Foreign exchange currency risk


In the wake of the Swiss decision to decouple its franc from the euro, Jonathan Pryor of Investec Corporate and Institutional Treasury provides key pointers on how not to be caught with a big foreign exchange loss.

1 Develop reliable cashflow forecasts
Pryor says: “Managing foreign exchange (FX) risk starts with the basic business practice of developing good cashflows. You need to know about your likely flows of currencies in the future. That doesn’t mean you have to know your future FX needs down to the last penny. With FX, nothing is certain but you should aim for an 80 per cent confidence level in your forecasts. As part of this process, you should ensure you’ve developed good relationships with your customers and suppliers. You need to understand the likely timings of their payments – do some customers pay regularly but late? – and the terms and conditions which affect payment. Of course, the more you can invoice in sterling, the more you will avoid FX risk. Some companies find that is possible, but not all. Basically, the more you can reduce currency risk, the better it is for business.”

2 Look beyond the obvious
“A lot of currency dealing takes place using spot (buying or selling a currency at its current exchange rate) or forward (agreeing to buy or sell in the future at an agreed rate) trades. These are fine in many circumstances but they may also mean you are missing out on benefits you could gain by using more flexible hedging tools. This would ensure you would buy or sell the currency you needed in the future at an agreed price, but would also allow you to reap some of the benefit from any favourable movement in exchange rates between the time you make the deal and the time you have to execute it. Essentially, this is a type of zero premium hedge – it protects you against adverse currency shifts while providing the potential to gain from favourable rate movements.”

3 Implement sound FX policies
“It is very important to recognise that currency markets can be cruel. You must never take them for granted. You need to take charge of FX policy in the company and make sure that everyone involved knows what the policy is and the guidelines for operating it. One key issue you need to consider when developing an FX policy is the exchange rate you have used in budgets. You need to make sure the rate is appropriate and the policy must ensure decisions on FX trading seek to protect that rate. Another issue is the price sensitivity for the products or services you are selling. For example, in clothes retailing, companies may budget substantially below the current market rate for the currency they use so they can hedge ahead for 12 months and cover themselves during both their spring and autumn seasons.”

4 Adopt a portfolio approach
“As with any business decision, it often pays to ensure that the eggs are spread around several baskets. In FX trading, that means using a variety of different approaches. For example, if you are planning to buy $1m (£665,000) in six months’ time, you could consider buying $400,000 on a flexible hedging solution, $400,000 on a fixed forward contract and leave $200,000 for the spot market when the time comes. The aim of the portfolio approach is to protect against risk while giving you the opportunity to benefit from favourable currency movements.”

5 Seek out a best practice partner
“The majority of small and medium-sized companies that need foreign exchange services will get them through one of the Big Four banks. But there are alternatives. The relationship you build is important. You need to be dealing with a currency dealer you can trust and with whom you feel comfortable – after all, some FX decisions may involve substantial financial trades. You should seek to work with a dealer who understands your business and who listens to what you are saying about your opportunities and concerns.”

Jonathan Pryor is head of FX dealing at Investec Corporate and Institutional Treasury

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About author

Peter Bartram

Peter Bartram

Peter Bartram is probably the longest serving contributor to Director, having first written for the magazine in 1977. He is a prolific freelance journalist with more than 4,000 feature articles published in dozens of newspapers and magazines. He has written 21 books, including biography, current affairs and how-to titles, and has recently launched a crime mystery website.

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