Negosentro.com | How to protect a business from currency fluctuations? | Entrepreneurs engaged in international trade may lose money because of the change in the exchange rate. But there are special mechanisms to protect against currency risks.
When does a business need protection from currency risks?
As a rule, the higher the volume of international trade, the higher the currency risks in business. To see if you need protection from them, you need to answer two questions:
- Does your business depend on currency jumps?
- What exchange rate will be critical for you, that is, at what rate will your profit decreased by 50-70%?
If your business is highly dependent on currency changes, it is worth considering protection from currency risks. At the same time, the scale of the business does not play a big role. What matters is what proportion of the revenue depends on the exchange rate, so protection from currency risks may be required by both a large company and an individual entrepreneur.
Let’s pick up an example. Revenue of your noodle business is highly dependent on the change in a particular currency exchange rate against the dollar, there is currency risk. But let’s say another thing: you sell filters for pools. The filters themselves are bought in Poland for example, and replacement cartridges to them are ordered in China. Cartridges are cheaper than filters, and if the currency rises in price, it will affect only a small part of your profits. In such a scheme, the currency risk is small, and it is possible not to protect yourself.
How can you protect a business from currency risks?
There are two options for managing currency risks:
No additional tools
In this version, you think through the scheme of purchases and sales so that currency risks were minimal or losses from the rate jumps were not on you. For example, you shift the risk to the buyer or seller of the product. This option does not require additional costs and will suit entrepreneurs who do not have free money and time.
With the purchase of additional tools
To reduce the currency risks of your business, you buy on the stock exchange special instruments – currency futures or options. These are contracts that allow you to freeze the exchange rate at one point and buy currency at this pre-fixed rate.
This method is more expensive and more difficult than the first because a person will have to understand how exchange instruments work, and get to the exchange, that is to find a broker and open a brokerage account. That’s why this method is beneficial to companies with a lot of turnovers and high financial risk.
How to protect yourself from currency risks without buying additional instruments?
Here are some tips to protect yourself from currency risk:
Diversification of currency is a very good method to avoid risks. Prices change rapidly and all the time. We can notice it by looking at strategies that exist in the FX market. The most popular ones are FX one minute strategies which are extremely fast and use currency fluctuations.
Pay in national currency
The easiest way to avoid currency risks is to buy goods in your native country. This solution is not suitable for everyone. The peculiarity of the business we have mentioned above is that you buy authentic goods in Korea: domestic soy sauce is unlikely to be in the same demand among buyers.
Transfer currency risks to the customer
To do this, you need to tightly tie the price of your goods to the foreign exchange rate in which you buy: if the rate has changed, immediately changes, and the price tag for the goods. But this is also not a universal solution.
Competition in this market is higher, and sellers try to keep the competitive price. In such conditions, the price tag, which changes every day, will scare away a significant part of buyers and will be uncompetitive. So you will not be able to transfer the risks to the client.
To compensate for risks
You can find markets that allow you to sell a product in the same currency in which you buy it. For example, instead of noodles you can buy oils in Greece for euros and supply them to Germany, where they too will be bought for euros. In this case, it will not incur losses from the jump in the rate, because all trades will go in the same currency. If the euro falls, revenue will decrease.
How to protect myself from currency risks through the exchange?
The deal of special transactions on the exchange, which helps to reduce currency risks, is called hedging. Usually, it is the purchase of currency options or futures – contracts on which the exchange rate is fixed for the buyer at a certain mark. To buy such contracts, you need to gain access to trading on the stock exchange, that is to find a broker and open an account.
Why buy currency options and futures?
Currency options and futures will come in handy if the exchange rate you are working with is quite volatile. If the rate has increased and you expect significant growth in the future, with the help of options and futures you will be able to fix the current rate in the future when other businessmen buy the currency at a new rate.
Such contracts will be useful for the entrepreneur in the event that the following conditions are met at the same time:
- The entrepreneur is purchased in currency and knows the date (in a month, three months, six months – any term) of his future purchase in currency;
- a significant share of an entrepreneur’s revenue depends on the exchange rate.
Hedging can protect against currency risks, but futures and options themselves are also very risky instruments: their principle of action is based on the assumption that the exchange rate will change in the future. Making such an assumption, you can lose. Do not forget about the value of the contract and commission on the stock exchange. If the change in course is insignificant or the amount you buy is small, all your benefits may go to buy the tool itself.