Optimising Your Hedging Strategy
Nov 15, 2021
For businesses that trade in foreign currencies and face a significant risk from fluctuations in the exchange rate, it is necessary to have a good FX hedging strategy.
Hedging against the risk of fluctuations in the exchange rate can allow a business to operate with a higher degree of certainty about what costs and revenues will be. A good strategy can even bring complete certainty to a business when it is trading in foreign currencies and allow it to operate almost as if it is trading in its own domestic currency.
Often FX hedging strategies are developed over time, starting with ad-hoc hedging for specific transactions and developing into more in-depth strategies. If you are looking to develop your FX hedging strategy for your business, it is worth running over what you are doing to see what you can do to optimise it.
Understand Exactly What Your FX Risks Are
The first step in developing a fully effective FX hedging strategy is understanding exactly what a business’ FX exposure is and what the priorities are.
If you can accurately forecast what transactions you will make in foreign currencies, then it is easy to understand what your FX risks are. For businesses that have ad-hoc or indefinite FX transactions which take place without being accurately planned, it is not so easy.
Either way, the best thing is to create the most accurate prediction possible of what a business’ FX risks are. After this, you can decide if you will look to mitigate against all of this risk or just prioritise certain areas.
If necessary and if possible, you may wish to attempt some kind of hedging for all of the FX risks that your business faces. Alternatively, you may just wish to prioritise the areas which need to or can be dealt with through FX hedging. The decision about what to do usually depends on the nature of the risk faced and the resources which are available.
Make Sure That You Understand Your Strategy
While many businesses and particularly many SMEs do actively hedge against the risk they face from fluctuations in the exchange rate, many do not actually fully develop a coherent strategy. It often makes things easier to have a clearly defined strategy and set ways of executing it.
To do this, it is a good idea for businesses that face FX risk to check that they clearly understand how the steps they are taking help to manage all of the risks they face. Also, they should know how to go about carrying things out.
As we will come onto later, advances in technology do make it easier for smaller businesses to develop sophisticated FX hedging strategies. Online platforms, like Bound’s, allow access to tools that help businesses to fully understand exactly what they are doing to hedge against the risk they face from FX exposure. On top of this, the tools which are needed to execute an FX hedging strategy are immediately available.
Make Sure Your Strategy is Easy to Follow
When it comes to executing your strategy, it should be easy to do so. FX hedging doesn’t need to be complicated and it should be a simple process to execute, say, a forward or an option trade as and when you need to.
Again, technology can help with this area as well. Online platforms usually offer the fastest form of FX hedging with a strategy immediately executable. This compares to the more labour-intensive process of calling a currency broker to make arrangements.
Make Sure You Have the Right FX Hedging Partner
It is worth making sure that you are using the right currency broker, bank, or online platform to help you to manage your FX risk.
Simplicity, effectiveness, reliability, and price are usually the main considerations.
Ideally, the company or online platform through which you arrange your FX hedging should help you to understand your whole FX situation. Your system should allow you to understand what risks you face and what resources are available to you to deal with them. Following on from this, it should be simple and fast for you to execute your FX hedging strategy, say by booking an option trade.
Another thing to think about is whether the company or online platform that you use is reliable. Brokers and online platforms should be FCA regulated at least and should have a reputation for providing good service. On top of this, they should offer competitive and consistent rates which allow you to carry out FX hedging at little cost.
As we mentioned earlier, more and more businesses are finding that online platforms are a very useful FX hedging resource. They allow quick access to a variety of FX hedging tools, competitive rates, and a level of convenience which was previously impossible for many businesses to come by.
Consider Using New Resources
It may be a good idea to consider using new resources in the future to aid you with FX hedging.
One obvious resource which often gets overlooked by UK-based SMEs which could be of help is option trades. While forward trades have been taken up by SMEs to a relatively good degree, option trades have been much less readily taken up. One study found that while 28% of UK-based SMEs use forward trades as part of their FX hedging strategy, only 10% use option trades.
Forward trades are simple and convenient, but they do not allow for the opportunity to benefit from favourable changes to the exchange rate. It may be worth considering whether the extra payment for the higher level of control which an option trade provides, may prove to be useful.
As well as option trades, there are further resources available as well which, depending on the nature of the business, may be useful as well. It may be possible to combine elements of internal hedgings, such as leading and lagging for example, into your wider strategy. Alternatively, limit orders may be something that you are able to make use of.
Reanalyse Your Approach
It is a good idea to reanalyse your approach to FX hedging in the future and see if you are able to refine things further. One good piece of advice is to keep an eye out for improvements in technology that allow for enhanced analysis of a business’ FX hedging strategy.
Optimising Your Hedging Strategy in Summary
The key thing behind optimising an FX hedging strategy is to make sure that you fully understand what it is that you’re doing, that you’re certain there isn’t a better alternative approach, and to make sure that you have the right resources to help you. Many businesses and in particular many SMEs either do not hedge against FX risk or do so in an ad hoc and disorganised fashion.
Exchange rate fluctuations can cost businesses a large amount of money and taking the time to find a sensible way to approach the problem can help a business enormously. Part of the process for many businesses is taking the time to analyse what is being done and see if there is a need for improvements to be made.
Bound provides an online platform that is specifically designed to help businesses, particularly SMEs, manage their FX risk in the most simple and effective way possible. If you are interested, please head over to the platform to see how it works.