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What is FX exposure and how to protect your business from it?

International companies have known how hard Forex exposure can sometimes hit, especially during uncertain times. There are many events and challenges global businesses face, and adding currency fluctuations to your bucket list of struggles only complicates things. However, there are very effective ways known to financial traders and investors that can be used to counter those risks and protect your business. Let’s define what Forex exposure is and how to counter it effectively using effective tactics.

Understanding FX Exposure

International businesses typically are involved with several currencies, depending. These companies often have to produce products in one country and sell them in another, which exposes them to numerous fiat currencies. When you have to exchange one currency for another, exchange rates can affect business negatively. One popular method to protect from these fluctuations used by many investors and businesses is hedging against the FX exposure. Hedging can be very effective but requires a deep understanding of key financial concepts. Hedging has been used widely by international businesses to protect against sudden price fluctuations. There are several types of Forex exposure including transaction exposure, transaction exposure, and economic exposure.

  • Transaction exposure — Influences specific financial transactions due to Foreign exchange rate changes.
  • Translation exposure — This can influence the variation of a company’s assets, liabilities, and income on its financial statements.
  • Economic exposure — The company’s market value and future cash flows are impacted by exchange rates.

The most basic example for Forex exposure would be a company that is selling goods in the USA but has to pay its employees in Japanese Yen. It has to sell products (cars, TVs, etc.) in the USA and convert dollars to yen to pay its workers in Tokyo. If the exchange rate fluctuates rapidly, the company might find itself in a situation where it has to pay more USD than it used to.

The Impact of FX Exposure on Business: Famous Examples

To avoid speaking dry financial terms, let’s take a look at some famous examples where companies got screwed by Forex exposure.

Volkswagen AG (2015)

During the 2015 emission scandal, Volkswagen had a significant financial loss due to not only the scandal itself but also for holding large sums in foreign currencies due to their global operations. The Euro weakened and since the company had reserves in other currencies, earnings were heavily impacted when converted back to euros from abroad.

Apple Inc. (2015)

In 2015 Apple’s CEO Tim Cook mentioned in an earnings call that the strong U.S. dollar had shaved billions from Apple’s revenues. Since Apple’s main revenues come from overseas, the strong dollar meant that the company’s profits declined when converted back to USD, when in fact the company was very profitable in other currencies.

Netflix (2020)

Foreign exchange rates had a significant impact on Netflix’s 2020 revenue. As a company that receives a substantial portion of its subscription revenue from outside the United States, Netflix is heavily impacted by Forex exchange rates. The strong US dollar affected Netflix’s income negatively, showing that even subscription-based digital services are not immune to the fluctuations of currency markets.

Countering FX Exposure through Financial Instruments

Several financial instruments are used to counter FX exposure and hedge against risks. One such asset class is futures, which are historically used to lock in the exchange rate for a transaction that will occur at a future date. Futures obligate the buyer to purchase and the seller to sell a particular asset at a predetermined future date and price. Currency futures are effective in protecting against advert exchange rate fluctuations and ensure stability of the internationally operated businesses.

Unlike futures, options do not obligate but give the buyer the right to buy (call option) or sell (put option) an underlying asset at a specified price (strike price) before a certain date (expiration date). Options are also used to hedge against advert price movements. However, both options and futures are complex financial instruments and businesses must hire professionals to avoid mistakes and losses.

Practical Steps to Manage FX Exposure

Knowing which instruments are used for hedging against FX exposure is one thing, but to actually put it into practice is a completely different matter. To access all the financial assets and buy and hold them, you need to open a brokerage account. Financial brokers are intermediaries that allow financial investors to access financial exchanges and buy and sell all the securities and assets. Select a suitable broker that is known to be reliable and then sign up for their account. Forex broker account allows investors to instantly exchange assets and ensure you can immediately counter any adverse movements that happen on Forex markets. Another important thing is to monitor FX rates regularly to make informed decisions and stay informed. If you need to mitigate FX exposure risks but do not have enough experience, the best course of action is to hire professional experts or contact your personal account managers in the brokerage firm.

I'm Dom Farnell, a retail investor sharing my market experiences through blogs and articles. Though not a professional advisor, I aim to offer practical insights based on real-world experience, exploring strategies, challenges, and opportunities in investing.

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