management. Alternatively, hire
external consultants who specialize in forex markets.
o Utilize Tools and Subscriptions: Invest in advanced forex forecasting tools and
subscribe to reliable financial market updates. These resources can provide the
necessary data and insights needed to make timely and informed hedging
decisions.
o Regular Updates: Ensure that the team or consultants provide ongoing advice
and updates to management on currency trends, potential risks, and upcoming
hedging opportunities to keep the strategy dynamic and responsive to market
changes.
Conclusion
Recommended Strategy
Considering the Tanzanian tour operator's need for practical and effective mitigation of
transactional forex risk, a diversified approach incorporating Natural Hedging, Forward
Contracts, Options, Multi-Currency Accounts, and Regular Monitoring and Forecasting is
recommended:
1. Natural Hedging: Match currency inflows with expenses in those same currencies to
minimize the need for conversion and associated risks. This reduces exposure to forex
fluctuations by naturally offsetting cash flows in the same currencies.
2. Forward Contracts:
o Action: Secure forward contracts for a substantial portion of expected inflows.
o Example: Hedge 70% of anticipated USD, EUR, and GBP revenues over the next 6-
12 months to lock in exchange rates and provide revenue certainty.

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 3. Options:
o Action: Purchase options to cover critical periods characterized by cash flow
mismatches or anticipated high volatility.
o Coverage: Aim to cover an additional 20-30% of exposure, which provides the
flexibility to benefit from favorable exchange rate movements while having
protection.
4. Multi-Currency Accounts:
o Action: Maintain bank accounts in USD, EUR, and GBP to strategically manage the
timing of conversions to TZS.
o Benefit: This allows the company to take advantage of favorable exchange rates,
reducing the need for immediate conversion and providing rate flexibility.
5. Monitoring and Forecasting:
o Action: Establish a dedicated team or consult external experts to continuously
monitor forex markets and provide timely advice on hedging actions.
o Benefit: Ongoing analysis ensures informed and proactive management of forex
risks, enhancing the company's ability to respond to market changes and
minimize potential downside.
By integrating these strategies, the Tanzanian tour operator can effectively mitigate
transactional forex risks, ensuring financial stability and optimized revenue management in an
environment of fluctuating currency exchange rates.

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Reference

Chance, D.M. and R. Brooks, (2008), An Introduction to Derivatives and Risk Management: Seventh
Edition, Thompson South-Western Publishers.

Hull, J., (2006), Options, Futures and Other Derivatives, Prentice-Hall. Ross, S.M., (1999), An Introduction
to Mathematical Finance: Options and Other Topics, Cambridge University Press.

Wilmott, P., S. Howison and J. Dewynne, (2002), The Mathematics of Financial Derivatives: A Student
Introduction, Cambridge University Press.