Foreign Exchange Risk Management: Choosing The Best Strategy To Secure Your Profitability
Desjardins has published its latest guide on foreign exchange risk management online. The purpose of this guide is to remind the importance of having an appropriate foreign exchange risk strategy for any company trading in a currency other than the Canadian dollar.
More and more companies are doing business in abroad, and there is every reason to believe that the trend will be further accentuated with the coming into effect this fall of the Comprehensive Economic and Trade Agreement (CETA) between Canada and the European Union (EU). To take advantage of the resulting opportunities, importing or exporting companies must guard against exchange rate fluctuations, otherwise their financial performance may be affected. If you want to complete package of forex and its winning strategies, then Forex Profiter will help you in all the ways.
Any fluctuation in the value of the Canadian dollar against the US dollar, the euro or other currencies has a more or less significant impact on the prices of goods and services imported or exported by companies. Concluding today a sale in euros that will occur only in six months, for example, carries a risk because we can not predict with certainty what will be the exchange rate of the euro against the Canadian dollar at the reception euros in six months. Fortunately, there are proven methods of hedging against such risks (defined as ” exchange rate risk ”) and avoiding that a transaction considered profitable turns into a loss.
The best strategy is not the same for all business models. Many factors can affect the exchange rate risk, depending on whether you import or export a little or a lot, depending on whether the payments are made during the transaction or in the medium term, or even depending on the currencies involved or the countries involved. where the customers or suppliers with whom we are trading are located.
The Canadian dollar, like any other currency, is constantly changing, as it is subject to fluctuations due to many factors, including the Bank of Canada’s key rate, energy prices, geopolitical events, acquisitions of Canadian businesses by foreigners, etc. Predicting changes in exchange rates is therefore not easy, and relying on forecasts always involves risk. Hence the importance of having a policy that reduces the risk, whatever it is, to secure the profitability of the company.
Risk Management Strategies
The choice of strategy depends on the degree of risk tolerance; some companies will protect 90% of their currency risk, while others will only protect 50%, believing that they can absorb the consequences of negative exchange rate movements. For any company doing business internationally, sound foreign exchange risk management is part of a four-step cycle:
● define its stakes and needs in terms of currency risk;
● choose the optimal hedging strategy to manage this risk;
● choose the hedging instruments;
● set up and regularly review its strategy according to changing needs and issues.
In the case of an importer, the risk is related to the appreciation potential of the foreign currency, since such an appreciation would require it to pay more for imported products. Conversely, in the case of an exporter, the risk is related to the depreciation of the foreign currency against the Canadian dollar: an exporter will receive less Canadian dollars than expected if the foreign currency depreciates as a result of sale concluded with a client abroad.
Foreign exchange risk is also evident, for example, in the case of companies displaying an early season price list, long before invoices are issued to foreign customers, or infrastructure projects that provide for payments. at the completion of certain steps. It manifests itself as soon as the company has an official agreement with a supplier or a customer.
Given the importance for a company to secure the profitability of its operations, there are three financial products designed to help protect against the risk of exchange rate:
● the futures contract, the rate of which is fixed at the time of signing from the market exchange rate plus a premium, or discount, for a transaction that will take place in X months;
● the option to buy or sell currencies, which gives the customer the right to exercise or not the contract at a specific rate (strike price) if the exchange rate evolves unfavorably for him; and
● the currency swap, which allows to postpone or overtake a futures contract; it also eliminates the exchange risk for a company whose cash flows are mismatched.
Too many complex factors are at play in the evolution of a currency so that an entrepreneur can afford to play the diviner; it is therefore essential to plan in advance ways to protect oneself. Your trader can help you determine the most appropriate exchange rate management strategy for your business given its operations, its degree of risk and its ability to tolerate risk.