In an earlier column, we presented best practices for small business owners to employ when attempting to mitigate currency risk in the Euro-zone. Here, we’ll provide an overview of what currencies might be most affected in 2014, take a look at best practices and offer some basic hedging tactics to consider as you seek to mitigate currency risk.
What this year may hold for currencies
A catastrophic event such as Greece leaving the European Union (EU) and reverting back to the drachma seems to be behind us, and other hot spots in the EU have reduced from a boil to a simmer. Still, just as the Euro crisis ebbs, other market and political issues flow, roiling the U.S. dollar and emerging market currencies.
The Federal Reserve embarked on a program of tapering (a reduction in the $85 billion per month of bonds the Fed was purchasing in the open market to stabilize the housing market and restore economic growth) aimed at reducing their purchases to nil by the end of 2014. New Federal Reserve Chief Janet Yellen reaffirmed the Fed’s commitment to their tapering plan while signaling that interest rates will remain at record lows until the labor market further recovers.
While this is great news for U.S. businesses big and small in terms of borrowing costs, it has caused investors to flee riskier assets, roiling emerging market currencies. The so-called BRIC countries (Brazil, Russia, India and China) and other emerging markets are experiencing setbacks and are no longer the steady drivers of economic growth they were following the 2008 financial crisis. When the Fed initiated its first $10 billion pullback from the bond market, these were the first currencies hit.
No one knows for certain how currencies will move in 2014 but we can anticipate the potential for certain pairs to be more volatile than others. Due to the tapering program, emerging market currencies will likely be under pressure for the remainder of 2014. Not all small businesses deal with emerging markets, but some do business in Southeast Asia and or South America. Both are geographical regions with current economic and socio-political issues and a resulting cooling of the once vibrant economic growth potential.
Revisiting best practices
Before we delve into some basic strategies to protect your small business from fluctuating currencies, let’s revisit some important best practices.
First, know your overall currency exposure. In today’s global economy, many small businesses are either engaged in cross-border commerce or plan to be soon. As a result, complex currency liabilities arise, so managing the value of future payments or receipts grows increasingly important. Once you know your exposure, you’ll discover potential vulnerabilities and you can employ basic hedges to mitigate currency risk.
Second, abandon the “casino mentality” and leave risk-taking to professional currency traders and investors. Devise a hedging strategy, employ it and sleep easy at night. Don’t fret thinking you could have fared better had you waited a week on a transaction. You know what rate you’ve bought at and your profit margin isn’t threatened.
Third, always maintain a long term perspective. Sure the market may initially move against you after locking in a rate but it will just as quickly move back in your favor. Ignore the noise and remind yourself, regardless of what percentage of exposure you hedge, that uncertainty is removed and instead focus on growing your business.
Basic hedging tactics
Hedging your currency exposure is much easier than it seems once you have the correct mindset, and there are a couple of commonly used and straightforward tactics to employ.
The forward contract is the most commonly utilized hedging strategy among small businesses and has seen an uptick of approximately 25 percent in usage since 2008. It’s a basic and sensible strategy for firms with regular payments and receipts, offering a hedge against volatility while allowing you to construct fixed and reliable cashflow forecasts.
At its core, a forward contract is a contract to buy or sell an asset (in this case a currency) at a specified price at a future date. You’re locking in a rate of exchange for a future payment, for example. For a majority of small business owners, this is as complex an instrument as you’ll need.
A forward-extra (sometimes known as a risk-reversal or forward-plus) would offer a protective rate guaranteeing you a price if the base currency weakens. If the market moves favorably, you may also have the opportunity to exploit that shift and buy at a cheaper rate.
Again the potential upside is capped but the gain is in guaranteeing a “worst-case” price, while retaining the opportunity for a better rate down the road.
Slow and steady wins the race
Sure it’s an oft-used cliché, but in this case is apropos.
In 2013, several global corporations, including behemoths such as Coca-Cola, took hits to their earnings and revenues due to rapid and violent currency movements which were unforeseen even by their savvy CFOs. If large corporations can be affected by currency volatility, so too can small business owners.
Know your currency exposure, lock in a hedge that will provide certainty for your business and don’t fret about short-term ebbs and flows in the currency markets – focus instead on growing your business.
Guido Schulz is global head of strategic management at Associated Foreign Exchange (AFEX), a global payment solutions provider to small and mid-sized companies.
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