Managing Foreign Exchange Risk Is Essential For Hedging?

Managing Foreign Exchange Risk Is Essential For Hedging?

26 Nov 2019 12:29 PM

Foreign exchange risk is a financial risk which exists when a home currency is converted into another during the transaction. The unfavorable currency movements lead to a lower value of assets which are quoted in the domestic currency in the international markets. All corporates dealing with international markets are exposed to foreign exchange risks. The foreign exchange markets fluctuate due to many factors which are beyond the control of a company and thus these risks have to be incorporated while quoting prices to the clients and suppliers overseas.

Factors such as the recent US China global trade war or geopolitical uncertainties due to UK Brexit or Pakistan’s terror attack on India etc lead to high fluctuations in the currencies and may trigger stop loss levels for high volume currency pairs. Thus dealing in currency is highly risky and calls for an expert who tracks the foreign exchange markets on a regular basis to assist corporates to manage them. The revenues earned abroad will be affected with the currency risks. Already the uncertainties due to global trade war have created havoc in the currency markets. Though some risk aversion assets like Gold, Japanese Yen, Swizz Franc have seen appreciation during such times, but in all it calls for better foreign exchange risk management.

Why manage currency risk?

Managing currency risk helps protect the cash flow both inflow and outflow along with the profit margins, which in turn helps to assimilate financial budgeting and forecasting. Once the cash flows are determined, it becomes easier for plan for the future and work around the costing accordingly.

With clarity around finances, the corporate is in a better position to understand the borrowing capacity especially when expanding from growth perspective.

Every change in currencies, affects the balance sheet which is turn affects the health of the corporate. Thus business benefits are many for effectively managing the foreign currency risks.

How does one go about managing forex risk?

The first step towards managing forex risk is to create a foreign exchange policy within the corporate. The corporate policy helps in understanding the risk which the company is ready to take along with key benchmark levels for all transactions. Once the cash flows is in place, the process of understanding which currency fluctuation will affect which portion of the balance sheet is important as many factors are in place at one go. Periodic reviewing of the operating cycle helps in pin pointing the risks areas. While negotiating with the clients (be it buyer or seller), the risk exposure before the execution of the transaction should be understood. Thus the level of hedging can be determined accordingly. Transaction risks occur due to time gap between the commitment of the contract and the actual cash flows. More often than not, these risks are easier to manage as they can he hedged using financial derivative instruments. Thus understanding the quantum to hedge is important. Formulating a corporate policy is easy but to review it periodically is the key with the ever changing foreign exchange markets.

Are corporates managing FX risk?

Keeping above factors in mind, how ready is a corporate to deal with the foreign exchange risks? Recent surveys shows about two third of senior financial officers have seen lower earnings due to un-hedged currency risks in the last two years, while more than half of them confessed that managing forex risk took away the larger proportion of their time. About 50% of them agreed that their organization is not equipped to deal with currency risks. Often, outsourcing risk advisory plays the trick in getting benefits of both reducing costs and effective risk management.

Most small and medium enterprises are often not advised on foreign exchange risks by their banks and on top of that also charge them heavy bank margin. Attaining transparency in the initial step towards managing risk in today’s scenario. Outsourcing the forex advisory service helps the corporate to focus on their core strength and making growth their primary line of action.

Myforexeye has been able to reach out to many SMEs and MSMEs to make their forex vertical a profit center instead of a cost center earlier. Rather than targeting the peaks or troughs as the case may be (exporter or importer), the protection of benchmarks are in focus. For a corporate safeguarding the costing takes center stage. Traders who are ready to take higher risk are advised accordingly. Managing both risks are important. The experienced advisors watch the foreign exchange markets through the trading hours to watch both fundamental and technical factors which move the currency markets. Periodical market news and insights are shared with clientele to keep them abreast of all happenings be it market related or political or technical.

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