how to mitigate exchange rate risk

Sri Lankan Export businesses & Exchange Rate Risk -Chapter 2- How to Mitigate Exchange Rate Risk

This Article is a continuation of “Sri Lankan Export businesses & Exchange Rate Risk – Chapter 1”

Please click here to read chapter one

How to Mitigate Exchange Rate Risk?

01. Sri Lankan exporters should pay in simple ways to avoid risks associated with the disparities in currency exchange rates in quotation prices and local currency or LKR. In said agreement, export transfer the exchange currency risk into importer (who stays in a different country. To cadre same importer should tie up with exporter’s local bank or needs to establish his own subsidizers to carry out business. But very rarely foreign country importer will like the deal, which may lead to loss of entire business into another exporter or another country exporter.

02. The exporter may strict to “USD value only” policy to avoid difficulties associated with currency convertibility since other currencies such as Indian rupees, Norwegian krone, South Korean won are not freely or quickly converted to LKR. In Sri Lanka and in international trade, USD is widely accepted. Therefore exporter can secure the payment.

03. Exporter being in international markets affected by adverse movements in exchange rates. Since foreign exchange risk owing the real impact on the bottom line Banking products and credit lines supports exporters to safeguard against future currency volatilities and fluctuations.

  • Foreign Currency Accounts – Allow exporter to receipt of contract payments in a foreign currency and use of those funds to pay invoices in the same currency. This helps reduce currency risk by not having to convert funds to local currency immediately. Therefore exporter can hold foreign currency until price become favourable.
  • Foreign Bill Negotiations – Credit facility or advance from a bank for the amount and currency that will be received from an overseas buyer. This can help to manage foreign exchange risk and enhance cash flow.
  • Foreign Currency Exports Loans – Simple credit facility or bank loan in the same currency as the export contract. These allow exchange rate risk to be managed, by being able to use the funds as working capital to fulfil export orders before you receive payment. Repayment of loan take in designated foreign currency, therefore exporter avoids foreign currency fluctuations completely.

04. Hedging is a practical selection for exporters to manage or avoid exchange rate risks. Exporter consults or negotiates their bank with a sales contract. Bank advise regarding the particular currency and risk associated with the same. And the bank may offer a range of products that can help manage exchange risk given below:

mitigating exchange rate risk

  • Forward Contracts – This is the most direct method of hedging foreign exchange risk. A forward contract allows the exporter to sell a set amount of foreign currency at a pre-agreed exchange rate with a delivery date from 3 days to 1 year into the future. In other words, the bank agrees to buy or sell a certain amount in a foreign currency at a fixed rate on a particular date. This allows Sri Lankan exporters to know the future exchange rate to foreign currency receivable from sales/exports proceeds. Therefore exporter can work peacefully and forecast accurate income. The exporter is 100% protected in a forward contract with the flexibility of benefitting for improvements in the FX
  • Par Forward Contracts – This hedging instrument that allows the exporter to manage Foreign exchange market exposures more effectively. The exporter must be guaranteed series of future Foreign exchange commitments over a fixed period of time. Applicable to Exporter who has FX rates of the entire series of forwards would be blended into a single FX Rate. A confirmation of the transaction has to be signed by both parties (bank & Exporter). Need to establish a credit limit before entering into a forward transaction.  Forward contracts obliged to do the transaction at the agreed rate, irrespective of the fact that the prevailing market exchange rate is advantageous or disadvantageous for the client.
  • Foreign currency options – Its derivative financial instrument that gives the right, but not the obligation, to sell a nominated foreign currency to a bank at a fixed exchange rate, either on a particular date or during a defined period of time. The Strike Price in foreign currency option is the exchange rate at which the currency will be bought or sold before that maturity date. If the strike price is more favourable than the spot exchange rate on the date on which this option matures, the option expired “in-the-money” and the holder will exercise it. However, if the exchange rate on the expiry date is better than the strike price, the holder will not exercise his option. In those cases, it is said that the option expired “out-of-the-money”. Due to speculation nature and Sri Lanka being a developing nation, Sri Lankan local bank not practised this tool.

Author Mr LesoKumar, Being banker by profession, he personally believes the partnership with right business banking is significance for the exporters to succeed in the trade. If you are an exporter, who intended to mitigate the risk associated with the exchange rate, please feel free to contact him through digital platforms for any advice in this regard.

Linkedin – Lesokumar SureshKumar

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