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MANAGE YOUR FOREX EXPOSURE

Businesses that trade or have operations overseas are likely to be exposed to foreign exchange risk (Forex Risk) arising from volatility in the currency markets. The most common cause of foreign exchange exposure arises from having to pay invoices for imported raw materials priced in a foreign currency or receiving foreign currency for your exported finished goods. However, exposure can also arise from:


  1. Your competitors having a cost base and/or selling their products in a foreign currency
  2. Assets located overseas
  3. Foreign currency borrowing or surplus cash balances of overseas subsidiarie
  4. Borrowing denominated in foreign currency
The impact that exchange rate fluctuations have on profitability will vary but in many cases it can be significant.

Assess Your Exposures

There is a raft of factors to take into account when assessing your exposure to foreign exchange rate risk, for example:

  • What proportion of your business relates to imports or exports?
  • What currencies are involved?
  • What are the timings of payments?
  • What impact would an adverse rate movement have on your profitability?
  • Is the level of overseas business likely to change?
Do you pay and receive in the same foreign currency – it may be possible to mitigate the exchange risk by using a foreign currency bank account?

Understand the Products

There are only three basic alternative methods to manage foreign exchange risk.

Do nothing and buy or sell your currency in the spot market.

You act on the day you want to buy or sell your foreign currency and the banks will quote you an exchange rate and the transaction will settle two working days later. Whilst simple, this approach means you will not know how much of home currency you will need to pay or receive for your foreign currency until the day in question – this can be a high risk strategy as the exchange rate may have moved significantly since you agreed the price with your customer/supplier. If rates have moved in an adverse way, your profit will be reduced accordingly

Lock in to fixed rates

As soon as you become aware of a need to exchange foreign exchange at a future date, you can fix the exchange rate by booking a forward exchange contract. This approach provides certainty but you could suffer an opportunity loss if rates subsequently move in your favour and you are obliged to transact at the forward contract rate.

Use Flexible Products

A currency option will offer you the potential for upside benefit if rates move in your favour – like a spot deal, but will provide protection against adverse rate movements – like a forward contract. For this flexibility, banks will normally charge a premium although there are a range of alternative structured option products available where an up front premium is not required

formulating your Strategy

It may not always be best to adopt any one of the three alternatives in isolation to manage your foreign exchange risk. Many businesses, reflecting their attitude to risk, their view of the currency markets, preparedness to pay premiums and a host of other factors, will adopt a portfolio approach – using a combination of spot, forward exchange contracts and currency options to do the task.

Implementing your strategy

It is often tempting to defer a decision to implement your foreign exchange risk management strategy, perhaps in the hope that rates may move in your favour in the short term.

Historically, currency markets have been extremely volatile and unpredictable. It makes sense therefore, once you have formulated a strategy, to implement it without delay and ensure your profits are protected.
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