How to protect your business from currency risk
What is currency risk?
Currency risk is also known as foreign exchange risk. This happens when the price of one currency rises (which is typically USD), causing the other currencies to fall, which may lead to losses.
Businesses that operate or deal with clients overseas are most susceptible to currency risk, especially if they deal with overseas clients frequently.
To put it simply, currency risk refers to the possibility of losing money in the face of unfavourable exchange rates, especially when the currency you’re dealing in is not USD. This means that you will have to pay more than usual.
What is transaction exposure and how does it affect your business?
Transaction exposure refers to the level of vulnerability that your business has. The higher the level of exposure, the more vulnerable your business will be, leading to the possibility of high monetary loss.
So how do you know if your business is exposed to transaction exposure? One thing that differentiates transaction exposure from currency risk is that transaction exposure often affects only the buyer, not the seller.
When you buy in foreign currency, and the foreign currency appreciates, your local currency weakens. For example, if you’re buying in USD, and USD appreciates, then SGD will be weakened. You will then have to pay more for the same number of products.
One way to calculate the exposure level of your business is to use this formula (source):
Asset Value (P) = a + ( b × S ) + e
a = Regression constant
b = Regression coefficient
S = Spot exchange rate
e = Random error term with mean of zero
Of course, you don’t have to calculate this on your own. As long as you deal with overseas clients frequently, chances are you’ll be more exposed than businesses that don’t.
What are the risks to Singaporean businesses?
Singaporean businesses that import from the US, China or anywhere in the world where suppliers prefer to be paid in a foreign currency may experience a rise in import costs when the value of their preferred currency falls.
Even if your business doesn’t import directly or sell internationally, there is likely to be a reliance on imports somewhere down your supply chain. This creates a knock-on effect with far-reaching consequences as prices rise and profit margins are squeezed.
However, despite these risks, there are ways to help you work around it. Always remember to do your own research before making a financial decision, especially if it involves large amounts of money.
Some of the ways that can help you minimise risks of transaction exposure include forex hedging, operating in SGD only, and operating through a US dollar account. Some of these alternatives provide a faster way to mitigate risks, but may also be high-risk. As such, you will need to consider the options and choose the best option for your business.
In financial terms, hedging refers to a variety of strategies that business owners can use to minimise financial loss, with the most popular one being taking the opposite position against most investors. Other methods include diversification and buying and selling puts instead of long-term positions.
Usually, large hedge funds control the stock markets, but in the case of foreign currency risk, business owners can also use similar strategies in order to minimise losses. One of the best examples would be choosing to deal in only your local currency, or USD, since most of the world’s currency is pegged to the USD.
However, forex hedging remains a high-risk activity, and should not be done, unless you have done sufficient research and have a high risk-taking ability. Usually, forex hedging is done by large hedge funds, and is not suitable for SMEs.
How can businesses mitigate currency risk?
There are three ways Singaporean businesses that trade internationally can protect themselves against the risks posed by forex market volatility:
Operate in SGD only or increase your prices.
Use forward contracts to hedge against currency fluctuations.
Operate through a US dollar account.
The drawback of the first two options is that unless you have leverage, global organisations and customers are unlikely to agree to take on the risk. Overseas suppliers may refuse to invoice in SGD and customers may insist on paying in USD, or go elsewhere.
The third option allows businesses to avoid currency exchange altogether when the market is unfavourable.
Here is where Airwallex, a global B2B Fintech, can help businesses that operate across currencies. Say you’re an international e-commerce business. By opening a US dollar account with us, you can collect dollars from your US customers, hold those dollars in your account, and use them to pay international suppliers when needed using our Borderless Cards and Transfers. You can also wait for the exchange rate to become favourable, and exchange your dollars to SGD at a point when it benefits your business.
Our Borderless Cards make it much easier for you to exchange your money when you want to, and our competitive transfer rates mean that you won’t have to fork out any unnecessary payments arising from currency risk if that occurs.
How Airwallex can help businesses hedge against currency volatility
Airwallex allows businesses to open multiple foreign currency accounts for free, online, and at the click of a button.
By opening multiple foreign currency accounts, including US dollar, Euro, Chinese Yuan and more, you can protect your business against fluctuations in the forex market.
With our competitive exchange rates, you can keep your money in Airwallex’s all-in-one account in various currencies, and hold until you want to change your money. This way, you’ll be able to minimise currency risk and maximise your money. Invest that money back into your business and your customers.
Zelda is a content writer at Airwallex SG. Outside of work, she is always on the hunt for the best aburi sushi and mandopop ballads. She has a soft spot for ginger tabbies and plans to adopt one.
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