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With each swing in currency value, the forex market can bring large gains or stinging losses. "Any business that is doing business across the border or with another country is going to have currency risk exposure, and that affects their bottom line," says Brendan McGrath, CFA, corporate risk manager for Western Union Business Solutions.
Here are a few measures businesses can take to evaluate their exposure to currency risk.
The smaller a business's profit margin, the greater the risk that it will be impacted by changes in currency value in the forex market. For example, if a Canadian commodities-based business has a 7 percent profit margin from U.S. sales, its profits could be wiped out by an unfavorable shift in the Canadian to U.S. dollar pairing. In a case such as this, the international business may want to hedge 90 to 100 percent of its overall exposure to ensure its margins are protected, McGrath says.
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To determine potential currency risk exposure, it's also important for international business owners to consider a foreign currency's volatility. Lower volatility means the value of currency changes slowly, over a longer period of time. Higher volatility means the price of a currency fluctuates more significantly over a short period of time. Significant volatility in the exchange rate can take its toll on a business - raising expenses, diminishing profits and making financial planning difficult.
Certain currencies - such as those in emerging foreign markets like India - can be more sensitive to market movements and are more volatile than money from more developed countries, McGrath says. To determine a currency's volatility, business owners can look at how rapidly and how much the currency value changes over time.
Conducting business in countries that have a lot of political or market instability may expose international companies to more currency risk. For example, speculation about the impact of austerity measures in certain European countries such as Greece and Spain had an impact on the euro's value, McGrath says. "It seems to be day to day, and traders are looking more at the news headlines than the economic data that comes out of countries," he says.
Regardless of a country's short- or long-term political and economic situation, it's important for businesses to carefully assess their risk exposure when dealing in foreign currencies to ensure protection against adverse market movements. "We always advocate if you a have a large exposure and a large negative move can affect you that you at least book a portion of your exposure and protect yourself," McGrath says. "Protecting your exposure against adverse movements is effective because it will ensure a business's costs don't increase or their foreign revenue doesn't decrease due to foreign currency fluctuations."
Determining a business's risk exposure is a lot like going to a doctor, says Victor Hinojosa, director of North American partnerships at Western Union Business Solutions. "If you don't know your symptoms, the doctor isn't going to be able to provide a lot of information," he says.
Here are some questions Hinojosa suggests business owners should consider:
· Which foreign market will I be doing business in?
· How much money will be allocated toward foreign exchange transactions this year?
· When do I expect to make those foreign exchange payments?
· When do I expect to receive those foreign payments?
· Do I have any online foreign currency accounts?
· Do I have an online foreign exchange system that I can leverage?
· Have I used any bids in that foreign marketplace in the past?
· How often do I make foreign exchange transactions?
· Do I make foreign exchange transactions on a consistent basis?
· Where do I conduct business?
In addition to consulting with a financial advisor, business owners can turn to the guidance and relevant resources provided by an online foreign exchange service.
By taking the time to evaluate risk exposure, international business owners can create more financial predictability. Knowing what to expect weeks, months or even years down the road can ultimately lead to a more healthy bottom line.
Example: 1USD = xx INR
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