Currency Risk of Converting US Dollars to Pounds

1 October 2011

Converting US dollars to pounds is usually done by traders to pay for goods and services in the United Kingdom. Due to the growth of outsourcing, multinational corporations, globalization, advanced transportation, and industrialization, traders in most countries seek conversion rates every time. International trade has a great impact on each country around the world.

Without international trade, countries will be limited only to the products and services that are within the country borders. Although in principle, international trade is no different than domestic trade. The behavior and motivation of involved parties in the trade do not fundamentally change depending on whether it is trade within the country or outside the country borders. However, international trade may be more expensive than domestic trade because of the additional costs imposed on international trade. Costs associated with country differences, time costs due to shipping delays, and tariffs can make international trade more costly than domestic trade.

Because of international trade, there is a need to convert US dollars to pounds for importation of goods and services from the Great Britain to the United States of America or to any other country where the sterling pound is not the currency. Due to the currency conversion, there is some form financial risk that both parties to the international trade are exposed. This financial risk is called currency risk, which is the risk that arises due to the potential change in the exchange rate of the US currency to the sterling pound or vice versa.

This form of exchange rate risk when converting US dollars to pounds can either be a gain or a loss. Losses due to exchange rates are typically neutralized through hedging all foreign exchange exposures. Hedging is a way business people handle currency risks by transferring such risks to other businesses which are prepared for such currency risks.

The currency risk of converting US dollars to pounds can either be transaction risk or translation risk. Transaction risk is a risk of unfavorable change in the exchange rate over time while translation risk is the risk that assets held in foreign currencies may change over time because of changes in the exchange rate. Currency risk can be very damaging for very large business projects which are often financed by very large debts. Due to fluctuations in exchange rates, the business projects of this kind often incur huge debt servicing losses which can often lead to restructuring.


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