How to hedge your forex payments
A hedge is any strategy that allows you to minimalise or remove financial risk. For foreign currency, this mean a strategy employed by businesses to reduce their exposure to foreign currency market movements and to provide more certainty and cash flow, defines Barry Fletcher, director of Business Development for Australia and New Zealand at American Express Foreign Exchange International Payments.
For exporters who deal only in Australian dollars, that is, who buy and sell wholly in Australian currency, you can stop reading here. But for everyone else buying and/or selling in currencies other than AUD, hedging is an essential part of maintaining your margins.
Why hedge? As an exporter you will almost certainly price your goods in a foreign currency to compete globally. The price at which your buyers purchase your goods or services will therefore be subject to currency movements until the time they pay their invoices—this could be 90 days down the track and the rate could have changed 20 percent since the sale. Hedging minimises the impact of those currency movements to allow you to retain your margins.
The first step is to understand how exchange rates affect your pricing. “The question has to be what FX rate an exporter has built into their pricing. They need to hedge at that point or better, then they can forget what the market does because they’ll have that price risk covered,” Fletcher says.
“If you don’t have much fat built in, you can’t really afford to stay at the whim of the market because there is going to be a time when the market will work against you and that will erode all your profitability.”
One of the easiest ways to avoid exposure to currency fluctuation is by holding a foreign currency account, which gives you a ‘natural’ hedge. If a lot of your costs and earnings are in US dollars, for example, it makes sense to have an account in that denomination because you don’t have to convert anything until you need the money in Australia. Then, “if your cash flow is strong enough, you can leave those US dollars in the account until the rate is beneficial to you,” says Fletcher.