Foreign exchange risk
What is foreign exchange risk?
Foreign exchange risk is the threat of financial loss as a result of changes to foreign exchange rates.
The risk can occur when a financial transaction takes place using a currency that’s different to the base currency of the company or individual, and value is lost before the transaction is completed.
Where have you heard about foreign exchange risk?
While businesses that import and export goods, services and supplies face greater foreign exchange risk, all companies that operate in international markets can experience a loss.
The assets of offshore investors are also at risk, however just as fluctuating exchange rates can cause a loss, they can also cause a gain.
What you need to know about foreign exchange risk.
Investors and businesses can take a few steps to insulate themselves from foreign exchange risk. Measures include invoicing in your home currency, creating forward contracts that establish a fixed future rate or matching any receipts and payments in the same foreign currency against each other.
You can also do what’s called leading and lagging; speeding up or slowing down the processing of receipts and payments.
There are four types of foreign exchange risk:
- Transaction exposure, where payments and receipts are directly affected by currency exchange rates
- Economic exposure, where market value is affected by unexpected currency rate fluctuation
- Translation exposure, where an international subsidiary changes a domestic currency to another currency
- Contingent exposure, where costs are being negotiated and currency fluctuations occur (either before a deal is reached, after or both)