Is currency hedging a good way to hedge or just pure speculation – for clients and currency dealers – two perspectives I’ve already experienced.
When I worked as a sales dealer in the bank sometime I couldn’t understand some of my clients. These days, as a client I see both sides of a coin and both sides are right in regard to FX risk management. Eventually, there are three ways to see this.
Me: Hallo my Dear Client! I see your FX exposure is growing rapidly, would you consider to set the fixed FX rate?
Client: Oh no, I am not a speculator.
Client: Okay, but how about we do it once!
Client: Hah, I won! Earned 2% extra.
Dealer is right.
The client and dealer seems to be happy. Client earned some extra money, dealer sold the product and made client happy. But what is a difference in goals for the two persons? The goal of the dealer is to sell (that’s somewhat obvious). It’s a measurable goal. On the other hand, the goalof a client is just to avoid the extra risk on his business deal regarding FX. He or she shouldn’t feel any joy about 2% extra money. The transaction should be done to mitigate the risk, it should never be about earning some extra money. And it should not be about emotions – this is not Friday night in a casino. It should all be about closing the final overseas trading margin.
Yet this happens very often. It’s hard to convince an exporter or importer to use a currency risk hedging solutions. Clients often forget that hedging is like closing the whole deal with a foreign counterparty. If you import clothes from India you can set the fixed price. You calculate your margin, for instance, 50%. But still, it’s not your final margin, because currency differences may reduce or increase your final margin. So it’s not going to be 50%, but rather like 45-55% at the end. To close your final margin and make your business more predictable you should set the fixed currency level.
Would you still do a business with your foreign counterparty if you did not agree on the final, precise price? Probably not at all! You should think about FX aspect of trade in the same way – know the price before you say “I buy”.
Client is right.
- As a client I understand it very well. Unfortunately, you Mr. Dealer have no idea about accounting staff.
I open a forward – that’s the good way to avoid FX risk – you say. I will change $150k with the fixed price at the end of the month to send to my counterparty. But please remember that I’ve got already another $77k in my banking account. This comes from the times when the rate was 10% higher than now. So as far as I send the money to India from my accounting point of view, I am going to send this $77k first (with much more higher rate).
So yes, it’s great, I will get some “cheap” currency now, but it’s going to be held on my account without any moves. Moreover, I plan to sign a new contract in the next three months. Well, this means that I’ve just fixed the currency rate for the next contract using the previous forward transaction when I still don’t know the next India’s contract details at all.
For God sake, Mr. Dealer, are you still with me? Anyone? Please explain later my boss why “I still get some loss on FX risk AVOIDING solutions”… There are two doubts:
- The FIFO Rule makes a forward contract useless if you already have bought the currency earlier.
- Even if I understand that using forward contract gives me a fixed price for the total import / export transaction, my supervisor may have a different “opinion”.
There are three extra tips, I believe very useful ones!
- Keep currency in two or more currency accounts. This let you avoid the First In First Out rule. You can keep as many currency accounts as number of your foreign counterparties. It seems to be complicated, but if you think about this more precisely, you calculate you can easily manage your FX risk divided per each counterparty or the single invoice.
- Don’t keep the currency in the account. Just do a forward and send this money separately at the delivery day (one invoice = one forward).
- Pay or receive your local currency. There is always a chance that someone can accept that. There are more and more international payment institutions that enable you to pay very small and local currency wherever with the good rates.
Dealer! Make an effort to understand your client and his world. If you do then you can build the long-term relations really easy.
Founder & CEO