Currency Exchange Hedging Strategies
It is essential when creating bespoke currency hedging strategies for your corporation that it is based upon market research and analysis, ensuring it fits your business needs. Correct implementation, monitoring and refining of the strategy is essential. Smart Currency Options Ltd., authorised and regulated by the Financial Conduct Authority (FCA), has developed a four step process.
1. Understanding the Risk
Foreign Exchange (FX) exposure is experienced by all importers and exporters of goods and services as they are permanently exposed to:
• Transactional Risks
• Translational Risks
• Economic Risks
There have been numerous high profile companies that have seen their entire profits eliminated by adverse currency fluctuations. Neglecting to account for volatile currency markets can lead to disastrous consequences. Understanding the factors that can affect the markets combined with proper analysis of your company’s exposure levels, are the first stages in establishing a bespoke treasury management strategy.
2. Developing the Strategy
Determining your company’s risk appetite
You will need to assess the risk appetite of your organisation. A good currency specialist can look at the different economic and business factors and their effects on your company’s currency exposure and help you assess how much risk your business can feasibly afford. Smart Currency Business will help develop this strategy with you, looking at your company’s exposure levels and creating different solutions to reduce this risk, through the appropriate currency tools and strategies.
Choosing the right tools and products as part of your strategy
There is a wide range of solutions and products that can be factored into your corporation’s hedging strategy. These include:
- Spot Contract: Buying or selling currency on the spot. A spot contract involves purchasing or selling currency at live market rates for immediate transfers.
- Forward Contract: Securing a currency rate for future use. A Forward Contract allows you to reserve an exchange rate determined on the day of the transaction for future use.
- Currency Option Contracts: a bespoke hedging solution that can give the policyholder the right, but not the obligation, to buy or sell underlying currency at an agreed rate of exchange on maturity of the option.
These bespoke solutions are likely to form part of your treasury management solution. These can range from straightforward options (called ‘vanilla’ options), like a ‘call’ option for a buyer, to more sophisticated types, like a ‘collar’. If the market moves in a corporation’s favour, it can transact at a spot rate. However, if exchange rates are unfavourable, the company can purchase currency at a rate that was previously agreed upon. A basic vanilla option gives you the right, but not the obligation, to purchase the underlying currency at an agreed price on the maturity of the option. Flexibility can be added to your strategy through combining it with different types of option products as well as spot and forward agreements to generate fluid hedging strategies covering the best and worst case within your comfort zone of risk.
3. Executing the Strategy
The hedging strategy you decide upon will be based on where the markets are at that moment in time, where the markets are forecast to be, and the micro exposure of your business from the various risk factors previously discussed. In light of the different risks that your company is exposed to, you will need to assess the tactical options available to mitigate your exposure to these risks. A robust currency hedging strategy often involves a combination of the different products and solutions available, based on the specific business needs and currency requirements of that company. This provides several levels of protection against currency risk.
By carefully considering all inherent and extenuating factors, Smart Currency Business consultants can help you develop hedging strategies to your specific requirements, lending our guidance to help you build your own bespoke currency strategy. Effective and efficient implementation of this strategy will help to minimise risk when protecting a company’s profits from losses of funds and unexpected expenditure caused by currency volatility.
4. Reviewing and balancing the currency strategy
Monitoring and refining the hedging strategy is an important part of protecting your business from unexpected currency risk. Smart Currency Business will review the risks that your company is exposed to and will continually assess the performance of your hedging strategy against those risks, making adjustments where needed to take into account market movements and changing economic and business factors.
A hedging strategy is not a one-size-fits-all approach; it is a bespoke solution, created according to your specific business risks and requirements. Your strategy will need to be reviewed regularly to ensure it remains effective, according to your company’s needs. As your business and the markets in which it operates evolve, so will your exposure to risk, and therefore your hedging strategy will need to evolve accordingly; an aspect that many companies neglect! At Smart Currency Business, we work continuously with you to assess the market and business dynamics, refining your company’s strategy to help achieve the best possible results.