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How can a business hedge itself against foreign exchange risk, especially if it is an importer?

Answers

Victor Hinojosa
Title: Director - Strategic Partnerships
Company: Wester Union Business Solutions
(Director - Strategic Partnerships, Wester Union Business Solutions ) |

Dear Anonymous,

I would begin with the simple things that you can control and then taking the steps to fix a rate.

What you control:
1. Purchase of product or product line
2. Currency you are going to pay in
3. Terms of payment
4. How much you are going to buy
5. Profit margin/cost minimization you are trying to achieve; in other words your goals

What you need to know:
1. Historical view of the specific currency
2. Current market view and forecast of the currency
3. Company risk appetite; what is your FX risk policy
4. Cash flow impact; delivery of the foreign funds and does the risk mitigation instrument impact working capital
5. Don’t try to profit on the FX exposure that you have

Fixing a rate:

1. Fix profit margin by utilizing the FX instrument that you are going to use to hedge; this comes from your FX risk policy
2. What percentage are you going to hedge on the above (25%, 50%, 75%...etc.)?
3. What duration? This comes from “What you control”
4. Insure that your solution and you goals are “aligned”

I hope this helps. I am trying to create a simple framework that you can leverage. I want to stress that every FX case is different and you have to consider many different variables as every business is unique and requires a unique solution. In our business we don’t have or can provide “turn-key” solutions that help you mitigate the FX in our global economy.

Good luck.

Regards,

Victor

John Webb
Title: Chairman
Company: FXPathway Pty Ltd
(Chairman, FXPathway Pty Ltd) |

Please have a look at www.HedgeHogFX.com
It has been designed and built specifically for trade transactions.
As you will see it firstly 'measures' exposure, and secondly provides the 'management' capability all of which is controlled and operated from a personal work station.

Topic Expert
Joan Varrone
Title: CFO
Company: Cloud Cruiser
LinkedIn Profile
(CFO, Cloud Cruiser) |

Remember that if you use a derivative (either and option or a forward) to hedge your exposure that you need to understand the accounting treatment of the gain/(loss) on the hedging instrument in terms of financial reporting. For example if the hedge has a gain it may be reported under foreign currency gain in Other income while the cost of the item would go up and depress your margin. On an economic basis you have covered yourself but understand the hedge accounting treatment so you do not have suprises to your reported results.

Topic Expert
Philippe Gelis
Title: CEO
Company: Kantox
LinkedIn Profile
(CEO, Kantox) |

Hi,

Please find below 6 simple rules which will help you successfully hedge your corporate FX risk. These rules are not a methodology to hedge FX risk but some simple ideas you should always remember while hedging. Note that FX hedging will always be highly dependent on the context, including both company-specific factors as well as market dynamics.

1.Define a FX hedging policy based on your risk appetite. If you want to successfully hedge, everyone in your company - Board of Directors, CEO, CFO, Treasurer(s), Accountant(s), etc. - need to know and share common targets and rules. Personally check that each Board member has clearly understood the potential risks of the hedging policy previously defined. In some cases, Board members prefer not hedging the FX exposure to minimize costs and benefit from potentially favorable currency movements. Calculate worst-case scenario and present the results to them.

2.Identify your FX positions and decide, based on the hedging policy previously defined, if they have to be hedged. It may seem obvious but to successfully hedge you need to exactly know your FX exposure, in every moment, and its potential impact on your company profitability and competitiveness.

3.Never, ever, try to forecast currency movements or, at least, do not only base your hedging decisions on currency movements forecast. Do not forget that no one, including leading banks, is able to successfully predict currency movements and “disasters” with potential high impact on FX markets (LTCM, Bearn Stearns, Lehman Brothers, Sub-primes, U.S. losing AAA credit rating, Greece default, etc.).

4.Never speculate with your corporate cash-flows. Do not forget that hedging FX exposure is generally not the core business of your company. That said, managing corporate FX risk should consist in having no FX profits nor loss but a 0 balance. And do not forget that no hedging FX risk is similar to speculating.

5.Buy only what you understand. Make sure you deeply understand the financial products you use to hedge corporate FX risk (Forwards, Futures, Options, Exotics, etc.). Buying derivatives is quite easy but understanding how they are built and the hidden related costs and risks is much more complex.

6.Definitely avoid to manipulate data. It is so easy to add or forget a “0” when filling in data into a spreadsheet. Implement a treasury-management system. It may seem expensive… but only until your first big data mistake.

Hope this helps.

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