Currency Risk

Currency Risk, also known as exchange rate risk, refers to the possibility that exchange rate fluctuations in international trade may cause adverse changes in the value of a company's accounts receivable, accounts payable, or cash flows. Usage scenarios include: when an exporter prices in US dollars but calculates costs in its local currency, a depreciation of the US dollar will reduce local currency revenue; when an importer has deferred payment, a depreciation of the local currency means it will need to pay more local currency. Precautions: companies need to assess the size of their exposure and can hedge through tools such as forward foreign exchange contracts, options, and currency swaps; they should also pay attention to the choice of settlement currency and exchange rate adjustment clauses in contracts. Unlike political risk, currency risk arises from market exchange rate fluctuations, not government actions; unlike interest rate risk, the former concerns exchange rates, while the latter concerns changes in interest rates. Foreign trade practitioners should establish exchange rate monitoring mechanisms, incorporate currency risk into quotations and cost accounting, and avoid severe exchange rate fluctuations eroding profits.