Fluctuations in global currencies have brought exchange-rate risk back to the forefront for many companies – particularly those working with suppliers, production, or customers in different countries.
Since the financial crisis of 2008 revealed the immense problems facing traditional financial institutions, change in the industry has accelerated. Businesses can now turn to a host of specialists to perform a lot of the functions that banks had previously dominated. Small and medium businesses who, until recently largely relied on traditional banks to undertake most of their FX requirements, are now frequently using foreign exchange specialists to undertake the buying and selling of their currency.
The Foreign Exchange Market
Support from a specialist offers more tailored solutions and a personalized service. Specifically, companies often find they can significantly reduce FX risks and cost by relying upon a specialist provider.
How A Specialist Can Prevent 3 Types of FX Risk…
1. Transaction Exposure
All companies involved in international trade enter into contracts whereby they commit to deals to be settled at a future date which require foreign currency purchase to complete. At the time of payment the rate of exchange may have moved in a detrimental way and subsequently seriously deplete the cash flow to meet the higher commitment.
A specialist broker can help a company examine hedging strategies for transaction exposure, such as a forward contract which enables a company to either buy or sell foreign currency at a pre-agreed exchange rate, enabling benefits such as delayed payment and the security of a locked-in exchange rate.
2. Operating Exposure
Operating exposure (also known as economic exposure) can have a considerable impact on a company’s market value, as it deals with the unexpected changes in exchange rates. It’s the possibility that the net present value of a company’s expected cash flow will alter due to an unexpected fluctuation in foreign exchange rates.
Companies can hedge against such unexpected currency fluctuations by investing in foreign exchange (FX) markets. For example, the use of forward contracts and spot contracts:
With a forward contract, two parties can fix the exchange rate between two currencies for a future date. This proves invaluable for currencies not required until a future date. The contract will affirm that on an agreed date in the future, a quantity of one currency will be exchanged for a specified quantity of another.
A spot contract is a contract that involves the purchase or sale of a currency for immediate delivery and payment on the spot date, which is usually two business days after the trade date.
3. Translation Exposure
The third type of risk is translation exposure, also known as accounting exposure. It’s a type of foreign exchange risk faced by multinational companies that have holdings operating in multiple countries.
Any business that has assets led in a foreign currency or that operates in a foreign marketplace using a currency other than the company’s home currency can be affected. The more assets a business possesses that are denominated in a foreign currency, the greater the translation risk.
Why? Changes in the exchange rate between the currency in which a company reports and those in which the company’s assets and liabilities are denominated, can have a large impact on an organization’s balance sheet – and it’s this very risk that is known as ‘translation risk’.
So, how does a specialist help to overcome such a risk? The protection against translation exposure can be gained through hedging techniques, something an FX specialist can assist in. Hedging is the purchasing of foreign currency, using either foreign currency swaps, foreign currency futures (an FX future contract), or a combination of the two.
Are you Handling Exchange-Rate Risk Effectively?
As we move away from the financial crisis of 2008 and begin to recover from the recessive environment with more robust regulatory processes embedded, it now makes more sense than ever before for companies to shop around when looking at business costs.
The time has come to use the best services available to you and turn to an FX specialist for your international payments. And in doing so, you can benefit from support in managing your risk, while also paying less in costs.
Central FX are one of the leading foreign exchange businesses in the UK, based in the heart of London’s financial district, we offer tailored solutions to businesses, guiding them through every step of making their international payments.
To discuss how we can help you or your business, contact us today.