A look at how FX hedging can help you mitigate foreign currency risk
Global currency markets have been experiencing larger than normal swings of late and with greater frequency, CFOs are citing foreign exchange volatility as a factor when companies miss their earnings targets. Increasingly, business leaders are looking to implement hedging programs to mitigate foreign exchange rate risk and create more certainty and stability within their organizations.
“For global businesses, the hedging of foreign denominated cash flows is vital to avoiding earnings swings,” says William R. Schumaker, vice president and foreign exchange advisor in International Banking at Bridge Bank. “Companies that maintain ineffective hedging programs, or those that do not hedge at all, unnecessarily expose themselves to financial risk.”
Foreign exchange (FX) hedging gives treasurers the ability to protect cash flow and profits by locking in certain rates of exchange. This is done for balance sheet items such as payables and receivables, as well as cash flow items such as forecasted sales and expenses.
Smart Business spoke with Schumaker about some of the key components of a successful hedging program.
Which tools can companies use as part of a hedging program?
Working closely with a trusted banking partner, an organization can easily gain access to the necessary and appropriate hedging tools available in the marketplace to mitigate their currency risk. There are myriad FX hedging instruments which can be employed to lessen foreign exchange rate risk, from basic FX spot transactions to range binary options. But you don’t need a sledgehammer to kill a gnat; future foreign currency exposures can be effectively managed with a simple FX forward contract. It is essentially the same as a standard spot trade, except that instead of the deal settling and funds being made available in two business days, settlement can be pushed forward to a predetermined future date of the customer’s choosing and with an exchange rate locked in.
This will protect company margins from unfavorable variations in the currency exchange rate from inception to settlement date. The price of the forward versus spot is adjusted marginally, accounting for the interest rate differential between the currencies involved given the duration.
With the nominal rate differentials between the U.S. and, for example, Europe, Canada or Great Britain, forward hedging costs in these currencies are relatively flat. A variation of the standard forward is the ‘window forward’ contract. Offering more flexibility, the window forward allows the holder to choose a ‘window’ of time in which to execute a future foreign currency conversion. This tool can be particularly helpful when you have expected cash flows with nonspecific settlement dates.
What hedging strategies are used by global companies?
Many companies choose to execute all of their hedging for the entire year in one fell swoop prior to the beginning of their fiscal year. While this static hedging strategy provides companies the opportunity to set budget rates for the year, it is also limiting. The practice of establishing cash flow hedges at the start of the year lacks flexibility as opportunities to react to FX forecast changes and favorable market entry points are largely lost.
A better method is often the layering of hedges. This dynamic approach realizes the correlation between time and risk; with longer dated exposures carrying a greater degree of uncertainty with respect to exchange rates. As an example, one might consider hedging shorter term commitments, perhaps out to six months, at 100 percent while commitments from six months to one year may have a hedge ratio of 75 percent and exposures beyond a year could be treated with yet a lower hedge ratio.
As time progresses, hedges can be adjusted to fit their appropriate ratio for the new time period. No matter how you implement it, this ‘rolling’ hedge structure should see more stable hedge results and provide a smoothing effect on forward hedge rates over time versus a single hedging event.
These are but a few key hedging concepts. The areas of netting, derivative accounting and effectiveness testing are important topics which demand attention. Nevertheless, it’s certainly worthwhile to consider developing a hedging program to protect against adverse FX movements.
Recent NewsBridge Bank Extends $12,000,000 Credit Facility to EllevationAlex Tsarnas Joins Bridge Bank Team to Lead Its Newly Established Banking Group, Business Escrow ServicesBridge Bank Expands Capital Finance Group Adding Several New PositionsBridge Bank Extends $25,000,000 Credit Facility to Health-AdeCloudBolt Announces $35 Million in Series B Funding
Recent InsightsCytoSorbents Delivers Technology to Calm the StormMasterClass Streams Inspiration When It's Needed MostLeaving LIBOR: 4 things to know about changing interest rate benchmarksRegional Intelligence Report Series: California OutlookRegional Intelligence Report Series: South Bay Outlook
We would like to welcome Alex Tsarnas to the Bridge Bank team. Alex will be leading our newly established banking group, Business Escrow Services. Read our press release to learn more. westernalliancebancorporation.com/bridge-bank-ho… - 3 days #mergersacquistions #privateequity #bridgebankIn observance of Presidents' Day, all Bridge Bank offices will be closed on Monday, February 15. #PresidentsDay pic.twitter.com/6eMQQeNJipOur team of asset-based lending professionals is growing! Read more about it here: westernalliancebancorporation.com/bridge-bank-ho… - 2 weeks 1 day ago #assetbasedlending #bridgebankOur Life Sciences Group recently provided a Term Loan to Bolder Surgical, a medical device company focused on commercializing mini-laparoscopic surgical devices aimed at improving and enabling laparoscopic procedures for pediatric patients. #lifesciences #medicaldevices pic.twitter.com/hKgRzmVhaZ“Not everybody can be famous but everybody can be great because greatness is determined by service… You only need a heart full of grace and a soul generated by love.” ~ Dr. Martin Luther King Jr. In observance of MLK Day, all Bridge Bank offices will be closed on Mon. 1/18. #MLK pic.twitter.com/rBAo4INJXBOur Technology Banking group recently provided a growth capital term loan to Funraise, a software company that provides a state-of-the-art fundraising platform, saving nonprofit organizations time and resources spent on data management. pic.twitter.com/StETyssfLeOur #Technology Banking group recently provided a credit facility to @DrinkHealthAde, an organic beverage company. To learn more details, read our press release. westernalliancebancorporation.com/bridge-bank-ho… - about 2 months 3 weeks ago pic.twitter.com/0eWWI16N08Our Technology Banking Group at Bridge Bank recently provided a credit facility to CloudBolt Software, an enterprise leader in cloud management and integration solutions. Visit westernalliancebancorporation.com/bridge-bank-ho… - about 3 months 1 week ago to learn more details. pic.twitter.com/8fzjGbAL6BWe honor all of the veterans who have served our country. Thank you. #HappyVeteransDay REMINDER: In observance of Veterans Day, all Bridge Bank offices will be closed on Wednesday, November 11. pic.twitter.com/IfoGP8ecCAWe would like to welcome Jon Berry to the Bridge Bank team! Jon supports our Technology Banking group and will be based in Austin. Read our press release to learn more. #technology #banking #Austin #Texas westernalliancebancorporation.com/bridge-bank-ho… - about 3 months 2 weeks agoIn observance of Columbus Day, all Bridge Bank offices will be closed on Monday, October 12. pic.twitter.com/BtX52D5RTPWe wish everyone a safe and relaxing #LaborDay holiday weekend. REMINDER: In observance of Labor Day, all Bridge Bank offices will be closed on Monday, September pic.twitter.com/09SIuoO7XGOur Technology Banking Group recently provided MIVA, an #ecommerce #software and service provider, with a credit facility. Read our press release to learn more: westernalliancebancorporation.com/bridge-bank-ho… - about 5 months 3 weeks ago #technologybanking pic.twitter.com/OUj49RdD5VOur Life Sciences Group is pleased to announce an upsized term loan for Fennec Pharmaceuticals, a pharmaceutical company focused on the development of PEDMARK™ (a unique formulation of Sodium Thiosulfate) for the prevention of ototoxicity from cisplatin in pediatric patients. pic.twitter.com/zrH2JslA27Stay safe as you celebrate #IndependenceDay. REMINDER: In observance of Independence Day, all Bridge Bank offices will be closed on Friday, July 3.” pic.twitter.com/EFLG0KJ3u5Our Technology Banking Group is pleased to announce that they have recently provided a credit facility to aPriori Technologies, a leading provider of design for manufacturability and cost (#DFM/DTC) solutions. #computersoftware #technology #banking pic.twitter.com/PuTYcnKMttLast chance to join us for what is sure to be one of the most interesting economic discussions in the history of this long-standing event, featuring economist, Dr. Christopher Thornberg & SJ Deputy City Manager, Kim Walesh Register now! #sjsueconsummit event.on24.com/wcc/r/2316585/… - about 9 months 6 days ago pic.twitter.com/sqxWOiCvsZThis Memorial Day, we honor and remember those who lost their lives while serving our country. REMINDER: In observance of Memorial Day, our offices will be closed on Monday, May 25. pic.twitter.com/Ae97NsXsDaThere’s still time to join us for what is sure to be one of the most interesting economic discussions in the history of this long-standing event, featuring keynote speaker and noted economist, Dr. Christopher Thornberg. Register today! #sjsueconsummit event.on24.com/wcc/r/2316585/… - about 9 months 1 week ago pic.twitter.com/TWo0MiGjijJoin us for what is sure to be one of the most interesting economic discussions in the history of this long-standing event, featuring keynote speaker and noted economist, Dr. Christopher Thornberg. Register today! #sjsueconsummit event.on24.com/wcc/r/2316585/… - about 9 months 1 week ago pic.twitter.com/pdtYAF2XrDBridge Bank’s #LifeSciences Group is proud to partner with iCAD, a global #medical #technology leader providing #innovative cancer detection and therapy solutions. bridgebank.com/lifesciences - about 9 months 3 weeks ago pic.twitter.com/oPIrnYlOTjCongratulations, @ArcturusRx on your big announcement and the accomplishments you and your team are achieving as you work on a vaccine for COVID-19. #COVID19 #coronavirus #vaccines #LifeSciences ir.arcturusrx.com/news-releases/… - about 10 months 2 weeks agoOur #LifeSciences team is proud to provide Valencell, a company that transforms the science of wearable #biometrics to enable impactful #health outcomes, with the creative #bankingsolutions they needed. pic.twitter.com/XCmNJpaVuvOrganizations of any size are at risk of data breaches or other types of #cybercrime, but you can defend yourself against #fraud by knowing the dangers and implementing best practices whether you’re #WFH or the office. #fraudawareness #cybersecurity westernalliancebancorporation.com/bridge-bank-ho… - about 10 months 3 weeks ago pic.twitter.com/bzKAaLYRGPLearn more about the several key initiatives we’re focused on right now. #WeAreInThisTogether #covid19 #CoronaVirus westernalliancebancorporation.com/~/media/pdfs/b… - about 10 months 4 weeks ago pic.twitter.com/ssOjI7DGnXCybercriminals are using concerns about COVID-19 to perpetrate scams – learn how to defend your organization against these scams and best practices to keep your business safe. #fraudawareness #cybersecurity #fraud #cybercrime #fraudprevention #WFH westernalliancebancorporation.com/bridge-bank-ho… - about 11 months 2 days ago pic.twitter.com/kZo07GPhVvBridge Bank is a proud sponsor of #FVCC2020, Florida’s largest statewide #VentureCapital Conference. pic.twitter.com/9l2lOPceVROur #LifeSciences Group helped @alluriontech create a customized #financialsolution to support their rapid growth. Allurion Technologies is a #medicaldevice company and creator of the Elipse™ Balloon, a breakthrough product in weight-loss technology. pic.twitter.com/OS96djwOA8Our Life Sciences Group welcomes Derek Scalf. Also, find out how to meet with our entire team during #JPM2020 westernalliancebancorporation.com/bridge-bank-ho… - about 1 year 1 month agoWe wish you peace, joy, and prosperity in the new year! #happynewyear2020 NOTICE: All Bridge Bank offices will be closed on Wednesday, January 1st in observance of New Year's Day. pic.twitter.com/B8efpD0GlQREMINDER: In observance of Christmas Day, all Bridge Bank offices will be closed beginning at 3 pm on Christmas Eve and remain closed through Christmas Day. pic.twitter.com/TIP2gGLliHOur Southern California Capital Finance Group is proud to announce their most recent relationship with H Code Media, Inc., the leading technology platform offering a full suite of integrated marketing and media solutions for the U.S. Hispanic market. pic.twitter.com/n9NyyS7odbBridge Bank extends $4MM credit facility to H Code Media, Inc., the leading technology platform offering a full suite of integrated marketing and media solutions for the U.S. Hispanic market. westernalliancebancorporation.com/bridge-bank-ho… - about 1 year 2 months agoWe honor all of the men and women who have served. Thank you. #VeteransDay pic.twitter.com/EpGp17Q39kThankfully #technology works its magic on our electronic devices. We wish you the best of luck changing the clock on your microwave! #daylightsavings pic.twitter.com/9VVKbEyeYgOur Technology Banking Group is proud to announce their most recent deal with Zipari, a growth-stage #technologycompany that offers the first and only consumer experience platform built specifically for #healthinsurance. pic.twitter.com/ImSLIn2TW5Bridge Bank Extends $10MM Growth Capital Term Loan to Zipari prnewswire.com/news-releases/… - about 1 year 4 months ago