Three ways to mitigate foreign exchange risk
To prepare, you may want to consider three of the most common approaches.
When it’s necessary to do business in a local currency, an important consideration is the value of local currency. For instance, if you’re exporting goods to Japan, a drop in the value of the yen will translate into diminished revenue in U.S. dollars.
Conversely, if you’re importing goods from Japan, a rise in the yen’s value will increase your costs, relative to the U.S. dollar. These values can fluctuate due to factors such as inflation, interest rates, the overall economy, and much more.
To prepare for these variations, you may want to consider three of the most common approaches:
1. Spot contract:
A contractual obligation to convert (“buy” or “sell”) a set amount of a foreign currency at a specified exchange rate for settlement on a date which is typically two business days after the transaction is executed. This type of contract locks in the cost or value of the foreign currency being exchanged, helping to mitigate exposure to adverse currency movement.
2. Forward contract:
A contractual obligation to convert (“buy” or “sell”) a set amount of foreign currency on a future, or “forward”, date at a specified exchange rate. A common reason for entering into a forward contract is to help stabilize the cost or value of future payables or receivables.
Conducting business abroad:
There are certain rules, regulations, and considerations to keep in mind.
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3. Currency account:
An account that can be held in a variety of currencies and essentially eliminates the need for conversion. A currency account may be a consideration for a company that has both receivables and payables in the same currency.
With international ventures, the added component of exchange rate volatility comes into play. Developing a plan to effectively manage this volatility may help minimize the risks associated with the ever-changing value of the U.S. dollar against the world’s currencies.