Key takeaways
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- Hedging is a risk management strategy.
- Hedging is like insurance against a negative impact event on a business bottom line.
- Hedging is likely to increase certainty and improve consistency.
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Hedging is a business risk management strategy, that is best thought of as a form of insurance. When companies who import and export products and supplies, hedge their FX exposure, they are effectively insuring themselves against the impact of a negative event on their bottom line. Here are five different benefits a business may experience when they work to hedge their FX exposure. <br> <br> • Protect Margins: Currency market volatility can significantly eat away at a company’s profit margin. Say, for instance, prices are set at the start of the year, with a 10% margin. Should the market move adversely, the 10% initial margin can quickly become 5%, or even fall into negative territory (depending on market movement and where it was initially set). All of a sudden, the company’s comfortable profit margin no longer exists, detrimentally impacting the bottom line. <br> <br> • Achieve Consistent Pricing: Following the above, margin protection allows consistent pricing to be achieved over the duration of an accounting period. Were a business not to hedge their FX risk, consistent pricing can only be achieved by absorbing the impact of any FX losses onto the balance sheet or passing onto their customers. By using hedging products, a business can achieve price consistency, while also avoiding a hit to the bottom line. <br> <br> • Increase Certainty: Every business craves certainty, in almost all aspects of their operations. Inherently, cross-border transactions bring increased uncertainty into a business. Hedging foreign exchange exposure, however, can significantly reduce or even eliminate (in the case of a forward) the uncertainty associated with foreign exchange transactions. <br> <br> • Improve Reporting: Coupling consistent pricing and increased certainty results in a higher quality of reporting, as well as the ability to produce more accurate forecasts. Furthermore, via the use of hedging products, the likelihood of achieving said forecasts (including budget rates) rises significantly. <br> <br> • Reduce Volatility: Overall, the aim of any hedge is to reduce volatility, and to offset or reduce the impact of adverse price movements. Businesses can achieve this by speaking to an FX specialist, such as Caxton, to receive tailored information on which products are most likely to suit their requirements.
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Hedging in Practice – limiting exposure to volatile FX markets
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The CEO of an international plant manufacturing recently highlighted how Caxton helped them navigate the currency markets and set a plan in place.
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“Caxton limits our exposure to changes in the market. So, we’re able to sell internationally as well as actively manage our foreign exchange rate.”
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“Caxton devised a plan to guarantee our exchange rates, despite the fact that Swedish Krona can be more difficult to plan for the future. The team’s experience leaves me to focus on daily operations. And if I have any queries, our dedicated account manager is always on had to help me, no matter what.”
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For more information and to get daily financial market updates, please visit the <a href="https://www.caxton.io/business/managing-risk" target="_blank">Managing Risk</a> page on our website.
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Was this article useful? Try:
- What Is A Budget FX Rate And Why Is It Important?
- What is Hedging?
- Case Study: Outplay Entertainment
If you're looking for more information on managing FX risk then check out our Managing Risk Hub or check out our FX glossary for frequently used terms.
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