Exchange rate risk — the unavoidable risk that accompanies all foreign investment — is always going to be present in the international business arena.
Since currency values fluctuate daily, even many times throughout the day, much of exchange rate risk comes from the fluctuation of the value of your local currency versus the value of the currency where you’re making or accepting payments.
If the exchange rate moves while you’re making a payment, you might end up paying more than what you thought you were going to, or you might be paying less, depending on which way the currency moved. The same is true when you’re accepting payment from overseas for goods or services. If the exchange rate fluctuates during the transaction, you might get paid more, or less than what you anticipated.
It might seem like a solution is to conduct all your business in a single currency, like the U.S. Dollar (USD). That’s not necessarily the answer, however. If you only use USD to pay your vendors, there’s a good chance you’re overpaying.
That’s because in single currency transactions, the exchange rate risk becomes a hidden cost. Yes, there’s some convenience to not having to watch currency fluctuations and enacting strategies to mitigate risk. Yet even though you seem to be avoiding exchange rate risk, you’re still absorbing hidden costs from the convenience. You aren’t taking steps to hedge against exchange rate risk, but your vendor is. You can bet on the fact that they’re building that cost into the invoice. The end result is that you’re still paying more, even if the USD is strong and rates are moving in your favor.
Reduce Currency Risk with Hedging Strategies
Like we mentioned, you’ll never completely outrun all the exchange rate risks you’ll encounter. A better option than paying everything in USD and relying on your partners to take the risk (and reap the reward) is to put your own strategies in place to reduce your own exchange rate risk. You’ll end up lessening your risk, get better prices, and preserve your bottom line. You may even be able to use exchange rate risk to your benefit.
These strategies, referred to as hedging, can help protect your profits and your business. Some additional tools clients can use to mitigate their FX risks for inbound or outbound global payments include:
Currency Forwards essentially let you buy or sell a currency now and pay for it later. Forwards can be used to lock in favorable exchange rates today, so you don’t have to worry about market moves later. This lets you protect your profits on the transaction and move on to other business. Currency forwards only require a small initial deposit, so they are a way to free up cash flow when you won’t be making payments for a long period of time. You can choose from fixed-date forwards, which lock in a specific date up to two years away, or window forwards, which allow you to draw funds at a specific rate as many times as you like during a window.
Market Orders let you set the rate you want to pay, and automatically execute the transaction when the market hits that rate. They are flexible, monitored 24/7, and can be changed or canceled before they execute if your plans change.
Multicurrency Accounts allow you to receive, pay, and hold foreign currencies in a single account, which makes them different from international bank accounts. You’ll save time and money on transactions because you can hold a foreign currency in your account without converting it to USD. Simply hold on to the funds until you decide how to use the money. Monex multicurrency accounts also have no required minimum balance and no maintenance or transaction fees.
Spot Transactions let you purchase and quickly send over 130 currencies at the live exchange rate, and send the money around the world in standard business two-day delivery. Certain currencies can be sent same or next-day delivery. Spot transactions are secure and ideal for international transfers when you need to make a payment quickly.
Choosing the Best Strategies for Your Business
Remember, hedging isn’t magic or some sort of scheme. It’s simply a collection of tools you can use while running your business.
Hedging tools become even more important as your payment terms get longer. Longer payment terms, like 60 or 90 days out, carry a higher risk. There’s more time for the rate to move against you, which gives you more incentive to hedge against that risk.
For assistance in choosing the best tools to reduce exchange rate risk in your business, contact us today.
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