What are the risks associated with foreign exchange?


Quick answer:

One risk associated with foreign exchange is exchange rates. Even if prices remain unchanged in local currency terms, but the exchange rate changes, the company’s results will be impacted. If one euro equaled $1.00 last year, but now equals $2.00, import costs increase. Multinational corporations operating in several countries must translate offshore results into dollars, making them vulnerable to foreign exchange gains or losses as well.

Expert Answers

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Risks related to foreign exchange, or FX, can challenge companies that do business abroad as well as companies that operate purely domestically but import some of their products. For example, if a company manufactures widgets, and one of the key components needed to produce a widget, which we will call a gadget, comes from a foreign nation, that company will be vulnerable to FX risk. This is because the price of the gadget could fluctuate based on fluctuating currency valuations even if the price remains unchanged in terms of the home market currency. Specifically, let’s say that one gadget costs ten drachmas last year, and the US dollar equivalent of ten drachmas was $1.00 last year. This means that the company paid $1.00 for the gadget. However, this year, a gadget still costs ten drachmas in its home country, but the conversion or exchange value of the US dollar compared to the drachma has changed. Now, the US dollar equivalent of ten drachmas is $2.00. Therefore, the company’s costs just increased because the price of the gadget doubled in US dollar terms even, though it was unchanged in drachma terms.

Moreover, multinational corporations that have operations in several different countries where various currencies are used are also at risk when thinking about FX fluctuations. Even if the prices of the products or services that multinational corporation provides remain unchanged, but exchange rates fluctuate, the company might need to recognize an FX loss or gain when translating sales in an offshore market into US dollars.

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