The answer to this depends on the size of your natural hedge:
This will depend on how you propose to manage your exchange rate risk.
Forecasting can be very difficult as you can never be sure of the timing of your currency receipts. If you find yourself in this position, then a risk management approach that allows you flexibility as to when you use your currency contracts will be the best for you.
Budget rates should be set at that rate where your business is profitable.
It can be tempting to look at the historical price action and select a more favourable rate that has traded recently. This can be fraught with danger as there is no guarantee that the price will return to those levels.
However, you can leave too much room between the budget rate and the prevailing market rate and that may negatively impact your competitive advantage.
To quote Roger Martin from his book The Opposable Mind, innovative thinkers have “the capacity to hold two diametrically opposing idea in their heads. Without panicking or simply settling for one alternative or the other, they’re able to produce a synthesis that is superior to either opposing ideas.”
Electing to manage your risk so that you are protecting your downside while at the same time providing the ability to generate a return from your FX risk management should provide superior results.
This question always makes me laugh.
Speculating is defined as making an investment in the hope of gain but with the risk of loss.
A well thought out currency strategy protects your COGS at the appropriately selected costing / budget rate while still providing the opportunity for gain. So, very little chance for loss.
The payments for COGS occur over time and under changing economic and market conditions. As such you would expect that a prudent currency strategy should also operate over same time horizon rather than a single transaction at a particular point in time.
Risk management products in and of themselves don’t cause problems. What does cause problems is how they are applied and whether you understand the repercussions if market conditions don’t eventuate as you might have thought.
Providing you have a reasonable forecast of your cashflows for your BUDGET period, this should not preclude you from managing the risk.
It simply means that you will need to review your position more regularly than if you have an accurate forecasting capability.
For example, you might know that you will need USD 10mio over the next 12 months, but there is some cyclicality to your purchases. After each month,
Normally, margins are set at 5% of the Face Value limit. So, if you have an AUD 10mio limit, then the margin would be AUD 500,000.
If you are exposed to the AUD/USD exchange rate that moves between 10 and 14c each year, and you use your facility to the maximum, then you are likely to be margin called.
To illustrate:
If you fully utilise your limit, you will have USD 7.6mio in hedging at 0.7600.
If the AUD then rallies to 0.8000, then you would be required to pay a margin call.
You will note that this facility doesn’t allow you to be fully hedged (unless the AUD went to 1.0000).
Normally, we recommend that you only put hedging in place up to a maximum of 10x the MTM limit, which in this case would be AUD 5mio.
So, to ensure you have the capability of managing your entire risk, you would likely need a panel of between 2 and 3 counterparties (if all were margin providers).
I have a few product rules:
FX risk is often considered a Strategy Risk, that is, it is a type of risk that you voluntarily accept in order to generate superior returns and is therefore not inherently undesirable.
They do, however, require an effective management system that is typically not rules based as this often replaces one risk for another.
An appropriately drafted policy will allow you to:
This is the basis of your strategy. Once you implement it, you might find that it requires modification, but you will only know that if your FOLLOW your strategy and measure the result.
But in short, yes, I believe every business should have a written Risk Management Strategy document and they should follow it!
Adrienne Sartori
Thank you for your upload