Outperform your budget FX rate: the 3 plus 1 benefits

Obtain the '3 + 1' benefits of a static hedging program! In the second article in our Outperform your Budget FX rate mini-series, we continue our presentation of combining a static hedging program with conditional stop-loss and profit-taking orders and a micro-hedging program for firm commitments.

In particular, we will discuss the exciting '3 + 1' benefits of a static hedging program.

Miss the first article in our series? Check it out here.

Outperforming the budget FX rate

In our previous article, we showed how such a combination of automated programs allows treasurers to systematically outperform a 'worst-case scenario' FX rate — the rate which can be used for pricing purposes during a given campaign or budget period.Let us now look at the pain points that such a program addresses.

Addressing the pain points

In these times of shifting global interest rates and supply chain disruption, CFOs and treasurers are particularly concerned about:

• The degree of accuracy in their forecasts
• The forward discount/premia of the currencies they need to buy and sell.
• Ensuring that they have sufficient cash buffers in place.

Is there a way to simultaneously address these pain points? The answer is: yes. To understand that, we need to introduce the '3 + 1' benefits of a static hedging program. Let's discuss them in more detail.

The '3 + 1' benefits of a static hedging program

When treasurers set a buffer between a reference spot FX rate at the start of the budget period and a 'worst-case scenario' rate they wish to 'defend' with the help of conditional stop-loss orders, they are in effect delaying the execution of hedges — while still keeping currency risk under control. This brings the following three advantages:

1. Mitigate forecast accuracy problems. As the forecasted exposure is not fully hedged at the onset of the campaign/budget period, there is less risk of ending up either under-or over-hedged.
2. Reduce the impact of unfavourable forward points. If your company is based in a strong-currency area like North America or Europe, and you sell into Emerging Markets, you are likely to sell and hedge in currencies that trade at a forward discount. Delaying the hedge execution automatically reduces the cost of carry.
3. Improve collateral management. As hedges are delayed, less cash needs to be set aside for the purpose of margin/collateral requirements. This is a welcome feature in times of unsettled capital and money markets, where cash is king.

These benefits are inherent to how a static hedging program, with its sets of conditional FX orders, is configured. But why '3 + 1'? Because there is a fourth potential benefit that does not come from the nature of the program itself — rather, it depends on how FX markets perform.This fourth benefit comes from the profit-taking orders that are set at a more advantageous FX rate than the rate to be defended in a worst-case scenario in currency markets. If these profit-taking orders are hit, you will be able to outperform the budget FX rate or price more competitively without hurting budgeted profit margins. But this is not a systematic feature of such hedging programs.

Summary and conclusion: a wide range of benefits

There is, alas, a sacrifice to be made when setting to obtain the '3 + 1' benefits described above. The buffer between the spot reference rate at the onset of the program and the worst-case scenario FX rate to defend is also a pricing markup that, if excessive, could hurt your competitive position. As a treasurer, you need to strike a balance between how valuable the '3 + 1' benefits are and a possible loss of competitiveness.Having said that, I hope you will share my enthusiasm for such a powerful combination of hedging programs made possible by Currency Management Automation solutions that, working alongside your existing systems, allow you to reliably monitor the FX markets.