On an average business day nearly U.S. $2 trillion trade in the foreign exchange market, where currency volatility has become the norm. Due to this inherent volatility, the value in the U.S. dollar fluctuates constantly against other currencies, but a decided downward trend is now clear. Numerous factors contribute to the dollar's decline and the big debate among market participants these days is whether the dollar has bottomed.

For world traders with transactions denominated in dollars, the increased short-term fluctuation of the dollar-and how to effectively hedge against unanticipated shifts-has become a vitally important element in business considerations.

The U.S. dollar has succumbed to broad selling pressure during the past months as it slumped to a 12-year low against the Canadian dollar in November, a record trough versus the euro, an 8-1/2 year low against the Swiss franc, a 4-1/2 year trough versus the Japanese yen and a four-month low against the British pound. On a trade-weighted basis, the U.S. dollar depreciated by over three-percent to trade at a nine-year low.

There are two principal catalysts for the U.S. dollar's across-the-board retreat.

First, America's record-high current account deficit continues to widen and deteriorate and is approaching a whopping six-percent of gross domestic product (GDP). Typically, once a current account gap exceeds five-percent of GDP it is deemed to be unsustainable and detrimental to the domestic currency.

Second, U.S. policymakers have made clear that they view a weaker dollar as part of the process needed to correct the United States' hefty external imbalances. The Bush Administration, while expressing support for a strong dollar, is actually pursuing a policy of benign neglect. The Federal Reserve has also signaled its tolerance for dollar depreciation, which is the result of an unsustainable rise in the current account deficit. With U.S. officials clearly indicating that they will not stand in the way of the falling dollar, traders have the green light to keep selling the greenback.

Steps to manage risk

Whether your company is importing or exporting manufactured goods, you can improve your bottom line with a few simple actions, such as formulating a foreign exchange risk management plan, monitoring the market for short-term opportunities, executing orders when favorable market opportunities arise, making and accepting payment in foreign currency and timely use of forward contracts. Not only will these tools empower you to control costs, but they may also build goodwill with suppliers and clients, leading to increased business.

Many manufacturers look for convenience and low fees/rates when selecting their foreign exchange supplier. They usually buy when a payment is due, aggregating various liabilities into one large payment.

Whether you are paying for tools and machinery for imports or exports, paying for the raw materials to manufacture tools and machinery, purchasing equipment from overseas or paying a parent company or subsidiary overseas, it is critical to plan how you will hedge against currency risk. Many manufacturing businesses have regular international payments that are usually deliverable between 30-90 days and are prime candidates for forward contracts and short forwards.

Once your manufacturing company has committed to conducting a transaction in a foreign currency, you are exposed to market fluctuations. There are simple ways to manage risk without undue stress.

One of the most basic means of protecting against currency exposure for a pending financial transaction is buying or selling funds "forward," using a forward contract. With a forward contract, you lock in a current rate of exchange on the payment for goods you have contracted to buy in the future. This way, you know what the funds will cost when you convert the currency at a future date. Once the exchange rate is established, the U.S. dollar amount is set, regardless of subsequent market movements, which can amount to five percent during a single month. A fixed rate allows manufacturers to budget effectively without currency fluctuations eroding profit margins.

The only typical requirement to enter into a forward contract is a deposit between 10-15 percent of the dollar cost of the funds. However, there are also forwards that require no deposit and can be executed within 45 days.

Because currency rates fluctuate from minute to minute, staying informed about the foreign currency market is a fundamental prerequisite for effectively managing foreign exchange. The key as with any client-supplier relationship is to select a foreign exchange expert who will work with you to improve your company's bottom line. Simplicity and convenience are both notable factors to consider when selecting a supplier. The supplier you select may mean the difference between a savings of several hundred dollars in the short term and potentially saving thousands of dollars in the long term.