4 Steps for an Effective Hedging Strategy

Last Updated: 23 Jun 2021

Currency exchange rates are volatile and can add extra risks in doing business with foreign companies, especially in today's economic climate. If exchange rates are not fixed when business deals are finalized with international customers, you open your business to currency risk that creates added costs, impacts profits, and can reduce your cash flow.

Disregarding Currency Risk is a Bad Business Practice, No Matter the Size of your Company or the Industry you Work in.

You do not have to put yourself at the mercy of the currency markets. Understanding market dynamics and putting customized hedging tools in place, such as Forward Contracts and Market Orders, is the foundation of a sound FX strategy.

1) Identify what Exposure your Business is Susceptible to

If you purchase, invoice, work with vendors, or run a business that incorporates overseas payroll using foreign currency, your business is exposed to risk and profit loss. Your operating budget and plans for business growth depend on acting on the known projections from solid budgeting practices.

Financial planning and expertise are crucial when it comes to managing the risks in currency volatility. You can estimate the income your foreign invoices will generate over the upcoming 6-12 months, for example, but you also need to assess the risk of your cash flow against currency exchange rates and be able to fully understand how that income could be impacted so you can plan and budget more efficiently.

2) Calculate your Exposure

Once you understand your business's exposure to currency volatility along with a view on your overseas clients’ currency costs when it comes to your invoicing, you can make an informed decision on your business's potential FX risk level.

Ask yourself:

a) What is your target or ideal FX rate that will keep your business within acceptable budget projections supporting your profit margins?
b) How can currency hedging help manage business risk?

In order for you to accurately determine the amount you should hedge for your business; you must first calculate future cash flows in foreign-denominated currencies. If you are sending and receiving money in particular foreign currencies, you have the option of applying netting (aggregating obligations and receivables to offset positions and reduce risk) to lower your hedging needs on a particular currency.

3) Choose the Right Hedging Tools for your Business

• Forward Contracts

A Forward Contract allows you to purchase a certain amount of foreign currency at a predetermined exchange rate, allowing you to lock in the exchange rate effective at the moment, guaranteeing the cost of payables or receivables irrespective of market volatility.
Forward contracts can create a currency budget benefit as they do not involve any upfront payment and can be tailored both to a particular amount as well as a product delivery date range so you can plan your budgets accurately.

• Market Order

A market order allows you to request a foreign exchange conversion for a specific amount at a targeted exchange rate. When it comes to Market Orders, there are two different types you can choose from depending on what you need for your business. The first one is Limit Orders. Limit Orders allow you to target exchange rates better than the current market rate, and the second option is Stop loss orders which protect your business against market volatility by giving you the ability to set a worse-case exchange rate that your business can tolerate and is willing to commit to.

4) Lock in your Rate

At the end of each year, you need to set your budget rate for any currency risk that may occur in the upcoming fiscal year. Predicting the direction of the exchange rate is not a realistic or safe practice so leveraging hedging solutions like Forward Contracts will aid in your financial planning practices.

Through Forward Contracts, you can lock in your budget rate early in order to hedge against unpredictable FX movements which can negatively impact your cash flow and financial performance, allowing you to keep your business on track throughout the year.

MTFX Hedging Strategies will Protect your Business Across Borders

Learn more about how our risk management strategies can help you retain your local customers and expand your international business. Contact one of our market experts and we will show you how foreign exchange currency risk management strategies can protect your business while increasing profits.

Open an account with MTFX today and start enjoying fast, cost-effective, and convenient international money transfers.

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