Correctly hedging a multi-national company’s foreign exchange exposure is most often the single biggest driver to more stable – and possibly higher – earnings.  Even though this is a/the major pain point, in our experience companies all too often get it wrong.

A sales or a procurement process usually takes a period of time with multiple touch points or is part of a field of competitors each with established premiums versus one another.  To hedge in this environment is quite simply impossible with a single forward or option trade.  In fact, the sales process usually involves the company giving away favorable rate moves and warehousing unfavorable ones.  Quite often, the ask for a hedging program is to match the best rate in a period.

All too often, companies spend their time obtaining exposure forecasts and trading them with a forward or an option and moving on to other tasks; the hedging being completed for the month or the quarter.  This is analogous to arguing that a bank buys $X billion against Euro every month for its client base so it should buy that every month using a forward or an option as your program now tells you.  How many banks would still be in business if that was their strategy?  It shouldn’t be any different for a company, after all to hedge is to sell as in sell one’s position to another company.  Inherently this involves trading in a manner that offsets the forecast at a rate that matches whatever the sales person gets – which inherently means over a time period that the sales process takes and culminates in the booking itself.

Our methodology puts a low-cost option structure in place driven by our client’s business economics.  We then use the property of options to sharply decrease in value when they are out of the money as an opportunity to restructure those options so that the hedge rate can keep being improved.  It works a lot like a tethered rock climb: you can improve the rate but have limited downside.  The trading model is set up for easy execution by our client’s team and their management is trained to supervise them.

Typically, in a 3-week period we look to:

  • Understand the economics of our client’s business units and their unique sales processes
  • Understand the current hedging strategy
  • Design a new hedging strategy
  • Work with the client’s accounting function on changes/issues in tracking/reporting
  • Present new approach to executives and train them in supervising the new program adequately
  • Train the client’s foreign exchange team in executing the strategy

If needed, we can add in related activities on managing the forecast rate process with FP&A and optimal hand-offs between sales/procurement and treasury.

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