What Is FX Risk?
FX risk is the chance that exchange rate movements will hurt your business. Here's how to identify it and manage it.
Key Takeaways
- FX risk is the potential for exchange rate movements to negatively affect your revenue, costs, or profit.
- Transaction risk is the most immediate form — the rate changes between agreement and payment.
- FX risk can be managed through natural hedging, forward contracts, and currency accounts.
The three types of FX risk
Transaction risk: the risk that the exchange rate changes between when you agree a deal and when payment is made. This is the most immediate and manageable risk. Translation risk: the risk that the reported value of overseas assets, revenue, or earnings changes when converted to your home currency for accounting purposes. Economic risk: longer-term risk that exchange rate shifts affect your competitive position and business model.
Transaction risk in practice
You agree to buy £50,000 of goods from a US supplier at today's GBP/USD rate of 1.27. Payment is due in 60 days. If the dollar strengthens to 1.18 by the time you pay, your costs in GBP terms rise by nearly 7% — a £3,500 additional cost on a single order. Multiply this across a year of purchasing and the impact becomes significant.
Natural hedging
Natural hedging means matching your currency inflows and outflows. If you receive USD revenue from US customers and also pay USD costs to US suppliers, the two offset. You are only exposed to the net position. This is the cheapest form of FX management — no financial instruments required — but it only works if inflows and outflows in the same currency are roughly matched.
Managed hedging
Where natural hedging is insufficient, businesses use forward contracts (locking in a rate for future payment), currency options (the right but not the obligation to exchange at a set rate), or multi-currency accounts to hold foreign currency and convert when rates are favourable. AskBiz's FX Risk Modeller shows your exposure by currency and helps you decide where hedging adds most value.