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Learning to hedge: what you need to know

Jeremy Thomson-Cook
Jeremy Thomson-Cook 12 January 2021

Currency risk is an ever present and the argument can be made that margin compression, supply chain disruption and a volatile market picture makes protecting a business against currency volatility even more important.

We know that businesses are going to have a lot on their plate as they emerge from their enforced hibernation and so we’ve put together a guide to working out what needs to be hedged, how it can be done and when it should be done. You already know the ‘why’; because you want to protect your business from some of the most unpredictable markets in living memory. 

Step 1: Know the know by knowing the flow 

How you approach hedging currently depends on whether you are new to protecting your business against currency risk. For those who have done this before, it is clear from conversations that those exposures will have changed in the past few months; have you changed suppliers or are you selling in other markets, altering your exposure?

Similarly, if you have taken on funding in foreign currencies such as raising money in debt markets, being lent money by a parent or group company, or drawing down revolving credit facilities, those exposures will need to be taken into account.

Once you understand just how your exposure sits in this new Covid world then we can take steps to limit the risk. 

Step 2: Cost-a Del Sol

Budget rate. Probably two of the most boring words in the English language, especially when seen next to each other. Budgets are not fun but like most things that are not fun, they have a habit of being incredibly important.
Once you know your exposures to the required currencies you need to work out your ‘budget rate’ i.e. what price you must achieve to make sure that you are not losing margin on the goods and services that are either being sourced or sold abroad.

For those that had costed rates before the crisis, conversations with suppliers and distributors need to be had to understand where flexibility may and may not be available moving forward.

You will also need to be mindful of what your competitors are doing; withdrawal of product lines, fixed pricing or huge discounts to pricing may show a business that has hedged inappropriately or is struggling to meet its budget rate. 

Step 3: Tool up 

You know how risk averse you are as a business through your day-to-day dealings, and protecting against currency risk is no different; many businesses will hedge 100% of their exposure as soon as its confirmed, most will let it sit completely exposed to every movement in the spot market.

Depending on how you view the level of risk you want your business to be subjected to will inform your choices around what products you wish to use to hedge those risks away. Similarly, depending on cashflow, certain products that require deposits against forward contracts or options structures may become more or less attractive.

Most businesses will be looking for a mixture of flexibility and security. 

Step 4. The beat goes on

We learn lessons from everything we do, and businesses are going to be learning a tonne from what has happened in the past few months, and in the months to come.

Businesses will need to make sure the efficacy of hedging measures are evaluated, and changes made as necessary. The best businesses are nimble and that is because their processes are.

Similarly, some of the risks that you may have identified in Step 1 may change via hedging, so a constant monitoring of ongoing business operations is needed.

For further help with hedging or international payments, feel free to email us at fx@equalsmoney.com or call +44 (0)20 7778 7500 today.

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