Money
Issue No. 52 - April/May 2010
How FX hedging can cut risk for SMEs
by Natasha Malani
Recent research on SMEs trading overseas has shown while more businesses are transacting at spot rates, fewer than 1 in 20 actively hedge currency risk.
This may be exposing SMEs to higher foreign exchange transaction costs.
SMEs don’t always recognise how complex their business has become, often taking the view foreign exchange finance instruments are for big companies only. But sharp fluctuations in the AUD in the past year suggest it’s unwise to ignore currency risk. If you don’t protect against currency volatility you can easily reduce or lose your profit margins when the currency moves against you. To mitigate this risk and protect margin, importers and exporters can use currency hedging products.
Managing FX risk need not be complicated. There are simple steps to consider when looking at hedging for the first time.
Step 1: Understand your exposure. If you import or export goods or services you likely have FX exposure. This exposure is a business risk, more so when the currency market is volatile. The risk will vary from business to business, but it can often be significant. To understand the impact currency fluctuations could have ask yourself:
• How much of your business relates to imports/ exports?
• What countries do you deal with and what currencies are involved?
• What is your budget rate?
• How frequently do you have to make your payments?
• Do you ever pay and receive in the same foreign currency; can you exploit natural hedges?
Step 2: Consider the types of FX products available.
There are three key product types used to manage foreign exchange exposure.
Spot: With a spot transaction you agree a rate on the day you want to buy or sell your foreign currency. This approach means you cannot know how much you will pay until the day you pay. This can be a high risk strategy, particularly if the payment is due far in the future or the currency market is volatile. You c...
