Hedging: information, insight and inspiration for the FX market

The UK’s decision to leave the European Union (EU) has left many corporates scrambling to review their business plans and ensure they are robust enough to withstand heightened volatility. Risk policies benefit all companies and it’s important to document exactly what is needed in order to mitigate financial loss. The following considers some of the best ways of introducing more options into hedging strategies to protect businesses from increased uncertainty in the foreign exchange (FX) market.

Evolve to survive: Creating a hedging policy is only the first part of treasury’s journey. Corporates need to devise an ongoing monitoring and evaluation process to maximise hedging options. These should be modified to account for internal company changes, as the financial landscape continues to evolve. Operating this way means that the treasury team is always proactively addressing potential risks and not passively ignoring issues, which could affect the financial objectives of the company’s core business.

Stick to your own: Each company’s hedging approach should be affiliated with its individual business undertakings and risk tolerance. While it can be tempting to follow the crowd and jump aboard new trends, it’s imperative to consider your options and decide whether the benefits received from hedging will justify the expenses.

The best way to do this is to determine what level of risk is acceptable to the company. Whether it is the overall cost of an option, or the lost profits from being on the wrong side of a futures contract, there is always an element of risk involved. This is the price for evading uncertainty in the financial markets.

Consider the structure of your hedge: The key is to plan your hedge structure, as there is no ‘one size fits all’ approach, and the type you choose will differ depending on the industry you are trading in.

A rolling strategy – presently the most popular approach – is suitable if you are trying to maximise the potential of cash flowing from already agreed-upon commercial transactions, and want time to adjust either your pricing or costs to compensate the effects of FX rate changes.

A layered strategy, can help even out the effect of FX rate changes on the company’s operating profitability. However, both these tactics can backfire if the pricing logic in your particular industry is highly volatile.

Take advantage of the low rates: Most large corporates have adapted to the persistently low-interest rate environment in some way. To some that means finding undervalued currencies in order to benefit from the eventual price appreciation. To others it means finding ways to shield portfolios from fluctuating forex prices.

Some investors choose to lengthen a hedge or move more debt to flexible rates. More investors tend to turn to this strategy as businesses come to accept the current nature of the market. Daring investors can simply short currencies they think will decrease in worth. Investors who use this strategy sell a currency for a predetermined price on a specific date in the future.

Utilise the latest trading software platforms: Some forex brokers now offer Meta Trader 5 (MT5) multi-asset trading platforms that come with a hedging option. Such software programmes can be more beneficial to maximise hedging opportunities, because they provide investors with extra flexibility and control over their trades. They also allow an investor to open multiple buy/sell orders simultaneously in real market time and provide additional protection to better shield themselves against losses in volatile markets, whilst still fortifying a general strategy.

Look to the future: One method to safeguard yourself from financial decline is to consider a currency futures contract – an agreement which provides the investor with the right to buy or sell a currency at a fixed exchange rate at a specified date in the future. One part of the agreement party agrees to buy the future at a specified exchange rate and the other agrees to sell it on the expiry date.

Such contracts can be used to hedge against foreign exchange risk and provide protection against exchange rate fluctuations. They can also allow the holder to fix prices for import and export purposes. Despite such advantages, it is worth noting that futures contracts come with expiration dates. Even if you have established fixed rates, as the expiration date approaches these can become less attractive and sometimes – if not managed correctly – a futures contract can expire as a worthless investment.

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