How to mitigate foreign exchange risk

7 min read

Currency risk is a critical issue to handle as it can have a significant effect on the efficiency and profitability of any business with an international footprint.

Each exchange rate movement affects how much you receive from sales and what you pay to suppliers. If it moves in your favour, you stand to gain, but it can have a crippling effect on your operations if the rate goes in the other direction.

Thankfully, your company doesn't have to face currency risk issues unaided. You can enlist the help of foreign currency payment providers such as Clear Currency to help you manage any fluctuations and stay competitive.

With a solid foreign currency risk mitigation strategy in place, you can build a stronger competitive advantage to propel your multinational business to greater heights.

Let’s take a deeper dive into understanding these risks and how you can best manage them.

What Are The Risks Of Foreign Exchange?

foreign exchange

Foreign currency risk is a financial risk brought about by the fluctuations of trading prices between your home currency vs. the local currency of the nation you are doing business in.

It impacts your business in the following ways:

1. Transaction risk

This involves the potential losses arising from each contract that you make. When you sign a contract, make a purchase order or buy from suppliers, your prices are based on the rate at the time of concluding the deal.

It’s impossible to predict what the price will be upon settling the transactions, exposing you to the risk of revenue losses, higher payments to suppliers, or lower margins.

2. Translation risk

When you consolidate the financials of all your foreign subsidies, you can incur losses on the balance sheet and income statement due to currency fluctuations.

Even though the values of the assets themselves have not changed, you can face medium to long-term balance sheet problems.

3. Economic risk

In the long term, the value of one currency may continue declining against another, affecting the future value of your business.

Goods and services priced in the declining currency will become cheaper and more competitive. This can slow down your business if your prices are listed in the stronger currency.

Foreign Exchange Risk Mitigation Techniques

foreign exchange risk mitigation techniques

In a survey on risk management trends, 70% of CFOs admitted that their companies fell prey to avoidable currency exposures.

To guard against this, consider exploring a mix of risk minimisation methods such as the following:

1. Matching or Natural Hedging Technique

The matching technique involves paying your liabilities with receipts denominated in the same currency to eliminate net exposures.

Here’s an example. An American company selling goods in Canada would only pay Canadian suppliers with Canadian dollars instead of sending US dollars across the border.

However, the volume of transactions involved would require the finance team to keep up to speed with exposures and manage the multi-currency transactions smoothly.

Clear Currency can help you manage multi-currency transactions risk-free. We offer a simple and cost-effective tool for handling multi-currency transactions on a single platform to help your finance team keep a keen eye on your receipts and payments.

2. Active Hedging With Financial Instruments

Financial instruments such as swaps, forwards, and futures are designed to lock in future exchange rates.

Forward Contracts

A forward contract is a firm commitment to buy or sell currency at a predetermined exchange rate on a specific date in the future.

It eliminates any uncertainty as you know exactly how much you will pay or receive at that future date.

Currency Swaps

With currency swaps, businesses exchange an equivalent initial amount in different currencies. The agreement is, in essence, a business loan in another currency that allows you to use and then repay at a predetermined rate.

Currency Options

Currency options give your business the right, without obligation, to trade a currency at a set rate (strike price) on or before the expiration date.

Unlike forwards, options remain flexible. You are not obligated to buy or sell at this rate when the contract ends.

Money Market Hedge

The money market hedge is an instrument where the domestic business locks in the trading value of the foreign businesses’ currency before an upcoming transaction. That way, the local company has a guarantee of how much it will pay.

Tip: Active hedging methods can be costly and complicated, so it's best to seek expert guidance. Here at Clear Currency we have a team of currency experts who can help you choose the right hedging solution for you.

Hedging Foreign Currency Risk: Main Takeaways

Foreign exchange risks come with the territory for any business operating across borders.

While there's no way to eliminate the risks, creating a solid risk management strategy can help you reduce your exposure.

You can either stick to matching techniques or currency hedging through derivatives such as:

  • Forward contracts
  • Currency swaps
  • Currency options
  • Money market instruments

Or better yet, err on the side of caution and explore different alternatives.

Protect Your Business: Mitigate FX Risks and Play It Safe With Clear Currency

Understanding which risk mitigation measure to take and when to do so requires expert knowledge.

Consider turning to Clear Currency for help. As a foreign exchange transfer specialist and advisory platform, we can help you:

  • Understand the hedging instruments and how to use them for your business.
  • Lower your exposure to fluctuating currencies and create stability through a dedicated FX transfer platform that works with over 35 different currencies in more than 130 countries.
  • Figure out the best strategy to create a winning risk management policy.
  • Receive and send money quickly on a secure FCA-regulated platform at a very low cost.

Whether you’re testing international waters for the first time or you’re already a seasoned multinational company, get in touch with Clear Currency to get help mitigating FX risks.

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