Central Bank & Trust has partnered with AFEX, Inc. – one of the world’s largest foreign exchange (forex) and currency risk management specialists – to offer our clients a full range of forex trading and risk management services. AFEX works with commercial and private clients around the world, offering personalized, cost-effective, strategic solutions. Here Rob Bollé, AFEX West Coast Regional Manager, outlines strategic approaches for better managing currency exposures in volatile markets.
Since the outbreak of COVID-19, volatility in the currency markets has been extreme – back to levels not seen since the Global Financial Crisis of 2008. With this in mind, and as 2020 draws to a close, it could be an ideal time to prepare for the New Year and continuing uncertainty in the months to come.
Some tips on planning for the future
Often, it seems as though currency volatility is a given—and a factor beyond your control. Though markets can be unpredictable, there are steps you can take to help temper the effects of volatility and better protect your margins.
It helps to take a look back at recent performance, evaluate your future needs, and consider your overall business goals. Here are some questions to ponder:
- What was the reality of my FX needs in 2020, versus what I thought this time last year?
- How did my budgeted rate hold up throughout the year?
- Were my margins affected by currency movement?
- What do I expect will change in my business?
- In the next three months / six months / twelve months?
- New products, new markets, new suppliers?
And most important, what is most important to you?
- Maintaining enough flexibility in my planning to weather uncertainty ahead
- Protecting my margins
- The ability to seize new opportunities as they arise without worrying about currency conversion costs
Hedging and risk management tools
To many people, ‘hedging’ sounds like a form of gambling. In our practice, it’s anything but. Our goal is to develop solutions that helps mitigate the impact of volatility on the bottom line, so our clients can plan more easily and more confidently.
We work with our clients to tailor strategies that align with their specific risk appetite and help them meet their business goals. In foreign exchange, there is a distinct hierarchy of approaches that, when blended, give you a firm strategic foundation. Here’s a quick guide to available tools:
And a deeper dive:
SPOT Transaction: You need to make a payment for delivery in one to two days’ time, at the prevailing rate of exchange. This is the simplest transaction, most suitable for occasional transactions and when you need to maintain flexibility.
Rate order: You want to make a payment when a currency reaches a specific rate within a specific time frame. If the currency doesn’t reach the rate within your time frame, you can choose to buy or sell the currency at the prevailing market rate or try again another day.
Outright (Fixed) Forward Contract: Imagine you are expecting delivery of goods or equipment in a few months’ time. Rather than purchasing and holding the currency until the payment is due, tying up cashflow, a forward contract locks in the exchange rate for that specific amount of currency for the fixed date in the future. It typically requires a small deposit, but it frees up cashflow and with a locked-in rate, you know your cost and can better plan ahead. The tenor can range from a few months to up to two years (and in some special cases, even longer).
Please note that with a forward contract, you are committed to the purchase or sale of the currency whatever the prevailing market rate is on the expiry date.
Flexible Forward Contract: Locks in the exchange rate for a series of payments over a specified period of time. As with an Outright forward, you are committed to the purchase of the currency at the agreed rate, but you can draw it down at any time over the term.
Currency options and FX structured products: These products give you the right, but not the obligation, to buy or sell currency at a fixed rate at a future date. They protect on the downside, but can also let you take advantage of market movement in your favor. A premium-structured option offers more upside potential, while a zero-premium option offers less. These approaches are more complex, and are not suitable for every client.
Devising a hedging strategy
Our practice is to work alongside a client to understand their business, their challenges, their ambitions and their goals. We typically start with a transaction analysis, reviewing past trades to uncover opportunities to increase efficiencies in processes and pricing, and then look to the future.
Our next step is to develop a tailored strategy, often blending a number of the tools described in this essay. In many cases, and particularly in volatile markets or times of uncertainty, we propose a layered approach, varying the hedged amount and the duration of the hedges, to build in flexibility.
There is no one-size-fits-all solution; each business is unique.
Don’t go it alone
After our discussions, the approach you take is ultimately up to you. You may decide to stick with spot payments for the near future, and consider incorporating hedging strategies into your financial planning at a later date.
The important thing is that you are able to make an informed decision, and that you know you can use AFEX as a resource for market insight, strategies, and support.
AEX Benefits in brief
- Preferential rates of exchange on more than 100 currencies
- Reduced wire fees on global payments
- Access to our secure online trading platform, AFEXDirect
- Proactive strategic support from a dedicated FX strategist
- Multi-currency holding accounts and cross-currency capability
- Favorable deposit terms on hedging products to free up more cashflow
- Free, non-obligatory trading facilities; set up your AFEX account in a matter of hours
For more information about AFEX and our foreign exchange and risk management solutions, and to schedule your complimentary FX risk consultation, please contact:
Regional Manager, AFEX West Coast