FX Hedging for Beginners: Reduce Foreign Currency Risk
This article is a contribution from one of our content partners, Bound What is FX hedging? FX hedging is a currency risk management strategy businesses use to protect themselves against losses caused by fluctuations in foreign exchange rates. Essentially, this means a business purchases financial products to protect itself against unexpected movements in exchange rates. Why do businesses hedge FX? When a business hedges its FX exposure, it enters into a financial contract that can lock in an exchange rate for a future date or protect the business if exchange rates move in the wrong direction. This means the business knows exactly how much it will pay or receive in its home currency, or at least will know a worst-case scenario, regardless of how the exchange rate changes. By doing this, CFOs and treasurers are able to forecast their financial performance more accurately. Many businesses also consider hedging FX exposure to prevent their margins from being compressed. Depending on the business, FX exposure can have very noticeable effects on top-line and bottom-line financial performance. How does FX hedging work? When a business hedges its currency exposure, it enters into financial contracts that mitigate the potential of financial loss. The finer details on this depend on the type of currency hedging method (which we’ll go over below). Depending on the business use case, companies can select different methods to help protect against losses caused by fluctuations in exchange rates. What are the different types of currency hedging? Internal Hedging Methods External Hedging Methods Automating currency hedging Many treasurers are looking into ways they can automate manual tasks such as currency risk management. Companies like Bound have put in place products to make this possible, giving businesses a cockpit of tools to make this a smoother process and improve efficiency. How to choose the right hedging strategy Businesses have the choice of internal and external hedging methods; they first need to decide which makes more sense for their business. The best hedging strategy for a company will depend on its specific circumstances and the way foreign currencies move through their businesses. Where treasury teams are uncertain of which strategy suits their needs, they should consult a financial advisor to choose the right hedging strategy for their needs. Currency hedging use cases Conclusion FX hedging is a complex topic, but it can be important for businesses that operate in multiple currencies to manage risk. By hedging their currency exposure, businesses can protect themselves from losses caused by fluctuations in foreign exchange rates. Recommended Reading Join our Treasury Community Treasury Masterminds is a community of professionals working in treasury management or those interested in learning more about various topics related to treasury management, including cash management, foreign exchange management, and payments. To register and connect with Treasury professionals, click [HERE] or fill out the form below. Notice: JavaScript is required for this content.
Franklin
Setting up a tech company’s new foreign office
This article is a contribution from one of our content partners, Bound Expanding a tech company to a new country In 2017 I was working for Paxos in New York City. After some back-and-forth with our CEO over the course of 6 months, I agreed to move to London to set up an office and build a team there. Paxos had an office in Singapore, so this wasn’t the first time it had opened a foreign office, but it was the second. 😉 We were working on a big project with some UK partners and I was traveling to London for one week each month anyway–YOLO. There were a million things to figure out when opening up a foreign office. Set up the legal entity. Find a payroll provider. Find and rent office space. Get new employment contracts. Learn the local laws. Get a visa for you and others. There is a lot. One thing that I didn’t think much about personally and the company didn’t think much about either, was how volatile exchange rates could potentially impact salaries. Not thinking about currencies For me, of course, the Post-brexit era wasn’t great on my newly negotiated USD-converted-to-GBP salary. I was negotiating a cross-currency compensation package around this time. I negotiated hard. At first, I was feelin’ good. I paid rent and food in GBP, but all my savings and investments were going back to USD. Then this happened. Feelin’ less good. I took roughly a 15% pay cut in my disposable income. From the job perspective, on the other hand, I was hiring UK staff. UK salaries were looking better and better for our USD-funded startup accustomed to NYC salary demands. We built the headcount up from 1, to 3, to about 25. Talent in the UK looked like a bargain. Then this happened. Now, personally I was feeling a bit redeemed, but our payroll budgets were getting blown out and it looked like the UK-office was overpaying for talent. Felt like I couldn’t win. My personal takeaway Well, that was the lesson. I’m a product manager. I’m not a currency trader. Should I really be surprised that it felt like I was always bleeding from exchange rate movements? If you’re not a currency trader but find yourself trading currencies, reach out to explore how you can use Bound’s app to minimise such losses and risk. Recommended Reading Join our Treasury Community Treasury Masterminds is a community of professionals working in treasury management or those interested in learning more about various topics related to treasury management, including cash management, foreign exchange management, and payments. To register and connect with Treasury professionals, click [HERE] or fill out the form below. Notice: JavaScript is required for this content.
How SAAS companies get burned by exchange rates
This article is a contribution from one of our content partners, Bound We 💜 finance teams from tech companies We spend a lot of time here at Bound talking with finance teams from venture-backed tech companies. Like most of the work conversations you probably have, our conversations follow a general outline like this: “Hey, Where you calling in from in the world?” [insert your favourite location]. Oh cool, my cousin lived there for a few years. She always said nice things. …… Wait for it…… here comes the obligatory weather comment… “Well, you’ve got better weather than us right now. I’d switch [weather-related complaint] for your [generic weather compliment that is, at best, loosely accurate].” Then the conversation turns to foreign cash flows–which some people might find boring, but we get pretty excited about here at Bound. After all, this is what we do. Why these finance teams talk about Bound Finance teams at growth-stage tech companies use Bound’s app to take foreign cash flows that normally bounce around with exchange rates and make them more stable and predictable. Classic use-cases for using Bound: Companies with these use-cases, use Bound’s technology to make these foreign cash flow streams more stable and predictable almost overnight. How exchange rates can hurt SAAS companies 🔥 One situation that comes up a lot with SAAS companies is the headache of foreign revenue contracts. Here’s an example of how exchange rates can potentially burn saas companies with a lot of international customers. THE SETUP Let’s pretend we’re a UK-based SAAS company with European customers. We report our finances in GBP. This is a fictional example roughly based on 2022 and 2023, but also includes simulated exchange rates into the future. We invoice monthly in arrears and recognize revenue evenly over the contract. THE SALE We sign a new contract with a new customer. Yeah! European customers don’t like paying in GBP, so we price European customers in EUR. The new contract is worth EUR 25,000/month for 24 months–EUR 600,000 total. Let’s pretend we sign the contract in Jan of 2023. The GBP/EUR exchange rate is about 1.125 at the time of contract signing. That’s roughly where the rate was for the first half of 2023. We’ll expect GBP 22,223.80 per month in revenue. Based on that rate, the sales team just booked GBP 533,371.26 . Nice work team! THE FIRST INVOICE 30 days later, we invoice the customer EUR 25,000 and record our GBP 22,223.80 in revenue. Of course, over the course of the month the exchange rate didn’t stay perfectly stable. We’ll pretend the GBP/EUR rate moved a little. Let’s say it’s now 1.127. Not a big deal, GBP 22,178.85. Whatever. GBP 44.95 isn’t a big deal. I can just write down our revenue a little, take a small currency loss or maybe I’ll just shrug this off. THE PAINFUL GBP RALLY But now let’s run a GBP-strengthening scenario for the remaining 23-months. At the time of writing, in early December 2023, GBP/EUR is up to 1.17. (This is mostly the true story of GBP/EUR over 2023) I’ve also thrown historic GBP/EUR data into a statistical rate simulator and told it to run a realistic GBP-strengthening scenario. Let’s see how our company does here for the rest of the year. So, that GBP 44.95 problem in the first month, that we brushed past, ended up being a GBP 63,525.13 problem over the course of the contract. That figure is harder to ignore, especially when you figure we have 50 customers with similar contracts. If the same scenario with all 50 of our European customers, we’re looking at currency losses or revenue write downs in the ballpark of GBP 3,000,000. And remember, currency losses aren’t just paper losses. This has a real impact to our GBP cash flow. THE MESSY RENEWAL One last problem. The renewal. The rate at renewal time was all the way up to 1.19. The customer is happy and wants to renew at EUR 25,000/month for another 24 months. Seems great, but that’s only going to be GBP 504,201.68 at this new exchange rate. So, I need to fight for a 6% price increase just to stay steady with the figures from our last contract or I realize revenue contraction from a happy customer. ;( Again, multiply that by 50 European customers and I’ve got a material renewal problem to deal with. We love this sh*t, so you don’t have to 😉 These are the types of problems that Bound helps SAAS-companies deal with. Reach out to see if you can make your foreign cash flows more stable and predictable. Recommended Reading Join our Treasury Community Treasury Masterminds is a community of professionals working in treasury management or those interested in learning more about various topics related to treasury management, including cash management, foreign exchange management, and payments. To register and connect with Treasury professionals, click [HERE] or fill out the form below.
Currency Markets: Hedgers, Capital Markets and Investors
This article is a contribution from one of our content partners, Bound One of my first lessons in hedging When I first started working in fintech, over a decade ago, I saw these videos on CME. I think the page might have changed a little in the past 10 years, but I think the videos are the same. Haha. I didn’t really understand hedging at the time, but this was one of my first lessons on how trading and capital markets work. Role of Hedgers Role of Speculators How I think of the market structure Today, I generally think of the market in 3 big segments. 1. People who have risk, but don’t want it—hedgers 2.Capital market and financial market participants that make everything work These roles are varied and different, but as a group they play the broad role of helping buyers and sellers find each other at efficient prices. Some examples of these are: 3. People who don’t have exposure, but want it—investors/speculators What role do you want to play? Anytime you have future cash flows in foreign currencies without corresponding hedges, you’re exposed to exchange rate movements between now and the time of that future cash flow. By doing nothing with future foreign cash flows, you’re running currency exposure similar to a currency investor/speculator, albeit for a different reason. Are you purposefully trying to take EUR risk? Join our Treasury Community Treasury Masterminds is a community of professionals working in treasury management or those interested in learning more about various topics related to treasury management, including cash management, foreign exchange management, and payments. To register and connect with Treasury professionals, click [HERE] or fill out the form below. Recommended Reading Notice: JavaScript is required for this content.
Where Are Foreign Exchange Rates Headed?
This article is a contribution from one of our content partners, Bound Introduction You know, we talk to a lot of people about exchange rates. One question we get all the time is where rates are going to go. First thing I want to be clear about here is that Bound is not in the business of trying to predict where rates are going to go. But one question that comes up a lot is what should be the default assumption? Where exchange rates will go if I want to assume nothing in terms of changes in supply and demand, volatility, and global macroeconomic changes. Bound’s Role and Services So I want to talk a little bit about how Bound thinks about that. The first thing I want to be clear about is what Bound is in the business of doing. Of course, we help companies make their foreign cash flows more stable and predictable. If you have unbound cash flows, so cash flows that just bounce around with the exchange rates, you can use one of our three automated programmes to make those cash flows more stable and predictable: The Flat Rate Assumption and Interest Rate Differentials But let’s get to the main question at hand here, which is, what should the assumption be if I assume zero volatility? A lot of people assume it’s going to be the same. Rates have been moving around over the last couple of years, and I know it’s not going to stay the same as we go into the future, but because I can’t predict it, I’m just going to assume that it’s going to stay the same. Because it’s just as likely to go up as it is to go down, so that’s my safest assumption. That ignores one really important principle, which is the interest rate on the two currencies, and that creates what’s called the forward curve. So let’s pretend we’re doing a trade today, dollars for euros, and then a year from now we’re trading those back. The current exchange rate today is about 110, so we would exchange 110 dollars for 100 euros. If the interest rates on those two currencies were exactly the same, we would just swap that money back. But since the dollar earns more interest over the course of the year, we can’t just swap those back and have that be fair, or whoever got the dollars on January 1st is in a way better position. So what we do instead is to take into consideration the interest earned over the course of the year, and the exchange rate needs to change. So in this example, the 110 becomes 115. The 100 euros become 103. The exchange rate needs to move, from 110 to 1.1214, to compensate for that small difference. Understanding the Forward Curve So that is the essence of the forward curve. Let’s take a look at a couple of real forward curves here. And again, this is the assumption that this is not about volatility. This is not about if the economy is going to strengthen or anything. This is just today’s exchange rate and the adjustment we need to make for the fact that these currencies have different interest rates on them. So you can see Pound<>Euro is going to dip a little bit, Dollar<>Swedish Krona is going to stay pretty level but come down, Euro<>USD and USD<>Brazilian Real are both going to go up. Because the Brazilian Real is quite a high-interest-rate currency relative to US dollars. And so this is almost a 5 percent adjustment over the course of the next 12 months, in where that exchange rate will go strictly because of the interest rate. So if supply and demand don’t change, if the economies of the US and Brazil stay exactly the same, there’s nothing else that changes. This is where a rational person would assume, just based on the interest rates, where this exchange rate would change. Misconceptions About Hedging That could be good for me or bad for me, depending on if I’m buying or selling BRL. Some people assume that this is a cost of hedging, saying, if I hedge the rate out a year from now, that rate could be potentially a lot worse for me. So I’m not going to hedge at all; I’m just gonna assume that it’s gonna be flat. But assuming that it’s flat is essentially making the assumption that it’s going to be volatile and it’s going to be volatile in the right direction to hold that flat because you’ll be fighting against the interest rate differences across these two currency pairs over the course of that whole year. The way Bound tends to think about volatility and exchange rates is that the default assumption is the forward curve itself, and volatility revolves not around a flat line but around the forward curve. Join our Treasury Community Treasury Masterminds is a community of professionals working in treasury management or those interested in learning more about various topics related to treasury management, including cash management, foreign exchange management, and payments. To register and connect with Treasury professionals, click [HERE] or fill out the form below. Recommended Reading Notice: JavaScript is required for this content.