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Monday, 11 January 2016
Dealing with foreign exchange risk: Part 2
Hello readers, today I decided to write about the foreign exchange risk. I dealt with the economic risk associated with foreign exchange in a previous article. I will be dealing with the transaction risk partly today. So Yes, there will be part 3. I will be writing about 3 ways the transaction risk associated with foreign exchange can be mitigated
Leading and Lagging
It will be to the advantage of a business to convert its currency to the one that will be needed if they believe that the currency needed will appreciate against its own currency. That way when the currency appreciates you gain some money. However, there is still a risk that the currency might actually fall. When this action is carried out it is called leading. Lagging on the other hand is for you to wait to the last minute before you exchange the currency if you believe that the needed currency will fall when compared with yours.
This can be used if you have a lot of foreign transactions. That is you buy and sell to the another country. To mitigate the risk while using this method, you use one transaction to cancel the other. For example a South Korean company owes you ₩10,000, however, another South Korean company owes your South Korean subsidiary ₩12,000. Then the ₩12,000 can be used to pay the ₩10,000 owed and the remaining ₩2,000 will be kept. If there are several months between each transactions then it won't be possible to use such method.
This is similar to netting except in this situation you will be using the money from a third party and for your subsidiary to pay of the debt. With this method, you open an account with the foreign currency you will be dealing with. Thus, if you receive £1,000 from one customer and in few days you are to pay another customer £900. Then deposit the £1,000 you have received and pay the customer you owe £900 from it.
So I mentioned earlier that there will be part 3, so do check out for it. Keep checking my blog regularly. Cheers!