Reasons for buying and selling foreign currencies: payment of profit, interest and dividends between countries

Published by Patrick Mutisya · 14 days ago

International Trade and Globalisation – Foreign Exchange Rates

International Trade and Globalisation – Foreign Exchange Rates

Objective

Explain the reasons why individuals, firms and governments buy and sell foreign currencies, focusing on the payment of profit, interest and dividends across borders.

Key Concepts

  • Foreign exchange market: The global marketplace where currencies are bought and sold.

  • Exchange rate: The price of one currency expressed in terms of another.

  • Current account transactions: Trade in goods, services, investment income (profits, interest, dividends) and transfers.

Why Do Economic Agents Need Foreign Currency?

  1. Payment of profits earned by multinational enterprises (MNEs) in a foreign subsidiary.

  2. Payment of interest on cross‑border loans and bonds.

  3. Payment of dividends to foreign shareholders.

  4. Other reasons (import payments, tourism, speculation) – listed for completeness.

Detailed Explanation of the Three Main Reasons

ReasonWho is buying/selling?Typical transactionEffect on exchange rate
Profit repatriationParent company of an MNEConvert subsidiary’s earnings from foreign currency to home currencyIncreased demand for home currency → upward pressure on its value
Interest paymentsBorrower (often a government or corporation)Convert home currency into foreign currency to meet interest obligationsIncreased demand for foreign currency → upward pressure on that currency
Dividend paymentsForeign shareholderReceive dividend in foreign currency, then sell it for home currencySimilar to profit repatriation – creates demand for home currency

Illustrative Example

Consider a UK‑based company, BritCo, that has a subsidiary in the United States. In the fiscal year the US subsidiary earns \$10 million in profit. To repatriate the profit, BritCo must exchange the \$10 million for pounds.

The transaction can be shown as:

\$\text{£ required} = \frac{\\$10\,\text{million}}{E_{\\$ / £}}\$

where \$E_{\\$ / £}\$ is the spot exchange rate (dollars per pound). If the spot rate is \$1.30/\£$, then:

\$\text{£ required} = \frac{10\,000\,000}{1.30} \approx £7.69\,\text{million}\$

BritCo’s demand for pounds increases, which, ceteris paribus, tends to push the pound’s value up relative to the dollar.

Impact on the Foreign Exchange Market

  • Large, regular outflows of foreign currency (e.g., profit repatriation) can cause the home currency to appreciate.

  • Conversely, large inflows (e.g., foreign investors receiving dividends) can also strengthen the home currency.

  • Central banks may intervene to offset excessive movements caused by these flows.

Summary Checklist

  • Identify the economic agent involved (firm, government, investor).

  • Determine the direction of the currency flow (home → foreign or foreign → home).

  • Assess the likely short‑run impact on the exchange rate.

  • Consider any mitigating actions by central banks or hedging by firms.

Suggested diagram: Flow chart showing the movement of foreign currency for profit, interest and dividend payments between a subsidiary, parent company, and foreign investors.