There are a few techniques to manage foreign exchange rate risks. Such techniques include: exposure netting, money market hedge, domestic pricing, price adjustments, and forward contracts. Let’s explore them more.

Exposure netting involves a company utilizing the same currency for payables and receivables. The net amount of payables should match the amount of receivables.

For example, a Canadian company exporting to France will receive payment in Euros and also make payments for imports from a market that uses Euros. So, this may require the company to set-up suppliers in a country where Euros are used, if they don’t already.

The risks of currency fluctuation is removed because currency would not need to be converted, it would require the company to set-up a bank account in the foreign market, allowing the company to make transactions with the foreign currency. This is a strategy that is ideal of larger organizations as it can mean setting up suppliers in a new market (to be able to make payments in the same currency), if they don’t already. It would also require careful attention as the payables and receivables amounts require to be equal in order for this method to be effective.

Another method is called: Money market hedge. If a company was unable to set-up suppliers to match the payables to receivables, the company could take out a loan in foreign currency. The loan should be in the amount of the expected sales in the same currency. This is a technique that companies with the ability to borrow can benefit from.

Domestic Pricing  is a relatively easy method as it simply involves the exporter to charge in their own currency, completely eliminating the step of converting currencies. However, this approach forces the customer to carry the risks of currency fluctuations, so not ideal.

Price adjustment requires the exporter to think about possible currency risks when developing their pricing strategy. The pricing will be slightly inflated in order to mitigate risks of additional costs of currency conversations. The risk is over-pricing compared to competitors and or not being able to cover all the costs of the currency fluctuations should economic conditions become unstable.

A forward contract is one of the most common strategies. A forward contract allows an exporter to set a pre-determined future currency rate. This contract is made with a commercial bank, wherein the exporter commits to selling a currency at the rate set. This strategy eliminates the uncertainty of future rates, helping minimize costly risks of fluctuations. However, this also doesn’t allow the exporter to benefit should there be favorable movements in currency rates. Future contracts are similar to forward rates, but they trade within markets instead. Also, much like stock options foreign currency options are also a possible method.

Copyright © Esha Abrol. Canada. November 2012