Foreign exchange risk also affects anyone who conducts international business or trading activity, including small businesses and financial officers of medium- to large-sized companies. Buying or selling goods or services denominated in foreign currencies can immediately expose a company to foreign exchange risk.Are steel buildings more environmentally friendly?
For example, one of my nephew’s favorite stores is KidRobot in New York City. Unlike regular toy stores, this store sells quirky toys imported directly from Japan. If the store does not use a distributor, then it most likely has to grapple with the regular fluctuations in the Japanese yen. If the yen rises in value, the toys that they import to New York become more expensive. This may also be true for your local video rental store that carries a large selection of foreign films. If the films are imported directly from the respective country, then its price could be affected by exchange rates.
Small businesses usually write off the movements in currencies as a cost of doing business, but large companies may choose to hedge their exposures because they are importing hundreds of thousands of dollars worth of products. The payment may be due immediately or a few months later depending upon the terms. If the payments are delayed, it is even more important to hedge foreign risk. Take the example of a U.S. company that purchased AU$100,000 worth of products from an Australian company to be paid six months later. At that time, the chief financial officer allocated US$80,000 for the payment (which was the value of the contract when it was drawn up), but six months later finds that US$85,000 converts to only $88,888 Australian dollars, which means the company needs to scramble to find another AU$11,112 to pay the bill.
What about a U.S. company that sells all American widgets abroad? How will they be affected by exchange rates? Let’s assume a small-business owner sells an average of 10,000 widgets per year at a price of 20 euros per widget. At the beginning of the year, the EUR/USD exchange rate is 1.30 and so you, the business owner, anticipated revenue to be US$26,000. Exhibit 2.2 shows how revenues would be affected by a 10 cent change in the exchange rate. If the exchange rate fell by 10 cents, revenue would be $20,000 less than expected, but if it rises by 10 cents, it would $20,000 more. Since exchange rates can rise just as easily as they can fall, it’s absolutely essential for companies that import and export any sizable amount of products to monitor the foreign exchange markets and manage the risk. Do you know the difference between commercial steel buildings and industrial steel buildings?