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Coping with a fluctuating Canadian dollar

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The exchange rate between the Canadian and U.S. dollars is a fixture in daily newscasts and newspapers, so you'd think we would have become a nation of currency strategists by now.

Far from it. Most small and medium‑sized exporters and importers have no formal policies for managing exchange rate risk—a process also known as currency hedging.

The current weakness of our dollar against the U.S. greenback is a headwind for importers and a tailwind for exporters. But recently, it was importers who were benefiting from a strong dollar and exporters who were suffering. Exchange rates definitely cut both ways.

If you have significant exposure to exports or imports, it's never too late to integrate currency strategies into your business plan. To do so, you need to examine your markets and ask questions about the impact of exchange rates.

To help you plan, here are some strategies for limiting your foreign exchange risk.

Structuring your business to offset currency fluctuations

With natural hedging or operational hedging, benefits flow naturally from basic business operations and long-term strategies. Here are some examples:

Matching foreign sales and expenses

Exporters can create a natural hedge against currency fluctuations by offsetting sales in a foreign currency against expenses in that currency. In practical terms, this means finding foreign suppliers.

Setting up a foreign bank account

For a Canadian company selling and buying in U.S. dollars, for example, a U.S. account can even out some of the differences between the currencies over time. It allows firms to time their transfers of U.S. dollars back into Canadian dollars. For companies with the required working capital, this is a simple, low-cost strategy.

Adding foreign operations

Internationalizing operations can smooth out currency differences, making a company more competitive.

Using financial instruments to hedge currency fluctuations

Buying and selling currencies using forwards, futures and options is a traditional way to hedge currency fluctuations.

You have to know your business and where the opportunities are. If you know the timing of your foreign cash flows, you might hedge part of your currency exposure using forwards and leave the remainder open to fluctuations on the exchange rate.

Your banker or a currency broker can help you decide on the best strategy for using the following hedging instruments.

Forward contracts are agreements to buy or sell a given amount of a currency at a set exchange rate on a specific future date. Forwards are obligations and are not generally flexible, should your needs change during the term of a contract.

Futures contracts allow you to buy or sell a currency at a set exchange rate in a given month. Futures are highly liquid, so they can be closed out before the settlement date, giving you flexibility.

Currency options give you the right, but not the obligation, to buy or sell a currency at a set exchange rate during a specific time period. As a result, they also offer a lot of flexibility.

Seizing and protecting business opportunities

A weaker loonie can make this an ideal time to begin exporting or expand operations abroad. To learn more, download BDC’s free eBook How to Succeed in Foreign Markets.

Export Development Canada also offers advice to entrepreneurs on managing foreign exchange risk.

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