Foreign exchange risk

Foreign exchange rates normally and typically fluctuate from day to day and even from hour to hour. These fluctuations may be very small, as under a smoothly operating gold standard in quiet times; or they may be very wide, under a freely moving paper standard during a period of instability. Whether large or small, exchange fluctuations impose, in almost every exportimport transaction, an element of uncertainty on either the exporter or the importer and in some cases on both. This exchange risk arises because foreign trade terms of sale are always finally expressed in a specified currency: the exporter's, the importer's, or an agreed third currency. As a rule the transaction will be completed in the exporter's currency.

Therefore, if the exporter is an American, and the terms call for dollars, the importer may find dollars either more or less expensive, when he must buy them to make payment, than they were when the import was arranged. In the former case he loses, in the latter he gains; in any event he, and not the exporter, bears the risk. If the terms are in the importer's currency, the situation is obviously reversed, and the exporter chances an exchange gain or loss when he converts the foreign-currency payment into dollars. If the terms are in an agreed third currency, the double exchange risk may be split up between the two parties. For example, if a Canadian newsprint manufacturer sells to an Australian publisher in pounds sterling, the Australian may bear the risk of fluctuations in the pound sterling-pound Australian rate, while the Canadian manufacturer may bear the risk of a pound sterlingCanadian dollar rate variation.

Occasionally the exporter does not wish the proceeds of the sale to be converted into his own currency; he has some use to which he can put the foreign currency. In such a case there is no exchange risk, assuming that the whole transaction is handled on a foreign-currency basis. Exchange risk is present in every international transaction in which one currency must ultimately be converted into another, and various are the ways in which foreign traders meet this risk.