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How to manage FX exposure around the world?
How to manage FX exposure around the world?

Al Bawaba

time2 days ago

  • Business
  • Al Bawaba

How to manage FX exposure around the world?

Companies that operate in several countries often have to convert into different currencies, which exposes them to currency risks, which if not addressed properly can become a significant problem. Foreign exchange markets are dynamic and they are sensitive to global developments such as geopolitics, wars, trade wars, and many more which makes it difficult to predict which currency will gain the upper hand. This is why companies need to have specific knowledge of these risks and strategies to mitigate Forex exposure risks effectively. Let's briefly review the main methods to manage FX exposure and analyze the best-known cases when companies effectively manage those risks. FX exposure types Forex is a popular market where trillions of dollars are traded daily, making it important to understand its dynamics. Both investors and traders should know how to protect against FX risks to reduce the chances of losses. There are several types of Forex exposure such as transaction, translation, and economics. Transaction risks happen when companies enter into foreign currency payables or receivables and become exposed to exchange rate risk and losses. Corporations hedge these risks using forward contracts, futures, and swaps which allow them to lock in rates or invoices in their home currency to transfer risk. Translation exposure also known as accounting exposure is when financial statements of foreign subsidiaries are converted into the parent company's reporting currency. This can potentially cause reported asset and liability values to change because of exchange rate fluctuations. While it does not create a cash flow risk, it still presents challenges for companies. The economic exposure also referred to as operating exposure simply reflects the impact of these rate changes on the firm's future cash flows and ultimately competitive position. This type of exposure is more difficult to calculate as it has a long-term effect on market value. To mitigate operating risks, companies should employ hedging strategies, including hedges and options. How to manage FX risks - best practices Managing FX risks is an important aspect of operating multinational businesses. Companies usually have a board-approved FX policy which includes a list of authorized instruments, hedge ratios, and reporting standards. This makes risk management very structured and effective. Corporate hedging often includes senior management oversight and periodic policy reviews, to ensure both strategic objectives and regulatory requirements are met. Corporations typically have dedicated risk management teams that execute hedges, and set counterparty limits. Business units provide transactional forecasts and operational insights. How to identify and measure the exposure To execute hedge and other FX risk management strategies, companies first need to identify and measure the exact exposure type and forecast impact. Real-time data, scenario modeling, and value-at-risk metrics help companies identify and quantify exact exposures across currencies. Effective measurement is concluded using unified dashboards that offer the ability to get all needed information and run what-if scenarios, analyzing currency movement's impact on projected cash flows. Hedging strategies After defining the types of risk and possible amounts and currencies involved it is time to mitigate those risks using various well-tested strategies. There are several methods available to ensure currency risks are minimized on the company's cash flow and financial statements. Natural hedges Natural hedging tries to marry foreign revenue with local costs. Basically, it sources inputs in the same currency as sales which reduces the need for financial instruments. This can be a very effective technique to mitigate some of the FX exposure risks. Forward and futures contracts Forward and futures contracts are powerful instruments to hedge against foreign exchange rate risks. These contracts allow participants to lock in future rates of exchange between involved currencies. This can be super important when dealing with an uncertain future where the forecast is difficult. Using these instruments, companies can ensure that their cash flow is stable even in adverse market movements. Having access to locked rates for predetermined data provides certainty on transaction costs. Swaps Forex swaps exchange principal and interest payments in different currencies. This is super useful to manage short-term and long-term funding and exposure which is crucial for international companies. Options and structured products Options are also contracts that grant the right but not the obligation to transact at predetermined rates. They are similar to futures contracts but without obligations. By locking the rates, options offer effective downside protection with upside participation. In other words, it limits losses if the asset falls but still profits if it rises. Best operational practices Some companies have a centralized treasury which allows them to reduce transaction costs, and improve hedging consistency by netting positions internally. The decentralized model, on the other hand, offers local autonomy and quicker decision-making. Many companies employ a hybrid structure to get the benefits from both models. Managing large capital is not easy and many transnational companies have integrated treasury management systems (TMS) to automate deal capture, confirmation, accounting, and generate real-time analysis. These systems can reduce operational risks and provide efficiency, but companies still need to check and monitor their automated systems to eliminate bugs and other errors. Another practical method is to diversify banking and non-bank counterparties to limit concentration risks. By establishing credit lines and netting agreements, companies ensure counterparty exposure remains within the threshold that was approved by management. Case studies - Success stories to learn from There are many cases where companies that operate in many different countries employed FX exposure risk management effectively and avoided losses. Apple's treasury hedges most of its projected foreign-currency cash flows. It uses a blend of forward contracts and options to stabilize earnings and reduce financial risks of FX exposure. Airbus typically manages long-term hedge portfolios with a maturity of several yours, which helps it cover net USD sales. It also employs natural hedges to smooth profitability from large commercial aircraft contracts. In 2022, Coca-Cola HBC responded to the strong US dollar by calibrating its derivative positions. It shifted hedge notions and maturity profiles to mitigate currency risks and preserve a stable cash flow. Starbucks Corp. Starbucks has 'price-to-be-fixed' contracts and Forex forwards to mitigate currency volatility costs in coffee bean purchases. This enables it to have stable expenses despite commodity price surges. Starbucks is an interesting case, as it directly employs these contracts to lock in future price rates and ensure profitability even if the prices surge for beans.

Japanese life insurers cut bullish yen hedges to 14-year low
Japanese life insurers cut bullish yen hedges to 14-year low

Japan Times

time6 days ago

  • Business
  • Japan Times

Japanese life insurers cut bullish yen hedges to 14-year low

Japanese life insurers cut protection for their foreign assets against a stronger yen to a fresh 14-year low, signaling subdued expectations of a sustained rally in the nation's currency. Nine of Japan's biggest life insurers collectively lowered bullish yen wagers tied to their foreign investment holdings to 44.4% at the end of the fiscal half in March, compared with 45.2% six months earlier, according to an analysis of their earnings reports. While U.S. President Donald Trump's administration's unpredictable policymaking has stoked foreign exchange market volatility, that wasn't enough to stop a three-year decline in yen hedging. The Bank of Japan's policy interest rate is still 3 percentage points lower than the nation's inflation rate, with the next potential hike seen further delayed. The continued decline in hedging suggests "life insurers see a lower likelihood of the yen showing the kind of strength it did in the past, and feel a need to hold unhedged overseas bonds to maintain exposure to foreign exchange risks,' said Ayako Sera, a market strategist at Sumitomo Mitsui Trust Bank in Tokyo. "The yen's real interest rates are just too low.' Still-high currency hedging costs are also weighing on life insurers' demand for overseas debt. Japan's 10-year notes yield more than 150 basis points on a compounded basis, much more than counterparts in the United States, United Kingdom, Germany and Australia once foreign exchange protection costs are taken into account, data shows. Life insurers offloaded a net ¥756 billion ($5.3 billion) worth of foreign bonds in the six months through March 31, Finance Ministry data showed. That marks the seventh consecutive such period of sales. Insurers dumped a net ¥21.2 billion of overseas stocks in the October-March period after buying ¥1.06 trillion in the six months through Sept. 30. A gauge that measures the yen's strength against currencies of Japan's major trading partners rose to a six-month high at the time amid broad weakness in the greenback. But the currency failed to hold gains and finished the second half of the fiscal year 1.6% lower as the BOJ added a reference to trade policies to its list of risks to the outlook for the economy and inflation. The likelihood of an interest-rate hike shrank further as the central bank this month delayed the expected timeline for reaching its inflation target. Overnight-indexed swaps signal a 64% chance of the central bank raising interest rates by 25 basis points by the end of the year. At the end of January, markets were fully expecting a quarter point hike or more by December. The yen's nominal effective exchange rate has edged up 0.8% since March 31. Asset managers and leveraged funds collectively boosted net yen longs to a record via futures and options earlier this month amid speculation the Trump administration's tariff policy will hit the global economy and fuel demand for haven assets. Unhedged positions risk causing losses should a drop in foreign currencies wipe out capital and income gains from overseas assets. That may prompt life insurers to rush for currency hedging, in turn exacerbating the slump in foreign currencies against the yen. Swaps, meanwhile, indicate an 83% chance of the U.S. Federal Reserve resuming rate cuts as early as September. Lower U.S. interest rates typically help reduce dollar hedge costs for Japanese investors, which are largely driven by the rate gap between the two economies. For this reason, "I see a rebound in demand for currency hedges going forward,' said Tsuyoshi Ueno, executive research fellow at NLI Research Institute in Tokyo.

UK Firms Race to Fix Currency Hedging After Surge in the Pound
UK Firms Race to Fix Currency Hedging After Surge in the Pound

Bloomberg

time22-05-2025

  • Business
  • Bloomberg

UK Firms Race to Fix Currency Hedging After Surge in the Pound

A surge in the pound and global currency volatility are driving a focus on foreign-exchange risk across Britain's boardrooms. Some companies are amping up hedges to protect their bottom line, others are avoiding locking in a level for sterling and a few are even considering moving manufacturing to the UK to avoid the exposure altogether, corporate treasurers said at an annual industry meet in Newport, Wales this week.

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