• Britta Barndok

What is the "inscrutable" FX risk?

Taking a stroll around SaepioX's website, the core business revolves around the keyword "FX risk". Now, for whoever it is unclear: FX risk refers to the Foreign Exchange risk. Simply put, the FX risk is a financial risk emerging from doing financial transactions in a currency other than the domestic currency of a company. That refers to the economic loss occurring due to currency fluctuations. The FX risk, therefore, stems from the risk that an investment's value may drop due to the fluctuations in the involved foreign currencies. 

The foreign exchange risk, or currency risk, affects both the investors trading in international markets, but also the businesses operating with import or export of goods and services to and from foreign markets. When trading in those foreign markets, the foreign currency needs to be converted back to the investor's or company's domestic currency. Therefore, the fluctuations in the exchange rates will affect the results by eventually having less revenue, and ultimately less profit than expected. Whenever investing or doing business with foreign counterparts, one will incur a potential real loss as soon as the currency fluctuates, which it does substantially. In fact, on average, a currency moves with around a significant 20% a year.

When talking about foreign exchange risk, it usually refers to one of the three specific risks regarding foreign exchange: 

  1. The transaction risk, corresponding to the threat a company faces when buying products or services from foreign countries. In this situation, the price of an item is determined in the selling company's currency. Meaning, the buyer might have to make a larger payment in its domestic currency, to meet the agreed price in the foreign funds while taking into consideration the fluctuation of exchange rates.

  2. The translation risk, referring to a situation where a parent company owns a subsidiary in a foreign market. Therefore, the parent company can be exposed to additional costs when the subsidiary's financial statements need to be converted back to the parent company's currency.

  3. The economic risk, also called the forecast risk, indicates the risk accompanied by the company's market value being steadily affected by inevitable exposures to currency fluctuations. 

Three types of FX risk, all equally important

In order to deal with the FX risk, many companies involved with foreign markets have implemented their own hedging strategies. Additionally, if the hedging strategies are done properly, they can safeguard from significant undesired losses deriving from the fluctuations in exchange rates. With all this in consideration, it is clear: no matter how big or small a business is, the FX risk is relevant for any company facing foreign currencies in one way or another.

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