Reference no: EM132676914

Foreign Exchange Risks

The growth of trade across borders over the past 3 decades has led to a significant growth in exports and imports as businesses tried to cut their costs and improve their margins. Despite the growth in international trade, businesses and financial institutions alike prefer the sales/transactions be in the currency of their home country as this reduces the hassle of having to convert the foreign currency into their currency and pay for the conversion costs. Hence, there is no guarantee that a product from a foreign market is at a fixed price all the time, despite it being at a fixed price in the domestic market. This is because of the constant fluctuations in the currency exchange rates in the market. When doing international business, it is important for companies to consider the risk of foreign exchange to ensure that they do not end up paying more than what they can for a product because of foreign exchange. Likewise, it is important that companies do not borrow a lot based on the financial performance of their subsidiaries in a different country as the fluctuations in the international market could lead to change in exchange rate which could affect the exports and imports. One good way of navigating the foreign exchange market without taking risks is by using the spot exchange option. Spot exchange happens when the deal can be concluded in one day and the buyer is willing to pay the seller the whole amount on that very day. While this is a good option, it might not be feasible for small or medium scale industries that do not have the resources that big industries have, especially when the transaction is a big one. The forward exchange is another way of avoiding the risks of foreign exchange. Forward exchange deals let the buyer and the seller agree on a rate of exchange on a future date (Hill & Hult, 2019). While this could prove to be risky for both the buyer and seller, it can help them navigate the risk of either overpaying or getting under paid.

Transactions with foreign businesses is common for most businesses today. With the competition in both domestic and international markets growing, due to the trade policies being adapted, it is important that businesses analyze and plan for their foreign investment to ensure they do not suffer any losses as managing the foreign exchange risks is one of the hardest things to do (Al Janabi, 2006). Even when a company or business operates in their own country with no foreign clients or suppliers, it is important for them to have a passive risk management plan in place to ensure that they are constantly monitoring the effects of the fluctuations in the currency market (Rupeika-Apoga & Nedovis, 2016). While businesses take precautions to secure their investments, it is also important that the government has strict policies in place to ensure that no domestic or foreign entity is acting in a way to depreciate their currency value in the international market. Although this can mean that there will be more business in the exports sector as foreign businesses can get purchase more for the same price, depreciating currency is not an ideal scenario as it makes it incredibly hard for importers to keep up with the demand. This can also make it hard for businesses trying to make a foreign direct investment or go international.

Real exchange rate volatility is another factor that could impact the risks businesses in a nation can face when dealing with the international market. A study showed that the fluctuations of a currency value against other currencies can have negative impact on the inward FDI of the nation (Kyereboah-Coleman & Agyire-Tettey, 2008). This is because the capital needed for the business might not always be the same. This could also mean that foreign businesses would be less willing to do forward exchange deals with businesses in the nation and even if they are, they would have to pay a lot more than what would be ideal for them.

Conclusion

Although there are a lot of transactions involving foreign exchange taking place every minute, it is important for the government to have strict policies in place and monitor business transactions to ensure that businesses do not run into the risk of suffering losses or impacting the value of the nations currency in the international market as this could lead have negative effects on economic growth.