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CurrencyCast

CurrencyCast is a treasury podcast series from currency management experts. In each episode, we look at the pressing foreign exchange (FX) risk issues facing treasurers and CFOs today and help them identify the potential gaps in their FX risk management strategy.

How to Outperform Your Budget FX Rate (S2EP6)

May 24, 2022
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5 Challenges of Protecting the Budget Rate

Currency fluctuations can significantly impact a company's bottom line, especially for businesses that operate internationally.  For Chief Financial Officers (CFOs) and Treasurers, maintaining stable prices across campaign periods is a constant challenge. This blog post explores the five key challenges faced by CFOs and Treasurers and unveils a powerful combination hedging program that can help them outperform their budget rate year after year.

Challenges of protecting the budget rate

  1. Budget FX rate protection: Ensuring the budgeted foreign exchange rate used for pricing remains consistent throughout the campaign period.
  2. Outperforming the budget rate: The desire to achieve a more favorable exchange rate than the initial budget estimate.
  3. Forecast Inaccuracy: The inherent difficulty of predicting future currency movements with absolute certainty.
  4. Unfavourable Forward Points: The potential disadvantage of selling in a currency with a forward discount (meaning the currency is expected to weaken in the future).
  5. Minimising Cash Flow Impact: The need to limit the amount of cash tied up in margin and collateral requirements for hedging activities.

Solution: A combined hedging program approach

The good news is that these challenges can be addressed through a strategic combination of hedging programs:

  1. Static hedging program: This program locks in a predetermined exchange rate for a specific portion of the budgeted exposure, providing a base layer of protection against currency fluctuations. The amount hedged typically depends on the degree of forecast accuracy.
  2. Stop-loss and take-profit orders: These conditional orders automatically execute trades when the exchange rate reaches predefined levels. Stop-loss orders safeguard the worst-case scenario budget rate, while profit-taking orders capitalise on favourable currency movements.
  3. Micro-hedging program for Firm Commitments: This program focuses on hedging individual firm sales or purchase commitments as they arise. It offers high precision and minimises cash flow impact compared to traditional hedging approaches.

Benefits of the Combined Hedging Program

  • Systematic budget rate protection: The combination offers a robust system for safeguarding the budgeted exchange rate.
  • Delayed hedge execution: Hedging decisions can be postponed until firm commitments are received, improving cash flow management. (Discussed in detail in a future CurrencyCast episode)
  • Precision micro-hedging: Firm commitments are hedged at the exact moment they occur, virtually eliminating transaction-related cash flow exposure.
  • Outperforming the budget rate: Profit-taking orders and favourable micro-hedge execution can lead to exchange rates exceeding the initial budget rate.

Conclusion

This combined hedging program empowers CFOs and Treasurers to navigate the challenges of currency fluctuations and achieve price stability across campaign periods. By leveraging automation solutions alongside existing systems, companies can monitor currency markets effectively and implement micro-hedging programs for optimal results. Don't miss out on this opportunity to gain a competitive edge! Stay tuned for the next episode of CurrencyCast for a deeper dive into the specifics of this powerful hedging strategy.

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