One of the biggest risk factors involved in operating an importing or exporting business is that while your sale is in progress the value of a foreign currency may change relative to the value of the U.S. dollar. This means some of your export profits can get lost in translation.

Overseas buyers typically pay in their own currency, which is then exchanged for dollars before it’s deposited in your bank. Here’s an example: You thought you were going to get $500,000 for that shipment of wooden chairs your company exported to France. But by the time your goods make their way overseas on a barge and the buyer takes delivery, the dollar has weakened against the euro and you end up only getting $460,000.

On the flip side: Instead of weakening, the dollar strengthens suddenly against the currency your buyer uses. By the time your merchandise arrives, it costs the buyer more in the local currency to equal the dollar value you agreed upon, and now the buyer doesn’t want to take delivery and close the sale.

As you can see, currency fluctuations can really take a bite out of your profits. That’s why savvy exporters and importer's use currency hedging to protect their companies from the risk of changing currency values. All the big retailers that operate internationally use currency hedging to make sure their profits aren’t eroded by currency changes, and small businesses can do it, too.
There are several ways to hedge currency.

Foreign Bank Account

you’re an importer and need to purchase merchandise abroad, one currency-protection method is simply open an account the country you are importing from. When the exchange rate is favorable, send U.S. dollars to foreign account for deposit. The bank will change them the local currency.

Now the money is locked the other country’s currency and ready to spend. The downside here it’s hard to time currency fluctuations.

Currency Forward Contract

Major banks offer currency forward contracts, are essentially an agreement exchange certain amounts of dollars for foreign currency a future date. This allows you to lock an import purchase or export sale at the current exchange , guaranteeing your transaction the agreed upon price.

Of course, if the U.S. dollar strengthens afterward, can’t profit from it; you’re locked an exchange rate. But you protected your business the risk of a weakening dollar.

Futures Contract

Similar forward contracts, futures are a commitment to purchase currency the future at an agreed upon rate based current exchange rates. You should purchase currency futures contracts a reputable exchange such the Chicago Mercantile Exchange or London International Financial Future Exchange.

Futures contracts have one important advantage forward contracts: There is a secondary market them, so you could opt to sell contract before the term is if you change your mind or your business needs the cash. On the other , futures contracts usually allow a range of final exchange prices than a fixed point, so you may get the exact exchange rate you want when the contract hits maturity date. Also, the contracts are only offered fixed amounts, may make it hard to hedge the exact amount you want through futures.

Currency Options

Banks offer currency options, give you an opportunity, but an obligation, to buy or sell a set amount of currency a set price, on or before a chosen date. Options come a “strike price,” the price which the currency can be bought or , and an expiration date, after your opportunity to purchase at the agreed upon price ends.

essence, futures and options allow you to bet where currency prices will go. You lock in at a you’re hoping will be at least good as the actual rate when the contract or option comes .

An important drawback to note contracts and options is that each of these currency-hedging strategies comes fees and commissions charged by bank, exchange, or other party administering the hedging vehicle. Weigh those costs to your business in evaluating you want to hedge currency.


Adapted from: allbusiness.com, August 27, 2010.