Analysing FX exposures to understand risk

Companies managing foreign currency programs to mitigate cash flow and balance sheet risk need solid analytical tools to track that risk and understand its potential impact. For smaller companies or those with limited foreign exchange (FX) exposure, Excel or other homegrown tools can help provide a basic overview; but as the program grows (with more globally distributed entities, more currencies with exposures, and more derivatives layered into the risk management program) these simple solutions often lack the analytical tools to answer the crucial questions confronting the FX manager. Whether responding to questions from other stakeholders or seeking to monitor the effectiveness of their risk management processes, treasurers and FX managers in growing companies with expanding foreign currency exposures want solid analytics to support their decision making.

In working with large and small companies around the world, three primary questions come up that require more substantive analytical tools to understand.

How accurate are my revenue and expense forecasts?

First, as companies grow and add overseas subsidiaries with revenue and expense forecasts to be hedged, FX managers need to ask how accurate these forecasts are each period. If some local treasurers consistently miss their forecasts – over-estimating expenses and under-estimating revenues for example, or submitting forecast numbers that widely miss the actuals – then knowing how to hedge these projected cash flows presents real difficulties.

“Without a tool to compare forecast trends for specific entities with the actual booked revenue and expense results can leave even a diligent FX manager with few options”

Hoping local treasurers make appropriate hedge requests or trying to predict how far off the submitted numbers might be can be a nightmare, but without a tool to compare forecast trends for specific entities with the actual booked revenue and expense results can leave even a diligent FX manager with few options. When under hedging can leave significant currency risk on the table and over hedging can have major accounting implications, FX managers need accurate information at their fingertips. Solid exposure management systems must provide some kind of progression reporting to show how forecasts have evolved over time and some tool to compare those evolving forecasts with the actual numbers once those are known.

What is my current hedge position?

Companies with expanding FX programs not only want to assess the accuracy of their forecasts; they also need to know their current hedge position and how it compares with relevant metrics. Before layering on additional hedges FX managers need to know how hedged they are now – by currency pair, at individual subsidiaries, and across the company; they need to compare their current hedge ratios with policy targets aligned with their risk tolerance; and they need to know how their average hedge rate compares with market rates, scenario rates, and budget rates reflecting targets they want to hit. Strong risk management tools provide the insight and analytics required to answer these questions and guide treasurers into the best decisions on mitigating their currency risks. Having this information at their fingertips provides treasury leaders the insight they need to analyse the effectiveness of their hedging programs.

Why am I experiencing FX gain/loss?

Useful exposure management systems provide key analytics around forecast accuracy and hedge policy metrics, but even then many corporate treasurers face a third vexing question: Why am I experiencing FX gain/(loss) when I thought I hedged my balance sheet risk? There can be many contributing sources to unexpected FX noise on the balance sheet; the most common factors include mismatches between balance sheet hedges and the underlying exposures, lack of alignment on the timing of when exposures are hedged and the period over which they are remeasured, and differences between balance sheet rates used for remeasuring exposures and valuation rates used for revaluing derivatives. However, whatever the reasons for the FX gain/(loss), treasurers want quick insight into these factors and analytics to support enhanced risk management practices to decrease this volatility. An excellent exposure management platform should provide tools to enable FX managers to conduct this analysis and present their findings quickly to other stakeholders. The ability to explain FX results on a balance sheet program is crucial for effective treasury leaders.

“Forward-thinking risk management tools must evolve to address the emerging questions of treasury leaders as markets change”

While these three questions represent the most frequently expressed concerns of treasurers and FX managers at companies with growing foreign currency exposures, new challenges regularly confront treasury leaders seeking to analyze their FX risks. What impact would theoretical hedging strategies have at mitigating risk if the company instituted a new policy? How do the different costs of hedging emerging market currencies influence the overall effectiveness of hedging these risks – and when do the costs outweigh the expected benefits? What is the most effective mix of currencies to hedge to achieve the highest level of risk reduction for the lowest administrative burden and trading cost? What might happen to the value of my derivative portfolio under shocked market conditions? Forward-thinking risk management tools must evolve to address the emerging questions of treasury leaders as markets change; that means you want to work with a company that understands both treasury technology and inter-related capital markets.

As companies expand their FX programs, many find that the simple tools that served them adequately at the beginning no longer offer the insights and analytics needed to answer vital questions. A solid risk management tool can put these insights at your fingertips, allowing you to quickly see for yourself and present to other stakeholders what the risks are that you confront. That way you can determine the most effective ways to face or mitigate those risks.


If your tools are no longer sufficient and you are looking for deeper insight, talk to Chatham Financial about how our risk management platform ChathamDirect can provide you with the effective analytical tools you need.

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