Forex Risk Management Tools
Risk Management Tools to Protect your Business from a Volatile Forex Market.
With the European debt crisis impacting confidence in the region and the current instability of the global forex market, SMEs that trade or transact internationally can be vulnerable to high foreign exchange transaction costs and revenue losses.
The fluctuating British pound can greatly alter the cost of trading internationally, and many small businesses are reeling from the financial insecurity of doing business abroad. When exchange rates are unstable, it can be hard for businesses to accurately predict or forecast their expenses and/or profits.
But there are ways to manage your business’ exposure to exchange rates and incorporate strategies that provide some insurance against fluctuating rates. These hedging strategies can minimise potential losses and protect profits. Every company involved in international business shoulders currency risk, and currency risk management is designed to protect your business from the negative impacts of currency movements, while still allowing your business to benefit from positive currency fluctuations.
Here’s an explanation of the hedging tools that SMEs can incorporate into their foreign exchange strategy to protect themselves from a volatile market.
Forward Exchange Contracts
Forward Exchange Contracts (FECs) allow you lock in an exchange rate now, even though the actual transaction won’t take place until a later date. FECs can be arranged up to a year in advance, which allows SMEs to be sure of the cost of their overseas transactions and purchases before they are actually made. It’s a smart way for businesses to protect themselves from currency fluctuations. Forward Exchange Contracts are useful because they allow SMEs to more accurately predict their cash flow and profit margin.
An Option is a forex risk management tool that protects businesses from downturns in the currency market, but also allows them to take advantage of positive currency shifts. When a business buys an option they secure the right, but not the obligation, to make an international purchase or exchange funds at a predetermined exchange date on a chosen date. Where Options differ to FECs is that the buyer is not obligated to settle on that date. If movements in the forex market present more favourable exchange rates than the rate that was set when the Option was bought, the buyer is not obliged to settle.
SMEs can use Options as an effective tool to reduce the risks of transacting when the market is in flux.
Most large companies that do international business can hire experts to watch the forex market and manage business dealings with it. But for SMEs, it is often not financially viable to hire such experts in house. Limit Orders are an effective tool for SMEs to outsource currency monitoring. When you place a Limit Order with a forex dealer, you specify a target exchange rate that you would like to transact at. The forex dealer then monitors the market on your behalf, and jumps on that exchange rate when/if it is triggered. This allows SMEs to get the best exchange rates for their international business dealings.
Different hedging strategies will suit different businesses, but it’s important for SMEs to be aware of the risk management tools that are available to them. Despite the current volatile nature of the Sterling, foreign markets can be used by SMEs to increase profits and add value to their companies. Currency markets are unstable in nature, but by using the available tools and creating and implementing an appropriate foreign exchange strategy, SMEs can successfully trade overseas and mitigate currency risks.
This information is brought to you by UKForex Foreign Exchange Services. It is not intended to constitute financial advice of any kind.