How can small businesses reduce currency risk

As a company, hedge against currency fluctuations: this is how it works

Currency risks should by no means be underestimated: On the one hand, they affect the company's cash flows, on the other hand, company values, assets or other earnings can be reduced. But what options are there for companies to hedge foreign currencies?

How dangerous is the currency risk really?

The currency risk describes the uncertainty about the exchange ratio between the reference and the foreign currency at the specified point in time, which is always in the future. Losses can arise from the translation of foreign currency items in the balance sheet on the reporting date - this is known as the translation risk. When it comes to imports, exports, financial assets and investments, with settlement only taking place in the future, there is a transaction risk because it is not yet known at which exchange rate the transaction will be carried out.

But there is also the economic risk: If there are sustained changes in currency parities, the long-term competitiveness of the domestic company is impaired.

What options are there to reduce currency risk?

Forward exchange transactions are static and passive forms of hedging. A fixed calculation rate is set here, which remains valid for a certain period of time. The advantage? It will not be charged. The disadvantage? Neither side can benefit from advantageous price fluctuations. In the case of currency options, these are dynamic and can also be actively controlled. The flexibility that this creates is extremely important for companies. Ultimately, you buy yourself time with money or bonuses, so that at the end of the term you have the option of using the rate set in advance. A fixed term and a base price are therefore determined.

The alternative to currency forwards or currency options? Securing with the right to vote. If a company assumes that the currency to be converted will crash in twelve months, the transaction is hedged against such exchange rate fluctuations. In the course of the conclusion, a premium of 1.30 percent of the equivalent is paid. Thus, the fee is lower than with a classic currency option. After nine months there is the option of voting. The second premium (4.1 percent of the equivalent) is now paid here; the deal now corresponds to a currency option with the base price agreed in advance and a remaining term of three months. However, you only make use of the right to choose if the second premium is significantly cheaper than the comparable currency option. Agreed exchange rate hedging measures also reduce any exchange rate risks.

There are so-called exchange rate hedging clauses, so that the price that was set in the contract in advance also forms the basis of the future exchange rate. Any receivables and liabilities are therefore secured in the course of the conclusion of the contract, so that the future exchange rate hardly plays a role. Another option is the so-called exchange rate insurance, which is also known as exchange rate loss insurance. In return for a premium payment, the insurance company will take on the exchange rate risk and step in if necessary. Loss can thus be prevented.