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How To Run An Effective Hedge Program

In a recent webinar called "Key Elements of a Successful Hedge Program" that w

During a recent webinar , "Key Elements of a Successful Hedge Program", delivered by Proformative, chief executive John Kogan outlined the various components of an effective hedging program.

The session utilized presentations created by Hedge Trackers, LLC founder Helen Kane and Polycom, Inc. vice president and corporate treasurer Walter Boileau. The webinar outlines the basic concepts involved in currency risk and the methods that can be utilized to effectively hedge that risk.

What hedging will not accomplish
It is important for institutions to be aware of certain benefits that hedging will not be able to provide. First, using a hedging program will not guarantee that the user attains the "best rate." It does not ensure that the organization employing the hedging strategy will obtain the lowest costs and the highest revenues.

Using these strategies also cannot compensate for poor forecasting. A hedging program will also not fix the problem of utilizing a plan or forecast rate different from the market rate at the time the rate was provided. In addition, hoping that currency hedging will change the gains and losses associated to a zero on the foreign exchange gain-loss line is unreasonable.

What a hedge program can provide
Currency hedging programs can be very effective at protecting a firm's operating margin. These strategies can be utilized to protect the bottom line results caused by both low margin, high volume activity and alternatively the high margin, low volume activity.

These hedging programs can help to make the revenues and costs associated with running a business easier to predict, and can help to make cash flows more reliable, especially those earnings that are being repatriated from other countries and converted to U.S. dollars. Hedging strategies can help to reduce the volatility of profits and losses associated with converting profits in denominated in foreign currencies into dollars.

Currency hedging strategies
The two financial instruments generally utilized by market participants to hedge foreign exchange risk are options and forward contracts. Kane stated that options contracts were basically insurance policies in this instance, and that one good way to rationalize the use of options to hedge currency exposures was purchasing car insurance for a 16-year-old driver. The cost of the premium is large, but the damage covered in case of loss is significant.

Forward contracts can be used to lock in the price of today's exchange rate for use at a future time. One of these financial instruments provides the user with today's spot rate for a conversion further down the line.

Communicating with management
Boileau delivered the second segment of the presentation by discussing how a finance official can communicate with the management of his institution in order to execute an effective currency hedging program.

The finance expert has spent many years working with CFOs, and said that when working with these officials, it is important to be "diplomatic" and to both inform and educate when explaining how foreign exchange hedging can impact the bottom line.

Visibility is a key concern because CFOs frequently only see the final gains and losses experienced by the hedge and not the underlying gains and losses contained in the margin.

Mitigation not elimination
One crucial point that must be communicated with management in order to avoid falling short of expectations is that currency hedging programs can be used to reduce gains and losses associated with foreign exchange, but will not eliminate them completely.

Foreign exchange risk management has become increasingly important to various firms that do business in the euro zone as a result of the speculation that the common currency may no longer be used by Greece.