3 Forex Risks & Strategies for Corporations
Many companies in America have business connections with certain institutions or companies outside the country. This association normally aims to tap a wide target market in these foreign locations. The problem is that these American firms will have exposed themselves to forex risks.
The risks emanate from the fact that the companies would have to conduct their operations using foreign currencies.
This corporate forex obligation is detrimental since any fluctuation in the value of these currencies translates into losses for the companies but there are some strategies corporations can do to combat the risks and make an ideal practice for corporations.
3 Forex Risks for Corporations
There exist three forms of foreign exchange risks that normally haunt American corporations. These risks include:
1. Translation risk
This forex risk occurs as a result of transactions that have been conducted using foreign currencies. A case in point is when companies own assets and subsidiaries in foreign countries.
These possessions are always expressed in foreign currencies, which present a problem when making financial statements. In this case, the affected firms would have to express these values in their currencies, in this case, dollars, before combining them with their assets. This requirement normally impacts majorly on financial statements.
2. Transaction risk
Transaction risk usually affects companies that have to undertake commercial transactions in foreign currencies.
It is a result of the requirement that demands that firms must convert foreign currencies into their own currencies to enhance consolidation and reporting. If they are lucky, these firms could reap immensely when their currencies perform strongly. This is not the case when the currencies weaken—the effects usually rear themselves in the form of losses.
3. Economic risk
Economic risk is usually evident when exchange rates plummet and affect the demand, revenue and costs of a firm’s product in a foreign territory. In the event that the foreign currency depreciates, such firms would witness an increase in the price of their products. This affects their sales negatively since the target market could shun these products.
3 Forex Strategies for Corporations
Fortunately, corporate forex risks are occurrences that can be controlled or even prevented. There are various corporate forex strategies that can assist companies in forestalling the occurrence of any forex risk. The following are the top three strategies:
1. Purchase of swaps
Currency swaps have proved themselves to be able preventers of forex risks. In this case, companies swap a certain amount of foreign currency with another company willing to conduct their sales in this currency. Upon its maturation, the company that received the currency will improve its situation in case it appreciates.
2. Use foreign bank accounts
Companies can somewhat lessen the effects of foreign exchange risks by depositing their currencies in foreign banks. This way, the currency will gain interest while awaiting an improvement in the exchange rate. When this happens, these firms can repatriate the money and reap handsomely from the increased value of the currency.
Hedging is a strategy that allows companies to offset currency holdings with forwards or futures contracts. For instance, companies that expect to make a certain amount of money can sell short this amount. In this case, they would be purchasing long a similar amount of the money in their currencies.
This strategy dilutes the shocks created by currency fluctuations thanks to the opposite position of derivative contracts.
Forex risks are among numerous risks that hover over all businesses. The fact that they can be controlled is good news for companies that conduct their activities outside America. They can still realize more sales thanks to the three aforementioned strategies.