Exchange Rate Risk and Its Mitigation Strategies
Currently, Rashid Enterprise is willing to receive payment in British pounds for the monthly exports it sends to the UK. While all of its receivables are denominated in pounds, it has no payables in pounds or in any other foreign currency. Yasmeen, the owner of the firm, wants to assess her firm’s exposure to exchange rate risk. As it stands, the current enterprise would expose the company to transactional and economic risks. Transactional risks are short-term cash-flow risks that may arise should the exchange rate of the pound turn unfavorably. Economic risks are similar to transactional risks but are more long-term, as they would affect future expected contracts between the company and its clients in the UK. Should the exchange rates turn unfavorably, in the long run, the company risks losing more profit from repeating transactions in a foreign currency.
The suggested route of using dollars instead of pounds to conduct transactions between Rashid Enterprise and its customers in the UK would help minimize transactional and economic risks, but only to a degree. Based on the name of the company and its owner, it could be assumed that Rashid Enterprise is located somewhere in UAE or the Middle East. The main currency in the UAE is the Arabian Emirates Dirham (AED), not the US dollar. While these dollars would be useful in conducting transactions with other companies abroad, they would require being converted to AED in order for the money to be used domestically. Thus, the economic and transactional risks would still be present. In order to further minimize these risks, Yasmeen would need to consider requesting payments in AED. This solution, however, is not without flaws.
The AED is not considered a global exchange currency, unlike the dollar or even the pound, meaning that the exchange rates would be unfavorable to the customers, who would, in turn, want to revise the conditions of the contracts in order to make them less one-sided. If Rashid Enterprise does not need a large amount of US dollars to conduct transactions with other clients and companies abroad, there is no difference between using dollars and pounds, as both foreign currencies would have roughly the same transactional and economic risks. Since it is mentioned that Yasmeen has to convert pounds to dollars every month, it could be assumed that her company needs dollars, but the amount of them is not specified. To conclude, unless the company needs dollars to conduct extensive foreign transactions, the change from pounds to dollars would not provide any significant changes to mitigate transactional or economic exposure.