Many small- and medium-sized firms engaging in import and/or export activity tend not to hedge despite the benefits of hedging being well documented. The reasons not to hedge come in all shapes and sizes: it’s too complex; it’s too costly.
There’s also a misconception that it is speculation; or in some cases firms aren’t aware of the benefits of hedging tools and strategies available to them. And in the case that companies don’t hedge despite being aware of its benefits – the excuse is often that exchange rates might even hold steady! These are costly, misguided beliefs!
So what are the benefits of hedging?
Many studies show that hedging is a necessary activity for firms operating in the contemporary globalized economy. Benefits of hedging include:
- Increase ability to forecast future cash flows
- Minimize the impact of exchange rate volatility on profits
- Diminish the need to attempt to forecast exchange rates
- Helps ‘buy time’ for a company to adjust its marketing and sales strategies should the domestic currency rise in value, thereby reducing the firm’s competitiveness abroad
Needless to say, if a firm has the financial ability to hedge at a reasonable cost, there’s no reason not to! Essentially, hedging is like FX insurance.
Managing this FX risk faced by importers and exporters all over the globe today is a three-step process: identify FX risk; develop a strategy; and utilize the proper instruments/strategies to hedge the risk.
Identifying FX risk
The most common type of risk faced by firms is transaction risk. For a UK importing company with costs in USD, measuring FX risk entails determining how many USD it expects to pay over the months aheads, versus the money the UK firm will expect to receive in USD (if any) over the same period. Simply put, this difference is the amount that needs to be hedged.
Developing a strategy
Developing a hedging strategy necessitates that the following questions be answered: when should FX exposure be hedged; what tools/instruments are available under the current circumstances; and how will the performance of the hedge be measured? Developing a strategy is contingent on where in the process a firm is (see flow chart below).
Using a proper hedging instrument
Implementing the proper hedging strategy involves a review of the company’s policies as well as the intentions of the hedge. Hedges can vary from something simple like purchasing the foreign currency, to more round about ways like purchasing commodities in the country where the company’s products are sold.
Now you need a tool to help you bring this all together. Hedgebook has been designed from the ground up to do just that – it is our reason for being. Take a look at the overview video on our Corporate solution page or reach out for a quick online demo.
If you are just starting on your hedging journey it pays to get the right tools and processes in place to ensure you get the full benefit – happy hedging.