Manage Currency Exchange Risk – What is the foreign currency exposure?
Managing Currency Exposure
One of the biggest challenges to a business involved in a foreign trade or has a foreign subsidiary is managing currency exposure. Also known as foreign exchange risk, FX risk, or currency risk. Currency exposure puts a firm at the risk of making financial losses. This is due to fluctuation of the exchange rate, a changing economic environment in the foreign country. Or a stronger currency becoming weaker. And unless a business adopts strategies for minimizing the risk, the company’s financial record will be in the Red.
Manage Currency Risk
The following are some ways of reducing the exposure or risk:
Futures Contracts; Simply known as Futures, this derivative financial instrument. Enables the seller and buyer to purchase or sell a product at an agreed future date. The standardized forward contract normally used for financial instruments and commodities. The predetermined price referred to as the forward price and protects both the seller and buyer.
Manage Foreign Currency Risk
Swap – A swap is also a financial derivative and involves two parties to a trade. Instead of settling payments via cash or money, the involved parties exchange cash flows, likened to barter trade. For instance, if the financial instrument is a bond, the parties may exchange the value of the interest accrued on the bond for the specified period. When formalizing the arrangement, the parties will agree on the future date, the rate of interest, mode of calculating and exchange.
Manage Currency Exchange Risk
Forward Contract – Simply known as a Forward. This instrument entails the involved parties agreeing to buy or sell a commodity or asset at a predetermined future date. It’s a type of non-standardized derivative that ignores the fluctuations that may take place after the agreement and when the exchange will happen. For instance, if the price at the start was $ 100 and they agree to settle at a future date for $120. The $120 price which referred to as the delivery price will hold even if the market price dips to 90 or rises to $130. In either case, both the buyer and seller are protected, as they would have made their planning based on the agreed price.
What is the foreign currency exposure?
Establish a Baseline Rate – Currency exposure managed by setting a base rate. It will define the lower as well as the upper boundary that is suitable for both parties. If the fluctuation, which normally defined as a percentage, is within the set range, a fixed price is adopted. Adjustments only are done when the prices go beyond the set parameters.
Final Thoughts
There you go- 4 ways of reducing the risk that occasioned by fluctuating currency exchange. Although all the above strategies work, their effectiveness may vary depending on the nature of trade, transaction period, fiscal and monetary policy. It’s therefore advisable to always research and adopt the best. At times, it may be beneficial to apply them selectively. A better approach is engaging a firm that specializes in managing currency exposure and related matters. Such a service will try to come up with the most feasible strategy for your company depending on the type of exposure. This allows you to focus on the core business and improving productivity, efficiency and profitability.ility.
