Learning from five mistakes made by customers entering into forward transactions. Improve currency risk management.

Our team gained experience in corporate banking departments of Citi Handlowy and mBank. We have worked with dozens of companies that managed currency risk more or less skillfully. No better learning than learning from someone else’s mistakes. Here we present you 5 tips on how to improve the operability of currency risk management in companies.

1. Compare the exchange rates of forwards

When entering into FX risk hedging transactions, you should always compare the price of e.g. forward transactions with two banks or payment institutions. It is by no means that a corporate dealer wants to deceive you.

In large institutions, the end-customer price goes through several departments (in plain English, it is because of the departments of bank liquidity, interbank trading and corporate sales), through several IT systems and there are many places where this price can be miscreated (recalculated). Therefore, by just comparing we always have an ace in our sleeve regarding the price correction or checking by the dealer whether the systems are converting the exchange rate correctly.

2. Avoid “key data” release days

On days when financial markets are nervous due to the expectation of a decision to reduce or increase interest rates, the liquidity in the market decreases and the spread between deposits and loans in a given currency increases. Thus, the forward rate may be less favourable for the company’s customer. Of course, we have no influence over the second factor, i.e. the level of the base exchange rate itself. If we think that the market is “on the top” and we would like to sell the currency on time, we have a dilemma – however, it is worth paying attention to the key data release calendar as well. In this way, we will manage the currency risk more responsibly.

3. Currency options – sales targets

Corporate dealers often suggest a purchase of currency options, which in fact is insurance as a single option – we pay a commission called a premium and have the right to buy or sell currency at a certain rate. Right – not an obligation. It works pretty much the same way as car insurance – it is worth having, but we would prefer not to have to use it.

However, the motivation for offering to us by a corporate dealer can often be his desire to reach sales’ target. Then they will reduce the price “especially for us”, so that the customer feels compelled to buy such a solution. This may be profitable for your business, but it is worthwhile to first get to know all the risks behind it (not when buying a single option, but when buying complex option strategies). This type of currency risk management is only for professionals.

4. Beware of treasury limits

Companies which conduct FX risk hedging transactions have a treasury limit – simply speaking, the level of acceptable loss on forward transactions estimated by the bank. It is worth remembering, because if we have an open forward transaction and the opposite spot price change causes that our transaction is in a loss – we can get close to the treasury limit. Then – the bank will call us and we have several options:
pay an additional deposit to cover the difference to
apply for a change of treasury limit

to close part of the forward transaction on a given day.

It is worth remembering about one drawback. In some banks, the valuation of derivative transactions is officially published to the customer on the next business day, when, for example, the threat of exceeding the treasury limit has decreased. Nevertheless, corporate dealers are obliged to call the customer and request one of the three actions. If you have a problem with this we invite you to contact our team – we will advise you.

5. Waiting for the best opportunity

Unfortunately, many customers prolong waiting for the best possible exchange rate in order to make a forward transaction that will hedge their company’s foreign exchange risk. Sometimes they let few days pass by – sometimes the exchange rate will change in favour, sometimes to the disadvantage. But it works as if the company did not have any forward transactions at all and still has an open currency position. How to manage currency risk? the best time: when the
exposure appears: e.g. when a commercial order is made or accepted,
“Entry in” into the warehouse,
Receipt of an invoice.

This is the full elimination of currency risk, the removal of a factor changing our commercial profitability. It’s all about sleeping well and earning just what we calculated at the beginning, and not counting on extra income or loss as a result of exchange rate fluctuations.

We recommend that you continue below:

Article – Currency risk management in small and medium-sized enterprises can be understood in a few simple steps.

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Trefix Team