Forex exposure management is an important consideration for any business dealing in multiple jurisdictions.
Unfortunately, foreign exchange is often overlooked and can result in both operational and accounting headaches later on.
In this article, we’re going to help you navigate forex exposure management. We’ll do so by breaking down the most impactful challenges and solutions to overcome them.
And, because forex can impact businesses of all sizes, the contents of this article will apply whether you have a small e-commerce business, work for a major corporate, or need solutions for an offshore company owned via bearer shares.
Feel free to use the table of contents to jump ahead to any sections that are immediately relevant to your search.
Table of Contents
- Forex Exposure Management 101
- How to Manage Foreign Exchange
- Frequently Asked Questions
- Ready to Explore Your Options?
Forex Exposure Management 101
One of the main reasons that international companies tend to open accounts in foreign countries, is to manage foreign currency requirements as they related to domestic expenses and revenue.
That said, simply holding local currency with local financial institutions is not always sufficient when it comes to managing forex exposure. Instead, depending on the complexity of the business involved and the volatility of the underlying currencies, sophisticated hedging mechanisms may be required.
With this in mind, let’s take a look at the different types of forex exposure and how they can best be managed.
Types of Foreign Currency Exposure
There are three types of foreign currency exposure that most businesses face when they engage in cross-border trade or when they have international operations:
- Transactional exposure
- Translational exposure
- Economic exposure
We’ll take a look at each of these and the available solutions below.
Transactional exposure refers to the foreign currency volatility that a business can face due to transactions (e.g. purchases and sales) that are denominated in a foreign currency.
Not surprisingly, businesses engaged in international trade or that have operations in different countries will face some degree of transactional exposure. However, there are effective ways that businesses can combat transactional exposure, which we’ll explore below.
While transactional exposure refers to the immediate impact that income and costs may have on a business due to currency fluctuations, translational exposure refers to the risk that such fluctuations could have on a business’ reporting.
In other words, how foreign currency volatility impacts the underlying value of a company’s assets, liabilities, and income. Again, this is important if you have a business that operates across multiple currencies, especially those currencies that are likely to fluctuate in value against the business’ reporting currency.
Economic exposure, like transactional and translational exposure, refers to the extent that foreign currency fluctuations could impact a business. However, it is the broadest of the three types of foreign currency exposure. This is because it considers both transactional exposure and the impact of currency volatility on operations.
With this in mind, economic exposure considers the impact that foreign currency could have on a business’ income streams, underlying assets, and expenses.
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How to Manage Foreign Exchange
Forex exposure management options range from simple and affordable to complex and expensive. With this in mind, it’s important to choose the options that best match your business needs and budget.
Below, we’ll explore a number of potential options, starting with the most straightforward and progressing to more complex.
Executing Contracts In Your Preferred Currency
One of the easiest ways that a company can approach forex exposure management is by insisting that any contracts they sign are executed in the currency of their choice. Not surprisingly, for most businesses, this would be the currency of their country of registration and reporting. That said, if a business has physical operations in a country, it will be difficult to manage forex exposure exclusively through contract negotiations.
Maintaining Foreign Currency Reserves
For smaller businesses with foreign currency exposure, they may be able to approach forex exposure management by opening bank accounts in the jurisdictions where they do business. In fact, many businesses choose to maintain sufficient reserves to offset any short and medium term liabilities in foreign currencies. Fortunately, opening both multicurrency and international bank accounts is possible for international companies. If this is something you would like assistance with, you can contact us for more information.
Purchasing Currency Swaps
More sophisticated business owners may choose to purchase currency swaps to manage their forex exposure. Currency swaps are derivatives that essentially involve exchanging interest in one currency for the same interest in another currency. In doing so, interest payments are exchanged throughout the life of the currency swap contract.
Hedging Through Futures Contracts
Another popular tool for forex exposure management is the purchasing of futures contracts. Again, this is a common choice for more sophisticated businesses with significant foreign currency exposure. In short, purchasing a futures contract allows businesses to protect against the potential loss that could arise from future currency volatility.
Frequently Asked Questions
Below are two of the most common questions that we receive from people looking to understand forex exposure management. If you have further questions you would like answered, don’t hesitate to get in touch with us directly.
How Do You Manage Transaction Exposure?
In order to effectively manage transaction exposure, businesses first need to assess the level of exposure that they face. In doing so, they will be able to determine appropriate hedging strategies to limit the impact that currency volatility could have on the business.
What Are the Three Types of Foreign Exchange Exposure?
The three types of foreign exchange exposure include transactional exposure, translational exposure, and economic exposure. These can impact any business engaged in cross-border trade. But also, any business dealing in currencies other than their home currency, which they use to finance the majority of their operations and for account purposes.
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