Devaluation of Currency

The devaluation of currency is the most obvious risk in international business transactions. The risk that currency will lose value affects both buyers and sellers for different reasons. Buyers will discover that overseas purchasing power erodes as the home currency loses value. Meanwhile, sellers accepting and holding foreign currency reserves will see their net worth adversely affected by depreciating notes.

Strengthening of Currency

Strong currency is a hidden risk to foreign exchange and the economic standing of particular nations--especially export and tourism industries. Strong currency values at home make goods more expensive to foreigners. Exporters and tourist destinations are unable to match prices with overseas competitors that benefit from doing business and setting prices in weak currency.

Political Fallout

Political fallout from warfare, inflationary schemes to print money, and military coups will place downward pressure upon the home currency, at best. At worst, rogue governments will seize all assets of foreigners and refuse to honor contracts in the name of revolution. Unstable governing regimes will cause the value of their home currency to fall on the world stage.

Conversely, stable governments may see domestic upheaval when citizens feel that treasury officials are not committed to sound foreign exchange policy. Politics often causes competing nations to engage in trade wars. In trade wars precipitated by unfavorable exchange rates, nations will purposefully devalue the home currency or legislate heavy taxes upon overseas profits. These actions influence the flow of capital back into the domestic country and punish those that trade internationally with losses. The risk to investors is that profits made overseas in foreign currency will be artificially weakened in value or burdened with taxes because of politics.

Corporate Finance

Although the individual may easily avoid foreign exchange risk by switching his spending habits and refusing to accept anything other than hard currency, the multinational corporation must weigh all risks involving foreign exchange. Further, investors should carefully analyze financial statements to ensure that profits are not skewed dramatically by sales overseas that are converted into the home currency.

Hedging Foreign Exchange Risk

Consumers dismiss losses automatically by refusing to purchase expensive imported goods and traveling overseas when prevailing sentiment indicates that the home currency is decreasing in value. Large investors and multinational corporations hedge against foreign

exchange risk through diversification and the use of futures contracts. Diversification entails transacting business in different countries featuring separate economic profiles, where fluctuating values will largely neutralize each other. Corporate managers avail themselves of futures contracts and repurchase agreements within the currency markets to lock in value.