How to Manage Foreign Exchange (FX) Risk

Taking your business overseas means navigating various issues around currency management and money management. A big issue underneath that umbrella is foreign exchange risk, or FX risk.

Foreign exchange (FX) risk refers to the potential losses from transactions due to fluctuations in the exchange rate. As exchange rates are far from static, it’s a reality businesses must face. Luckily, there are ways you can manage FX risk. We’ll go over them in this article.

We’ll also talk about the Wise Business account, an account that handles many global currencies and can help you manage FX risk in your growing international business.

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How to manage FX risk (+ Tools)

The best way to manage any type of risk, whether operational, cybersecurity-related, or financial, is to take a comprehensive approach from all angles. There isn’t one currency protection strategy for your business. This can sound intimidating at first but is reassuring. To manage your FX risk, you can use a combination of these methods:

Use a Multi-Currency Business Account

These accounts allow you to hold and manage many currencies without the constant need to convert funds. With Wise, you get competitive exchange rates and transparent fees. This saves time and money.

Effective management of FX risk is crucial for businesses operating internationally. Employing a variety of tools can help mitigate the impact of currency fluctuation risk on business operations and financial performance. Here are some essential FX risk management tools businesses can integrate into their strategies. Some have been mentioned before, but are mentioned here again to emphasize their importance.

Send Currencies at the Mid-Market Exchange Rate with Wise Business

Natural Hedging

This involves aligning your revenue and expenses in the same currency where possible.² By keeping both sides of the ledger in the same currency, you decrease your exposure to fluctuations. For an international business, this could mean moving operations and manufacturing to the location where they get the most sales. This decision will allow them to have the payables and receivables in the same currency, allowing them to avoid exchange risk.

Forward Contracts

A forward contract allows you to lock in an exchange rate for the future.³ Regardless of how the exchange rate moves, your business can expect consistency in cost. This makes forecasting more detailed.

Forward contracts are often used for fixed priced goods and services to be supplied at a future date. For example. a US-based small fashion company is buying textiles from a UK-based supplier. These textiles are critical to the business, and they place several future orders to ensure sufficient future supply.

If the business uses a forward contract, the price of the textile deliveries that have been ordered for a later date, e.g. six months from now, will be paid at a guaranteed price. If the forward contract is not used, the price of the textiles could increase, and the business may not have the funds to pay for the order when it arrives.

FX Options

FX options give you the right, but not the obligation, to exchange currency at a pre-agreed rate before a certain date.⁴ This is particularly helpful for businesses that need some degree of flexibility.

FX options allow the business to select put options, which allow the business to exchange currencies at a pre-determined price, known as the strike price.

Diversification

By spreading operations across many currencies, you can reduce the impact of fluctuations in any single market. This reduces reliance on one currency and minimizes the potential impact of exchange rate volatility.

Regular Tracking and Analysis

Many platforms provide tools to inform you about market movements. Up-to-date information allows you to reassess your strategies and make informed decisions.

Small businesses can do a variety of things to track and monitor currency exchange rates. One way is to set up alerts for a predetermined rate where you'll get an email or other notification. Another method is through custom dashboards that use APIs to give your business better oversight of currency changes.

Swap Agreements

Currency swaps involve exchanging principal and interest payments in one currency for equal payments in another.⁶ By using swaps, businesses can manage cross-currency cash flows and optimize their debt structures to lessen exposure to FX risk.

Currency Futures

Currency futures are standard contracts traded on exchanges that bind the sale of a specific currency at a future date.⁵ They enable businesses to lock in exchange rates, safeguarding against volatile currency movements. These instruments are used by companies looking to hedge their transactional or translational risks.

Automated FX Platforms

Platforms specializing in FX transactions provide seamless solutions for managing currency exposures. These platforms often offer competitive exchange rates, reduced fees, and integrated financial reporting tools. They simplify foreign currency management.

How Wise Business helps you manage FX Risk

Wise Business offers innovative solutions for managing FX risk. Their global business account allows customers to hold and manage 40+ different currencies. This reduces the need for immediate or frequent currency conversions. Wise provides transparent and competitive exchange rates, often much lower than traditional banks. This minimizes the costs associated with foreign transactions.

Wise offers real-time updates and tools to track market movements. They empower businesses to make informed decisions and plan their currency strategies. By leveraging Wise Business, companies can streamline their international operations, mitigate currency risks, and enhance financial efficiency.

Wise Business is a money service provider (MSP). Known for its simplicity and low fees, Wise is an excellent choice for international businesses who want an international account with clear and transparent exchange rates and global money transfer services.

Features to Manage Your FX Risk

What are examples of foreign exchange rate problems?

Engaging in international commerce can present a host of challenges related to foreign exchange rates. While these hurdles are inherent to cross-border transactions, understanding them is the first step in lessening their impact. Here are some common foreign exchange rate problems businesses may encounter:

How does increased foreign exchange risk affect business?

Increased FX risk can have significant implications for businesses operating in the international market. Understanding these effects is crucial for effective financial planning and maintaining operational stability. Here are some of the key ways in which heightened FX risk can impact businesses:

Conclusion

Expanding your business overseas comes with the issue of FX risk, and you have various tools in your arsenal to solve this problem. It could be getting a global business account or using other industry tools to manage the complexity of managing multiple currencies. It could also mean maintaining certain rules of thumb, such as diversification and natural hedging. Overall, it will take multiple tools and sound strategy to ensure that your business can grow effectively in the complex international business environment.