Statrys Payment Platform Ecosystem

3 Ways Small Businesses can Hedge Foreign Exchange Risk

Jonathan Cusimano
Published: 05 Feb 2020

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    Before we dive into the strategies to hedge your foreign exchange risk, do you know what is a foreign exchange (FX) exposure?

    If you don't, check our video below:

    How to Assess Your FX Exposure?

    Before implementing a hedging policy, a company must assess its FX and or exchange rate exposure on the market so it has a clear picture of its exposure and can better assess how to manage it.

    When a company transacts in a currency other than its domestic currency, it enters a market position.

    Example: For example, the Hong Kong-incorporated company below, whose domestic currency is HKD, is in a market position because it transacts in EUR and GBP.

    The table shows an example of FX flows dealt with by the company:

    How Do Small Businesses Hedge Foreign Exchange Risk

    Based on the data above, the company can assess its unrealized gains or losses as follows:

    How Do Small Businesses Hedge Foreign Exchange Risk

    How Do Small Businesses Hedge Foreign Exchange Risk

    The example above highlights that the company has FX exposure, which can be reduced or eliminated.

    It is critical for a financial officer to assess in real-time the company’s open FX positions to better manage them.

    Which hedging strategy is suitable for which type of company?

    1. No hedging strategy

    If a company decides not to hedge, it will be fully exposed to foreign currency fluctuations until the invoice is settled.

    As a result, the company will record an exchange rate gain or loss in its accounts.

    The person in charge of the hedging strategy at the company surely expects some FX gain, but this is a risky approach for a company, and it could ultimately negatively damage its relationships with shareholders and banks.

    In rare cases where companies have adopted this strategy, the main reasons were lack of access to hedging tools, or the company has a global policy not adapted to local markets.

    2. Partial Hedging Strategy

    A company may decide to implement rules to reduce its FX exposure on, for example:

    • Sales and purchases (e.g. hedge a certain percentage of the total sales or purchases volume).
    • Exposure at the end of each day, week, or month (e.g. hedge a volatile currency based on its weight on overall sales volume).
    • Net exposure at a certain exchange rate range (e.g. hedge a certain percentage of the total sales volume when the exchange rate falls within a certain range [‘limit order’ or ‘stop order’]).

    Partial hedging strategies are usually implemented by companies that do not wish to take a systematic hedging approach.

    3. Systematic hedging strategy

    If a company adopts a systematic hedging strategy, it will have almost no FX exposure.

    Given that the FX market is extremely volatile, with rates changing within short periods of time, it is impossible to have no FX exposure.

    The flip side of systematic hedging is the opportunity loss if the exchange rate changes favorably during the hedging period.

    This strategy is rarely adopted by SMEs because financial institutions do not offer such services for SMEs.

    However, if a business knows its payment flows, it is recommended to adopt a systematic hedging strategy.

    If a business can only estimate its payment flows, it will be more challenging because it would not know if the amount hedged is too much or not enough.

    Looking for a new way to make affordable hedged FX trades? Consider opening a Forex Account with Statrys and start making FX trades the smarter way.

    Still not confident enough to start trading? Read our complete guide to Forex for Business.

    author
    jonathan Statrys
    Jonathan Cusimano

    Jonathan Cusimano is Head of FX at Statrys. With nearly a decade of experience in banking and Fintech, Jonathan has advised and assisted many SMEs in their FX hedging and treasury management strategies.

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    Statrys Limited is licensed as a Money Service Operator (No. 19-02-02726) in Hong Kong. ‍ Statrys UK Limited is a Small Payment Institution (FRM: 911226) registered with the Financial Conduct Authority in the United Kingdom. Statrys UK Limited (FRM: 902805) is a registered agent of PayrNet Limited (FRM:900594), an Electronic Money Institution authorised by the Financial Conduct Authority in the United Kingdom under the Electronic Money Regulations 2011 for the issuing of electronic money. Trade financing services are offered by our partner, Velotrade Management Limited, regulated by the Securities and Futures Commission of Hong Kong (CE Ref #BJL007)