Multi-currency accounts are a great opportunity to mitigate various forms of volatility. Volatility represents the degree to which a variable changes over time. The bigger the magnitude of a variable change, or the more rapidly it changes over time, the more volatile it is.
Any currency can experience periods of high volatility. For example, The peak of COVID-19 situation introduced high levels of volatility in foreign currency markets almost never seen before.
These levels of volatility can make and at same time, break businesses that relies on importation or exportation of goods, however, the risks associated with it can be reduced by having and utilizing the right measures.
Foreign exchange risk In relation to volatility
By simple definition, this is the risk imposed on a business’ financial performance by changes in currency exchange rates. These changes happens due to volatility, which is a measure of the amount by which price becomes unstable over a given period. These unstable exchange rates can ravage a business’ profitability by eating into margins.
Sources of foreign exchange risk
Practically, any situation in which a corporation uses foreign currency to transact can be considered a foreign exchange risk. But businesses that deal with multiple currencies are more exposed to these risk than others.
These risks can arise from a number of sources, including:
• Importing or exporting of goods
• Denomination of other costs, such as capital expenditure, in foreign currency
• Receiving income such as royalties, interest, dividends etc, in foreign currency
• Having offshore assets such as operations or subsidiaries that are valued in a foreign currency.
The danger for businesses
There are various ways that volatile foreign exchange can affect your business. For example:
- If you are an international investor, fluctuating exchange rates make it more difficult for you to know the best place to invest becausee one wrong guess about the exchange rate movement, you could lose a substantial amount of money. One cannot merely look at what the interest rate is across countries but must also speculate about the exchange rate change.
- A falling in domestic exchange rate can increase costs for importers, thus potentially reducing their profitability. This can lead to decreased dividends, which in turn can lead to a fall in the market value of the business. It can also increase the cost of capital expenditure where such expenditure requires, for example, importation of capital equipment.
- A rising domestic exchange rate can make exports can less competitive, thus reducing the profitability of exporters. This can lead to decreased dividends, which in turn can lead to a fall in the market value of the business
- A rising domestic exchange rate can also decrease the value of investment in foreign subsidiaries and monetary assets (when translating the value of such assets into the domestic currency)
Managing foreign exchange risk
While typically volatile exchange rates can make a business uneasy, there are a number of proven strategies that enable effective swaying against foreign exchange risk. Having a multi-currency account is very helpful in such cases. Some of these strategies offer by our partners are stated below:
- Hedging
A simple method is to match any outgoing foreign currency payments against foreign currency inflows received at exactly the same time. This method is rarely used due to the uncertainty of timing of the cash flows. The inflow and the outflow must occur at exactly the same time to provide a ’perfect’ hedge
- Foreign currency bank accounts
This method of managing foreign exchange risk can be used when the timing of the foreign currency inflows and outflows don’t match. The timing issues can be managed by depositing surplus foreign currency in a foreign currency account for later use, or by borrowing foreign currency to pay for foreign currency purchases, and then using the foreign currency to repay the loan.
- Forward exchange contract
This enables the business to protect itself from adverse movements in exchange rates by locking in an agreed exchange rate until an agreed date. The transaction is deliverable on the agreed date.
For example, if a business purchasing capital equipment wanted certainty in terms of the local currency costs, it would buy US dollars (and sell local currency) at the time the contract was signed, with a forward rate agreement. This would lock in the local currency cost, ensuring that the cost paid for the equipment will equal the original cost used to determine the internal rate of return of the project.
- Foreign currency options
These enable an entity to purchase or sell foreign currency under an agreement that allows for the right but not the obligation to undertake the transaction at an agreed future date.
It’s highly valuable to have someone on your side who can guide you through the complications of foreign exchange risks. At Damalion, our partners are specialists that could help business owners form strategies adapted to their individual needs, they also offer impressive interest rates on foreign currencies, in addition to instant currency conversion, also provide tools to protect you when currency fluctuates.
If you need help managing your businesses’ foreign exchange risk, contact your Damalion expert to open a multi-currency account.
