Financial Exchange Risk
Foreign exchange risk (also known as FX risk, exchange rate risk or currency risk) is a financial risk that exists when a financial transaction is denominated in a currency other than the domestic currency of the company. Like all risks, FX risk is managed using the standard risk management process. Armed with the understanding of your current exposure, the priority for business management must be whether to accept, reduce or transfer the FX risk identified. There are ways you can mitigate your FX exposure and therefore risk and these are not all as foreign a language as the currencies we may deal in.
- The most common and ‘easy’ way is to match your FX receipts with your outflows – referred to as a natural hedge. Daily mark-to-market to ensure that hedging works as intended and risk limits are not exceeded.
- Another option is to ensure a clause is included in your contracts to foreign counterparts setting out the treatment of the FX rate difference whether this be a gain or loss.
- You could also consider Forward contracts; it is a term used to describe a contract of an agreed amount at an agreed point in the future regardless of the FX fluctuations and performance.
- The only way a company can avoid FX risk is to trade solely in the domestic currency. Meaning suppliers and even customers must all be local or at least transacting in local currency. Which, for many companies involved in cross border businesses, this is not an option if long term success and profit is an objective of your company.