It doesn’t matter whether your business operates domestically or internationally, or you use a single currency or multiple currencies to make and receive payments.
At some point, your business will be impacted by the foreign exchange market. Exchange rate risk can affect your profits over time. That’s why it’s important to understand how the foreign exchange market operates, what causes exchange rate risk, and what steps you can take to keep those risks under control.
What is the foreign exchange market?
First, let’s talk briefly about how the foreign exchange market works. The foreign exchange market is also known as the FX market, forex, or currencies market. Some form of the FX market has been in place for the past 300 years. It’s global and open for trading twenty-four hours a day, five days a week, making it one of the largest exchange markets in the world in terms of trading volume.
Currencies are traded for one another on the foreign exchange market. This trading action is what sets their value, or exchange rate. Currencies are traded in pairs, such as U.S. dollars (USD) traded for Mexican pesos (MXN) and vice versa. For example, this currency pair recently traded 1 USD to 20.01 MXN, and 1 MXN to .05 USD.
What Can Cause Exchange Rate Risk?
The forex market is open for trading 24 hours a day, five days a week, with a daily trade volume of $6.6t. occurring any time of the day and night. This much trading each day can result in large rate movements in a short amount of time, leading to exchange rate risk.
Exchange rate risk refers to the possibility of losses in international financial transactions due to fluctuations in the value of currency. These fluctuations can be caused by many different local and global factors, including:
- trading activity within the forex market or other markets
- economic news
- political news
- other global news
- weather events, like storms, flooding, and droughts
There are three major types of exchange rate risk:
- Transaction risk is when rates change before your transaction is finished
- Translation risk is when the value decreases on financial statements due to rate changes
- Economic risk is when a company’s value is impacted by fluctuations.
Can You Avoid Exchange Rate Risk?
You can’t completely avoid exchange rate risk. It affects investors who trade in international markets, or businesses who import or export products or services to other countries. It also affects companies with employees based in different countries, who get paid in their local currency.
One strategy that some businesses employ is to use a single currency, such as the USD, for all transactions. However, in a global economy, rate fluctuations affect everyone, no matter what currency you’re using. Even if you operate only in USD, somewhere along the supply chain, rate fluctuations will affect someone you do business with, and their losses will be passed along to you. That might translate to a higher price for raw materials from your supplier, higher transportation costs, or your customers not buying as much as before because of their own additional operating expenses.
That doesn’t mean you’re stuck with just accepting exchange rate risk. You can take steps to minimize the effects and protect your profits from large market swings.
How can you protect your business against exchange rate risk? Hedging is a strategy used by many businesses to limit risks while sending or receiving payments in foreign currencies. There are many hedging techniques available. Here are some that we recommend at Monex USA:
- Forward contracts to lock in an exchange rate today
- Multicurrency accounts hold several currencies without exchanging them
- Market orders to execute transactions when the market hits a specified rate
Help in Navigating the FX Market
The landscape of the FX market changes every day, even minute by minute. It’s hard to keep up with what’s happening. You don’t have time to monitor every piece of news, politics, weather, and rate change that occurs in each 24-hour cycle, while also managing your business. The best way to control your risk and get the most out of the forex market is to have an expert like Monex USA on your team.
Monex USA and its global affiliates make up one of the world’s largest commercial foreign exchange providers, offering industry-leading foreign exchange, risk management, and international payment solutions to clients. With a collective 36 years of FX expertise and more than 70,000 clients worldwide, our experts are ready to help you with sending and receiving your overseas payments and protecting your profits through hedging. Our award-winning forecasting expertise will help protect your business.
We have FX solutions to save you time and money on your foreign payments and investments and protect your profits from foreign currency risk. For more information, or to talk to an expert, please visit MonexUSA.com.
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