Many small companies doing business in global markets face challenges in managing foreign currency exchange (“forex” or “FX”) and international trade can be tricky during ordinary times. Moreover, during periods of great FX market volatility this task can become extremely dangerous. Small company owner/CEOs with exposure to currency risk can suffer uncomfortable losses literally overnight which have nothing whatsoever to do with their business.
Sharp changes in FX rates are unpredictable and can be disruptive when the level of volatility is high. And right now it’s extremely high due to the COVID-19 crisis. The crisis caused a crash of nearly every global market and recovery is uneven and sporadic.
FX volatility can lead many people to consider hedging to reduce their risks. However, to hedge successfully, one must know which strategy will likely make the most sense for them.
Effects of the COVID-19 Crisis on FX Volatility
It’s not an exaggeration to say that the effect of the COVID-19 crisis on the global economy remains devastating. Many small businesses are now looking into bankruptcy relief options and many more will fail during an extended recession. Those businesses that have high exposure to forex risks have compounded risks and are more in danger than ever. The coronavirus crisis triggered a period of extreme FX volatility. Thin liquidity on the market is complicating this situation further.
Unsurprisingly, developing countries have been hit the hardest by this crisis. Not only are they losing income due to the slowdown of manufacturing and global trade. They also suffer because remittances have gone down. Those payments are a major stream of cash inflow for most developing economies.
All things considered, currencies of developing countries are at risk of rapidly losing value against the dollar. Even overall stable currencies from advanced economies, like the Australian Dollar, are weakening. For the most part, this is happening because of the slow down in global trade. Such economic fluctuations, compounded with the uncertainty regarding the pandemic, make the global FX market volatile in the extreme.
Services That Help Protect Against Forex Volatility
This crisis and the subsequent global economic recession may be with us for an extended period. Therefore, if small company CEOs want to make it through, improved forex management skills are important. In order to do this, one should use every possible tool, from a crisis cash management plan to an FX hedging for volatility guide. The latter should also come with assistance for everyone who isn’t an experienced FX trader.
The good news is that today there are many services that provide small businesses and independent investors with access to hedging. Moreover, they also offer currency counseling. This means that experts working for these companies can give small company CEOs advice on how and when to hedge best.
Many foreign currency exchange companies are offering these services. Some also offer cheap international currency transfers, which makes them a popular alternative to banks. However, these companies are rather versatile and not all of them are suited for clients who seek to protect themselves from extreme FX volatility. For this many companies may need to look for foreign currency exchange companies that feature a corporate FX desk.
Best Hedging Strategies for Extreme Volatility
Natural Hedges
Natural hedges aren’t really hedges. They are more about managing your business’ resources in the most efficient manner. In essence, to use natural hedging, companies need to monitor all currencies the business is dealing with very carefully. Use them right to minimize the need for conversion.
For example, if you accept payments in USD and EUR but need to pay your suppliers in EUR, you should pay from your Euro account directly. This way, you will avoid losing money both when converting EUR to USD and back whenever you need to make a payment. The aforementioned FX companies offer multi-currency accounts for businesses. They allow you to hold and use your balance in several currencies with minimal fees.
Balance Sheet Hedges
Balance sheet hedging is not common in the way that it’s only offered by a few FX companies. To offer this service the company must hold a separately regulated subsidiary for options business. Check this out when comparing FX companies if you are interested in this type of hedge.
The purpose of balance sheet hedging is to protect your business’ balance sheet from the effects of currency fluctuations. It’s rather complex and requires a lot of skill. You’ll need to make forecasts for the impact that FX rates in your non-primary currency will have on your assets. Then, you’ll hedge to prevent your balance sheet from being affected if the numbers change unfavorably due to FX volatility.
Dynamic Hedges
Dynamic hedging is a strategy for international businesses that need to set prices in a different currency. The effect of daily FX rates changes on these sellers is profound, especially during high volatility periods. Therefore, hedging might be their only way to avoid huge losses.
This type of hedging is when the company uses the daily FX rate to set their prices. However, at the end of the day, it hedges accumulated sales. This means that the company is hedged at the current rate. Next, the seller will need to decide whether they want to remain at this rate and keep prices the same or change when the rates change.
Rolling Hedges
Rolling hedges are forward contracts, currency options, and swaps. They are tools that allow you to keep the FX rate at a certain level using specialized contracts. These tools differ from each other greatly, so you’ll need to choose carefully.
For example, both forward contracts and options allow you to fix a specific FX rate. Therefore, when the contract matures, you’ll use this rate to pay instead of the current rate. This can be a huge advantage when the FX market is volatile. But while forward contract must be fulfilled, options allow you to choose between the current and set contract rate. Therefore, if the FX market swings favorably, you’ll be able to get the best deal regardless of your hedging contract.
In Conclusion: Act Fast to Withstand Extreme FX Volatility Conditions
Hedging can help you minimize or even completely avoid risks associate with extreme FX volatility. However, you must never forget that it will only be effective if you implement the right hedging strategy at the right moment. The coronavirus crisis is already here. Therefore, it’s essential that you act fast if you haven’t already. Use the help of an experienced and trustworthy FX company to help you make the best of this dreadful situation.
Source: FX hedging for volatility guide
About Scale Finance
Scale Finance LLC (www.scalefinance.com) provides contract CFO services, Controller solutions, and support in raising capital, or executing M&A transactions, to entrepreneurial companies. The firm specializes in cost-effective financial reporting, budgeting & forecasting, implementing controls, complex modeling, business valuations, and other financial management, and provides strategic help for companies raising growth capital or considering M&A/recapitalization opportunities. Most of the firm’s clients are growing technology, healthcare, business services, consumer, and industrial companies at various stages of development from start-up to tens of millions in annual revenue. Scale Finance has multiple offices in the Carolinas including Charlotte, Raleigh/Durham, Greensboro, and Wilmington with a team of more than 45 professionals serving more than 130 companies throughout the region.
