Is market volatility hurting your bottom line? Working with an experienced FX expert to understand the world of hedging could be the solution. Follow along as we discuss different types of hedging strategies with our risk management.

Market volatility can mean lost money on foreign exchange (FX) transactions. That’s where hedging comes into play.

Hedging is the practice of protecting your business from a future change in price. In foreign exchange, it works by taking a position that prevents you from losing out if the currency market moves against you, but you could also miss out on some benefits if the exchange rate for the currency pair you need to trade changes in your favour.

There are a number of ways you can employ this approach that can help protect your business’s profits from currency fluctuations.

Developing a hedging strategy is a three-step process beginning with gaining visibility into your FX exposure, defining your FX risk management goals, and then creating a hedging strategy that addresses your business’s forex needs.

 “Hedging is basically practising risk management, when you hedge you are giving yourself protection against negative market movements,”

There are many different types of hedging strategies to address a business’s forex needs. Each hedging strategy comes with its own set of advantages and disadvantages.

One product that remains at the centre of hedging strategies is Forward Contracts*. Forward Contracts are an option for businesses trying to take advantage of a positive rate today on a payment that needs to be paid in the future.

*If you book a Forward Contract, it may mean losing out if the market rate improves because you’re contracted to settle at the agreed rate. 

One Currency Hedger client, North American Produce Buyers, discussed why they use Forward Contracts in hedging and how it has helped their business. “…produce can sometimes be unpredictable, bad weather can affect a crop so I use forwards, I like the stability and knowing that I’m not getting taken advantage of if the market dips,” Vice President of Finance, Steven Moffat said.

Now that we have defined Forward Contracts and how they can help a business, let’s dive into 3 of the most common hedging strategies for businesses.

1. Forward Contracts for specific invoices

This is both a volatility tool and a simple risk management strategy. This strategy is ideal for businesses looking to book a 1:1 hedge for a given payment in the future.

For example, a business would receive an invoice they need to pay in 6 months, so their hedging strategy is to book a Forward Contract solely dedicated to that payable. That means the Forward Contract is for the same amount of money and matures on the same date as that payable is required. This is a great strategy for smaller businesses that are new to hedging.

2. Several Forward Contracts with different maturity dates

This approach is made up of multiple Forward Contracts with different maturity dates.

For example, a business has a consistent need to buy AU$100,000 per month for the next 6 months and beyond. A Rolling Hedge would consist of booking 6 different Forward Contracts, 1 for each month. When each month’s Forward Contract matures, the business takes delivery of it and then books the next Forward Contract for 6 months into the future. This is a great strategy for businesses with somewhat predictable FX needs within 6 months.

3. Multiple Forward Contracts with different amounts and maturity dates

This strategy also consists of multiple Forward Contracts with multiple maturity dates. These Forward Contracts would be for different amounts and mature at different times but are layered over one another in the same period of time.

In this approach, the near months are hedged with larger amounts of money and the further months are lighter, with smaller amounts of money. This is ideal for larger businesses with more complex needs.

Choosing between one of these strategies can feel overwhelming, but that’s where our FX experts come in to help you create a simple yet effective hedging strategy for your business at no additional cost, so you can stay focused on growing your business.

At currency hedger, we have a dedicated group of FX experts who focus on risk management and working with our clients to help you understand how hedging tools like Forward Contracts could impact your forex ventures.

Our FX expert, John wilkins, starts with 3 simple steps to help our business clients choose the right FX hedging strategy for your businesses, “My risk management team is ready, experienced, and available to help you find the best hedging strategy for your business. We start with a 3-step process to gain visibility into your business’s currency exposure, understand your risk management goals, and finally show you a variety of hedging strategies that may work for your business.”

1. Understand FX exposure volume:

How much foreign currency does your business transfer each year? If you have a large FX exposure volume, you may want to choose a more sophisticated hedging strategy that can help you reduce your risk exposure.

2. Define risk management goals:

Discuss what your business wants to gain from your hedging program. Do you want to protect your profits from currency fluctuations? Do you need more flexibility in your hedging strategy?

3. Selecting a risk management plan:

The last step in the process is supplying you with all of the applicable information so that you can choose the right hedging strategy for your business.

Once you and your FX expert have completed this process, it is time to put the hedging plan into action. The best hedging strategy for your business will depend on your specific needs and circumstances. If you are not sure which hedging strategy is right for you, contact currency hedger today.

When choosing the right hedging strategy for your business it is important to understand the pros and cons behind each approach.

Forward Contracts for specific invoices

Pros:

Cons:

Several Forward Contracts with different maturity dates and Multiple Forward Contracts with different maturity dates and amounts

Pros:

Cons:

A real-life example of a hedging strategy in practice can be seen through a Canadian-based exporter of energy. This business received USD payments from their customers and their need was to also sell in USD instead of the native CAD. This meant that their FX needs were consistent with good predictability. In early 2022, after reviewing their trading history and future expected demand, the hedging team brought two hedging solutions to the business’s attention.

The first option was several Forward Contracts with different maturity dates at a 75% ratio over 12 months.

The second option was multiple Forward Contracts with different amounts and maturity dates at 80% for months 1-3, 60% for months 4-6, 40% for months 7-9, and 20% for months 10-12. The client elected to use the strategy that created multiple Forward Contracts with different amounts and different maturity dates to take advantage of a smoother average rate over time. Since the USD/CAD pair oscillated between 1.3100 and 1.3800 at the time, the client was able to achieve an advantageous exchange rate over time.

No matter which one of these strategies seems like the best fit for your business, it is important to find an approach that protects your business from market volatility and reduces your risk exposure.

Looking for additional information on hedging strategies for your business?