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Dealing in the Spot Market

Dealing in the Spot Market

An effective forex trading strategy does not have to be limited to only forward contracts. At times, Trading foreign currency directly in the spot market, at the current spot rate, is the most effective strategy for a business to minimize its costs or maximize its profits. Sometimes, it can be more profitable to execute a currency exchange at the current spot rate to take advantage of favorable pricing for a product, or to receive payment immediately from a client, regardless of what the current spot rate is. But even when transacting in the spot market, there are various tools a firm can use to maximize its profit (or minimize its loss) on the currency exchange. There are various types of trade orders a firm can utilize in a foreign currency strategy, which give flexibility in limiting the price at which it can buy or sell a currency in the spot market, to prevent surprises should prices rise or drop while the currency exchange is being executed. Some of these trading tools are briefly outlined here:

Limit Order

 
Limit orders are used to buy or sell a specific amount of a foreign currency at a specified exchange rate (or better). A buy limit order will only be triggered at the specified FX rate (or lower); whereas a sell limit order will only be triggered at the specified FX rate (or higher). For example, a business places a buy limit order to exchange $10,000 U.S. Dollars for Euro, but only if the Euro spot rate reached $1.10 or lower.

Stop Loss

 
A stop loss order protects the value of a business’s currency holding by establishing a “floor” on an acceptable exchange rate. This floor represents the maximum the business is prepared to lose on the currency trade: if the value of its currency holding declines below the floor, the holding is liquidated (sold) to ensure that the business doesn’t lose value (or if the floor is set below an exchange rate in which there is already a loss of value, it can serve to limit further losses).

One Cancels Other (OCO) Order

 
By combining a limit order with a stop loss order, and adding the condition that if one of these orders is triggered then the other is canceled, a one cancels other (OCO) order is created. For example, an OCO order can be used to set an upper limit order and a lower stop loss order at which a currency holding is to be sold. If one is triggered, the other is cancelled, thus the currency holding is free to trade within this pre-set range.
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Hedging Strategies

Currency Exchange Hedging Strategies

It is essential when creating bespoke currency hedging strategies for your corporation that it is based upon market research and analysis, ensuring it fits your business needs. Correct implementation, monitoring and refining of the strategy is essential. Smart Currency Options Ltd., authorised and regulated by the Financial Conduct Authority (FCA), has developed a four step process.

 
 
 

1. Understanding the Risk

Foreign Exchange (FX) exposure is experienced by all importers and exporters of goods and services as they are permanently exposed to:
• Transactional Risks
• Translational Risks
• Economic Risks
There have been numerous high profile companies that have seen their entire profits eliminated by adverse currency fluctuations. Neglecting to account for volatile currency markets can lead to disastrous consequences. Understanding the factors that can affect the markets combined with proper analysis of your company’s exposure levels, are the first stages in establishing a bespoke treasury management strategy.

 

2. Developing the Strategy

Determining your company’s risk appetite
You will need to assess the risk appetite of your organisation. A good currency specialist can look at the different economic and business factors and their effects on your company’s currency exposure and help you assess how much risk your business can feasibly afford. Smart Currency Business will help develop this strategy with you, looking at your company’s exposure levels and creating different solutions to reduce this risk, through the appropriate currency tools and strategies.

Choosing the right tools and products as part of your strategy
There is a wide range of solutions and products that can be factored into your corporation’s hedging strategy. These include:

  • Spot Contract: Buying or selling currency on the spot. A spot contract involves purchasing or selling currency at live market rates for immediate transfers.
  • Forward Contract: Securing a currency rate for future use. A Forward Contract allows you to reserve an exchange rate determined on the day of the transaction for future use.
  • Currency Option Contracts: a bespoke hedging solution that can give the policyholder the right, but not the obligation, to buy or sell underlying currency at an agreed rate of exchange on maturity of the option.

These bespoke solutions are likely to form part of your treasury management solution. These can range from straightforward options (called ‘vanilla’ options), like a ‘call’ option for a buyer, to more sophisticated types, like a ‘collar’. If the market moves in a corporation’s favour, it can transact at a spot rate. However, if exchange rates are unfavourable, the company can purchase currency at a rate that was previously agreed upon. A basic vanilla option gives you the right, but not the obligation, to purchase the underlying currency at an agreed price on the maturity of the option. Flexibility can be added to your strategy through combining it with different types of option products as well as spot and forward agreements to generate fluid hedging strategies covering the best and worst case within your comfort zone of risk.

3. Executing the Strategy

The hedging strategy you decide upon will be based on where the markets are at that moment in time, where the markets are forecast to be, and the micro exposure of your business from the various risk factors previously discussed. In light of the different risks that your company is exposed to, you will need to assess the tactical options available to mitigate your exposure to these risks. A robust currency hedging strategy often involves a combination of the different products and solutions available, based on the specific business needs and currency requirements of that company. This provides several levels of protection against currency risk.

By carefully considering all inherent and extenuating factors, Smart Currency Business consultants can help you develop hedging strategies to your specific requirements, lending our guidance to help you build your own bespoke currency strategy. Effective and efficient implementation of this strategy will help to minimise risk when protecting a company’s profits from losses of funds and unexpected expenditure caused by currency volatility.

4. Reviewing and balancing the currency strategy

Monitoring and refining the hedging strategy is an important part of protecting your business from unexpected currency risk. Smart Currency Business will review the risks that your company is exposed to and will continually assess the performance of your hedging strategy against those risks, making adjustments where needed to take into account market movements and changing economic and business factors.

A hedging strategy is not a one-size-fits-all approach; it is a bespoke solution, created according to your specific business risks and requirements. Your strategy will need to be reviewed regularly to ensure it remains effective, according to your company’s needs. As your business and the markets in which it operates evolve, so will your exposure to risk, and therefore your hedging strategy will need to evolve accordingly; an aspect that many companies neglect! At Smart Currency Business, we work continuously with you to assess the market and business dynamics, refining your company’s strategy to help achieve the best possible results.