How forward points optimisation improves currency management

As global interest rates continue to shift, it's becoming increasingly important for currency managers to actively manage forward points. Failing to do so can compromise a firm's competitive position.In this article, we'll explore how currency managers can take advantage of interest rate differentials between currencies to improve pricing, control financial gains, and generate savings through forward points management.Learn more about forward points optimisation in our latest episode of CurrencyCast.

What are forward points?

Before we dive into how to manage forward points effectively, let's first understand what they are. Forward points reflect the difference between the spot and the foreign exchange rate between two currencies. For example, the Euro USD spot rate is at 105.75, and the three-month forward rate is 106. There are 25 basis points, but where does that difference come from?Imagine a situation where US dollar interest rates are higher than euro interest rates, but at the same time, the spot and the forward rates are identical. Here's what would happen from the perspective of a Euro based investor. They would borrow money to buy dollars in the spot market, make a deposit at a higher dollar interest rate, and sell the proceeds forward to secure those gains in euro terms.Soon, the interest rate gap between the euro and the dollar would shrink, while at the same time, the difference between the spot and the foreign exchange rate would increase, reflecting forward bonds and a weaker dollar on a forward basis.

Hedging with forward points

When it comes to pricing and hedging with forward points, there are two rules of thumb: in the event of favourable forward points, anticipated execution as much as possible. In the event of unfavourable forward points, delay hedge execution as much as possible with the help of conditional orders.Here is an example of how forward points management can impact your company.A mexican tour operator selling holiday packages in Canadian dollars can use either the spot or the forward rate for pricing. Because the Canadian dollar trades at a forward premium to the Mexican peso, pricing with a spot rate and hedging the transaction exposure results in a foreign exchange rate that can be added to the tour operator's profit margins.However, by pricing with a forward rate instead, the foreign exchange gain would vanish. But at the same time, the Canadian dollar price of the holiday packages would be lower, while the budget and profit margins of the tour operator remain intact. This can generate more sales in terms of existing assets.Currency managers cannot afford to neglect forward points management, especially when interest rates shift worldwide. To manage forward points effectively, you need to capture all exposure as soon as it is generated from any company system, such as the ERP, spreadsheets, or a booking engine, with the help of API connectivity.Effective forward points management is unthinkable without automation.

Automation can save you

Forward points management is essential for effective currency management, and thanks to automation and a strong API-based FX rate feeder, you can provide commercial teams with all the rates they need for pricing purposes.In hedging with favourable forward points, you will capture all exposure as soon as it is generated, thanks to API connectivity. In hedging with unfavourable forward points, you will be able to monitor markets 24/7, instantly update conditional orders and automatically calculate weighted average exposure rates.By automating your forward points management process in currency management, you will be able to generate big savings for your company.

Getting buy in from the C-suite

Trying to get the C-suite on board to implement new tools in the finance function seems to be a difficult task for many treasurers. In our experience, the best way to get their buy-in is with a data-driven approach that highlights the benefits.Let's take a look at all the advantages that automated forward points management brings and will help you drive the conversation:

• Eliminate silos between the treasury and commercial functions
• Improve the quality of their FX exposure collection
• Achieve better pricing with a strong FX feeder

As you can see, managing forward points is critical for effective currency management. In a multi-currency world with several of FX and credit markets situations, financial teams have the opportunity to optimise interest rate differentials between currencies to generate savings, capture financial gains and enhance the firm’s competitive position.With the help of automation technology, this can be an easy, stress-free process for treasurers and CFOs alike. Learn more about how Kantox's currency management automation solution comes into the picture.