Protecting Against Foreign Exchange Fluctuations
BY KRISTEN BURKE
As businesses in the United States struggle in the wake of the COVID-19 pandemic, they’ve had to mitigate risk, preserve cash, and implement strategies to protect themselves from turbulent economies, both domestic and foreign. Foreign currency exchange rates can fluctuate greatly due to factors like unemployment, civil unrest, trade deals and more, and these fluctuations can translate to unanticipated losses for your business.
For example, if your business makes a deal to sell a product to a company in Germany for 50,000 Euros, and at the time of the deal, a Euro is worth approximately $1.10 U.S. dollars, your business would expect proceeds of $55,000. However, if the exchange rate drops by the time of delivery and payment to $1.04, you would only net $52,000. Ultimately that foreign exchange fluctuation would cost your business $3,000.
And that’s just on one deal. Obviously, if the exchange rate goes up, your business could potentially benefit, but it’s a gamble.
Fortunately, there are a number of strategies your organization can implement to reduce the risk of losing money due to fluctuations in foreign currencies.
• Deal Only in U.S. Dollars. Perhaps the easiest strategy is to only invoice or pay in U.S. dollars, thereby removing any exchange or transactional risk. However, some foreign partners may charge you considerably more if they have to take on the exchange risk themselves.
• Open a Foreign Currency Bank Account. Another option is called “matching,” where your business opens a foreign bank account and uses foreign currency payments to pay foreign suppliers. Again, this reduces the risks involved with the need to exchange funds.
• Negotiate a Foreign Exchange Contract. A popular and effective hedging strategy is to use a foreign exchange contract, where your business and your foreign partner lock in an agreed-upon exchange rate for a set date in the future.
• Conduct a FX Swap. A foreign exchange swap (FX Swap) is appropriate if you need a foreign currency for a short term and then will need to trade back to your base currency. This involves two transactions: the purchase of one currency for another, and then, purchasing back your original currency at an agreed upon point in the future via a foreign exchange contract.
• Perform a Currency Swap. A foreign currency swap is an agreement between two parties to swap the principal and interest payments on a loan made in one currency, for payments of equal value in another currency. If your business is taking out a loan in a foreign country, this strategy may give you better interest rates.
Bottom line: During these economically challenging times, strategies to minimize the impact of foreign currency fluctuations on a company’s operations could protect margins and reduce operational risk.