Foreign exchange risk, for those who are not really aware of what it means, can be referred to the losses incurred by an international monetary transaction owing to certain fluctuations in currency. Foreign exchange risk (FX risk), which is otherwise also known as currency risk, describes that the value of an investment might depreciate due to any change that might be observed in the relative value of the currencies involved in the transaction. This is, in a nutshell, the essence of foreign exchange. However, it would be puerile to restrict the domain to just the definition and provide no further insight into the topic at hand. Though, the entirety of foreign exchange might not be possible to wade through within the span of one article, there are a few essential points that you must understand to be able to understand the topic better.
An Insight into Foreign Exchange Risk:
As we have already stated at the beginning of the article, foreign exchange risk refers to the risk associated when there are significant losses incurred by an international financial transaction due to fluctuations in the currencies involved. Any kind of appreciation or depreciation in the base currency or the denominated currency will have an impact on the entire system of cash flow arising as a result of the transaction. The domain of foreign exchange affects several investors and business people who have to deal with international transactions on a daily basis. Therefore, understanding the inherent risks of foreign exchange is all the more important to these people, without which they could end up in a soup.
A Few Foreign Exchange Risk Management Techniques:
Now that we have spoken about what a foreign exchange risk is, it is time to look into a few techniques in which these risks could be managed.
Risk Sharing-
Just as the term suggests, the parties involved in the transaction (for instance, the seller and the buyer), agree to share the burden of the risk associated with the transaction so that their relationship is not affected and depends solely upon the quality of the product and the reliability of the supplier.
Payments Netting-
This method proves to be beneficial to the companies that are exposed to transactions involving multiple currencies. The technique allows the companies to control the way the payments are dealt with since all the payments are netted to a singular transaction.
Natural Hedging-
This method of foreign exchange risk management offers the firm quite some protection from the fluctuations in exchange rates because the relationship between the revenues and costs of a foreign subsidiary body furnishes a natural hedge.
Conclusion:
The right implementation of one or more than one techniques can shave down the risk associated with the foreign exchange transaction and help a firm thrive. It is always crucial that you remember that transactions that involve foreign currencies have risks associated with them. But that does not mean that you have to give in the risks and suffer from the losses. You can always use the techniques mentioned above to hedge the risk and make a favourable transaction.
