A Practical Approach to Understanding Currency Risk

If you are a multinational corporation or a remote freelancer, you may have experienced the negative impact of currency fluctuations on your profits. That's why it is essential to have a good understanding of currency risk and ways to mitigate its potential effects.

Let's dive into the basics: 

Currency Risk: What Is It?

Currency risk, also known as exchange-rate risk, is the possibility of suffering financial losses due to changes in the value of one currency compared to another. This risk mainly affects individuals or businesses involved in international trade or investment activities.

These exchange rate changes can result in earnings reductions for a business owner and freelancer; for instance, if a company accepts payments in one currency but incurs costs in another.

While there are many reasons for these, changes in economic circumstances, government policy, and international commerce are a few potential causes of currency volatility. 

Over time, foreign exchange risk is a potential profit or loss source for international investors and enterprises with cross-border assets or activities.  

Foreign exchange (FX), futures contracts, and options contracts are among many derivatives used by hedge funds, mutual funds, and multinational organizations to manage risk.

How Does Currency Risk Affect Your Business?

Due to currency changes, cross-border companies may incur additional costs in one or more countries. Changes in the currency rate between the Nigerian Naira and the Euro, for instance, might affect the amount of goods/products/services brought in by a Nigerian firm that conducts business in Europe. 

The corporation may see a drop in earnings if the cost of doing business in Europe increases due to a stronger Euro rate than the Nigerian Naira. 

Similarly, a stronger Nigerian Naira than the Euro might make it more costly for European clients to buy items from the Nigerian firm, resulting in reduced sales.

If your company lacks insurance, currency risk may have devastating effects. For instance, if your local currency's value declines compared to the currency you are paid, your earnings will fall. However, costs will increase if the value of your local currency rises.

Types of Currency Risk 

Transactional Risk

A corporation runs the risk of incurring financial loss due to variations in currency rates between the time it initiates a transaction and the time it makes or receives payment. 

If a Nigerian firm proposes to buy items from a Japanese supplier and pay in Japanese yen, the cost of those goods might rise if the Yen appreciates against the Nigerian naira before payment completion.

Translation Risk

The risk associated with converting financial statements from one currency into another into the native currency of a corporation is known as translation risk. 

Suppose a U.S. firm has a Nigerian subsidiary, but the value of the naira depreciates; in that case, the firm may incur a loss while translating the subsidiary's financial statements into dollars.

Fiscal (Economic) Risk

Simply put, economic risk is the danger associated with fluctuations in broad economic indicators. If a U.S. firm invests in a nation with a high inflation rate, for instance, the value of its dollar holdings may fall as the local currency loses purchasing power.

How Can Ratefy Help?

Ratefy can assist businesses in mitigating the effects of currency risk and volatility by facilitating the conversion of funds across currencies and depositing those funds into your local bank account at a good exchange rate.

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