Navigating Foreign Exchange Risk: Essential Strategies for Businesses

What is Foreign Exchange Risk?

In essence, foreign exchange risk refers to the potential loss caused by fluctuations in currency exchange rates. These fluctuations can affect the value of goods or services you buy from or sell to overseas markets, resulting in you paying more or receiving less in your local currency than expected.

To understand exchange rate fluctuations, let's suppose that you operate a company in Hong Kong and do business with clients in Europe. You agree on a deal to sell a shipment of goods in euros, and as you're based in Hong Kong, the funds will then be transferred to Hong Kong dollars.

To determine the cost of the shipment, you convert from HKD to EUR, give them the EUR price, and then anticipate converting that EUR payment to HKD once the deal has concluded.

However, there is a delay, and it takes several weeks for your client to pay the money. During this time, the foreign exchange rate changes to the point where those euros are worth considerably less HKD. The client pays the agreed-upon amount in EUR, but you get less HKD than projected in your initial calculation.

Depending on the extent of the change and the size of the order, it could result in a significant reduction.

How Foreign Currency Risk Can Affect Businesses

As the above example shows, foreign exchange risk can leave a company seriously out of pocket when conducting business in another currency.

As another example, imagine that your company agrees to pay EUR 100,000 for machinery from a European supplier. You calculate the cost to be around HKD 850,000 and determine that it's a cost-effective option. In the days or weeks that it takes to complete the deal and confirm payment, the euro strengthens against the Hong Kong dollar, and you must now pay HKD 900,000 to finalise the deal.

It’s the same machinery, supplier, and deal—yet due to currency fluctuations, the cost has increased substantially. In this case, the additional HKD 50,000 paid would typically be recorded as a foreign exchange (FX) loss.

Foreign currency risk doesn’t just affect the value of goods and services—it can also impact your long-term plans, such as international expansion. For example, imagine your company plans to expand to the United States and allocates USD 1 million to establish a branch office scheduled for six months later.

When you made the plan, the exchange rate was USD 0.15 per Hong Kong dollar, meaning you’d need HKD 6.67 million. However, six months later, the Hong Kong dollar weakens to USD 0.13, and now you need HKD 7.7 million—over HKD 1 million more than your original estimate.

Why Does Foreign Exchange Risk Happen?

For businesses, foreign exchange risk occurs when their income, liabilities, or assets are in a different denominated currency than their home currency. The currency exchange market is highly volatile and remains in a constant state of change, and as every purchase and sale must be converted to a different currency, the company is exposed to market volatility.

Types of Foreign Exchange Risks

There are three types of foreign exchange risk: transaction risk, economic risk, and translation risk.

Transaction Risk

This type of foreign exchange risk is the one highlighted in the example above.

It occurs when a business purchases products from a company in a different country and must convert its home currency to the supplier's currency.

When the seller's currency appreciates compared to the buyer's currency, the buyer must pay more. In this scenario, only the buyer is exposed to FX risk, as the seller will receive the same amount in their own currency regardless of what happens to either currency.

So, if the seller agrees on a price of €100,000 for which the buyer initially pays HKD 850,000, the buyer will pay more if the euro appreciates (as they must send more HKD to cover the full EUR bill), but the seller will still receive EUR 100,000.

Economic Risk

Also known as forecast risk or operating exposure, economic foreign exchange risk occurs when a company's market value is subject to changes in the exchange rate.

For example, a US business sells furniture that it sources from Hong Kong. It pays suppliers in Hong Kong using HKD and then sells those products in the US in USD. If the HKD appreciates against the USD, it suddenly becomes more expensive for that company to purchase the supplies it needs.

Economic foreign exchange risk is a significant issue for international businesses, as it can greatly increase wholesale prices irrespective of anything that the business has done. The supplier didn't increase their prices, but as a result of an exchange rate fluctuation, they automatically became more expensive for their US client.

Economic risk of this nature usually triggers a domino effect that can have serious and far-reaching effects on the company's operations, as it may be forced to increase prices, potentially impacting relationships with domestic buyers.

Translation Risk

Translation risk or translation exposure occurs when a company holds assets or liabilities in a country other than its own and must report those assets/liabilities on financial statements.

For example, a company based in Hong Kong conducts most of its business in the US. Its financial reporting doesn't change from the first quarter to the second, but due to a change in the foreign exchange rate between these two reporting periods, its earnings are much less for Q2 than for Q1.

It's a risk often faced by large parent companies with numerous subsidiaries. A parent company based in Hong Kong may have subsidiaries based in the UK, Germany, Canada, the US, and Australia. All of those subsidiaries will likely report in their native currencies, and the parent company must then convert those earnings and assets to HKD on the company's financial statements.

How to Manage Foreign Exchange Risks

Foreign exchange risk is a common issue in this globally connected business marketplace, and the more you scale your business, the more of a problem it becomes. Fortunately, there are various solutions for mitigating the risk associated with foreign currency fluctuations:

Hedging

Currency hedging strategies are where you offset one risk with another. It's like buying and shorting a stock at the same time. In this case, however, a company may hedge their foreign exchange risk by investing in an exchange-traded fund (ETF) that generates a profit if a foreign currency strengthens against its home currency.

So, if they are converting HKD to EUR and worry that the latter will strengthen against the former, they can invest in an ETF that would profit from such a scenario.

The trick is to match the liability to ensure they are not over or underexposed. If the HKD strengthens, the foreign transaction becomes cheaper but the ETF loses; if the EUR strengthens against the HKD, the transaction becomes more expensive, but that expense is covered by the profit received from the ETF.

FX Options

FX options are another hedging method. These derivative contracts give the holder the right to exchange one currency for another at a fixed time in the future, thus giving them an option if there are significant and costly exchange rate movements.

Currency Swap

Currency swaps are agreements between two parties to exchange funds in their home currencies at an agreed-upon rate. Depending on the agreement, the parties may be able to create a more favourable deal than they could get elsewhere, thus protecting themselves from currency risk.

Many major multi-national brands have used currency swaps to get around exchange rate fees, with one of the first cases coming in the early 1980s when IBM conducted a swap with the World Bank.

Regular Monitoring

The best way to prepare for currency risk is to monitor the exchange rate and prepare for any fluctuations, either by bringing deals forward, converting the necessary funds in advance, conducting a currency swap, or opting for a hedging strategy.

Use Multi-currency Accounts

Many international businesses use multi-currency accounts to protect themselves from foreign exchange risk. If they hold a foreign currency bank account in their target currency, for instance, they can make all payments from that account and don't need to worry about currency fluctuations or exchange rate fees.

These days, operating a foreign currency bank account is standard practice and facilitates smooth, fast, and risk-free transactions.

How Aspire Can Help You Navigate Foreign Exchange Risks

For startups and SMEs looking to scale globally, managing foreign exchange (FX) risk can be challenging—especially with limited access to tools like currency swaps, hedging, or FX options. If you're running a startup or SME and seeking a simpler way to manage FX risk, Aspire's Business Account may be a suitable solution.

Aspire’s Business Account is a virtual business account designed with globally focused Hong Kong businesses in mind. It allows you to open local accounts in HKD, USD, CNY, EUR, and GBP, so you can send and receive local transfers in these currencies. This helps you avoid unnecessary conversion fees and manage FX risk more effectively.

In addition, Aspire's Business Account also allows you to send money in more than 30 currencies across over 130 countries with low and transparent fees. You can also enjoy FX rates three times cheaper than banks.

Sign up for an Aspire Business account today to continue growing your business and expanding into new international markets.

Frequently Asked Questions

How do foreign exchanges affect businesses?

Foreign exchange rate fluctuations impact everything from the cost of raw materials and services to how attractive and financially viable a company's products are to international customers.

How do you stabilise the exchange rate?

As a business, there isn't much you can do to stabilise a currency, but you can mitigate exchange rate risk using hedging strategies, currency swapping, and multi-currency accounts.

What causes exchange rate fluctuations?

Currency fluctuations occur as a result of inflation, political instability, trade tariffs, changes in interest rates, and various other factors. They are tied to economic health and financial policies, as well as financial markets, and they can fluctuate considerably over the course of a single day.

Will I always lose money if the exchange rate changes?

Not necessarily. If you're using HKD to buy something in EUR and the euro suddenly drops in value, that purchase will be cheaper. At that point, the strength of HKD compared to EUR means you'll need less of the former to meet the required amount of the latter.

Of course, managing FX risk is about preparing for the worst and not simply hoping for the best.

Are all businesses exposed to FX risk?

If your company buys raw materials from local suppliers in the same currency as that used by your customers and shown on your financial reports, there is no FX risk. However, if you conduct any kind of business overseas in a foreign currency, whether you're buying raw materials, paying for services, managing subsidiaries, or selling to international clients, there is an element of foreign exchange risk.