What are the risks in the foreign exchange market?

What are the risks in the foreign exchange market?

The currency market is the largest investment market in the world, with an average daily volume of about five trillion dollars. Foreign currencies can fluctuate in value because of inflation, unemployment, or election results. Volatility can also be triggered by other news or global events like weather or pandemic.

Running a business that is exposed to the foreign exchange market means you will always be subject to foreign exchange rate risk. Throughout each week, the value of different currencies is always in flux—from hour to hour and from day to day. For businesses, this can result in a substantial profit or loss.

Foreign exchange risks can be classified into the following three types of risks:

  • Transaction Risk
  • Translation Risk
  • Economic Risk

Transaction Risk - Any time a company receives or sends a payment in a foreign currency, there is a risk of the exchange rate changing before the transaction is complete. If the rate moves against you, the transaction will cost more and have a significant impact on the company's bottom line.

For example, a European company with operations in USA is looking to transfer 500 USD in earnings to its European account. If the exchange were 1 euro for 5 dollars, and the rate subsequently falls to 1 euro for 6 dollars before settlement, an expected receipt of 100 euro (EUR 500/5) would instead be worth 86 dollars (USD 500/6).

Translation Risk - Refers to the risk that a company’s equities, assets, liabilities, or income will change in value as a result of exchange rate changes.

For example, a parent company that reports in Canadian dollars but oversees a subsidiary based in China faces translation risk, as the subsidiary’s financial performance – which is in Chinese yuan – is translated into Canadian dollar for reporting purposes.

Economic Risk - Currency rates can fluctuate based on the economic situation of the countries whose currency you’re trading. These may be affected by various factors, such as world news, political actions interest rates, Inflation, and the economic health of the country. The economic risk can have an impact on a company’s market value and operations from exposure to unexpected currency fluctuations. This can affect a company’s future cash flows, foreign investments, and earnings, not only for the near term but also for the long term.

4 Tools that will help you to manage foreign exchange risk with okoora ABCM™

Since none of us have a crystal ball to accurately predict the future, guessing the future currency rates is a gamble that is best avoided. With okoora ABCM™ you can protect your business from exchange rate fluctuations -Minimize risks by locking exchange rates with AI-driven methodology and execute one-click rate protection.

Here some of the hedging tools that okoora ABCM™ developed:

Lock rate & pay later- Whether you’re an importer or exporter, it can be frustrating to monitor the international market only to miss the ideal moment for a transfer. Let’s assume you want to buy something from a supplier in China, but you don’t really have to pay for it until several weeks (or months) later. You agree to pay the person the $100 worth of goods in their local currency yuan. However, by the time your payment is due, you simply cannot guarantee that the $100 will have the same worth against the Chinese yuan. To avoid paying more, you create a forward contract to lock-in your exchange rate, reserving current prices and protecting yourself against any market volatility. With ABCM™ you’ll be able make the most out of your payments, and never miss out on any favorable currency rates. You can minimize any future cashflow uncertainty by locking the exchange rate when it seems most advantageous and keep current on what’s happening in global financial markets with AI-driven insights so that you can make real-time informed and confident decisions.

Compare hedge-Currency rate risk management is an important aspect of every multinational company’s business and having the right currency rate risk management strategies is crucial in order to achieve financial targets. However, currency rate risk management can be very complex and consists of different transactions with many differences such as costs, time ranges and profit and loss characteristics. okoora's ABCM™ Compare Hedge tool enables you to choose the right hedge strategy for your business. The compare hedge tool is supported by a smart optimization engine that chooses the most appropriate hedge strategy alternative for you from a wide range of possible hedge transactions.

Hedge policy-Your business depends on future cashflows and must have enough cash on hand to sustain operations, especially if it has overseas operations. It is difficult to come up with a hedging strategy that takes cashflow projections and market variables into account especially when your bank offers expensive hedging transactions that are not always suitable for you. ABCM’s hedging toolkit is powered by smart hedging methodologies and by a wizard that enables you to take the right action at the right time in order to minimize the uncertainties in juggling multiple currencies.

Limit board-Timing is everything. If your business depends on timely alerts to keep you on track, you can have multiple alerts competing for your attention. Keeping up and managing different reminders and alerts can often be quite challenging, and you may find yourself missing vital market-related alerts, causing you to make uninformed and costly business decisions. With okoora ABCM™ you can stay informed about what's going on in the global markets with timely alerts and AI-driven insights, so you can make informed and confident decisions in real time. With okoora's ABCM limit board you can set the rate you want to pay, and automatically execute the transaction when the market hits that rate.

To Manage Foreign Exchange Risk With okoora ABCM™ Click here