What is an Exchange Risk?

Foreign exchange risk (ForeignExchangeExposure) refers to the potential risk of a company's costs, profits, cash flow or market value rising or falling due to fluctuations in foreign exchange rates. Fluctuations in foreign exchange rates may cause losses to enterprises as well as opportunities. Since the US dollar is still the most important currency in the world, the main official reserve of countries in the world is still the US dollar. The US dollar is also the main currency in China's foreign exchange reserves and the key currency for the foreign exchange exchange rate set by the State Administration of Foreign Exchange. In 2012, China's foreign exchange reserves reached 331.5 billion U.S. dollars, becoming the country with the world's largest foreign exchange reserves. Therefore, our foreign exchange risk mainly refers to the exchange rate changes between the US dollar and various currencies. ^[1]

Foreign exchange risk

Foreign exchange risk (ForeignExchangeExposure) refers to the potential risk of a company's costs, profits, cash flow or market value rising or falling due to fluctuations in foreign exchange rates. Fluctuations in foreign exchange rates may cause losses to enterprises as well as opportunities. Since the US dollar is still the most important currency in the world, the main official reserve of countries in the world is still the US dollar. The US dollar is also the main currency in China's foreign exchange reserves and the key currency for the foreign exchange exchange rate set by the State Administration of Foreign Exchange. In 2012, China's foreign exchange reserves reached 331.5 billion U.S. dollars, becoming the country with the world's largest foreign exchange reserves. Therefore, our foreign exchange risk mainly refers to the exchange rate changes between the US dollar and various currencies. ^[1]

Foreign exchange risk (Foreign Exchange Exposure)

Foreign exchange risk may have two consequences, either gain (Gain) or loss (Loss). One

When certain emergencies occur,

Companies, corporations, individuals and countries engaged in foreign economics, trade, investment and finance

Narrow foreign exchange risk refers to

1. The primary funding security in foreign exchange

Fund security is the most important issue in transactions. Because there is no guarantee from a clearing institution, the client's deposits used to buy and sell foreign exchange contracts are not protected by any regulatory agency and are not given priority consideration in the event of bankruptcy; the client's funds are also not protected in the case of a bankruptcy broker. According to US bankruptcy law, stock or commodity customers have the priority to settle claims, so the probability of them holding all their funds when the broker goes bankrupt is quite high. However, because the foreign exchange spot is neither a stock nor a commodity, a foreign exchange spot customer is neither a stock customer nor a commodity customer. Because of the lack of legal status, bankruptcy liquidation procedures can only be entered as unsecured creditors, which may lead to loss of capital.
2. Risks in the market itself < br Because the foreign exchange market operates 24 hours a day and there are no maximum and minimum limits for exchange rate fluctuations, it may take a month or even a few hours in a day when the fluctuation is severe Monthly fluctuations. Because the trend of foreign exchange is affected by many factors, no one can accurately predict the trend of foreign exchange. When holding a position, any unexpected exchange rate fluctuations may lead to a large loss of funds or even little.
3. High leverage brings high risk. <br /> Although every investment has risks,

Enterprise foreign exchange transaction risk is related to the settlement of a specific transaction. It refers to the loss caused by the reduction of the amount converted to the domestic currency due to changes in the exchange rate during the various transactions conducted by the enterprise in foreign currencies. Various transactions include: goods or labor transactions conducted by credit, foreign exchange loan transactions, forward foreign exchange transactions, investment in foreign exchange, etc. Transactions can also be divided into completed transactions and outstanding transactions. Completed transactions are listed in the balance sheet, such as accounts receivable and payable in foreign currencies; uncompleted transactions are mainly off-balance sheet items, such as future purchases, sales, rents and expectations expressed in foreign currencies Incurred income and expenses, etc.

Internal precautions

The internal technology of technology transaction risk prevention refers to the methods used by enterprises to prevent and reduce foreign exchange risks. Before signing a transaction contract, take measures to prevent risks, such as choosing a favorable denomination currency and appropriately adjusting the price of goods.

Asset and Liability Adjustment Act. Assets and liabilities expressed in foreign currencies are vulnerable to exchange rate fluctuations. Changes in currency value may result in a decrease in profits or an increase in debt after conversion to currency. Asset and debt management is the rescheduling or conversion of these accounts into currencies that are most likely to maintain their own value or even increase their value. The core of this method is: try to hold coin assets or soft currency debt. The value of coins tends to remain unchanged or rise relative to the local currency or another base currency. The opposite is true of soft coins, which tend to fall in value. As part of normal business, the implementation of asset and debt adjustment strategies is conducive to the natural prevention of transaction risks. Under the loan method, when an enterprise has accounts receivable expressed in a foreign currency, it can borrow a foreign currency fund equal to the amount of the accounts receivable to prevent transaction risks.

Choose a favorable denomination currency. The magnitude of foreign exchange risk is closely related to foreign currency currencies. The currency of the receiving and paying currency in the transaction will be different. In terms of foreign exchange receipts and payments, in principle, we should strive to collect foreign exchange in hard currency and pay in soft currency. For example, in the import and export trade, import payment strives for soft currency, and export receipts strives for hard currency; when borrowing foreign capital, for borrowing soft currency, the risk is relatively small.

Establish currency preservation clauses in the contract. When negotiating a transaction, through consultation between the two parties, an appropriate value preservation clause is established in the contract to prevent the risk of changing exchange rates. There are many types of currency preservation clauses, and there is no fixed model, but no matter what kind of preservation method is adopted, as long as the parties to the contract agree and can achieve the purpose of preservation. There are mainly gold preservation, hard currency preservation, and "a basket" of currency preservation. Hard currency hedging clauses are currently used in contracts. There are three points to be aware of when entering into such a hedging clause: first, clearly specify the currency that should be paid when the payment is due; second, choose another hard currency for hedging; finally, indicate in the contract that the settlement currency and the hedging currency are in the contract Current spot exchange rate. When the payment is received and paid, if the settlement currency depreciates more than the stipulated amount in the contract, the payment will be adjusted at the new exchange rate between the settlement currency and the value-maintaining currency so that it is still equal to the original value of the value-maintained currency converted in the contract.

Appropriately adjust the value of goods. In the import and export trade, the principle of collecting coins for export and paying for soft coins for imports should be generally adhered to, but sometimes for some reasons, exports must be traded in soft currencies, and imports must be traded in hard currencies. This poses foreign exchange risks. In order to prevent risks, the adjusted price method can be adopted. There are mainly two methods: the value-added protection method and the price-value maintenance method.

Prevent transaction risks through risk sharing. Refers to the parties to the transaction to share the risk caused by exchange rate changes according to the signed agreement. The main process is to determine the base price and basic exchange rate of the product, determine the method and time for adjusting the basic exchange rate, determine the exchange rate change rate based on the basic exchange rate, determine the ratio of the exchange rate risk sharing between the two parties, and adjust the base price of the product according to the situation. .

Flexible control of collection and payment time to prevent foreign exchange transaction risks. In the rapidly changing international financial market, receiving or paying in advance or late will have different benefits for foreign trade companies. Therefore, enterprises should flexibly grasp the time of collection and payment according to the actual situation. As an exporter, when the denominated currency is strong, that is, the exchange rate is on the rise, because the more the payment date is pushed back, the more exchange rate income can be received, so the enterprise should delay the shipment of the goods as much as possible within the performance period specified in the contract, Provide credit to external parties to extend the duration of export bills of exchange. If the exchange rate is in a downward trend, you should strive to settle the exchange in advance, that is, expedite the performance of the contract, such as collecting the foreign exchange before the goods are shipped in advance. Of course, this can only be done on the basis of mutual agreement. Conversely, when an enterprise acts as an importer, adjustments are made accordingly. Because using this method, the benefit to the company is the loss of the foreign party, so it is not easy for the foreign party to accept. However, enterprises should be aware of this. On the one hand, they can avoid the risk of foreign exchange collection when conditions permit, and on the other hand, they can prevent foreign companies from passing on risks to our enterprises.

External management technology

In addition to internal management technology, enterprises also have many external hedging tools to choose from, such as forward foreign exchange contracts and foreign exchange options trading. Carrying out foreign exchange transactions is a practical, direct and scientific method.

Preventing trading risks through forward foreign exchange transactions. When conducting forward foreign exchange transactions, the enterprise signs a contract with the bank, which stipulates in the contract the name, amount, forward exchange rate, delivery date, etc. of the currency sold by the buyer. The exchange rate does not change during the period from the signing of the contract to the delivery, which prevents the risk of future exchange rate changes. A variant of forward foreign exchange transactions is a forward contract with a date option, which allows a company to execute foreign exchange transactions on any day within a predetermined time frame. Of course, forward foreign exchange transactions are inherently risky. The key to whether a company can avoid losses and gain benefits is whether the exchange rate prediction is correct. At the same time, while avoiding the risk of adverse exchange rate changes, forward foreign exchange transactions also lost the profit opportunities brought about by favorable exchange rate changes.

Use foreign exchange option transactions to prevent transaction risks. The so-called foreign exchange option is a contract signed in advance by the two parties to a foreign exchange option transaction in accordance with the agreed exchange rate whether to purchase a certain currency or sell a certain currency in the future. The foreign exchange option contract gives the option buyer rights but no obligations. Options are divided into call options and put options. For hedgers, foreign exchange options have three advantages that are unmatched by other hedging methods. The first is to limit foreign exchange risk to option premiums; the second is to retain opportunities for profit; the third is to enhance the flexibility of risk management.

Analyze existing data and develop hedging policies

One of the biggest mistakes that finance executives or finance departments can make is not to work closely with their business units to look at past foreign exchange risks.

Regardless of the type of foreign exchange risk, it is important to ensure that the risk management strategy is consistent with the company's overall goals. This also means that companies avoid cash flow risks, which may jeopardize their ability to pursue their strategic needs.

Analysis of existing data

Although foreign exchange risk management is a tedious, manual process, it is important to understand your currency risks and how to monitor those risks. For data integrity reasons, foreign exchange risk management is the most difficult financial task. Therefore, analyzing existing data is the most critical component of hedging.

Fundamental analysis focuses on important economic data and political news to determine the direction of currency value. All currency markets are interconnected and will help to understand the current events driving the direction of the foreign exchange market economy and make better decisions. Risk appetite, global stock markets and commodity markets can also affect foreign exchange markets, especially in countries where investment inflows and outflows exist. Other elements of the basic analysis include monetary policy decisions, interest rate markets, and changes in tax and regulatory laws.

Some companies may adopt a comprehensive risk management system, especially when the level of risk is high or management has a defensive attitude. A comprehensive risk and impact analysis should consider economic, regulatory, and operational factors.

However, due to the low level of risk, the cost of the integrated risk management strategy is greater than the benefits, or the management chooses to adopt a speculative approach to deal with exchange rate changes. In both cases, it is important to proactively develop your hedging policy. To respond to market developments and have the right media in your company to quickly approve hedging policies at the right level.

Develop a hedging policy

Once the risk has been identified and evaluated, the next thing to consider is to determine which hedging strategies can better enable the company to achieve its strategic goals within its risk appetite. Once these are identified, it is important for companies to develop hedging policies based on these goals. Once the hedging strategy is determined, the content of creating the policy should be straightforward, because the policy should clearly define the hedging strategy in the following areas: what financial instruments are used, who has the right to use these tools, the division of responsibilities, and how to manage and control the policy. This includes reporting to senior management and the board.

Having a sound foreign exchange strategy is critical to the success of a global business. Use the data you have available to choose the method of hedging foreign exchange that most closely matches your company's goals.