Money
Issue No. 18 - August/September 2004
FX Hedging:
To Hedge or Not to Hedge
I am often intrigued by the way many corporations approach FX risk management. Recently, at a function, I was speaking to a CFO who was vested with the responsibility of managing his company’s FX exposures. This company, a well known exporter, distributed its product in USD to many parts of the world and like many exporters, margins are now being squeezed. When I asked him why they didn’t take out long term FX cover (to manage their exposure) he commented that by doing so was tantamount to speculating! I then asked this CFO what trigger was used for them to instate the limited hedging that they did, and how did they choose the hedge products they used? The answer: "It was mainly gut feel…"
The AUD exchange rate has, of course, appreciated significantly over the last 18 months against most currencies. Will the dollar move up or down from here? This is anyone’s guess, and guess it is. Economist and bank FX dealers are paid to have an opinion and as importantly, share it.
It is all very well for a FX dealer or an economist to say now is the time to hedge but they do so with all care and no responsibility. If they are wrong, dealers within the bank have the early warning systems that (should) recognise the error and can exit that position at little transactional cost. The corporate hedger, however, generally does not have the same luxury.
So, what should the average corporate do?
Firstly, identify the risk. Who are your competitors? What are they doing and what effect will it have on your sales if your company hedges to a differing extent to your competitors? Where are your natural hedges and how can you best take advantage of them? What is the worse case scenario if you do nothing and the exchange rate moves significantly against you?
Secondly, identify the products you are going to use to manage the risk.
There are two main hedge products for foreign exchange; forward exchange forward contracts and currency options. ...
