Tag: foreign exchange

Welcome to Our Awesome Blog!

Where Are Foreign Exchange Rates Headed?

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.

FX Hedging is not Gambling

This article was written by HedgeFlows Many finance professionals in small corporations find dealing with foreign currencies quite challenging. Surprisingly, only 4% of UK SME exporters hedge their currency risks, while some businesses still consider FX forwards to be a form of gambling. This raises a question: why do most major corporations adopt FX hedging strategies while smaller companies often see it as an unnecessary expense? This article delves into the most common mistake made by finance teams when it comes to hedging and presents a more structured and robust approach to understanding this complex practice. The most Popular (and often wrong) Reason for Buying FX Forwards Numerous finance professionals view the primary aim of “hedging” using FX forwards as securing a more favourable FX rate for future transactions. While this notion holds some truth, it fosters a decision-making framework that is too flexible, leading to unpredictable incentives and behaviour. Traditional FX forwards are by far the most popular hedging instruments and enable businesses to fix today’s exchange rates for a specified amount of currency to be exchanged in the future. By entering into FX forward contracts, parties agree on a predetermined exchange rate for future transactions, shielding themselves from fluctuations in exchange rates. This fixed rate mitigates uncertainty and provides stability for both parties involved in the contract, regardless of FX market movements. When asked why they use FX forwards, all too often, people say they do it to get a better exchange rate, reduce their costs, or boost their revenues. Unfortunately, setting the goal of achieving a superior FX rate through hedging requires individuals to forecast future exchange rate movements, a task fraught with difficulty. Even the most skilled FX traders in leading banks and hedge funds struggle to consistently predict currency fluctuations correctly, a feat made more challenging for small finance teams lacking the resources and information flow available to top traders. Attempting to outsmart the foreign exchange market by aiming for preferential rates when buying and selling currencies is akin to challenging a casino at its own game. The unpredictable nature of FX rates contributes to the perception of hedging as a gamble, as individuals attempt to foresee future market conditions without a crystal ball. The fear of making incorrect decisions driven by current market rates is a significant concern for inexperienced finance managers and treasurers, who worry about the potential impact on their careers. Experienced finance teams mitigate this unpredictability by aligning their hedging strategies with well-defined and communicated internal objectives and metrics and implementing processes to effectively manage uncontrollable factors like FX risk fluctuations. Clear Internal Objectives Although the primary objective of FX hedging may vary for each business, key common goals and strategies can provide stability to your hedging approach despite the fluctuating nature of exchange rates. The prevalent strategies include Balance Sheet Hedging and Cashflow Hedging. Balance Sheet Hedging A balance sheet hedging programme aims to safeguard profit margins against currency fluctuations, reflected as FX Gains & Losses in accounting records. Typically, balance sheet items like foreign currency bank account balances, AP/AR, and other assets and liabilities in foreign currencies can lead to FX Gains & Losses for any accounting period. Often, foreign invoices are accrued at one exchange rate and settled later at a different rate, resulting in such FX Gains & Losses. The significance of hedging is better understood when it is directly linked to underlying exposures. Assessing hedging performance accurately necessitates considering hedges together with underlying assets or liabilities in foreign currencies. For many businesses, FX risk may be unidirectional. For instance, a company might solely buy or only sell in a foreign currency. In such scenarios, mitigating the impact of currency fluctuations on profit margins is achieved by hedging any contract or invoice denominated in a foreign currency promptly upon commitment. Nonetheless, understanding when FX risks arise is crucial. FX risks often emerge as soon as a contract is signed or even earlier, but accounting only captures a part of these risks when invoices are recorded in the ledger. In the above case, the exchange rates moved unfavourably from the time the sale invoice was entered until it was paid, and thus, the person who would have made the hedging decision looks like an unsung hero, even when the performance of the FX contract is viewed on its own. However, market exchange rates could also move in a favourable direction, in which case, the decision to hedge may seem like a wrong one – it would be better to wait and exchange currencies later. If the decision to hedge or not to hedge is based on an individual’s views of where the exchange rates are going, the company risks ignoring the key fact. The company is exposed to currency risks in a specific direction, and it must hedge if it wishes to remove FX gains and losses from the income statement. This is why it is important to view the hedges combined with the underlying risks to demonstrate their value: simply by fixing a predictable value of foreign invoices and thus protecting profit margins from unexpected currency swings. In the above example, the result FX Gain & Loss is nil, exactly the desired outcome. Cashflow Hedging Imagine that the above-mentioned company decided to hedge such an invoice even earlier, when the sales contract was signed. This means the company would enter into a FX forward contract, locking in a guaranteed exchange rate of 1.2525 (1.2500 and a small cost that often needs to be paid to purchase a FX forward). As a result, the company would lock in the value of £79,840.32 ($100,000/1.2525). More importantly, when the client pays $100,000 a month later, the cash flow can be exchanged at the guaranteed rate, and the company can collect the full £79,840.32. However, in this case, the hedge existed even before the invoice appeared on the balance sheet. Until the invoice date, this hedge relates to a forecasted transaction. Such a hedge is called a cashflow hedge because it does not…

4 WAYS TO ASSESS YOUR COMPANY’S FOREIGN EXCHANGE EXPOSURE

4 WAYS TO ASSESS YOUR COMPANY’S FOREIGN EXCHANGE EXPOSURE

This article is written by GPS® Capital Markets When you take a close look at any business’s operations, most planning and management are determined by the company’s size and vertical. When I’ve talked to executives about how they run their companies, the consensus is that there’s a mountain of difference between how to approach a small business’s operations versus a sprawling multinational’s. However, there’s one important exception to the rule, and it’s what we’re going to discuss in this blog: When it comes to  doing business in multiple markets—no matter the details—all companies face foreign exchange exposure. How well a business assesses, forecasts, and manages fluctuating costs across currencies could be the difference between sinking and swimming. Take a look at these four ways you can start understanding your exposure.  Treasury and finance professionals working to document and understand FX risks classify different types of exposures to track and mitigate them. Ultimately, the more data you can collect about these dynamics, the better you can optimize over time.   Not all companies will face these exposures, but as a company grows, its FX risk can become more nuanced and bring different dynamics into play. Depending on how long you’ve been working at your company and how large/complex its operations are, it may be difficult to tease out the financial dynamics happening in each subsidiary. The most successful treasury professionals will be able to audit payments and transactions and find ways to consolidate or refine overall processes to save money or time. All refinement or optimization—the buzz word of the decade—begins with accurate data collection that can later translate into advanced analysis, visualization, and reworking of processes to mitigate FX exposure.  Data aggregation tools, like GPS’ FXpert platform, keep track of your company’s activities across markets. This makes it easier to see exposure and create actionable plans for reduction of risk. With a complex view, different supply chain, acquisition, or payment procedures can be developed.  If each of your subsidiaries does reporting differently, it can be difficult to get to a single point of data truth to understand exposure. Combine this with different operating languages, currencies, vendors, and lines of business, and you can get yourself into a big mess. Determining FX exposure, especially in a complex manner over many years, is most successful when you have all your ducks in a row and operate in a uniform manner. With FXpert, you can standardize payments with intercompany netting and report on all your transactions to meet regulatory requirements in one place.   Trying to assess FX exposure on your own, even with an experienced in-house team, can prove too much for a treasury professional to handle. Whether your operation is expanding into new markets or acquiring subsidiaries with different transaction practices or software, bringing in experts who deal exclusively in FX covers your decisions and provides new ideas. Having seasoned experts available 24/7 and ready to help with any FX question provides peace of mind and the ability to get second opinions on any hedging strategy.  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 to get more information. Notice: JavaScript is required for this content.

Exchange Rates and How they Affect Every Business

Exchange Rates and How they Affect Every Business

The world has gotten more connected through globalization and advances in technology. This has changed the way small business owners operate. And the burning question many businesses are asking is how exchange rate affect business? In the past, small businesses usually focused on their local area. They made and sold products or services to people nearby, and they got their supplies from local sources. This is usually within the same city or state, and always within the same country. But with globalization, there are new benefits and challenges for business owners. They now have a bigger market to sell their products to and can choose from suppliers all over the world. However, they also face challenges like understanding different markets and cultures and dealing with foreign languages. Many small business owners might not fully understand how changes in exchange rates affect their businesses. These exchange rates play a big role in all international transactions. It’s important to know how the foreign exchange markets work. And how they can impact your business. To read more blogs related to how exchange rate affect business, check out: Navigating the Foreign Exchange Market: Its Functions, Players, and Importance to Business Owners 10 Factors that Influence Exchange Rates between Currencies What are exchange rates? Exchange rates, simply put, are the rates at which one currency can be exchanged for another. These rates fluctuate constantly based on a myriad of factors, including economic data, geopolitical events, and market sentiment.  Imagine you’re running a U.S.-based company importing electronics from Japan. If the exchange rate is 110 Japanese Yen (JPY) to 1 U.S. Dollar (USD) and suddenly shifts to 100 JPY to 1 USD, your purchasing power increases. You can now buy more goods for the same amount of USD because each dollar now costs fewer yen. There are two primary types of exchange rates: Floating Exchange Rates: These are determined by market forces, with prices fluctuating continuously based on supply and demand. Fixed Exchange Rates: Some countries peg their currency to another major currency (like the U.S. dollar or the Euro). This keeps their exchange rate stable against the pegged currency. For example, if $1 USD equals €0.85 EUR, this exchange rate tells you how much European currency you can get for your U.S. dollars and vice versa. How Exchange Rate Affect Business 1. Impact on Import Costs When considering the effects of exchange rates on your business, it’s crucial to understand the multifaceted impact these rates can have. For businesses involved in importing goods, the strength of the domestic currency plays a pivotal role. A stronger domestic currency can lead to reduced import costs, as your currency now has more purchasing power internationally. Conversely, a weaker domestic currency can increase these costs, impacting your profit margins. For instance, if you’re importing electronics from Japan and the US dollar strengthens against the Japanese yen, your purchasing power increases, enabling you to buy more goods for the same amount of money. 2. Effect on Export Competitiveness Export competitiveness is another critical area affected by exchange rates. A weaker domestic currency can make your exports more competitive in the global market as your products become cheaper for international buyers. However, if your domestic currency strengthens, your exports might become more expensive and less attractive, potentially reducing demand.  Let’s say a Canadian furniture manufacturer exports to the U.S. If the Canadian dollar weakens against the US dollar, its products will become more competitively priced in the U.S. market. 3. Influence on Profit Margins The impact of exchange rates extends to the profit margins of businesses, especially those with significant foreign revenue or expenses. Fluctuations in currency values can lead to exchange rate gains or losses when converting foreign revenue back to the domestic currency. For example, a UK company receiving payments in US dollars will see an increase in profits when converting to pounds if the US dollar strengthens against the British pound. 4. Implications for Investments Investments in foreign countries are also subject to the influence of exchange rates. If a U.S. company has investments in Brazil, a depreciation of the Brazilian Real against the US dollar could decrease the value of these investments when converted back to dollars. Additionally, the repatriation of earnings from foreign subsidiaries can be affected by fluctuating exchange rates, influencing the overall profitability of overseas operations. 5. Challenges in Pricing Strategy Pricing strategy in international markets is another aspect that can be impacted by exchange rates. Constant fluctuations might necessitate frequent adjustments in pricing to maintain consistent revenue in the home currency. A software company based in India, for instance, might need to adjust its pricing in euros frequently to maintain a steady revenue stream in Indian rupees. 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 to get more information. Notice: JavaScript is required for this content.

10 Factors that Influence Exchange Rates between Currencies

10 Factors that Influence Exchange Rates between Currencies

Have you ever wondered about the factors that influence exchange rates? Aside from interest rates and inflation, a country’s exchange rate tells you a lot about how healthy its economy is compared to others. Understanding the dynamics of exchange rates between currencies is crucial for both investors and businesses operating in the global market. The exchange rate of a currency is its value in terms of another currency, and this rate is influenced by a multitude of factors, ranging from economic policies to market speculation. This blog post explores these factors in detail, offering real-world examples and discussing their general impact on exchange rates. Learn more about foreign exchange in: Navigating the Foreign Exchange Market: Its Functions, Players, and Importance to Business Owners Exchange Rates and How they Affect Every Business 10 Factors that influence exchange rates 1. Interest Rates Interest rates, set by a country’s central bank, are the cost of borrowing money. Higher interest rates offer lenders higher returns relative to other countries. If the U.S. Federal Reserve increases interest rates, it can lead to an appreciation of the U.S. dollar as investors seek higher returns. Influence on Exchange Rates: Higher interest rates attract foreign capital and cause the exchange rate to rise. 2. Inflation Rates Inflation indicates the rate at which the general level of prices for goods and services is rising. In the 1980s, Japan’s low inflation rate contributed to a significant rise in the value of the Japanese yen. Influence on Exchange Rates: Lower inflation rates are often associated with a higher currency value as purchasing power increases relative to other currencies. 3. Economic Policies Economic policies include government fiscal policy and monetary policy, which affect economic activity. The introduction of quantitative easing by the European Central Bank in 2015 led to a decline in the Euro’s value. Influence on Exchange Rates: Government policies aimed at stimulating economic growth can lead to depreciation or appreciation of the currency, depending on how the market perceives these policies. 4. Public Debt Public debt is the total amount of money that a country’s government has borrowed.  In the early 2010s, Greece’s public debt crisis led to a significant fall in the Euro’s value. Influence on Exchange Rates: Countries with large public debts are less attractive to foreign investors due to the risk of inflation and default, leading to a decrease in currency value. 5. Level of Income This refers to the national income and purchasing power of a country’s residents. Higher income levels in the U.S. can lead to increased imports, affecting the dollar’s value. Influence on Exchange Rates: Higher income levels can lead to more imports, causing the local currency to depreciate against foreign currencies. 6. Terms of Trade Terms of trade relate to the ratio of export prices to import prices. Australia’s strong terms of trade during the commodities boom in the early 21st century led to a stronger Australian dollar. Influence on Exchange Rates: Improved terms of trade (when export prices rise relative to import prices) strengthen a country’s currency. 7. Political Stability Political stability refers to the degree of predictability and consistency in a country’s government. The Brexit vote in 2016 led to a sharp decline in the value of the British pound due to political uncertainty. Influence on Exchange Rates: Political stability tends to attract foreign investment, leading to a stronger currency. 8. Current Account Deficit Definition: The current account deficit measures the balance of trade, foreign income, and direct transfers. The U.S. has run significant current account deficits, impacting the dollar’s value. Influence on Exchange Rates: A larger deficit can lead to the depreciation of the currency as more capital leaves the country. 9. The Stock Market Definition: The stock market reflects the performance of publicly traded companies and investor sentiment. A bull run in the U.S. stock market can attract foreign capital, boosting the dollar. Influence on Exchange Rates: A strong stock market can attract foreign investment, leading to currency appreciation. 10. Confidence and Speculation Definition: Market confidence and speculation involve investor perceptions and future expectations about a currency. Speculation about the Eurozone’s stability during the debt crisis influenced the Euro’s value. Influence on Exchange Rates: Confidence and speculation can cause rapid swings in currency values based on investor perceptions and predictions. These factors can intertwine and interact, creating a complex web that determines the ever-shifting landscape of exchange rates. Understanding these forces can help you navigate the financial terrain, whether you’re a seasoned investor or just a curious globetrotter.  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 to get more information. Notice: JavaScript is required for this content.