What Is Currency Risk? All You Need To Know

What Is Currency Risk?

Currency risk, often known as exchange rate risk, is the risk that foreign investors or businesses operating internationally face in terms of erratic profits or losses resulting from fluctuations in the value of one currency relative to other.

Currency risk refers to the risks associated with fluctuations in the relative values of different currencies. For example, when the profits or dividends from an investment are converted from a foreign currency into GBP, these adjustments can result in unforeseen gains or losses.  

Currency risk is crucial for businesses to assess as it directly impacts their profitability and financial stability. 

Fluctuations in exchange rates can significantly affect the cost of imported goods, the value of foreign investments, and the competitiveness of exports. 

Sudden currency devaluations or appreciations can lead to unexpected losses or gains, disrupting budgeting, pricing strategies and cash flow projections.

Here’s a more detailed overview on currency risks to help you assess them properly for your business.

The Types of Currency Risks

Below are the different types of currency risks that you probably should track..

1. Transaction Risk

When a business imports or exports, this transaction risk occurs. In this case, the future cash flows become unclear as the home currency paid or received will change if the exchange rate varies between agreeing to the contract in a foreign currency and receiving or paying cash. 

2. Translation Risk

This occurs during the import or export process for a business. The amount of home currency paid or received will fluctuate if the exchange rate moves between committing to the contract in a foreign currency and paying or getting the cash. This in turn will make the future cash flows lack certainty.

3. Economic Risk

Economic risk is defined as a possibility that an investment or the future prospects of a company, whether domestically or internationally, will be impacted by macroeconomic conditions, or state of the economy as a whole. Exchange rate swings, changes in laws or regulations. 

Political turbulence, or the imposition of economic penalties are a few examples of the economic risks. To measure, or predict these economic risks, financial analysts employ a range of econometric models and indicators, including the Economic Uncertainty Index.

4. Jurisdiction Risk

Jurisdiction risk is defined as the possible legal, financial, or reputational consequences that could result from making investments or conducting business in a certain area or nation. The distinct political, legal, economic, and regulatory landscape of the relevant jurisdiction is the main cause behind such risks.  To minimize potential losses and make the right decisions, businesses, wealth managers, and investors must have a thorough understanding of jurisdiction risk. 

5. Interest Rate Risk

Interest rate risk is the chance that a shift in interest rates could lead to a loss. Changes in interest rates can have a great impact on exchange rates. When a country raises an interest rate, its correlated currency grows more valuable and the opposite occurs 

To minimize your currency risk, get an expert solution by speaking to Excel Currencies. 

Why Should You Resolve Currency Risk?

You may look to resolve the currency risk for your business for several key reasons -

1. Ensuring Financial Stability

Unmanaged currency risk can lead to financial instability, as businesses may experience unexpected losses due to unfavorable exchange rate movements. By resolving currency risk, companies can maintain financial stability, ensuring they can meet their financial obligations and sustain operations even in volatile market conditions.

2. Enhanced Competitiveness

Currency risk resolution enables businesses to remain competitive in the global marketplace. By managing exchange rate fluctuations effectively, companies can maintain stable pricing for their products or services, preventing competitors from gaining an advantage through currency-related price fluctuations.

3. Facilitate Strategic Planning

Resolving currency risk provides businesses with greater certainty when developing strategic plans and setting long-term goals. By understanding and mitigating the impact of currency fluctuations, companies can make more informed decisions regarding investments, expansion initiatives, and international partnerships.

4. Protecting Profit Margins

One of the primary reasons to resolve currency risk is to protect profit margins. Fluctuations in exchange rates can directly impact the cost of goods sold and the revenue generated from international sales. 

For businesses that import or export goods, sudden currency movements can erode profit margins or even lead to losses. By hedging against currency risk through financial instruments such as forward contracts, businesses can lock in exchange rates and safeguard their profitability.

The Bottom Line

Undoubtedly, currency risk assessment is crucial for businesses to effectively manage their international operations and achieve their goals. By understanding the potential impact of exchange rate fluctuations on their financial performance, businesses can make the right decisions and implement strategies to mitigate currency risk. 

Furthermore, effective currency risk management enables businesses to focus on their core operations and strategic initiatives without being unduly distracted by currency fluctuations.

This is why you must choose Excel Currencies for your business, to reduce your currency risk.

Get in touch with us today.