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When a company buys things from suppliers in other countries, they have to deal with the possibility that the money they need to pay might change in value. This can happen because exchange rates between different currencies can go up or down. To handle this risk, companies can use tools like contracts to lock in exchange rates or keep a close eye on the currency market to make smart decisions.
Certainly, for every transaction it should have been predetermined hedging position.
Increasingly, many businesses have dealings in foreign currencies and, unless exchange rates are fixed with respect to one another, this introduces risk. There are three main types of currency risk as detailed below.
Economic risk. The source of economic risk is the change in the competitive strength of imports and exports. For example, if a company is exporting (let’s say from the UK to a eurozone country) and the euro weakens from say €/£1.1 to €/£1.3 (getting more euros per pound sterling implies that the euro is less valuable, so weaker) any exports from the UK will be more expensive when priced in euros. So goods where the UK price is £ will cost € instead of €, making those goods less competitive in the European market.
Similarly, goods imported from Europe will be cheaper in sterling than they had been, so those goods will have become more competitive in the UK market. Note that a company can, therefore, experience economic risk even if it has no overt dealings with overseas countries. If competing imports could become cheaper you are suffering risk arising from currency rate movements.
Doing something to mitigate economic risk can be difficult – especially for small companies with limited international dealings. In general, the following approaches might provide some help:
Try to export or import from more than one currency zone and hope that the zones don’t all move together, or if they do, at least to the same extent. For example, over the six months January to June the €/US$ exchange rate moved from about €/US$0. to €/US$0.. This meant that the € had weakened relative to the US$ (or the US$ strengthened relative to the €) by%. This made it less competitive for US manufacturers to export to a eurozone country. If, in the same period, the £/US$ exchange rate moved from £/US$0. to £/US$0., a strengthening of the US$ relative to £ of only about8%. Trade from the US to the UK would not have been so badly affected.
Make your goods in the country you sell them. Although raw materials might still be imported and affected by exchange rates, other expenses (such as wages) are in the local currency and not subject to exchange rate movements.
Translation risk. This affects companies with foreign subsidiaries. If the subsidiary is in a country whose currency weakens, the subsidiary’s assets will be less valuable in the consolidated accounts. Usually, this effect is of little real importance to the holding company because it does not affect its day-to-day cash flows. However, it would be important if the holding company wanted to sell the subsidiary and remit the proceeds. It also becomes important if the subsidiary pays dividends. However, the term ‘translation risk’ is usually reserved for consolidation effects.
If the exposure to the foreign currency is huge then no worry if you be able to perform hedge deal with either local or foreign banks and also in the same time you dont have to gamble you only hedge each foreign transaction only , so for example when you expect to pay supplier bill € M 4 after 3 month in the same time you will have to sell the same amount then you will zero impacted in any bad or good fluctuates by this swap deal.
