If your business imports or exports, you inevitably have to deal with foreign currency payments. Due to currency fluctuations, this forex exposure can end up costing your business and affecting your bottom line. However, there is a solution: Currency hedging can be used to protect your business against exchange rate volatility, ensuring your cash flow is always protected.
Currency risks and your business
Importing and exporting businesses are naturally exposed to foreign exchange risk, because they are constantly working in different currencies. Buyers typically pay for goods in their own currency, which is exchanged into US Dollars before it’s deposited into the seller’s bank account. So, the value of the foreign currency may change relative to the value of the Dollar at the time.
For example, you are a South African clothing importer and you thought you were going to pay USD100,000 for the shipment of clothing your company ordered from the UK. But by the time your goods arrive, the Dollar has strengthened enormously against the Rand and you end up having to pay USD160,000. This means that you will end up making less profit on your goods, or worse, making a loss. As a business, it’s impossible to take these kinds of risks on a regular basis.
See also: Is your forex broker saving or costing you money?
Currency hedging protects your business from loss
Currency fluctuations can really take a chunk out of your profits, which is why importers and exporters use currency hedging to protect their profits. Big retailers and small businesses alike can benefit from currency risk management tools.
Currency hedging is done by setting up a financial contract that protects your business from unexpected, expected or anticipated changes in currency exchange rates. Hedging can be likened to an insurance policy; it mitigates risk and ensures a steady and predictable cash flow – something that is vital when running any kind of business.
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A forward contract is a non-standardised contract or agreement set up between two parties to buy or sell a currency at a specified future time, at a price agreed upon at the time of contract initiation. This allows you to lock in an import purchase or an export sale at the current exchange rate, guaranteeing your future transaction at the agreed upon price.
Futures currency hedging
Futures currency hedging is similar to forward contracts, in that a futures contract is set up between two parties. The futures contract specifies the price at which a currency can be bought or sold at a future date. When the expiration date comes, the currency pair must be traded. One of the advantages of a futures contract is that you can opt to sell your contract before the expiration date if you change your mind or if your business needs the money.
A limit order provides an upside price target. You set a price target above where the market is currently trading and when the market hits your price, your order is automatically filled. A limit order ensures that you don’t miss the opportunity to take advantage of your target price.
A stop-loss order does exactly that – it stops loss. It allows you to set a "worst case" price to trade at below the current market level. Your order will be filled if the market drops to (or beyond) your protective price.
An OCO order ("One Cancels the Other") combines a stop-loss order with a limit order, allowing you to set an upper and lower price range. The moment that your upper or lower price target is hit, your order will be filled at that price and the other price target is immediately cancelled.
An experienced, trusted forex partner makes all the difference
When it comes to foreign exchange, it’s important to find a forex partner who you can trust. There are plenty of forex providers who take advantage of their clients and slowly but surely widen their rates over time, or quote a certain rate only to add exorbitant fees and commissions once the transaction is complete.
We pride ourselves on being completely transparent with our clients. We offer low fees, and the rate you see will always be the rate you get. What’s more, our hedging specialists and forex brokers are always on hand to assist you with whatever query you may have.
We specialise in helping businesses develop strategies to manage their currency risks. We can conduct a free assessment of your currency management processes and facilities. Get in touch with us on firstname.lastname@example.org or give us a call on +27 (0) 21 657 2153.
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