Global finance and exchange rates are major topics when considering an offshore venture. I will explain in detail what hard and soft currencies are. I will then go into detail to explain the reasons for currency fluctuations. Finally I will explain the importance of hard and soft currencies in risk management.
hard currency
Hard currency is usually from a highly industrialized country and is widely accepted around the world as a form of payment for goods and services. The hard currency is expected to remain relatively stable over a short period of time, and to be highly liquid in the forex market. Another criterion for hard currency is that the currency must come from a politically and economically stable country. The US dollar and the pound sterling are good examples of hard currencies (Investopedia, 2008). A hard currency basically means that the currency is strong. The terms strong and weak, ups and downs, strength and weakness are relative terms in the world of foreign exchange (sometimes referred to as “Forex”). Ups and downs, strengthening and weakening indicate a relative change in the situation from the previous level. When the dollar “strengthens,” its value rises relative to one or more other currencies. A strong dollar will buy more foreign currency units than before. One consequence of a strong dollar is lower prices for foreign goods and services for American consumers. This could allow Americans to take a long deferred vacation to another country, or buy a foreign car that was previously too expensive. US consumers benefit from a strong dollar, but US exporters are hurting. A strong dollar means that it takes more foreign currency to buy US dollars. American goods and services become more expensive for foreign consumers who, as a result, tend to buy fewer American products. Since it takes more foreign currency to buy strong dollars, dollar-denominated products are more expensive when sold abroad (chicagofed, 2008).
soft coin
Soft currency is another name for “soft currency”. The values of soft currencies fluctuate often, and other countries do not want to hold these currencies due to political or economic uncertainty within the country with the soft currency. Currencies from most developing countries are soft currencies. Often, governments from these developing countries set unrealistically high exchange rates, and peg their currency to a currency such as the US dollar (Investment Words, 2008). Soft currency collapses because the currency is too weak, an example of this is the Mexican peso. A weak dollar hurts some people and benefits others. When a dollar depreciates or weakens compared to another currency, the prices of goods and services from that country rise for American consumers. It takes more dollars to buy the same amount of foreign currency to buy goods and services. This means that American consumers and American companies that import products have reduced purchasing power. At the same time, a weaker dollar means lower prices for US products in overseas markets, which benefits US exporters and foreign consumers. With a weaker dollar, it takes fewer units of foreign currency to buy the right amount of dollars to buy American goods. As a result, consumers in other countries can buy American products with less money.
Currency volatility
Many things can contribute to a currency’s volatility. Here are a few of the strong and weak currencies:
Factors contributing to currency strength
Higher interest rates at home than abroad
Low inflation rates
Local trade surplus compared to other countries
Large and consistent government deficits crowding out domestic borrowing
Political or military unrest in other countries
Strong local financial market
Strong domestic economy / weaker foreign economies
There is no record of defaulting on government debt
Sound monetary policy aims to stabilize prices.
Factors contributing to currency weakness
Lower interest rates in the home country than abroad
High rates of inflation
Domestic trade deficit compared to other countries
Fixed government surplus
Relative political/military stability in other countries
Collapsing local financial market
Weak domestic economy / stronger foreign economies
Recurrent or recent default on government debt
Monetary policy targets that frequently change
importance in risk management
When venturing abroad, there are many risk factors that must be addressed, and keeping these factors in check is critical to the success of companies. Economic risk can be broadly summarized as a series of macroeconomic events that may dampen the enjoyment of the expected earnings of any investment. Some analysts divide economic risks into financial factors (those factors that lead to currency inconvertibility, such as external indebtedness, current account deficit, etc.) or a desperate government restricting the rights of foreign investors or creditors). Altagroup, 2008. Companies’ decisions to invest in another country can have a significant impact on their local economy. In the case of the United States, the willingness of foreign investors to hold dollar-denominated assets helped finance the large US government budget deficit and provide funds for private credit markets. According to the laws of supply and demand, an increase in the supply of money – in this case money provided by other countries – tends to lower the price of that money. Funds rate is the interest rate. An increase in the supply of money provided by foreign investors helped finance the budget deficit and helped keep interest rates lower than they would be without foreign capital. A strong currency can have a positive and negative impact on a country’s economy. The same applies to the weak currency. Too strong or too weak currencies not only affect individual economies, but they tend to distort international trade and economic and political decisions around the world.
Conclusion
Hard currency is usually from a highly industrialized country and is widely accepted around the world as a form of payment for goods and services. The hard currency is expected to remain relatively stable over a short period of time, and to be highly liquid in the forex market. Soft currency is another name for “soft currency”. The values of soft currencies fluctuate often, and other countries do not want to hold these currencies due to political or economic uncertainty within the country with the soft currency. Many things can contribute to currency fluctuations; Some of these things are inflation, the strength of the financial market, and political or military unrest. Companies’ decisions to invest in another country can have a significant impact on their local economy. In the case of the United States, the willingness of foreign investors to hold dollar-denominated assets helped finance the large US government budget deficit and provide funds for private credit markets.