The world is becoming more interconnected every day. Businesses and individuals all over the world are constantly engaging in transactions that include the exchange of one currency for another. Referred to as the foreign exchange market, Forex or simply the FX market, it is a decentralized and over-the-counter market where all currency exchange trades occur.
Forex, Foreign exchange or FX is the conversion of one currency into another at a specific rate known as the foreign exchange rate. Conversion rates for nearly all currencies are continuously fluctuating due to market dynamics of supply and demand. In a free economy, the value of a country’s currency is determined by supply and demand. It means a currency’s value can be tied to another country’s currency, such as the US dollar, or even to a basket of currencies. The government of a country may also set the value of its currency.
It is not a gamble to manage foreign exchange risks. It is all about adapting decisions in response to constantly changing market conditions. Therefore, companies tend to adopt risk-mitigation plans, which typically include buying a financial product to offset their exposed assets or liabilities. Currency fluctuations can be neutralized with a quick, personalized monitoring activity, bringing the benefits of securing marketing margins, optimizing cash-flow estimates, and avoiding speculations on exchange rate trends.
An organization’s treasurer is responsible for managing a variety of financial risks, including foreign exchange risk, interest rate risk, liquidity risk, and funding risk. When it comes to handling cross-currency transfers and receipts, treasurers traditionally have two choices. These options are narrowly described as follows:
- Strategic FX management to hedge current or future cash flows.
A treasurer would often book a foreign exchange (FX) trade via phone or a single or multi-dealer platform to currency exchange in order to process a cross-currency transaction. They would then transfer the purchased currency to the beneficiary for cross-currency transfers.
- Operational FX management using international payments.
The FX trade and payment are merged into a single contract in this situation. The payment instructions are received via host-to-host connectivity or the bank payment platform SWIFT and are straight-through-processed (STP).
FX Management, when done right, assists companies with a hedging need to reduce their account exposures and to increase efficiency in their cash flow management. The decision to hedge foreign exchange risk necessitates a thorough examination of the exposed underlying as well as the selection of the appropriate hedging instrument. As a result, all threats must be identified: some may be covered, while others might be neutralized. Then, in accordance with accounting standards, an acceptable structure for all stakeholders must be established.