exchange risk affects companies in myriad ways: through overseas
transactions, the conversion of one currency to another on the balance
sheet or changes in a company's competitive position in the market.
Whatever the source, the consequences can be far-reaching, reducing
profits and straining relationships with partners and customers. How
will a 10 percent swing in foreign exchange rates affect your earnings?
How about 20 percent?
Despite the growing case for hedging, even the most experienced CFOs
often hesitate to recommend a foreign exchange strategy to their boards.
Some believe hedging is a form of speculation. In the case of foreign
exchange, it is not. Hedging actually reduces risk by revealing the
underlying expense or revenue. Others believe they are immune because
they price and report in dollars. They are not. Anytime a cross-border
transaction takes place, one party inherits the foreign exchange risk.
Still others assume that foreign exchange movements even out over time.
They do not. The Canadian dollar is now at levels last seen when Jimmy
Carter was president. It's not enough to hope the market will move in
The right mix of hedging products — from spot contracts and currency
swaps to over-the-counter options — can minimize the probability of a
business disruption by offsetting the exposure of hedged items. As the
Federal Reserve Bank recently observed, "Strongly governed companies use
derivatives more when the degree of currency exposure, expected
financial distress costs and growth opportunities are higher." When
implemented responsibly, a successful foreign exchange hedging strategy
can go beyond mitigating foreign exchange risk to actually improving the
bottom line. Hedging a benchmark exchange rate can be a valuable tool
for an overseas sales force by removing foreign exchange risk from the
pricing equation and allowing the company to negotiate from a more
competitive position when bidding for overseas contracts. For public
companies, hedging creates shareholder value by increasing earnings
predictability. Simply put, foreign exchange hedging helps companies
compete more effectively in an increasingly global market.
Although putting a hedging strategy in place is less complicated than
many CFOs expect, there's more to it than simply calling up your
friendly neighborhood trader. A diligent company will follow these six
steps to get started:
- Collect data about your business to develop a clear picture of your
foreign exchange exposure. Review transactions with overseas
contractors, vendors and customers, as well as foreign currency invoices
and monthly transfers.
- Determine the ways in which foreign exchange hedging can benefit
your current and future business plans.
- Plan how you might work with a trusted foreign exchange advisor to
set up a hedging strategy and monitor its risks and results.
- Establish a foreign exchange "policies and procedures" document to
formalize your strategy your strategy — and do this before you begin to
expand your business, rather than after the fact.
- Select the right financial tools for business. Currency accounts,
forwards and options can all play an important role in hedging FX
- Work closely with accounting, senior management, and other financial
team members to ensure the strategy you select is appropriate. Make
sure the strategy matches the companies risk reward objective in your
foreign exchange policy.
Foreign exchange risk is a reality in today's global business
environment. Accordingly, companies need to plan for volatility. Finance
teams need to bring viable foreign exchange solutions to their
management. Do not let FX exposure prevent you from making your numbers.
The views expressed in this column are solely
those of the author and do not reflect the views of SVB Financial Group,
or Silicon Valley Bank, or any of its affiliates. This material,
including without limitation the statistical information herein, is
provided for informational purposes only. The material is based in part
upon information from third-party sources that we believe to be
reliable, but which has not been independently verified by us and, as
such, we do not represent that the information is accurate or complete.
The information should not be viewed as tax, investment, legal or other
advice nor is it to be relied on in making an investment or other
decisions. You should obtain relevant and specific professional advice
before making any investment decision. Nothing relating to the material
should be construed as a solicitation or offer, or recommendation, to
acquire or dispose of any investment or to engage in any other
Foreign exchange transactions can be highly risky,
and losses may occur in short periods of time if there is an adverse
movement of exchange rates. Exchange rates can be highly volatile and
are impacted by numerous economic, political and social factors, as well
as supply and demand and governmental intervention, control and
adjustments. Investments in financial instruments carry significant
risk, including the possible loss of the principal amount invested.
Before entering any foreign exchange transaction, you should obtain
advice from your own tax, financial, legal and other advisors, and only
make investment decisions on the basis of your own objectives,
experience and resources.