Foreign exchange risk or currency risk refers to the possibility that an investment’s value may decrease due to changes in the relative value of the involved currencies. In other words, it’s the probability that a company or investors will lose money on international trade because of currency instability.
If a currency’s value fluctuates between the date a contract is signed and the date it’s supposed to be delivered, a loss for one of the parties (buyers or sellers) could exist.
Types of Foreign Exchange Risk
- Transaction Risk
Occurs when a company buys products from a supplier in another country, and price is provided in the supplier’s currency. If the supplier’s currency appreciates vs. the buyer’s currency, the buyer will have to pay more in its base currency to meet the contracted price.
The risk of transaction exposure typically impacts one side of a transaction: the business that completes the transaction in a foreign currency.
The company receiving or paying a bill using its home currency is not subjected to the same risk.
- Translation Risk
Refers to how a foreign exchange transaction will impact financial reporting; i.e., the risk that a company’s equities, assets, liabilities or income will change in value as a result of exchange rate changes.
This risk occurs because subsidiaries of a parent company in another country denominate their currency in the countries where they are located. The parent company faces potential losses when it must translate the subsidiaries’ financial statements into its own country’s currency.
- Economic Risk
Also known as operating exposure, this refers to the impact on a company’s market value from exposure to unexpected currency fluctuations. This can affect a company’s future cash flows, foreign investments and earnings. Exposure is greater for multinational companies with many overseas subsidiaries and a large number of transactions involving foreign currencies. Economic exposure can have a substantial impact on a company’s market value and its Effects are far-reaching and long-term in nature. Because of this, hedging against economic exposure can be challenging as it deals with unexpected changes in foreign exchange rates.
- Jurisdiction risk
It arises when laws unexpectedly change in the country where the exporter is doing business. Jurisdiction risk is a uncommon risk and it exists primarily in unstable countries.
Causes of Foreign Exchange Risk
Foreign exchange risk is caused by instability in international currencies. There are multiple causes of these fluctuations :
- Macroeconomic factors such as significant swings in exchange rates
- Government policies could result in a drop or boost in market movement
- Changes in inflation, interest rates, import-export duties and taxes also impact the exchange rate
- If a government is unable to repay its debt and it defaults on its payments, it can have a direct impact on investment rates because its repercussions can trigger other business-related issues. Government debt can also cause political unrest and might even change government policies, which can impact the exchange rate and, in turn, affect business transactions.
- Collapse of a foreign government is another cause of currency risk.
Ways to Mitigate Foreign Exchange Risk
However big a problem is, a solution is always present somewhere. Foreign exchange has some risks but there are ways of mitigating this risk so you as an exporter or importer won’t have issues with your business. Here are some of the solutions offered by our partners:
- Utilizing forward contracts.
Through our currency exchange partners, both sellers and buyers can use forward contracts to buy or sell currency for a future delivery date, which eliminates the risk of the currency moving against them and eating into their profit margin. And by employing a forward contract in your invoicing, you have “insurance” against the possibility of losing money due to exchange-rate volatility.
- Hedging.
Foreign exchange trading, also known as hedging is a financial strategy that helps to manage exposure and foreign exchange risk and financial loss. Hedging, which our partners helps with, offsets a potential loss from foreign exchange trading by taking an opposite position in a related currency.
- Providing tools that might protect your company when and if currencies fluctuate.
Currencies are always fluctuating, going up and down and strengthening or weakening against one another. Importers and exporters can exploit these changes; currency weakening when they need to sell it or strengthening when they need to buy it. Our partners provide tools such as Market orders that permit businessmen to exploit currency strengthening in their favor so that the company may be protected when currencies fluctuate.
- Instant Currency Conversion irresspevtive of your location
Our partners gives access to fast, simple and seamless multi-currency conversion thanks to multi-currency accounts or all buying and selling of foreign currencies. You can purchase Foreign Currency Drafts in USD, GBP, EURO, AUD, CAD, JPY, SGD and AED and there will not be any foreign currency margin on the same. Removal of transaction fees for international payments is also a benefit that could derived from them.
- Offering Attractive interest rates on foreign currencies
With our partners, you can earn interest on short and long-term deposits with a consolidated monthly statement and enjoy potential foreign exchange gain depending on market conditions. If interested, you may place your foreign currencies on short and long-term deposits at your home branch.
- Our partners are specialists that could help importers and exporters form strategies tailored to their individual needs.
It’s highly valuable to have someone on your side who can guide you through the intricacies of everything from forwards, to market orders, to holding foreign currency, because the timing of when you buy or sell currency has a huge impact on your profitability.
Also, Complicated political climates, natural disasters, and economic crises could arise and have negative impact on the economy of the foreign country an importer or exporter is transacting with and if the businessman is unaware of such situation, he might be in a profit declination. Therefore, it is invaluable to have someone at your side who could guide you through.
Selling internationally, if carefully executed, can significantly increase your bottom line. But, knowledge, planning and the development of risk mitigation strategies must precede any international trade efforts. Otherwise, you could fail to realize the benefits from a global business expansion.
To minimize those risks, please contact your Damalion partner now to open your multi-currency account.
