Over the years I’ve worked with many business owners, CFOs and Boards to help them manage their currency risks and here are some of the things I wish business owners knew about currency hedging…
Because of this, it’s a common misconception that you should lock in exchange rates whenever you can.
It’s true, locking in an exchange rate can be beneficial, particularly if its…
For many businesses, there is little connection between their cost management strategy and their currency risk management approach. But the first priority of any currency strategy should be to protect and maximise operating margins and that means managing your COGS.
Like most financial market decisions, fixing all your currency positions comes with a trade-off.
Many business owners spend so much time focusing on losing money, they forget that markets can also help improve profitability. As a result, they have a strategy to be fully hedged only with fixed rate instruments.
While this might eliminate the risk of losing money against a costing / budget rate, you may leave yourself open to missing out on favourable movements. So, your currency strategy needs to
This is perhaps the hardest thing to do: balancing fixed rate hedging with the more flexible tools so that you can ensure profits are protected if markets move against you, while still being able to take advantage of great rates should the opportunity present itself.
In a highly competitive industry, an entirely fixed rate portfolio could mean the difference between losing or growing your market share and over the long term, may negatively impact your profitability
This doesn’t mean that the strategy should be based on trying to pick a “good” rate. This is basing your decisions on…
This means that…
Over the years I’ve seen many business owners try option-based products, only for them to have disastrous outcomes. The result: option structures have a singularly bad reputation for undermining the success of businesses.
Of course, simply using any product puts the how before the what. Let me explain.
In an interview with former chess World Champion Anatoly Karpov, considered the greatest chess strategist of all time, he put it this way:
‘Strategy is knowing what to do when there is nothing to do. Tactics are knowing what to do when there is something to do.
So, strategy is WHAT you do, while TACTICS are how you do it.
To continue with the chess analogy, if tactics are individual chess pieces, strategy is how you move them across the board.
In currency markets accumulating risk management products are the tactics, and the strategy is how you put them together so they provide a successful result for your business in all market conditions.
This often begs the question:
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.
Recently an exporter client said:
“I want to wait for the bottom of the market before we put any more cover on”.
You can only know what the top and the bottom pf a market is in retrospect.
The other real risk with this approach is that you can become paralysed in your decision-making waiting for the best rate possible which can vanish very quickly in fast-moving, highly volatile markets.
Then you have missed the bottom and might find yourself taking positions that are loss-making as they are worse than your costing / budget rate.
My general recommendation is to use a version of dollar cost averaging (DCA), where you take consistent positions on a regular basis to accumulate currency transactions at exchange rates appropriate for your business.
This doesn’t mean that the strategy should be overly complex, in fact when it comes to currency risk management often…
When we talk about simplicity, I mean that you should understand the products that you are using to affect the strategy. You should know the outcomes that will occur under various market conditions and the impact they will have on your profitability. In essence, undertake scenario analysis for each product as well as for your overall portfolio.
If the product you are considering cannot provide easily and objectively measurable outcomes, then it it’s likely that it’s not appropriate for the strategy you are looking to implement.
Often the best thing you can do to simplify your risk management approach is to
A successful currency risk management policy includes a lot of moving parts.
There are the underlying business activities; the currency pairs; the costing / budget rate; the maturity horizon; the selected counterparties; the industry and your position in it and of course the volatility in the market. (You can find an example of our policy template here.)
Having a plan means that you can articulate and anticipate the impact of the greatest of these risks on your business as well as consider your own risk appetite.
For many, market volatility is perhaps the most overwhelming aspect of currency risk management. But with a plan, you can measure the impact and take steps to ameliorate any potential negative outcomes.
To quote Benjamin Franklin: ‘If you fail to plan, you plan to fail”.
This will then remove any…
Another common comment from clients is that they believe the market will be trading at certain levels over the medium term.
Recently a client said:
“I think that the market will remain below 0.7000 unless a certain single event occurs.”
If only currency markets were impacted by one event at a time, it would make it so much easier to manage.
But the reality is that there are so many conflicting influences on exchange rates and with markets being forward looking, what is important today may not have a long-term impact on the direction of the currency.
Perhaps more importantly, just because you believe the event is important, doesn’t mean that the broader market views it the same way.
It can often be very difficult to see our own bias unless we are specifically looking for it and can appreciate the impact it has on our own decision-making process.
An approach such as this then allows you to
It’s very easy to get caught up in the emotion of fast-moving markets, especially when the moves have occurred overnight and you wake up to an exchange rate that’s more than 100 pips different than when you went to bed.
According to Bob Proctor, the difference between responding and reacting is:
“When you react to a situation, the situation is in control of you; when you respond to the situation, you stay in control”.
The most effective currency strategy, therefore, is one that is considered, easy to understand and implement, where the results are measurable and the risk of loss to your business is very small.
Adrienne Sartori
