Hedging Strategies & Solutions For Risk Averse Companies
Posted Under: News
The COVID pandemic impacted our economy significantly in 2020 and throughout most of 2021 – well, that’s kind of a redundant comment. As we begin 2022 we’re still affected by the pandemic although more so than ever in the last 24 months there’s signs of normality on the horizon but the only thing we can know for certain is that we don’t know what the future will bring.
One of the big effects from the last two years was the highly volatile markets, both downward and upward, and we’ve seen something similar during the early stages of 2022 largely because of the Russian invasion of Ukraine.
No matter what happens in the future, businesses need a plan to manage risk. Proactive businesses, with sound guidance and education from their FX partner, are implementing strategies and solutions that will help minimize risk and free up cash flow in their operations.
Hedging to Protect Your Business
Depending on the type of business you’re in, you may have situations where strategic hedging can protect you from rate fluctuations. One example is for businesses that have longer payment terms, such as 30, 60, 90 days, or longer. As an importer these payment terms might help your business with cash flow in the short term, but they must be managed correctly. FX rate fluctuations that move against you can cost your business substantially more than what was initially projected even if you invoice, or are invoiced, in USD.
If, as we recommend, you transact in the currency of your overseas counterpart you at least have control over hedging strategies. Importers who are invoiced in U.S. dollars often do not realize they have FX risk and, what’s more, it’s a risk that can’t be hedged even if you do realize it.
U.S. exporters, invoicing in dollars, run the risk of non-payment in the event the currency move adversely against the buyer which becomes more of a problem if shipment has been made and there’s no risk mitigation tool in place, such as a letter of credit.
What can you do? It’s not necessary to substantially change your business. By adding some hedging strategies and tools, you can continue to operate as normal, while protecting against the effects of wild rate fluctuations. Here are three common hedging strategies to look at.
Window Forward Contracts: Lock in Today’s Rates for the Future
The first strategy is a Window Forward contract. Many businesses use these like an insurance policy. A window forward contract allows you to lock in an FX rate today for a specified amount of currency to be delivered during a period (a ‘window’) in the future.
These are especially useful for businesses that forecast payables or receivables into the future and are not sure of the exact date the funds are either going to be paid (for an importer) or received (for an exporter). If a payment or receipt is falling due in 90 days from now, there can be a lot of fluctuation in the currency market during this period but by locking in a rate today you can plan for profits and cash flow while protecting against market volatility.
Multi-Currency Digital Wallet: No Need for International Bank Accounts
The second strategy is multi-currency accounts. These accounts allow you to buy currencies at a good rate and hold them in the account for future payments.
An important distinction is that Multi-Currency Accounts are not the same as international bank accounts. Like the name implies, they let you make or receive payments in multiple currencies. You can continue to hold the currency without exchanging it, so if the market rate goes against you, you can wait until it’s favorable again, or simply use the currency as it is.
Multi-currency accounts are less cumbersome to set up than international bank accounts and are a good option for cash-rich businesses with a surplus of liquidity. As an exporter you might want to collect a foreign currency and hold onto it until the time is right to convert into your home currency.
Market Orders: Trade Any Time the Market is Favorable
The third strategy is Market Orders They are useful for businesses with narrow margins, such as international lawyers or beverage importers, to use to trade currencies at favorable rates. Market orders let them take advantage of short-term fluctuations.
With a market order, you place an order to execute at a specified target rate for a currency, rather than on a specific date. If the market rate hits your specified rate, at any time of the day or night, an automatic trigger goes out to the market to buy (or sell) that currency for you.
The order executes automatically, allowing you to take advantage of news-based fluctuations that only last for a few minutes. The order will happen when the market meets your specification, even if you’re not watching, and they remain in effect either until they reach the expiration date that you set, or until you cancel them.
What’s Your Strategy?
As much as we all hope this wild ride is over soon, we don’t have any idea when the economy will return to normal. In order for your business to thrive through this volatility, you need to have a risk management strategy. If you ignore the current economy, you’ve actually implemented a strategy to ride the volatility wave, crossing your fingers for luck and hoping nothing bad happens.
Rather than expecting the worst and waiting for it to happen, you can be proactive and prepare by trying to use the market movements to your business’ advantage.
The tools above are just some of the strategies you can use to minimize risk, protect your profit margins, and better plan your cash flow. In addition to these tools, it’s important to note WHO is watching your back when you’re trading currencies. The experts at GreenShootsFX can help you select and implement the strategies to protect your business.