Interconnected Markets and Cash Flow Hedging Agility
This article is written by GPS Capital Markets Each morning, as I walk through the GPS headquarters in Salt Lake City, breaking news plays on flat screens lining the area where account executives and other members of the GPS team work. Whether it’s a natural disaster, international conflict, or trade agreement, being in an FX company will make you believe that a butterfly flapping its wings in South America could really cause a storm in the northern hemisphere. Breaking news flashing across screens can start a domino effect, with account executives checking reports, looking up currency movements, or getting on the phone to talk to cash flow hedging and other clients who might be impacted by events. When I was a college and graduate student studying cultural anthropology, every spring I applied for grants that would help me do fieldwork abroad. With a longtime love of cross-cultural exchange and the growing possibilities of big data, I started focusing on what’s called Network and Complex Systems Theory, which uses mass data gathering and visualization techniques to study underlying patterns in different systems, which could be economic, as we’re focused on at GPS; ecological; social; and more. Besides studying interconnected data points, just traveling between my home in Utah and Europe provided me with a fascination for the way trends spread and impact events in (sometimes) predictable ways. Today, it’s exciting to work in a field where I see the contemporary world’s interconnected nature daily—like having a finger on the pulse of a complex network of investing and divesting, growth and absorption. Seeing the proactivity and how detail-oriented the multi-person teams supporting our clients are also inspires me. Especially during the past year, unforeseen conflicts and shifting trade agreements (see All Eyes on the Peso by Michael Buck) create ripples and test GPS’ ability to predict and respond on the dot when market disruptions occur. While nobody has a crystal ball, cash flow hedging can anticipate and obviate losses. Examples of how businesses increase agility with cash flow hedging For companies of any size, foreign exchange exposure can increase operating costs, cause cash flow and balance sheet discrepancies, or increase anxiety about the value of assets and liabilities. To better understand how GPS teams assess cash flow exposure and provide agile solutions as events occur, the following provides specific examples of scenarios that required quick pivots of cash flows due to war, subsidiary closure, and more. Many examples show how GPS clients utilize hedging advice when unforeseen events take place and can illustrate the benefits of person-to-person collaboration that takes place in cash flow hedging programs. How cash flow hedging works When companies set up cash flow hedging processes, forecasting cash flows starts 12 months in advance. This process allows business to lock in better rates, providing certainty about the actual cost of expenses and liabilities. When a business implements a cash flow hedge, the use of a hedging instrument (a derivative) locks in the amount of a future cash inflow or outflow before market volatility hits. Cash flow hedge accounting then connects the income statement of a hedging instrument and a hedged transaction, offsetting the predicted changes in cash flow. Matching cash flows to offset losses due to currency market volatility, the change in the value of the derivative designated as a cash flow hedge will be reported as a component of other comprehensive income (OCI) and then reclassified into earnings in the timeframe when a forecasted sale or debt happens. Different types of cash flow hedging strategies There are three main types of strategies to offset forecasted cash flow issues: static, rolling, and layered. Common cash flow hedging strategies: The benefits of dedicated customer service while hedging cash flows The above examples show that conducting international business comes with multiple opportunities and challenges that many treasury departments struggle to manage if they are relying on individual banks. Yes, GPS beats bank rates and saves clients millions, but more importantly, advisors provide 24/7 attention to each client, getting to know their business needs and anxieties inside-out. Working in tandem with real experts in the FX space, clients get to engage in granular business development conversations on an ad hoc basis. If you find out that a supplier or payee in a subsidiary goes out of business, GPS will be there to give recommendations for finding new contracts, shifting resources to other markets, or simply implementing different hedging strategies. If a war or international trade relationship shifts, GPS uses its large bank of data and its experts’ decades of experience to create plans to offset losses or win new contracts across unaffected markets. 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. 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FranklinFXBEACON: FOSTERING DEVELOPMENTAL RELATIONSHIPS IN BUSINESS: A HOLISTIC APPROACH
This article is written by GPS Capital Markets My wife loves to explore the world. Anyone who has gone on an adventure with us knows that my wife’s trips are always outstanding. My trips, on the other hand, are usually all about business and developing relationships with people around the world. A few years ago, we visited Notre Dame in Paris. We took a behind-the-scenes tour of the restoration work being done on this magnificent cathedral. The emotion and feelings evoked from seeing this masterpiece cannot be replicated. Only a few weeks later, it caught fire and burned down. My feelings of heartbreak from this personal interaction would not have been the same. If I had not visited and experienced it in person. Working at GPS Capital Markets is for me all about creating true Developmental Relationships in business. It requires being meaningfully connected to current and prospective clients. Even if that means traveling hundreds or thousands of miles to see them. For instance, a few years ago, I was visiting a client in their office. And they had a mountain bike propped up against the wall. As an avid mountain biker myself we were able to develop a close relationship based on mutual interests. This client then took me on a tour of their building. And showed me a map of where they do business around the world. Noticing they did business in China, I asked about the challenges they had doing business there. He had incorrectly assumed they didn’t have options for dealing with CNY currency risk. We were able to customize a very effective plan to help them reduce their risk by millions a year. None of this would have happened without having been there in person. In the ever-evolving business landscape, the importance of Developmental Relationships cannot be overstated. Repeatedly, I have experienced a very fractional relationship approach to sales. They had multiple handoffs from the initial call to implementation and ongoing support. This is especially true in the technology space where a lot of knowledge is required. In order to advise a client on their best course of action. But how does this relate to foreign exchange and our ability to provide a great service to our clients? Let me relate three examples of how and why this works for me. What Is Right for the Client? Okay, I know this sounds trite and everybody says something similar, but here are ways I practice and train our employees with this skill. All of this happens before we start “selling” someone on our tools and services. If you have never met your provider and all they do is sell you more and more risky products, it is not very likely you will have a true partner. Find The Right Partners When choosing a football club to sponsor, it was important to understand who we were doing business with. Partnering with prominent organizations, such as Burnley FC, opens doors to a vast network of professionals and enthusiasts alike. But not all relationships are the same. We met with the owners of the club on multiple occasions to ensure that our end goals and cultures were a good fit. At the end of the day, the people in the organization, and their willingness to help us as a company were deciding factors. These partnerships extend beyond traditional networking events, offering unique opportunities for interaction, and fostering relationships not only within the business community but also among passionate sports fans. Such as the one we co-sponsored to bring together top women leaders in Northern England to hear the inspiring journey of Lola Ogunbote, Head of Women’s Football at Burnley’s Football Club. This also applies to our clients, we don’t just do business with anyone, we are selective about who we do business with. Foster a Culture of Success In the pursuit of organizational growth and success, fostering partnerships with like-minded entities is essential. One such collaboration is a strategic alliance we have with the women’s business community in the UK. They are passionate about creating environments for senior female professionals to connect, meet, collaborate, and create long-lasting professional friendships. This harmonizes nicely with the GPS Capital Markets ‘Women in Business’ Employee Resource Group (ERG) that we established last year. These partnerships align with principles of diversity and inclusion and provide a mutually beneficial relationship. GPS is an organization that specializes in creating bespoke FX solutions for clients, an opportunity to further understand the unique needs of female CFOs and provide tailored FX solutions that aid in the professional success of women in finance. This all works toward a better relationship with our clients. Incorporating partnerships with organizations like Burnley FC into developmental relationships adds a unique dimension to our business growth. In addition to learning how to grow a beautiful turf field and understand the specific needs of women CFOs, these collaborations offer a diverse range of opportunities, from expanding professional networks and enhancing leadership training, to fostering global perspectives. By integrating the strengths of these partnerships, businesses can create a holistic developmental environment that propels them toward sustained success in the competitive business landscape. To return to my initial anecdote, I got to visit Notre Dame this week between meetings and see the progress they have made in restoring it. Feelings of gratitude washed over me, as I appreciated all the opportunities life has given me. Not just to see beautiful things, but the experiences and opportunities to help others achieve their goals in a meaningful, solid, and present way. Also Read Join our Treasury Community Treasury Mastermind 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 the form below to get more information. Notice: JavaScript is required for this content.
FXBEACON: 75 HARD, 100% SMART: CURRENCY HEDGING LESSONS FROM MY “75 HARD” JOURNEY
Imagine that at the beginning of July, you decided to join me on a personal journey. To transform physically and mentally by taking on the “75 Hard” fitness and mental wellness challenge (which I started 66 days ago). For those who are not familiar, “75 Hard” consists of 5 daily challenges: A) Two 45-minute workouts (one has to be outside) B) Stick to a diet of your choosing (no alcohol and no cheat meals) C) Drink a gallon of water each day D) Read 10 pages of a non-fiction book, bonus rule E) Take progress pictures If you skip a day, you start over. Throughout the process each day, I wake up knowing that I’ll face grueling workouts. Couple with mental toughness exercises, and strict discipline requirements. Meanwhile, in the business world, many companies are navigating their own set of daily challenges. Like the hurdles I’ve encountered on my journey. Surprisingly, there’s a striking similarity between a commitment to “75 Hard” and a business strategy called Currency hedging. Hedging or protecting against/mitigating risk. Currency exchange uses the same principles of resilience and adaptability you need to complete “75 Hard.” And each is equally vital for businesses seeking success in an unpredictable world. Think about how important your health is to you. That headache that lasted a little too long, that cramp in your calf, the lower back pain that keeps you from sitting in certain positions. People regularly spend hundreds of thousands of dollars on their physical health. If you ask anyone over the age of 70 if they would rather have the health they had in their 20’s or a few million dollars, they will unanimously choose their health. We can all agree that the financial health of a company is just as important to the longevity of that business as physical and mental health are to humanity. By Currency hedging, businesses are able to reduce the effect of adverse market movement. Such as fluctuations in interest rate differentials or currency exchange rates, similar to the way mental and physical exercise combat the adverse effects of aging. By doing so, these companies can safeguard their profitability and long-term viability. So far, I’ve learned that the daily consistency required by “75 Hard” has created both physical and mental predictability in my life. Although challenging, I know what to expect each day. Without that predictability and routine, there is no way I would have been able to make it this far. Almost identically, hedging strategies provide businesses with stable financial footing by minimizing volatility and eliminating a variable from their business. This stability is crucial for effective planning and decision-making. This enables companies to pursue their strategic and FP&A goals with far greater confidence. Although predictability is the ultimate goal, nothing happens exactly as planned. Because of the unpredictability that life has around every corner, “75 Hard” also emphasizes adaptability. By requiring participants to complete their daily tasks, rain or shine (my run in southern California during Hurricane Hillary can attest to that), it forces participants to stay nimble in the face of uncertainty. Similarly, businesses need to have the ability to adapt to shifting market conditions. Hedging allows them to respond to unexpected changes by providing at least one concrete aspect of the business as a safety net that cushions the impact of adverse events. This protection ensures that companies remain agile in a dynamic business environment. Locking into metaphorical sunshine for the foreseeable future. Kiss those rainy runs goodbye. Every day, companies invest significant resources in various projects and operations. Wouldn’t it make sense for these same companies to do everything in their power to protect those investments? Hedging their currency exposure safeguards these investments, ensuring that they yield returns even in unfavorable circumstances. The ever-changing economic markets have become a nonfactor. In the world of business, competition is fierce, and companies that hedge effectively can gain a competitive edge over their rivals by reducing their vulnerability to market fluctuations. This allows them to focus on strategic growth rather than reacting to external crises. Doing the physical part of “75 Hard” In the same way that I’ve committed to diet, exercise, and mental improvement over the past 66 days, businesses need to demonstrate the same discipline if they stand a chance at surviving our current market. It’s crucial to manage risk so that, regardless of the uncertainties that may arise, these companies are protected. Lifting weights, going on hikes and runs, and daily reading have cultivated the necessary mental toughness, teaching me to push through discomfort and setbacks. This has better prepared me for the unpredictable challenges that life throws my way. In a similar sense, companies that hedge are better prepared to withstand economic downturns, emerging stronger on the other side. Both “75 Hard” and foreign currency hedging require a long-term perspective. The short-term sacrifices that I’ve made each day have led to long-term gains in my personal fitness and learning. In the same way, in order to help secure a company’s long-term financial success, they must practice delayed gratification. Make small sacrifices now, and reap huge rewards later. By taking time now to consider and protect against potential risks over time, companies are protected from whatever the market throws at them. Throughout “75 Hard,” I have strived for continuous improvement in the same way that most businesses that work with GPS do. This improvement mindset is such an important piece to the equation in order for companies to refine their hedging strategies and learn from past experiences to be better equipped to protect their assets and investments. The correlation between hedging in the business world and the principles behind the “75 Hard” regimen, although unorthodox, is striking. These similarities emphasize a strong connection rooted in discipline, resilience, adaptability, and a forward-thinking approach. Just as individuals take on the “75 Hard” challenge to cultivate physical and mental fortitude, companies adopt hedging strategies to safeguard their financial stability and mitigate FX risk. Embracing these fundamental principles can empower both individuals…
Oscar Augustine
Getting to Know the Animal of your Corporate FX Risk
This article is written by GPS Capital Markets Over history, people have developed systems for measuring time and keeping track of information. From cataloging the patterns in the night sky—like constellations—to creating educational anecdotes to pass on wisdom about life, love, or economics—like fables or parables—many of these metaphorical systems have featured animals. Like in Aesop’s fable “The Crow and the Pitcher,” when the bird puts pebbles in the pitcher, it raises the level of water until he can drink. The tale helps pass knowledge on about how to make steady progress working through problems. GPS approaches FX exposure analysis in the same methodical way. As we enter the Year of the Dragon, we can look at the categories of FX exposure and ways to approach hedging them by comparing them to the Chinese zodiac. Are you approaching your balance sheet exposure with the patience of an ox or the cunning of a snake? Are you ready to channel the luck of the dragon to push your company forward this year? Read through our list to learn more about knowing the animal of your corporate FX risk and taking inspiration from the positive qualities ascribed to it to respond to risks. The Pig: Transaction Exposure If the financial services industry had a mascot, a pig would be a great choice. With its long association with reliability, it’s no wonder kids learn to save using piggie banks. In the Chinese zodiac, people born in the year of the pig are good in business dealings. There’s even a story about a pig and chicken who want to start a business: The chicken says she will contribute her eggs and expects the pig to hand over the bacon. The pig in this story is the business partner with the most to lose and a life-and-death commitment to getting the business to succeed, whereas the chicken is a fair-weather partner who will likely cut and run when things get rough. Transaction exposure is the day-to-day risk associated with invoices and contracts. A pig-like approach to foreign exchange is what we at GPS Capital Markets provide. Each of a client’s risks is assessed, documented, and hedging strategies put in place to save and optimize practices over time, day by day, invoice by invoice. With the reporting and analytics capabilities of FXpert, regularity and dependability in your FX trading and hedging strategies improves steadily. The Rat: Translation Exposure One of the main types of FX exposure is Translation Exposure or Exchange Rate Exposure. This exposure takes place when financial statements (balance sheet, profit and loss) must be translated from a subsidiary’s local currency into the parent company’s currency. The consolidation necessary to assess the company’s accounts reflects the ethos of the Chinese zodiac rat. Rats, like squirrels and other rodents, scavenge, consolidate, and guard resources. Consolidation gives confidence to investors and board members. As the translation of funds occurs, it’s worth leaning into the positive aspects of the Chinese rat, being meticulous in accounting for exposure risk before it becomes a real problem on your balance sheet, and putting plans into place to mitigate losses as a result. Learn more about hedging. The Ox: Economic (or Operating) Exposure Every seasoned business owner has faced years when nothing seems to go right. Even when your books are balanced and the leadership is making good decision after good decision, larger market forces have flattened strong companies and entire economies. Economic exposure is the risk inherent in fluctuating currency markets on a broader scale. In terms of macroeconomics, there’s still ways to predict and model these dynamics; however, one of the most important ways to brace for variability in markets is to take the ox as inspiration. Oxen symbolize hard work. Whenever populations moved or tamed territory through history, oxen were present to pull carts and plows. To face wide exposure, you must be strong, independent, and supportive of the rest of your treasury team. Even when a client has thousands of pending invoices, at GPS we move forward like a stubborn ox until the client has a clean shop and fully functioning accounting practices in place. The Dragon: Mitigating Corporate FX Risk In February 2024, we ushered in the year of the dragon. An ancient symbol of China and associated with luck, the dragon also symbolizes powerful, energetic, and visionary leaders. When it comes to an overarching metaphor for corporate leadership tackling exposure risk, there’s no better image than the dragon. When you consider expanding into new markets, business leaders need a good measure of courage and luck to set up subsidiaries and deal with exposure as it arises. Another aspect of the dragon is that it’s a giver of abundance and longevity. At GPS, we provide the extra help treasury department and C Suite leaders need to grow their businesses across national boundaries and foster success far into the future. Because our individualized customer service is coupled with the leading FX rates and technology, we have long-term clients who trust us to help lead their companies forward with the spirit of the 2024 dragon. ALSO READ 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.
Understanding Currency Exposure: 7 Essential Terms you should Know
This article is written by GPS Capital Markets Imagine you are part of the finance department of an artisan chocolate producer in the UK. Renowned for its premium products, and your small to medium-sized enterprise (SME). Then you decide to import macadamia nuts from Hawaii to bring an great flair to its product offering. The idea sounds intriguing. But as you delve into the specifics of doing business internationally, the challenges with foreign currency exposure come to play. When engaging in international trade, treasury departments play a critical role in safeguarding an organization from risk. So, where should you begin? A solid understanding of key terms related to currency exposure is an excellent starting point. This knowledge will guide you as you make informed decisions for your company. We have compiled a list of top fundamental currency exposure terms and their definitions. Defining Foreign Currency Exposure Exposure to foreign exchange risk involves the potential for financial loss due to frequent changes in foreign exchange rates. These fluctuations can negatively impact transactions made in a foreign currency rather than in the company’s domestic currency. The concern for a company is that fluctuations in foreign currency rates could influence its future cash flows. This is due to the unstable nature of foreign exchange rates. It’s not only companies that engage directly in transactions denominated in foreign currencies that are at risk of foreign exposure. Firms with indirect connections to foreign currencies also face this risk. Products imported from China can affect an Indian company competing with them. This is if the value of the Chinese yuan drops against the Indian rupee. This can grant importers a cost advantage over the Indian company. This shows how shifts in foreign currency values can impact companies. Even if they do not engage in direct foreign exchange dealings. Foreign Exchange (FX) Hedging Foreign exchange hedging is a strategy used by corporations to protect themselves from the risks. These risks are associated with fluctuations in exchange rates. By locking in exchange rates for future transactions through contracts like forwards, options, swaps, or futures, companies can ensure financial predictability. This can also reduce exposure to adverse currency movements. Let’s say our UK chocolate producer expects to pay his Hawaiian supplier $100,000 in 6 months, it can enter into a forward contract to buy $100,000 at a fixed rate today. If the US dollar (USD) strengthens against the euro (EUR) by the payment date, the company is shielded from the increased cost. Because it is already locked in a more favorable exchange rate. This practice is crucial for budgeting, forecasting, and protecting profit margins in international business operations. To learn more about hedging instruments, explore the article, “6 Benefits of Incorporating FX Hedging Solutions.” Derivatives The term derivative refers to financial instruments whose value is derived from an underlying asset, like stock, bond, or currency. In the currency market, these instruments allow corporate treasurers to hedge against foreign exchange risk. This will ensure that currency fluctuations do not adversely affect the company’s finances. Common types include forwards, options, futures, and swaps. Types of Derivatives Currency Forward Contracts A currency forward contract is a binding agreement between two parties to exchange a specific amount of one currency for another at a predetermined exchange rate on a specified future date. For example, the treasurer of a US company that expects to pay a European supplier €1 million in three months for goods imported from Europe, may choose to hedge against the risk of the euro appreciating against the dollar by using a forward contract to lock in today’s EUR/USD exchange rate for the transaction. By doing so, the company knows exactly how much it will pay in USD, regardless of future exchange rate fluctuations, aiding with its financial planning. Also Read Currency Swaps Imagine you are a Canadian company, needing Japanese yen (JPY) for an invoice due to a Japanese supplier in six months, but currently holding Canadian dollars (CAD). After locking into a forward contract, you determine that the supplier is going to be late delivering the product by 30 days. You can enter an FX swap by exchanging CAD based on the current spot rate and agree to extend the transaction by 30 days prior to the contract expiring. This swap allows you to hedge against the risk of JPY appreciating against the CAD over the next three months, while also giving you the flexibility to change the payment date, ensuring you know the exact cost of your future payment. Currency swaps involve two simultaneous transactions: exchanging a specified amount of one currency for another at a spot rate and reversing the exchange rate at a predetermined future date and rate. This tool helps in hedging against exposure to currency fluctuations and securing short-term funding in a different currency without impacting the balance sheet. Currency Options A currency option, also known as an FX option, is a financial instrument that gives the holder the right, but not the obligation to buy or sell money denominated in one currency into another currency at a pre-agreed exchange rate, or strike price, within a specified period. For instance, an Australian company that expects to pay $1 million in New Zealand dollars NZD in six months for goods from New Zealand, is concerned the Australian dollar (AUD) might weaken against the New Zealand dollar (NZD), increasing costs. The treasurer may buy an FX option to lock in a current exchange rate of 1.10 AUD/NZD for $500,000 NZD. If in six months, the AUD/NZD rate worsens to 1.20, the company can exercise the option, saving money by paying at the locked-in rate. If the AUD strengthens, say to 1.05, they can let the option expire, paying at the better market rate, with the option’s premium as the only cost for this price protection. Currency Futures Contracts FX futures contracts entail standardized agreements to buy or sell a currency at a predetermined price on a specified future date These contracts specify the currency amount, exchange rate, and settlement date. As all contract…
6 BENEFITS OF INCORPORATING FX HEDGING SOLUTIONS
This article is written by GPS Capital Markets As companies expand and start doing business internationally, they often engage in cross-border transactions, exposing themselves to currency exchange rate fluctuations. Currency exposure risk is an inherent outcome of engaging in the FX market. This uncertainty can impact transactional cash flows, making it imperative for corporations to employ effective risk management strategies. One such crucial strategy is Foreign Exchange (FX) Hedging. It is crucial to understand that the purpose of hedging practices is not profit generation. The primary goal is to safeguard the company and prevent significant financial losses. So, what is FX hedging? FX hedging involves the use of financial instruments to offset or reduce the risk associated with currency exchange rate movements. There are a variety of common instruments corporations use to hedge, such as forward contracts, options, swaps, and netting. We’ll dive in further on these individual instruments later. The Role and Benefits of FX Hedging There are significant benefits that come along with the time and implementation of having GPS Capital Markets come in and advise each of its clients about their FX exposure risk. Let’s discuss why this is such an important aspect of how each multinational corporation does business. Hedging your cash flows is crucial to managing financial risks and ensuring stability and predictability by protecting the company from adverse movements. Hedging can also allow for better budgeting and financial planning, as it provides a degree of certainty for future cash flows. This is particularly important when dealing with international transactions, where you can be subject to significant fluctuations and need to protect your profit margins. Better predictability also leads to greater confidence in management to make strategic decisions related to investments, expansions, and other business initiatives. Something often not considered is the benefit of improved relationships with creditors, which leads to potentially lower borrowing costs. Creditors love the predictability they can see with future cash flows. Lastly, hedging activities are often subject to accounting and regulatory standards. Properly executed cash flow hedging can help the corporation comply with these compliance standards and provide accurate financial reporting. In summary, 6 of the main benefits of incorporating an FX hedging program are: 1. Risk Mitigation 2. Financial Stability 3. Budgeting and Planning 4. Protecting Profit Margins 5. Enhancing Creditworthiness 6. Compliance and Reporting Hedging Instrument Definitions Knowing the overall benefits FX hedging can provide to corporations, let’s define each of the different hedging instruments that are commonly used among GPS clients. Forward Contracts: A forward contract is an agreement between two parties, a buyer and seller, to exchange a specific amount of currency A for currency B at a future maturity date. The exchange rate (forward rate) is determined at the time of entering the contract and reduces exposure to fluctuations in currency rates. Options: An option is a financial derivative that gives the holder the right, but not the obligation, to buy or sell a specified amount of one currency in exchange for another at a predetermined exchange rate (the strike price) within a specified period of time. There are two types of options commonly used, a call option and a put option. Call Option: A call option gives the holder the right to buy a specified amount of the base currency (the currency being bought) at the agreed-upon exchange rate (strike price) before or at the option’s expiration date. The seller (writer) of the call option has the obligation to sell the specified amount of the base currency if the holder chooses to exercise the option. Put Option: A put option gives the holder the right to sell a specified amount of the base currency at the agreed-upon exchange rate (strike price) before or at the option’s expiration date. The seller (writer) of the put option has the obligation to buy the specified amount of the base currency if the holder chooses to exercise the option. FX options have a specific expiration date, after which the option is no longer valid. The holder must decide whether to exercise the option before or on the expiration date. Unlike forward contracts, options provide the holder with the flexibility to choose whether or not to exercise the option. If market conditions are favorable, the holder may choose to exercise the option; otherwise, they can let it expire. So, you wonder, why wouldn’t you always take the more flexible route and always book an option? There is a premium that is paid to the seller for the right to exercise the option. It is the cost of purchasing the option and is determined by the exchange rate, time till expiration, and market volatility at the time. Swaps: FX swaps or currency swaps refer to two different ways of managing forward contracts. The first one is when a company has a forward booking for a future date and needs to change the value date of that contract. In this situation, you can move the value date forward or backward with an FX currency swap. The second example involves changing the amount of a forward contract that a company has on its books. If a company needs to reduce the amount of a contract, they can sell the currency forward to reduce the outstanding amount of their hedge. This can be very beneficial for managing cash flows and financing needs in different currencies. Currency swaps are often used by multinational corporations to obtain a desired currency for a specific period without engaging in a spot foreign exchange transaction. This can be very beneficial for managing cash flows and financing needs in different currencies, without having to incur a transactional cost. Netting: Netting in the context of foreign exchange refers to a process that allows market participants to offset or consolidate multiple transactions or positions involving the same currencies, resulting in a single net amount for settlement. Netting can help reduce credit and liquidity risk by consolidating obligations, as well as reduce administrative complexities and costs for a corporation. Implementing FX Hedging Meeting with an FX advisor from GPS Capital Markets can…
FX RISK AND CURRENCY MARKETS IN A US ELECTION YEAR
This article is written by GPS® Capital Markets Download Article Once every four years, the world witnesses a highly anticipated event: the US presidential elections, yet the influence of these elections on currency markets and associated FX risk begins well before November 5th. This holds especially true in 2024, which will see both current US President Joe Biden and Donald Trump, the probable Republican Party nominees, each seeking a second term, and where both candidate’s foreign and economic policies are well known. Historically, the US presidential election has been a catalyst for heightened volatility in FX markets. While we know past performance is no guarantee of future outcomes, there is much to be gained by observing the impact of the past three presidential elections: 2020 Biden vs. Trump, 2016 Trump vs. Clinton, and 2012 Obama vs. Romney. In this article, we will analyze the impacts and risks of each candidate by currency and recommend the best ways to hedge exposures that are open. IMPORTANT DATES First, let’s begin by looking at a timeline of important dates extending into the coming year that will likely have currency market-moving effects. Each date indicates a period of uncertainty—a potential driver of FX market volatility. By staying informed and adapting your approach to FX risk as the election year progresses, you can effectively hedge your exposures and protect against FX risk. THE CANDIDATES If current polling persists, the 2024 election will be the result of a Biden-Trump match. However, there is much speculation about the outcome of former President Donald Trump’s legal scrutiny and its effects on his candidacy. The front-runner for the Republican Party has a series of court dates from January through May, and their outcomes have the potential to change the landscape of the election significantly. If the present election probabilities hold true, with Joe Biden facing off against Donald Trump as the most probable scenario, then our focus will be on global trade negotiations and the impact a possible Trump win would have on tariffs. FX RISK DUE TO CURRENCY MOVEMENTS ON ELECTION YEARS USD In our analysis, we employed seasonal charts to evaluate the performance of the USD during election years. Since the election takes place on the Tuesday following the first Monday in November, dates can vary. Our observations encompassed daily movement between October 28th and November 25th of each respective year. The chart of the Bloomberg US dollar index illustrates that during this period, the USD exhibited a 3.8% increase in 2016 when Trump was elected, a 2.2% decrease in 2020 when Biden won the election, and a relatively stable movement in 2012 when Obama was reelected. This represents a 6% swing in the dollar’s value between the two presidential candidates. Source: Bloomberg US dollar index percentage movement, election years 2020 (yellow), 2016 (orange), and 2012 (blue). MXN The Mexican peso could be the currency that falls the most in the event of a Trump victory—in the month when he was elected, the USD appreciated 8.1% against the peso, whereas it depreciated 6.2% following Biden’s victory. Considering that Mexico is the United States’ largest trade partner, with a total volume of $736 billion in total trade transacted in 2022, the election will unquestionably present many opportunities and challenges for this currency. RELATED ARTICLE: Could You Be Managing Your EM FX Risk Better? Source: Bloomberg USD/MXN percentage movement, election years 2020 (yellow), 2016 (orange), and 2012 (blue). CNY A Trump victory could have a similarly negative impact on the CNY. During the month of Trump’s election, the USD appreciated 2.4% against the yuan. In contrast, the more sympathetic Biden saw the dollar depreciate by 2.5% in 2020. It’s worth noting that China is the United States’ third-largest trade partner, with $715 billion in total trade transacted in 2022. Source: Bloomberg USD/CNH percentage movement, election years 2020 (yellow), 2016 (orange), and 2012 (blue). JPY The Japanese yen could equally feel the pinch, surpassing the broader dollar index under a Trump win. During the month of his election, the dollar appreciated 8.1% against the yen, whereas in 2020, Biden saw the dollar appreciate 0.1%. Japan is the fourth-largest trade partner of the United States, with $239 billion in total trade transacted in 2022. Source: Bloomberg USD/JPY percentage movement, election years 2020 (yellow), 2016 (orange), and 2012 (blue). AUD The Australian dollar is a higher-risk currency that has the potential to exhibit greater movement compared to other major currencies, as indicated by its elevated implied volatility. In the month when Trump was elected, the Australian dollar experienced a 2.1% depreciation against the US dollar, whereas when Biden secured the victory, the Australian dollar appreciated by 4.6%. Source: Bloomberg AUD/USD percentage movement, election years 2020 (yellow), 2016 (orange), and 2012 (blue). Note that the rate is inverted compared to the other pairs. MONETARY POLICY The market is currently factoring in the likelihood of some aggressive interest rate cuts from the Federal Reserve. So, it’s worthwhile to examine the behavior of the cash rate in election years. The chart below illustrates the Fed Funds rate, with each election year represented by a different color. There doesn’t appear to be a clear pattern or consistent trend, as each election year corresponds to vastly differing points in the economic cycle. This may serve to validate the independence of the Federal Reserve. 2020: The Republicans lost power to the Democrats; rates were cut early in the year post-COVID to 0.25%. 2016: The Democrats lost power to the Republicans; rates remained at 0.5% throughout the year before increasing a further 0.25% after the election. 2012: The Democrats remained in control, with rates remaining at 0.25%. 2008: The Republicans lost power to the Democrats; rates moved lower in the backdrop of the Global Financial Crisis. 2004: The Republicans remained in control, with rates moving higher in the later part of the year. Source: Bloomberg Fed Funds Upper Target across the last five elections. CHANGES IN THE OPTIONS MARKETS The magnitude of risks, as well as the potential changes in the FX markets, can be observed as higher implied…
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.
Patrick Kunz