What’s the best way to manage currency risk?

How you develop a currency-management strategy depends on a number of things: your company’s treasury policy, your attitude toward risk, the kinds of currencies you’re handling and your overall business model. So how do you go about modelling a currency management risk strategy that’s right for you?

Photo: John Woodworth

In a new research paper recently published here on Business without Borders a currencies expert argues that any strategy must accommodate your company’s cash flow and your risk tolerance. Don’t bet on the direction you expect currencies to move, says Richard Baigent, Global Markets, Head of Corporate Sales, HSBC Bank USA (HSBC sponsors Business without Borders).

Is your company interested in flexible, fixed or hybrid currency hedging? In flexible hedging you let your currency contracts settle on whatever the spot rate is on that day. Fixed means you set you currency exposure in advance and keep to it through “forward contracts” right up to settlement day. In a hybrid approach you employ options to participate in flexible exchange rates and to protect against worst-place scenarios.

Baigent discusses the range of factors that go into determining whether your company should adopt a flexible, fixed or hybrid strategy. One trap to avoid is building an overly complex hedging strategy. Compliance with attendant rules quickly would become burdensome, he writes. “As a result, most Canadian treasurers will prefer to stick to nothing more complex than vanilla options such as basic caps, collars and floors alongside spot and forward contracts – and certainly avoid excess leverage or anything that could potentially result in an over-hedge.”

For an introduction to hedging see our feature here. And you can read about how one company’s vice-president of treasure compares and contrasts managing cash in the United States and Canada here.