Endless Risks of Forex rate Trading
With a daily trade volume of over a trillion dollar, the Forex rate system is the largest financial market in the world. This system is used by central banks, financial institutions, MNCs and individual investors, each having their own specific types of risk.
Devaluation of Forex rate
Devaluation of Forex rate value is the most crucial risk in international business transactions. The risk that currency will lose its value affects both buyers and sellers for varied reasons. Buyers will realize that overseas purchasing power reduces as the home currency’s value decreases. Sellers who are accepting and holding forex reserves will find their net worth being adversely affected by depreciating currencies.
Strengthening of Currency
A strong currency is a hidden risk to forex and the economic pillar of some countries especially the tourism and export industries. Strong home currency values make home goods dearer to foreigners. Exporters of goods and tourist destinations cannot match prices with their overseas rivals who benefit from doing trade and set prices in weak currencies.
Multi-National Company Risk
Major multinational companies derive a considerable share of their revenue from overseas markets. These companies would be badly affected if the currency values in one or more of their major foreign markets significantly depreciate as this would lower the value of their revenues, while raising the value of their expenses. Thus many of these firms use complex hedging strategies meant to significantly reduce risk in the events of worse currency shifts.
Investment risk is the more classic kind of risk faced by almost every forex investor, from billion-dollar hedge funds to individuals trading small accounts. An investor sells and buys two currencies alternately, with the hope that the one being bought appreciates value wise relative to the one being sold. If this does not happen, he will suffer loss. With high borrowing limits provided to investors, minor losses on the basic currencies can lead to major losses in the brokerage account.
Political fallout from war, military situations will affect the home currency tremendously. As worst case scenario, government will capture all the assets of foreigners and dishonour pacts in the name of revolution. An unstable government will cause the value of the home currency to depreciate globally. Reversely, a stable government may see domestic revolution when its citizens feel treasury officials not being committed to sound forex policy. Often politics involves competing nations in trade wars.
In trade wars caused by unfavourable exchange rates, nations will devalue the home currency or heavily tax overseas profits. These influence capital inflow into the domestic country and punish those trading internationally with losses. The risk to investors is that overseas currency profits value will be weakened artificially or burdened with taxes.
Forex rate risks are related to the failure of transacting international trade. Lost purchasing power for daily transactions and huge trading losses for big investors and MNCs will arise from the failure to understand the complicacies of foreign exchange. All sectors of international trade must take care to hedge against forex risks.