Use of Hard and Soft Currency in Global Financing Operations
A hard currency refers to a currency that is commonly used around the globe as means of exchange. A hard currency remains stable over a short period of time and extremely liquid in the Forex market (Connolly, 2007). Hard currency mainly comes from country with stable economic and political environment. Hard currencies are mainly from the industrialized countries. A soft currency is a currency that has fluctuating value due to unstable economic and political environments in the country of origin. They are also known as weak currency. Foreign traders avoid using the soft currency because the fluctuating nature of these currencies presents enormous risk. Most currencies from developing countries are soft currencies (Connolly, 2007). This is because many developing countries are characterized by volatile political and economic environments. Hard and soft currencies play a significant role in global financial operations, as well as, in the management of risks.
How Hard and Soft Currencies are used in Global Financing Operations
Currencies are an essential element in international trade (Connolly, 2007). For instance, US exporters have to sell their goods in the currency used in the destination countries. They would then exchange these foreign currencies into dollars. This means that if the value of the destination currency is not stable, the exporters may suffer losses as a result of weakening of the foreign currencies. Similarly, US importers have to convert the dollars into the local currency of the nation of origin of the imported goods (Connolly, 2007). This means that if the value of the currency in the nation of origin is not steady the importers may end up paying additional dollars for the imported goods. Thus, many traders avoid using the soft currencies so as to evade the losses associated with the fluctuation in value of the currency.In order to encourage trade, developing countries accept the use of soft and hard currency within their jurisdiction. Soft currencies are used in domestic trade by the country’s citizens while the hard currencies are used by visitors and international traders (Connolly, 2007).
Local who hold soft currency convert it into hard currency in order to access foreign goods and services. Developing countries maintain reserves of the hard currencies in order to maintain the stability of their soft currencies. When the value of the soft currencies depreciates against the hard currency, the state releases additional hard currencies into the economy so as to make it cheaper for people to purchase the hard currencies. The state may also reduce the amount of the local currency that is circulating within the economy through tools such as interest rates. The developing countries have to control their currencies from depreciating in order to enable these countries to obtain imports at cheaper rates.Similarly, when the value of the local currency appreciates against the hard currencies, the developing states have to bring the value of the local currency down (Connolly, 2007). This is because the appreciation of the local currency hurts the export industry.
Since the exporters receive payments in hard currency forms, an appreciation of the local currency means that the exporters will receive less of the local currency for every unit of the hard currency. The developing countries control the appreciation of the local currency by lowering the exchange rates and buying the hard currencies out of the economy thus limiting their circulation.The hard currencies facilitate trade by creating a level playing field for all parties within the transaction (Connolly, 2007). Citizens from both the developing and industrialized countries are able to enjoy fair trade as a result of the stabilization of the exchange market. The hard currency also facilitates global financial operations by providing a standard medium of exchange. The Forex market is a vital institution in globe trade (Connolly, 2007). It represents the largest market in the globe where monies are traded. Since the hard currencies are extremely liquid within the forex market, it becomes easy for traders to use these currencies while trading.
Importance of Managing Risks
Companies are exposed to risk when they engage in cross border trade because they have to deal with other currency (Connolly, 2007). Trading in multiple currencies is risky because the value of the currencies can fluctuate within a short period of time. Fluctuation in currency value can lead to low profit margins for organization. Use of soft currencies can hurt the profitability of a company when the value of the company changes. Companies that export their products would receive low value for exported goods in situations where the value of the currency in the destination country appreciates (Connolly, 2007).
Fluctuation in currency value can also result in loss of asset values. Companies that operate in foreign countries hold their assets in foreign currency. The values of these assets are affected when there is a fluctuation in the values of the foreign currency. Hard currencies play a significant role in the management of risks. Hard currencies rarely fluctuate in value and thus, their use as standard means of exchange helps companies to avoid risks associated with currency fluctuations (Connolly, 2007). Companies can sell their products using the hard currency and operate using these currencies without fear value fluctuation. Countries that run operations across borders can also value their assets in hard currency forms so as to avoid fluctuation in the value of the company’s asset.
Connolly M. (2007). International Business Finance. USA. Taylor & Francis