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Global currency markets have been experiencing larger than binary trade exchange rates budget balances and interest rates 2015 swings of late and with greater frequency, CFOs are citing foreign exchange volatility as a factor when companies miss their earnings targets. Increasingly, business leaders are looking to implement hedging programs to mitigate foreign exchange rate risk and create more certainty and stability within their organizations. Schumaker, vice president and foreign exchange advisor in International Banking at Bridge Bank.
Foreign exchange FX hedging gives treasurers the ability to protect cash flow and profits by locking in binary trade exchange rates budget balances and interest rates 2015 rates of exchange.
This is done for balance sheet items such as payables binary trade exchange rates budget balances and interest rates 2015 receivables, as well as cash flow items such as forecasted sales and expenses. Smart Business spoke with Schumaker about some of the key components of a successful hedging program.
Which tools can companies use as part of a hedging program? Working closely with a trusted banking partner, an organization can easily gain access to the necessary and appropriate hedging tools available in the marketplace to mitigate their currency risk. There are myriad FX hedging instruments which can be employed to lessen foreign exchange rate risk, from basic FX spot transactions to range binary options.
This will protect company margins from unfavorable variations in the currency exchange rate from inception to settlement date. The price of the forward versus spot is adjusted marginally, accounting for the interest rate differential between the currencies involved given the duration. With the nominal rate differentials between the U. This tool can be particularly helpful when you have expected cash flows with nonspecific settlement dates.
What hedging strategies are used by global companies? Many companies choose to execute all of their hedging for the entire year in one fell swoop prior to the beginning of their fiscal year.
While this static hedging strategy provides companies the opportunity to set budget rates for the year, it is also limiting. The practice of establishing cash flow hedges at the start of the year lacks flexibility as opportunities to react to FX forecast changes and favorable market entry points are largely lost. A better method is often the layering of hedges. This dynamic approach realizes the correlation between time and risk; with longer dated exposures carrying a greater degree of uncertainty with respect to exchange rates.
As an example, one might consider hedging shorter term commitments, perhaps out to six months, at percent while commitments from six months to one year may have a hedge ratio of 75 percent and exposures beyond a year could be treated with yet a lower hedge ratio.
As time progresses, hedges can be adjusted to fit their appropriate ratio for the new time period. These are but a few key hedging concepts.
The areas of netting, derivative accounting and effectiveness testing are important topics which demand attention.