If you believe that currency and exchange rates are something that only bankers must worry about, you’re wrong. Many businesses, whether they realize it or not, are subject to currency risk. With the recent huge swings in global currencies, enterprises with customers, suppliers, or manufacturing in foreign countries are once again concerned about exchange-rate risk. Due to the outbreak of the coronavirus, March and April saw substantial changes in currency values.
Strict controls aimed at containing the outbreak slowed the global economy, resulting in a drop in oil prices and financial markets.
The market is looking for safe havens, favoring the yen, dollar, and Swiss franc. Smaller currencies and commodity currencies, such as the NOK, SEK, AUD, NZD, and emerging economic currencies, have been hit hard, but some of the losses have been reversed since April. The essential takeaway is that if you are associated with a suitable broker for US forex traders, you are almost certainly exposed to currency risks. Events outside your control may cut your profits and raise your costs.
What is the problem with managing currency risks?
According to a survey of 200 financial executives and nearly 300 hedge managers, 70 percent of CFOs said their company’s earnings were reduced in the previous two years due to avoidable, unhedged FX risk; 58 percent of CFOs in larger businesses said FX risk management is one of the two threats that currently occupy the largest portion of their time, and 51 percent said FX is the risk that their organization is least well enough to deal with.
Small and mid-sized enterprises are similarly vulnerable to currency changes, but according to a survey conducted by Nordea in late 2020, too many SMEs misjudge their currency risks.
Businesses with a turnover of more than 2 million euros and a reasonable quantity of imports and exports believe currency swings caused them unanticipated financial losses during the COVID-19 pandemic.
However, over half of SMEs have not taken precautions against this, and according to the poll, the largest impediments to risk management are a lack of time and knowledge.
On the other hand, managing your currency risks can benefit your company:
- Cash flow and profit margins are protected.
- Financial forecasting and budgeting have improved.
- Gain a better understanding of how currency changes affect your balance sheet.
- Borrowing power increased.
Businesses hurry to avoid potential losses when currency rates vary. What currency risks should they manage, and how should they hedge them?
Ways of Managing Currency Risk
- Examine your Business Cycle
Examine your company’s operational cycle to see where FX risk arises. This will aid you in determining the susceptibility of your profit margin to currency movements.
- Stick to the rules of FX Risk Management
A successful FX policy starts with a thorough knowledge of the company’s financial goals and the impact that changes in FX rates might have on those goals:
- Changes in FX rates may threaten the company’s EBITDA target if the operative income and expenses are in different currencies.
- If the financial assets are in different currencies, recalculating the assets using fresh FX rates could put the P&L bottom line at risk, as well as the equity ratio targets.
- Whatever the financial goals are, the FX risk management policy guarantees that any FX risks that could endanger those objectives are consistently monitored and controlled.
- Manage your currency risk exposure
There is a significant delay between making business decisions and witnessing the consequences of those actions on the company’s financial account, especially when it comes to physical things. During that period, buy and sales orders are signed, supplies are shipped worldwide, and things are produced, stored, and distributed.
Invoices are issued, reviewed, approved, and eventually paid in parallel to the physical process. In the meantime, currencies appreciate and depreciate. If the company’s design and production expenses are in a different currency than its sales receipts, variations in FX rates can easily wipe out the sales margins it utilized to make its initial decision.
- Invest for long-term to get through volatile times
The unfortunate thing is that you can’t avoid volatility whether you’re investing in bonds or stocks. The good news is that by using a long-term and systematic manner, you can minimize volatility. When you are a short-term trader, volatility becomes a major problem for you. Volatility in equities tends to even out over time, at least in the long run. A methodical or staged strategy also helps to reduce volatility.
- Examine your portfolio to reduce interest rate risk
Interest and price volatility are linked because rising inflation typically results in higher interest rates. This influences stocks and bonds. When interest rates are lowered, bond prices rise, increasing the NAV of bond funds. Lower rates reduce future profits at a lower rate, which increases the value even in the case of shares. When interest rates rise, the opposite is true. You can move maturities if you’re in bonds, and if you’re in equities, you’ll need to adjust your position to rate-sensitive sectors like banks, NBFCs, autos, and real estate.
- Stick to low-impact names
When you are unable to quit or enter a specific stock within your price range, you are exposed to liquidity risk. When markets become more unstable, this situation becomes even worse. Liquidity may be difficult to come by in a market that is collapsing. In usual circumstances, however, you can minimize this risk by sticking to equities with minimal impact costs.
- Accomplishment over reinvestment risks
A dividend plan pays out rewards, but unless you reinvest them at the same rate, you’re unlikely to build up as much money over time. A growth strategy, on the other hand, simply reinvests the profits. As a result, a growth plan has no reinvestment risk, whereas any periodic payout in the type of interest paid does. The answer is straightforward. You can choose growth plans in index funds, and low-dividend and high-growth firms’ inequities.