You should give a forex

Hedg­ing on cur­rency mar­kets of­fers rel­a­tively pain free pro­tec­tion against world events and now it is cheaper than ever

The Herald Business - - Professional Brief -

ASK any fi­nance di­rec­tor and they will tell you that their com­pany is not in the game of spec­u­lat­ing in the for­eign ex­change mar­kets. Bet­ter to con­cen­trate on core busi­ness and let the deal­ers in banks worry about the va­garies of the money mar­kets.

Since the abil­ity to hedge fu­ture cur­rency risk has ex­isted for many years through the use of For­ward Forex Con­tracts, it is per­haps sur­pris­ing that many com­pa­nies still elect to deal in the spot (two day de­liv­ery) mar­ket at the point when their cur­rency cash­flows fall due. In the cur­rent geopo­lit­i­cal and eco­nomic cli­mate, where it is im­pos­si­ble to pre­dict rate move­ments with any de­gree of con­fi­dence, it is not over-stat­ing things to sug­gest that th­ese un­hedged ex­po­sures are a di­rect form of spec­u­la­tion.

Al­though this spot prac­tice still ex­ists, a fair per­cent­age of Scot­tish com­pa­nies are pru­dent in their risk man­age­ment through their use of for­ward con­tracts – hedg­ing as soon as ex­po­sures are known or highly prob­a­ble, and quan­tifi­able. For­ward con­tracts are pop­u­lar as they guard against neg­a­tive cur­rency fluc­tu­a­tions and de­liver what com­pa­nies set out to achieve. They do suf­fer from one ma­jor weak­ness: com­pa­nies can­not par­tic­i­pate in a favourable ex­change rate move­ment.

Forex op­tions of­fer this flex­i­bil­ity and eco­nomic ben­e­fit. The con­cept may not be new but their di­ver­sity and cost-ef­fec­tive­ness cer­tainly is, and wor­thy of fur­ther in­ves­ti­ga­tion. There is no doubt that forex op­tions have suf­fered poor press in the cor­po­rate sec­tor as there is an up­front pre­mium to pay and, con­se­quently, they are per­ceived as be­ing ex­pen­sive. But, over the years, banks have ad­dressed this ob­jec­tion by struc­tur­ing op­tions which re­duce or even elim­i­nate the up­front pre­mium.So how do they work?

There is a daz­zling ar­ray of prod­ucts with strange names that seem de­signed to bam­boo­zle and turn off the very clients they would like to at­tract: knock-ins, knock-outs, risk re­ver­sals, par­tic­i­pat­ing for­ward op­tions, and many more. They sound com­plex but on closer in­spec­tion are fairly in­tu­itive and do not re­quire in-depth tech­ni­cal knowl­edge to be un­der­stood.

Cru­cially, they are ex­cel­lent ways of in­creas­ing a com­pany’s bot­tom-line through par­tic­i­pa­tion in a pos­i­tive rate move­ment. By be­ing pre­pared to give up a per­cent­age of a favourable move, a com­pany can en­joy a re­duced pre­mium or nil pre­mium hedg­ing strat­egy. An­other fea­ture of op­tions is that they are an ideal ve­hi­cle to hedge un­cer­tain ex­po­sures such as ten­der­ing for con­tracts or an­tic­i­pated but not yet con­firmed sales.

If the con­tract is re­quired, the un­der­ly­ing ex­po­sure is al­ready cov­ered – if not then there is the abil­ity to walk away from the op­tion leav­ing the pre­mium as the only cost, which was al­ways known. In ad­di­tion, there may be the op­por­tu­nity to sell the op­tion or gain from a pos­i­tive move.

Con­tent sup­plied by Caro­line Don­ald, Cor­po­rate Trea­sury Ser­vices, An­glo Ir­ish Bank

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