Managing currency risks: What solutions are available?
Although spot and forward transactions are the most popular approaches to foreign exchange, a range of other instruments are available. These can allow you to lock in a worse-case rate for future cashflow certainty and still benefit from favourable market moves.
Is your business making the most of currency hedging solutions? Take this quick quiz to see how you can tap into the broader suite of treasury products to manage foreign exchange risks.
Your guide to developing an effective currency hedging strategy starts here...
The information in this tool is provided for information purposes only. It does not have regard to the specific objectives, financial circumstances or particular needs of any specific client and it should not be regarded as advice or a recommendation of any nature. Advice should be sought before embarking on any course of action.
To hedge or not to hedge?
In international trade, foreign exchange rate moves can make the difference between a business transaction being profitable or unprofitable.
But hedging isn't suited to all companies that work across international boundaries. Businesses that are fully hedged may miss out on potential upside if a currency market improves.
As a first step, you need to decide how much of your expected foreign exchange requirements to hedge. Among the factors to consider: your internal budgeting, including how this would respond to a change in market rates; and how your competitors are managing currency risk.
Hedging Q1 of 3
1. Confidence about cashflows
The more certainty you have about foreign exchange fund flows, the more confident you can be about locking in rates and the less likely it is you will find yourself with unwanted hedges.
Consider how visible the company's cashflows are. Think about types of risks that could change the pattern of your international business operations and trading activities and whether early warnings about significant impacts are likely.
What certainty do you have over your cashflows?
Hedging Q2 of 3
2. Know your competition
Be aware of how other companies manage their foreign exchange risks. In some sectors, not being left behind by the competition is everything.
Take, for example, the travel industry, which operates on tight margins and caters for consumers who shop around on price.
A travel company that opts for forward hedges while rivals manage foreign exchange requirements in the spot market could become uncompetitive if foreign exchange rates improve.
What proportion of their FX do companies in your industry typically hedge?
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3. Foreign exchange margins
Can you afford to have hedges that are underwater? Or do you need to be able to transact close to where the market is trading?
Take the example of the 2008 financial crisis. When problems first started to unfold, many treasurers took out forward contracts on the assumption that the US dollar would continue to weaken. However, when it became clear that systemic problems were global, other currencies weakened against the dollar - which was then seen as a safe haven. Some companies were hedged out of business as a result of being on the wrong side of large market moves.
To what extent can you allow for a difference between the prevailing market rate and your hedged rate?
Hedging might not be for you
Your responses suggest you are not yet in a position to commit to hedging. Speak to your Investec treasury dealer for help in achieving the best possible rates in the spot market.
Hedging might be for you
Your responses suggest that hedging may be appropriate for a portion of your company's foreign currency flows. Your next step is to quantify how much you can commit to hedging - and over what time periods.
Speak to your Investec treasury dealer about how to take your foreign currency risk management to the next level.
Let's talk about hedging
Your selections indicate that you are ready to find out more about developing your hedging strategy.
Your Investec treasury dealer can give you information to help you benchmark your hedging strategy against competitors.
Keep going to find out what your hedging portfolio could comprise of...
The power of hedging
This section of the Investec FX Strategy Selector explores what type of foreign exchange hedging portfolio is best suited to your business needs, looking at how you rate the following:
The ability to benefit in both favourable and unfavourable conditions
Your risk appetite
Outperforming current market rates
Treasurers can select from a wide variety of instruments and approaches. Factors that influence the choice of hedges include cashflow planning and treasury hedging policies.
Investec's treasury specialists can help you identify hedging solutions to meet your objectives, from reducing cashflow uncertainty as a result of foreign exchange movements to outperforming current market rates.
Portfolio Q1 of 3
4. Having the best of both worlds
Plain-vanilla forward contracts have the advantage of giving you certainty about your rate, but you could end up worse off than leaving your trade to the spot market.
Flexibility is pre-defined: as the market improves, your hedged rate will adjust in your favour. One disadvantage of flexible contracts is that your protected rate usually isn't as attractive.
How much foreign exchange rate flexibility are you seeking?
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5. Managing uncertainty
Many treasurers aim to achieve better than market rates in a hedging portfolio. But, along with the potential gain comes uncertainty.
Before selecting contracts with greater flexibility and the opportunity to deal at better than market rates, consider whether your business would be able to cope, if this came at the expense of having a variable amount of currency delivered at the end of a contract.
Treasurers are encouraged to set an appropriate limit on uncertainty when identifying techniques for mitigating currency risks.
How much uncertainty are you willing to accept?
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6. Outperforming the market
Outperformance products can offer better rates, but there will be additional risks.
In some cases, there is the possibility of your hedge disappearing, leaving your business unprotected.
These deals are generally only appropriate for a small proportion of foreign exchange requirements, as they are higher risk.
How much outperformance are you looking to achieve?
[As you chose low uncertainty you are unable to select a lot of outperformance]
You do not require either flexibility or outperformance linked to your foreign currency exposure so your hedging requirements are best managed using forward contracts, which provide a known rate for buying or selling currencies in the future.
Speak to your Investec treasury team dealer or call the dealing team on 0800 055 6339 for help in achieving the best possible rates.
You would benefit from market improvements, while still having protection at an underlying rate. You can achieve this by including more hedging solutions in your portfolio.
Your Investec treasury dealer can give you information to help you benchmark your hedging strategy against competitors. Or call the dealing team on 0800 055 6339.
Hedging and Outperformance
You would like your hedged rate to improve as rates improve. You might also look to include an element of outperformance and acknowledge this comes at the expense of uncertainty about how much currency will be delivered.
Speak to your Investec treasury dealer or call the dealing team on 0800 055 6339 about your foreign exchange risk management requirements.
You are primarily interested in generating outperformance in your hedging portfolio, using instruments that do not provide protection against adverse market moves. Outperformance solutions can allow you to deal at better-than-market rates, but with more uncertainty about how much currency you will receive.
Outperformance contracts should only be used if you understand and accept the risks involved.
Speak to your Investec treasury dealer or call the dealing team on 0800 055 6339 about building the optimal hedging portfolio.
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