four Tips to Manage Exchange Rate Risk

Exporters face risks with fixed or floating exchange rates. In fact, even if you denominate all trade in dollars, the exchange rate can still play a major role in determining demand for your product or service. So, the bottom line is that you can mitigate, not eliminate, exchange rate risk. Here are some strategies to consider:

1. You should do a sensitivity analysis for all of your major markets when you are doing your business forecasts. First, look at the range of the exchange rate fluctuations over the previous years, and then decide a reasonable plus or minus range around the current exchange rate. Recalculate your bottom line for each market using the high and low calculation. This will give you an indication of your company’s exposure to exchange rate changes in a given market. If there is a major impact on your bottom line, you may want to consider one of the following hedging strategies.  For major currencies, the organized currency markets can provide a variety of responses.
2. You can purchase currency on the futures market to align with your expected collection date. With this you can be assured of the price, but at a cost.
3. You can also purchase an option to buy at a certain price if the exchange rate exceeds a certain level. This is similar to a “put” in the stock market and is less expensive than a forward contract. It does, however, expose you to market fluctuations until you reach the strike price.
4. For currencies that are not freely traded, you can request the payment in dollars (or at the local currency equivalent on the spot market on the day the contract closes). This may minimize your risk but it also shifts the risk to your buyer. This could cost you sales if your competitors do have a similar requirement. A dollar denominated sales strategy does lessen risk, but it also limits your opportunities to expand markets.
5. If there is a significant market risk, you may also want to keep the pipeline short to minimize your exposure in a particular market. If you have a local operation (warehouse or subsidiary), you can keep inventory to the bare minimum. You can also limit the term of your price quotes (for example, instead of 90 days, you could quote the day of the sale and require pre-payment).

As an exporter, there is an implicit exchange rate risk with every transaction. Most risks are small and you can build in the margin to cover those risks. (If you can’t build in the margin, you might want to reconsider the sale.) The trick is identifying when there are larger risks and taking the appropriate steps to protect your business.