Foreign trade is now a component of sales and/or purchasing activities for many businesses. The exchange rate can have a significant impact on profit margins. Businesses have tools available to mitigate the risk of currency fluctuations.
The Foreign Exchange Forward (commonly known as the Forward FX Contract) is a common tool used when purchasing or selling goods in a foreign currency. The Forward FX contract allows the business to lock the exchange rate today for a transaction that will take place in the future. By doing this, the profit margin is locked in. It is recommended that businesses match the value and timing of the Forward FX contract to the underlying business transaction that is taking place. Banks will provide quotes on most any pair of currencies.
Non-Deliverable Foreign Exchange Forwards (NDFs) are similar but permit a hedging of foreign currencies where the government restricts access to the currency or if the business wishes to compensate for risk without a physical exchange of funds. A prime example of this restricted currency is the Chinese yuan renminbi.
Foreign Currency Loans are often used to mitigate risk by companies with assets in other countries. This tool is used by matching the value of the foreign asset with a loan of equal value in that currency. By doing this, the value of the asset and the value of the liability move together without any fluctuations in the currency. The foreign currency loan substitutes for a loan that may have otherwise been made in U.S. dollars.
These financial tools should not be confused with foreign currency speculation. Speculators often take positions in exchange traded futures that are highly leveraged. By comparison, it is sound business to match specific business transactions and foreign held assets by utilizing the foreign currency financial tools available. As always, it is important to transact business through a proven and reputable financial intermediary.