Currency fluctuations need not be an issue for exporters with simple research and exmanination of your business and market, these strategies can help you effectively currency-proof your business.
Can a business truly be currency-proof? It can get pretty close, say our experts from HSBC Bank Australia: Andrew Skinner, head of trade and supply chain, and Ian Collins, head of sales for global banking and markets. The key to currency proofing is not about gambling on the foreign exchange market, but examining your own business and finding out its requirements. Here’s a basic guide to the different forex strategies available.
How can exporters prepare for currency risk?
Ian Collins: “If you are trading in US dollars make sure you set up a US dollar foreign currency account as well as an Australian dollar account. To an extent, this insulates you from having to be absolutely precise in your timing of US dollar receipts. If you have a good understanding of the cycle of your business, then you can design a hedging strategy. The critical aspect is to model your cash flow projections as accurately as you can. Once you do that, you can effectively take out the negative currency risk because you’re hedging back the Australian dollars from that account so you don’t have to keep changing each individual contract.”
Andrew Skinner: “If you only had an Australian dollar account with your bank and you receive US dollars, they’ll be automatically converted into Australian and you’ll get the rate on the day which may not be the best outcome; there’s a timing risk.”
What strategies would you recommend to treat currency risk?
IC: “It comes down to the client’s own risk appetite. For example, you could enter into a forward foreign exchange contract and exchange US dollars for Australian dollars 12 months in the future at, say 93.32. The spot rate is currently 97.5 cents and the difference is the forward points, derived mathematically by the interest rates between the US and Australia—the US interest rate is 3.1 percent, our interest rate is 7.72 percent, so one year forward, the difference in the forward rate compared to the spot rate in forward exchange will be approximately five percent. That’s simplified, but that’s how you look at it.
“You’re not trying to guess where the currency rate is going to be, it’s just the mathematical difference between borrowing in one currency and investing in another. That locks away all your currency risk, but it may not suit everybody.
“Given where the Australian is in terms of its long term cycle, we’re seeing more exporters buying ‘disaster insurance’ by buying currency options, specifically Australian dollar call options, that is, an Australian call / US put. If the current spot is 97.5, you may want to lock away in your forecasts a worst-case rate of 99 cents for one year. You would probably pay $19,500 for that, per million-dollar contract. What does that give you? It gives you cover in one year’s time at a rate of no worse than 99 cents, but if it’s lower than 99 cents then you just convert your US dollars that you receive in one year’s time at the rate.
“Buying an option gives you more flexibility. Most exporters would tend to do it monthly, say for the next calendar year. At the end of the month they might buy a 99-cent call: at $1 million per month, it’ll give $12 million worth of cover in 2009 at nothing worse than 99 cents. They put that into their cash flows and don’t have to worry about the currency because if it’s lower, they get whatever the lower rate is and they’ve protected the worst-case rate. Think about it as insurance against a currency risk. You pay a premium and you get a worst-case level of cover.
“Some exporters are more sophisticated. They’ll buy an option at 97 cents and sell another at 102, above parity. By having what we call a call spread strategy, protecting against the Australian dollar going higher, they’re saying ‘we don’t think it’s going to go massively higher but I don’t want to pay too much for my protection, so if I buy my 97 cent call and sell one at 102, that’s reducing the cost of my strategy’.
“Another strategy is you buy a call option but you pay a premium at maturity and only if the exchange rate is at a certain level. An example of that would be to buy a 98-cent call today and you pay a premium if, at maturity in one year’s time, the exchange rate is at or below 102. Then the premium you pay at maturity would not be the $21,000 we said today but maybe $30,000 and then only if the Australian dollar is above 102. But if the Australian dollar is above 102 you pay nothing. Alternatively you could just choose to pay a fixed premium at maturity in US dollars matching the timing of the receipt of your funds.”