Foreign-exchange risk and market volatility
The currency market is the second most important financial market in terms of volume. Exchange rates are negotiated over the counter, in many cases according to barely predictable elements: interest rate spreads, trade exchanges, political stability… This results in erratic movements, reinforced over the last few years by the importance of speculative positions, which are estimated at three-quarters of all trades.
Due to volatility, foreign-exchange risk has become a key challenge for treasury and financial departments. A company with an international network is required to import and export or to invest in either local currencies or in USD. It will be therefore essential to monitor the exchange rates in EUR.
In fact, the currency exchange rate may fluctuate between the trading date and the cash-flow date and an unfavourable movement could compromise the profitability of the transaction. This is what is called foreign exchange risk.
Foreign exchange risk management is thus fundamental but it is often considered to be too complex, expensive and time-consuming. Nonetheless, with a simple, tailored monitoring activity, it can neutralise currency fluctuations and bring the following benefits:
- Securing marketing margins
- Optimising cash-flow estimates
- Avoiding speculations on exchange rate trends (or positioning the company in an equivalent situation)
The decision to hedge foreign exchange risk requires an accurate analysis of the exposed underlying (for example, a contract, the budget or a period) and the choice of the right hedging instrument.
It is therefore necessary to identify all risks: some may be hidden, some neutralised… Then, it is important to define an appropriate framework for all stakeholders, in compliance with accounting standards (IFRS for example).
Currency hedging for companies
There are various hedging instruments that allow to smoothly and effectively manage this type of risks, applicable to either sold or bought currencies. The instruments below are listed according to their complexity, from the simplest to the most structured ones:
- vanilla options
- option collars
- flexible forward
- knock-in and knock-out barrier options
The simplest solution, which is most companies’ choice, is a forward transaction that ensures a sell or buy rate on a given future date. In this case, the company fully secures marketing margins. However, economic rivalry may oblige companies to opt for other strategies, therefore currency options are often considered as a solution.
Such a framework requires regular revisions in order to always benefit from the best hedging according to specific currency trends and exposed business volumes.
Fairways FX: a solution designed to unleash operational and financial gains
With Fairways FX, you have access to first-class technology and advice from experts in order to consolidate all the information related to your positions and to optimally hedge foreign exchange exposures. We provide assistance with decision-making, real-time market data and management tools to ensure that you get the best deal when making your foreign exchange transactions.