Exporting to the United States – A Team Canada Inc Publication

5.9 Reducing the risk of exchange rate fluctuations

Fluctuations in the value of the Canadian dollar relative to the United States dollar can affect export profits either positively or negatively. This is called foreign exchange risk or FX risk, and you have to factor it into your operations plans and your pricing. If you don't, your budgeting may go off track, you may not have enough cash to meet payment obligations, and you may even risk bankruptcy.

There are two major types of FX risk or FX exposure:

Transaction exposure

Suppose you conclude a contract with a buyer and he commits to pay you in U.S. funds 60 days after delivery. Now suppose the Canadian dollar drops in value against the U.S. dollar by the end of that 60 days. Because of this, your buyer's payment will be worth more to you once it's converted into Canadian currency. Conversely, if the Canadian dollar rises during that 60 days, the payment will be worth less to you after conversion to Canadian currency. The risk of this happening is called transaction exposure.

Economic exposure

If transaction exposure is the small picture, this is the big one. If the Canadian dollar rises a great deal, as it did beginning in 2003, Canadian goods and services will cost more in the United States. This may cause U.S. buyers to buy less, drive harder bargains or look for better deals elsewhere.

You can minimize foreign exchange risk by using tools such as:

Forward contracts

In these contracts, you agree to sell a fixed amount of U.S. currency to a commercial bank, at a fixed price, at some future date. This removes your uncertainty about what your export deal will actually be worth and protects you if the Canadian dollar rises against the American. On the other hand, if the Canadian dollar goes down (which means the payment will be worth more than formerly), you don't get the benefit.

Exposure netting

In this strategy, you match U.S. currency inflows with U.S. currency outflows, to eliminate or "net out" the exposure. If your types of transactions allow it, and if you pick the right financial instruments, you can come out very close to even.

Currency options

These contracts give you the right (but not the obligation) to buy or sell foreign currency at a specified price, within a defined time period. Unlike forward contracts, options let you benefit from favourable fluctuations in exchange rates.