The Business of Currency Risk Management

Unlike most financial markets, currency markets move in relative terms.  They are impacted by the economic and political conditions and policies of one country compared to another as well as the observations of traders and commentators as to the successful (or not) implementation of these economic and political policies when one country is compared with another.

How then, do we take this information and use it to achieve the best possible result as it applies to the management of currency exposures?

In this paper we will discuss:

  1. How to define currency risk management;
  2. The application of Benjamin Graham’s investment approach to currency risk management; and
  3. Why it pays to take a disciplined approach to currency risk management

The first step is to define currency risk management.  Most organizations consider risk management to have the single goal of protecting business from the negative impacts of currency fluctuations.

However, with increasing volatility in financial markets as well as intensifying global competition and more challenging lending conditions, why would we confine ourselves to considering only potential currency losses when there are also the benefits and profits associated with favourable currency movements to consider.

Thus, we can define currency risk management as being:

as much about return enhancement as it is about risk reduction [1]

Despite its apparent differences to other financial markets, we can look to apply intelligent principles that have been successful in other financial markets.  Benjamin Graham is considered a giant within the investment community and his guiding investment principle can easily be applied to currency markets:

Investment is most intelligent when it is most businesslike [2]

By combining these two principles, we can consider the key elements of a businesslike approach to currency risk management as being:

  1. Sound and considered decisions based on careful analysis, experience and a disciplined focus on long term objectives;
  2. A clear strategy and methodology to ensure that the business stays on course and achieves its goals;
  3. Management that regularly and objectively monitors performance, critically assessing all aspects of the business to ensure its ongoing success; and
  4. While maintaining a keen focus on the underlying business, they will always be looking into the future to minimize surprises and take advantage of changes in the broader environment

The businesslike approach is about discipline and regular review based on business merit.  It is unconcerned with the overwhelming “noise” from the media, and daily fluctuations or market movements – which can be an enormous distraction for long term business owners.

[1] Lionel Martinelli, Professor of Finance, EDHEC Business School 24/08/11

[2] Benjamin Graham, The Intelligent Investor