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GROW International expansion

Management of the currency risk

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GROW Currency risk definition

• According to Investopedia the currency risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders they face currency risk if their positions are not hedged.

• For example an European investor with assets in Switzerland made a beautiful profit following the appreciation of the Swiss currency: an investment of 100 EUR equivalent to CHF 120 (rate of 1.2) before the crash leads to a value of the asset of EUR 120 (new rate of 1) after the crash all other things being equal.

• Conversely a Swiss exporter which was waiting EUR 10k (equal to CHF 12k) for the payment of an invoice received only the equivalent of CHF 10k after the crash resulting to a decrease of its turnover by 17%. A profitable operation may create a loss due to a currency adverse movement.

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GROW Currency risk hedging strategies

• In order to prevent the currency risk a company can develop two main strategies:

The internal hedging strategies leading to the implementation of a strong treasury department.

The external hedging strategies leading to the intervention of a bank or a financial institution.

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GROW Internal hedging strategies

• The choice of the currency in the contract: This mainly depends on the power of negotiation of the company. A leader in

a market may oblige its counterparties to buy the goods with its own currency but this may also deteriorate the commercial relationship between the partners.

Most of the international trades are processed in USD even between two companies not based in the United States of America.

Unfortunately the probability to conduct business only in its own currency is very low even for a major company.

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GROW Currency risk internal hedging strategies

• The indexation clauses: Even if the currency of the contract is denominated in the local currency of the

seller the currency risk is share between the partners. For example the buyer receives a compensation for half of the trade loss via a price adjustment in case of adverse fluctuation.

The payment may be link to a basket of currency for example including the currency of the buyer and the currency of the seller. The result is the same than if half of the payment is denominated on the buyer currency and the balance on the seller currency.

The clauses of indexation are a good way to share the risk (and so to reduce its own risk) between two trading partners without hurting the commercial relationship and at a low cost.

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GROW Currency risk internal hedging strategies

• The netting or pooling strategy: The aim is to match the payments and the receipts of funds in a same

currency.

For example a Swiss company which has to pay and to receive USD the same day can create a natural hedge.

However this strategy is applicable only for the large companies with a central treasury management.

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GROW Currency risk external hedging strategies

• Factoring: The aim is to discount the invoice via a factoring company. Accordingly the

client receives the money immediately and can process a spot conversion reducing the currency risk.

Even if the factoring may ease the liquidity of a company the operation has also a cost (called discounting price).

The factoring may be with recourse (in case of non-payment the factoring company will ask for the refund) or without recourse (more expensive but the operation will also decrease the risk of non-payment).

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GROW Currency risk external hedging strategies

• The financial instruments: The banks propose a large range of services in order to help the companies to

hedge their positions. The most famous is the forward.

The forward is the commitment to sell/buy a currency against another at a specified price on a future date. For example if a Swiss company would like to buy goods for USD 10k in one month the treasurer may enter into a forward: he will buy USD against CHF in one month at a rate of 1. At the specified date CHF 10k will be exchange against USD 10k (independently of the rate of exchange) in order to allow the payment.

Swap options… the banks have lots of products more or less adapted to your situation. Besides insurers like COFACE can also provide hedging products.

However these products have a cost and the hedge remains often imperfect.

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GROW Currency risk external hedging strategies

• Example: A Swiss based company should receive EUR 10k from a client the second of

February. Accordingly the Swiss company enters into a forward and sell EUR 10k against CHF 12k due date second of March.

However a delay appears in the payment and the funds are received the 10th of March whereas the due date of the forward is 8 days before. In this case the Swiss company has to make a spot change in order to honor the claim under the forward and is not covered until the receipt of the funds hopefully without a crash meanwhile.

Some solutions exist to be perfectly covered (option roll of the forward…) but with an additional cost.

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GROW Currency risk external hedging strategies

• Specificity of the financial instruments: A hedging strategy will cancel the currency risk and reduce the uncertainty.

However afterthought the hedge may lead to a loss of opportunity:

In comparison with the company unhedged the company hedged may loose an opportunity to make a profit but the risk and the uncertainty is reduced.

A Swiss company should receive USD

Depreciation of USD vs CHF

Appreciation of USD vs CHF

Company unhedged Loss Gain

Company hedged Gain vs the company unhedged

Loss vs the company unhedged

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GROW Conclusion

• All the situations are different but a large range of hedging strategies exist in order to help a company to reduce its currency risk.

• Nevertheless the hedge remains often unperfected may have a cost and lead to a loss of opportunity.

We would be happy to discuss with you about your business and your approach of the currency risk.

Please do not hesitate to contact us!

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GROW Contact us

Coaching Startup LLC Route de Saint-Julien 184 1228 – Plan-les-Ouates Genève – Suisse

www.Coaching-Startup.com

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