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.
Currency fluctuations can negatively impact a company's bottom line. But for Chief Financial Officers (CFOs) and Treasurers that have the ability to update their prices across campaign periods, what we would call catalogue-based pricing, protecting profit margins is not an easy task.
This blog post explores the five key challenges of trying to keep prices steady during a particular campaign or budget period. It also unveils a powerful combination of hedging programs that can help managers outperform their budget rate, year after year.
The good news is that these challenges can be addressed through a combination of FX hedging programs:
Let's see an example of how this would be done.
A German manufacturer of Thermoplastic Polyester (PBT) and other compounds for the automotive, construction, and telecommunications industries hedges its GBP-denominated sales by securing the FX rate during two consecutive budget periods.
This type of FX risk management creates a number of ‘pain points’ for the treasury team, including FX risk, forecasting risk and suboptimal forward points management—to say nothing of the largely manually executed processes.
We backtested an FX hedging program that uses conditional orders to protect —and even outperform— the company's GBP-EUR budget rate, period after period, between 2020 and 2023. The program consists of a combination that includes:
A static hedging program. This program sets conditional orders that protect a worst-case scenario GBP-EUR rate (including a 1.75% markup) for the budgeted exposure.
A micro-hedging program. This program hedges incoming firm GBP-denominated sales orders as they materialise, automatically adjusting the remaining exposure.
Given the markup vis-à-vis the budget rate, and the fact that sales orders are by definition hedged at a more convenient rate (otherwise stop-losses would have been hit), the budget rate is outperformed year after year, even during episodes of GBP weakness. In our backtested simulation, annual outperformance averages 3.28%.
To reduce the cost of hedging, conditional orders are set both on the ‘static’ exposure and on the micro-hedging program for firm sales orders. This achieves, on average, savings of slightly more than 150 basis points in terms of the overall exposure, as GBP currently trades at a 1.53% annual forward discount to EUR.
As an additional way to mitigate the cost of hedging, we suggested connecting to a multi-dealer trading platform to take advantage of the ‘best price execution’ features that put liquidity providers in competition with one another, reducing bid-ask spreads.
This combined hedging program empowers CFOs and Treasurers to navigate the challenges of currency fluctuations and achieve price stability, campaign by campaign. By leveraging API-connectivity alongside existing systems, companies remove FX risk by protecting budgeted profit margins.
Don't miss out on this opportunity to gain a competitive edge! Watch this episode of CurrencyCast for a deeper dive into the specifics of this powerful hedging strategy.
