Although the global economy is said to be on the road to recovery now, the last financial depression has left a deep impression and even deeper lessons to learn. One of these lessons involves the understanding of foreign exchange risk and the importance of mitigating and managing that risk.
Despite the improving financial climate in most of the developed nations, it won’t be wrong to say that situation is still shaky in most parts of the world. Fluctuations in exchange rates are ever more likely and this leaves businesses and economies ever more prone to foreign exchange risks.
Contrary to popular belief, foreign exchange risk is not exclusive to businesses dealing in one more than one currency. As a matter of fact, it may also impact other businesses especially those who rely on imported services and products or those who have offshore assets.
No matter if the currency value rises or falls, foreign exchange risk can have devastating effects on profitability and that is why businesses must learn to mange it efficiently. Here are five useful tips for managing foreign exchange risk before it starts toppling profits and revenues.
Hedging means matching any outgoing payment in foreign currency against inflowing foreign currency received at the same time. Since the timing of inflow and outflow is not accurately predictable, this method is not used very often. However, with perfect timing, hedging proves to be profitable management strategy.
Foreign Currency Bank Accounts
Of course, the timing of inflow and outflow does not match as ideally as required for hedging. Businesses can also mange the timing issue by depositing a hefty sum of foreign currency in a foreign currency account. This money can be used later when the timing of inflow and outflow of foreign currency matches. Also, businesses can chose to pay for foreign currency purchases by borrowing foreign currency.
Limit and Leave
A wise thing to do is to limit your foreign currency orders so that you are able to stop and leave as soon as you hit your profit target. Limiting the profit target allows businesses to play it safe and saves the trouble of keeping a constant eye on the forex index. Similarly, you can choose to limit your losses and control your risk conditions.
Protect With contract
A wise thing to do is to protect the business by locking the exchange rates through a contract. These contracts are valid till the agreed time period and any fluctuation during this period will not affect the business. However, this may also bind your business with the same rate even when the change is favorable for your business.
Contact a Broker
Businesses must keep in touch with their brokers or bankers so that they are always open for sell and purchase options at the best possible time. If the currency to be hedged happens to move in line with the borrowed currency, then it may be the right time to sell currency options. If it moves against it, buying currency option is more favorable instead.