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What Is Currency Risk: A Complete Understanding

Triston Martin

Sep 29, 2022

Currency risk or exchange risk occurs when fluctuations in the foreign exchange rates negatively impact the financial values of any asset. So, when you are leading a business at an international level, you may face an unexpected loss because of the difference in currency rates at the international level!

Due to the fluctuation in the exchange rates, the currency risk will always remain there. The only way to reduce currency risk is through hedging activities. It may not be a reliable option, but it will keep you safe to some extent!

If you think of trading at the international level but are afraid of currency risk, this post is for you. Here we will explore more about currency risk, so get into this article without wasting any other second!

What Is Currency Risk?

Currency risk is a result of foreign exchange rate fluctuations. It is also referred to as exchange rate or foreign-exchange risk. The people who own Multinational companies (MNCs) and investors having business worldwide mostly experience currency risk.

The risk occurs because of the currency’s price difference bet two different nations/countries. Currency risk can create a lot of profit and loss in the business of MNCs depending on multiple factors. Because of the currency risk, most people like to expand their business in Asian countries.

The currency risk problem arose in the 1990s; in 1994, the currency risk issue started getting attention due to the crisis in Latin America. Currency risk can be controlled by hedging. Handling the currency risk was the talk of the town till the 1990s, and there are some ways of managing it.

Currency Risk Example

To clarify things, here is an example that will help understand the currency risk. Suppose you want to invest in a company based in London; you pay 100 euros to buy shares. When you purchase the shares, the exchange rate is 1.2 euros to 1 USD.

Now, if the currency rate changes, euros and dollars come to an equal amount, you will face a loss, and if the rate of euros increases, you will get a profit. And this entire process is called currency risk.

Pons And Cons Of Currency Risk

The currency risk is problematic as it directly influences your investment. Sometimes the table turns in your favor, and sometime, you may experience loss. If you are all into foreign investment, the currency risk is unavoidable; you must get used to it.

Some invest in countries with rising interest rates underpinned by strong currency value. However, they will still face currency risk, but there will be very low chances of getting a loss in that investment. The currency risk comes with every foreign investment, so the company should manage it appropriately.

Currency Risk Management

The currency risk will always be there when you make a foreign investment. It is an inescapable risk. Some things will help to mitigate any negative impact on the business. There is a specific way of handling currency risk, which is called managing currency risk.

Like many others, you may also think is managing the currency risk is a big problem. In the survey by HSBC and F.T. remark, 70% of chief finance officers (CFO) said that their companies have suffered from reduced earnings for two years because of this unavoidable currency risk.

Managing the currency risk is not a big problem, but the biggest barrier is the lack of time and knowledge. Not only small and medium size businesses, companies with 2M euros and large level importance and export also experience the currency risk.

Ways Of Managing Currency Risk

The following are a few ways of managing the currency risk:

Investigate Operating Cycle

The most helpful way is to investigate your whole operating cycle. Testing the operation cycle will help in learning where the risk exists. It will help you determine many factors related to your business and finance.

The Uniqueness Of The Flow Chart

It is the key to determining the currency risk or fluctuation. The thing that allows you to grow without loss and profit in the currency risk is accepting that you have a unique flowchart. Every business has a unique flowchart!

Decide Your Rules And Stick To Them.

You must decide on some currency risk rules and stick to them. The risk management policy allows for systematically monitoring and mitigating currency risks that jeopardize financial objects. While deciding the management policy will be a big job, decide the rules properly and stick to them.

Manage Your Exposure To Currency Risk

The businesses to financial status are investigated by following a whole method. All the things are investigated, and before making a decision, it is determined how it will affect the company’s bank account.

The whole process is performed due to appreciating and depreciating the currency. The currency risk is managed by managing your exposure and using financial instruments that will help you; this is also called a hedge.

Automate Risks Handling

Automating the handling will also help all large and small businesses. It minimizes operational risk and human error that way causes some difficulty for the business.

Benefits One Can Bring To The Business By Managing Currency Risk

Currency risk can be mitigated by hedging. A currency hedge fund is mutual funding that is specifically designed to mitigate currency risk. The advent of the U.S. dollar has designed the currency hedge fund for all kinds of markets. So, you can also use this strategy to manage currency risk. But do you know the benefits of currency risk management?

Many people running a business do not know the benefits of handling the currency risk; here are some benefits you will get by managing the currency risk.

  • Protection of your profits and flow of the cash
  • Better understanding and investigating how currency risk will affect your balance sheet.
  • For the improvement in the financial forecasting
  • Improve budgeting.

If you want to know what currency risk is, you should also know about its management and what are the benefits of managing it.

Conclusion

The currency risk arises due to exchange rate fluctuations and will always remain there whenever you trade between two countries. It can bring a huge profit or a massive loss for your business. You can follow up a strategy to combat this risk and can make your business a success story!


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