Currency exchange risk: How to handle the ups and downs

Currency exchange risk: How to handle the ups and downs

Currency exchange is one of the biggest risks for Canadian businesses when selling internationally, but many companies do little about it, believing it’s all out of their control. Here’s how you can work with your bank and Export Development Canada (EDC) to manage the risks. 

Currency exchange is one of the biggest risks for Canadian companies, but ironically, it’s often ignored. Many companies take a wait-and-see approach, hoping for a favourable exchange rate at the time of their transaction.

The problem, as I explain below, is that there’s a hidden cost to your business when you don’t manage your currency exchange risk—even when the gamble pays off and your business comes out ahead financially.

Why are exchange rates so important to companies that sell internationally?

An exchange rate is the value of one country's currency in relation to another’s. For example, at the time of writing:

• C$1.44 buys one U.S. dollar
• C$1.50 buys one euro (€)
• C$1.80 buys one British pound

The challenge for those who sell internationally is that currency values between countries are always in flux.

Say you sell equipment to, or have a service contract for €100,000 with, your customer in France and give them 90 days from the invoice date to make a full payment. Your expectation is that at the current exchange rate (C$1.50 for one euro), you’ll receive the equivalent of C$150,000 when the bill is paid.

But what if the value of the euro drops during that time from C$1.50 to C$1.40? Now, you’ll only receive $140,000. It’s easy to see how the risk of fluctuating currency exchange rates can diminish, or even decimate, your profits from a sale.

But wait a minute, you may be thinking, what if the euro’s value goes up to C$1.60? Then, you’ll gain an extra $10,000! That makes it tempting to do nothing about the risk, or assume that sometimes you’ll win, sometimes you’ll lose, and it will all even out in the wash.

The hidden cost of ignoring currency exchange risk

There are many factors that can influence the value of a nation’s currency exchange rates, including:

• central bank policies
• inflation and interest rates
• balance of trade between countries
• geopolitical risks
• commodity prices
• market trends and technological shifts

But the reality is that you have no control over any of these things because an exchange rate can fluctuate at any time—sometimes drastically.

Failing to manage that risk can hurt your business, even if you come out the winner in the exchange-rate gamble. Never knowing what loss or gain you’ll take from fluctuating exchange rates means your company is constantly working in a sea of uncertainty. For smaller companies, especially, you can’t be sure what your profit will be for each transaction, or how much cash flow you’ll have to fulfill the next contract. The cost of that uncertainty is huge. It means your company will be less competitive and may grow at a slower pace due to inadequate cash flow to fulfill contracts and pursue new opportunities—not to mention the personal stress that taking such a risk can bring.

Impact of a weaker Canadian dollar on exporters

Since October 2024, the value of the Canadian dollar has fallen when compared with several major currencies. Several factors are behind this, including interest rate cuts by the Bank of Canada, a flagging economy, fluctuating commodity prices and a potential renegotiation of the Canada-United States-Mexico Agreement (CUSMA). While a weaker Canadian dollar may make your exports cheaper for foreign buyers, there are risks that you should keep in mind:

• Higher import costs: If your business relies on imported materials or components, your costs will rise and negatively impact your profit margins.
• Complex pricing strategies: Constantly revising your prices could affect customer relationships.
• Debt costs: Any debt in a foreign currency becomes more costly to service.
• Cash flow management: Currency fluctuations make cash flow harder to predict, which could affect your operations.
• Competitive pressure: Other countries might lower their own currencies, creating a “race to the bottom.”

A persistently weak Canadian dollar could also point to larger economic issues, which could hurt investor confidence and opportunities for expansion.

How foreign exchange hedging helps mitigate risk

Foreign exchange (FX) hedging is like creating a financial safety net. With FX hedging tools, you can help protect your business against the risks of currency fluctuations.

Let’s go back to my example of selling €100,000 worth of equipment or service to a customer in France. If your FX hedge included a contract that locked in the exchange rate at C$1.50 for 90 days, you’ll know exactly how much money you’ll receive, regardless of exchange rate fluctuations.

This means you can accurately plan for cash flows and profits while protecting your company from adverse currency movements. It also allows you to offer more consistent pricing, which builds trust with your buyers.

There are downsides to using FX hedging tools that you should keep in mind. They can be complex, so you’ll need a basic understanding of financial instruments and market conditions, so you can choose the right time to hedge, which is critical to maximize benefits. They may also involve fees or premiums.

How to manage currency exchange risk with foreign exchange guarantees

Foreign exchange guarantees (FXGs) are the simplest and most cost-effective way to hedge your currency exchange risk. There are three main types of foreign exchange guarantees that Canadian banks offer. Derivatives, including futures and options, are more complex methods of hedging against currency uncertainty. We’ll get to them later; first, let’s look at the most common foreign exchange guarantees: Spot rates and forward contracts. 

Spot rate

The spot rate locks in the value of a currency “at this moment in time.” So, whether the exchange rate fluctuates up or down during the period of time before you get paid, you’ll know exactly how much money you’ll receive from a sale and can plan accordingly. Don’t be afraid to negotiate the posted rate your bank charges.

Forward contract

A forward contract locks in an agreed-upon exchange rate for a transaction on a specific date in the future, which isn’t necessarily what the exchange rate is now. This can be a good plan if a currency’s value is expected to fluctuate significantly. But on the agreed date, the bank must buy the foreign currency from you, and you must provide it. The added risk here is that if your customer is late with  payment (or doesn’t pay), you’ll still owe the bank and will typically have to pay a penalty if you can’t provide the currency on time.

Hedge currency risks with futures and options

Spot rates and forward contracts are great choices to help even out currency fluctuations. If you need more flexibility or longer-term solutions, I suggest looking into futures and options.

Futures

A currency future is a contract that says you’ll buy or sell a specific amount of foreign currency at a set exchange rate on a specific date. These contracts are traded on exchanges, so they’re transparent and easy to buy or sell. While you lose flexibility, you won’t lose sleep over “what ifs.” Futures are ideal for businesses with large and predictable currency exposure that need guaranteed pricing, or for ongoing, high-volume contracts where consistency is important.

Options

An FX option is a financial contract that gives the buyer the right, but not the obligation, to exchange currency at a certain rate by a certain date. It’s your safety net, but one that you can choose not to use if the exchange rate swings your way. Options are complex contracts that cost money upfront, but they can work well for companies that need flexibility or operate in markets with high volatility. They let businesses hedge against risks without giving up potential gains.

How EDC supports FX risk management

To provide exchange rate guarantees, banks require collateral. For the world’s major currencies, the rule of thumb is 10% of the volume of your contracts. So, if you have $50 million in forward contracts, you’ll typically be required to put $5 million in an account with your bank as collateral. That means the money will be tied up when you could be using it to complete contracts or grow your business.

EDC offers solutions to this challenge. We can provide a Foreign Exchange Facility Guarantee (FXG) to your bank that replaces their need for collateral, so you have currency rate protection without tying up your cash. With our FXG, you can:

• protect your profit margins;
• improve cash flow management;
• increase borrowing capacity; and
• access advanced FX tools.

EDC can provide up to 100% of your financial institution’s collateral or margin requirement, giving you a unique advantage to grow your business with confidence.

Examples of managing foreign exchange volatility successfully

• Acadian Seaplants Limited is a biotech company that started as a small seaweed harvester in Nova Scotia. Now, it’s the largest independent manufacturer of marine plant products of its type in the world. They use our FXG to free up working capital, so they can expand into new markets.
• Averna is a Montreal-based technology company that builds innovative test solutions for various industries. Because the company designs and tests solutions throughout a product’s lifecycle, they have a long order-to-cash cycle. EDC’s FXG helps them guard against the ups and downs of currency swings.
• Manitoba’s ECBVerdyol manufactures revegetation, erosion and sediment-control products for construction projects. While they rely on natural hedging for half of their currency exchange needs, they use our FXG to protect against foreign currency fluctuations.

Read more about how each company used EDC’s FXG to mitigate currency risk, free up working capital and grow internationally.

Developing a foreign exchange policy

Understanding foreign exchange risk is a great first step to developing a foreign exchange policy to help your company. To create an FX hedging strategy tailored to your company’s needs, download our guide, How to make your FX hedging strategy work smarter.

By taking a proactive approach to managing currency exchange risks, you’re not just protecting your profits, you’re creating stability and opening doors to growth in international markets.