Wednesday, September 30, 2015

5 Simple Strategies to Manage Foreign Exchange Risk

TWS||With Wahome Ngari
In our previous post we saw that the economic conditions responsible for the decline of the Kenya shilling against the dollar still prevail and that one can only speculate when and where the exchange rates will eventually stabilise. We also discovered what is foreign exchange risk. 

Foreign exchange risk as you may already be aware, is a major threat to the success of any business. You however need not be worried as there ere are strategies that one can adopt to manage this risk as a way to navigate the vitality of the shilling. 
1. Develop a plan

The business environment is very dynamic thus enterprises have to review the foreign currency needs of the business and establish a plan to minimise the effects of exchange rate fluctuations. The business should not base its plan on currency speculations as this is not its core business. The aim should not be to neither make a profit or loss but rather balance out the effects of the fluctuating shilling to the business.

2. Hedge through a forward exchange contract

If the enterprise is fairy exposed to the effects of the volatility then it would be preferable to hedge through a forward exchange contract. This is the most common method used in managing foreign currency exposure. The business protects itself from adverse movements by locking in an agreed exchange rate for each transaction. The downside of this approach is that the business will not benefit from advantageous exchange rate movement as the contract price is locked. Continuous situation analysis informs the business managers when to reverse the position.
3. Hedge through matching currency outflows with inflows

For enterprises exposed to substantive external trade with both foreign currency inflows and outflows, one could try and match the timing of these receipts and payments. This is otherwise known as the perfect hedge. The practicality of this method is however limited due to uncertainties related to timing of cash flows.

4. Maintain foreign currency bank accounts

Maintaining foreign currency accounts for currencies that the business regularly transacts in eliminates the need for multiple currency conversion and the attendant risks. Foreign currency accounts could also help in managing the cash flow timing challenges discussed in point 3 above.

5. Borrow in foreign currency

Importers who rely on bank funding to pay for their imports could consider securing facilities denominated in foreign currency. The need for conversion from local to foreign currency is thus eliminated. This also affords the business the opportunity to determine the best time to make foreign currency purchases in the market.

While these are wise consideration for the enterprise, it is also prudent to consider how individuals can navigate the volatility. In the next post we give you tips on how you can insulate yourself against the negative effects of currency volatility.

If you need more help, ask us about the WealthCreation Masterclass where these concepts are taught.
Wahome Ngari – Principal Consultant/ CEO, Citadel Consulting Ltd

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