There are many ways to manage currency exposures. Some give you long term fixed rate outcomes so that your business has complete certainty as to the exchange rate. Other approaches simply take the prevailing rate of the day with the hope that if the market moves adversely, this can be either absorbed into profit margins or passed on to consumers.
So, this begs the question:
Are all approaches to the management of currency risks appropriate and if not, what does a sound currency risk management strategy look like?
Ideally, any currency risk management approach should allow you to hope for the best and prepare for the worst. In our parlance, this is protect your business from unfavourable movements in the exchange rate while allowing it to benefit from favourable ones.
Key to achieving success in this endeavour is to have a comprehensive knowledge of the currency exposure profile with particular emphasis on events that can significantly alter that profile by either making it materially larger or smaller. This then provides the foundation on which to build the currency strategy. The more detailed the knowledge of your exposures the more sophisticated your potential currency strategy can be.
Armed with this information, we can then consider the following:
What is the purpose of our currency risk management strategy?
The answers may not be different from those I suggested above. You may want:
- Certainty as to a long-term exchange rate; or
- Being able to achieve the best rate on the day.
But why not take best of both worlds? We want our clients to be able to use their currency positions when the hedge rates are better than the current market rates while still being able to use a more favourable spot rate if that is available. Over the long term, this type of approach will generally result in exchange rates that are superior to a long-term fixed rate and very regularly better than the average spot rates over a medium to long term time frame.
Advantageous currency outcomes and therefore, a sound risk management programme, have a very real role to play in the attainment of a business’s competitive advantage particularly as it can provide an additional revenue source that can support lower product margins or provide cashflow for other uses. In this way, the currency risk management programme contributes to a business’ ability to staying ahead of its competition by providing lower prices or greater benefits and services that justify higher prices.
This should not be confused with speculating on exchange rates with a view to generating a profit stream. Rather our goal is to support the underlying business activities of each client by creating an appropriate risk management strategy such that it that can outperform both fixed rate hedging without sacrificing the opportunities that arise from highly volatile markets.