There are many forms of risk in international payments, but principally, many corporate entities are concerned with the risk that foreign exchange fluctuations pose to their business. Volatile exchange rates can often undermine the profitability of any project or business line if appropriate measures are not adopted to insulate your firm from such risks. In the world of foreign exchange, there are a multitude of alternatives that are available and strategies to fit almost every level of risk. The key is to work with a partner that can help narrow the range of choices to something that makes sense for your business, outline the pros and cons of each strategy in question, and will then work with you in implementing the remedy that best aligns your organizational goals with the day’s market realities.
The conversation around identifying and implementing a foreign currency hedge or risk management strategy, should in our view, begin with a review of the process itself.
At Cambridge Mercantile Group, our dedicated professionals will help guide you through the process shown above, providing guidance at each stage while posing the right questions to ensure that your hedging strategy remains well aligned with the broader financial and/or business goals of your organization. By following this six-stage process, we will help you identify, implement and execute a hedging strategy that is uniquely tailored to your business needs, both now and in the future.
Forward contracts often form the backbone of foreign exchange hedging strategies for both large multinational corporations and small business alike. Simply put, a forward contract allows you to lock in today’s rate, for settlement at a future point in time. The spot rate is adjusted for the difference between the interest rates for the two currencies in question and the passage of time. Forwards are completely customizable in that they can be booked for any amount of foreign currency and any expiry date within two years. Once locked in, a forward provides you with absolute protection from an unfavorable movement in the exchange rate, guaranteeing you the ability to buy or sell a foreign currency at your specified price by the expiry date, regardless of what happens in the market.
A closed forward is the most price efficient type of contract due to the fact that they are booked for expiry on a specific date. By limiting the date at which the contract can be drawn down or exercised, you obtain the most favorable price possible.
Open Window Forwards
Open window forwards offer a range of dates, up to three months, whereby the contract can be drawn down or exercised. This increase in flexibility may in some cases result in a slightly less favorable rate based on the interest rate differential between the two currencies in question.
Non-Deliverable Forward Contracts
NDFs, as they are known, can be executed in many currencies for which there isn’t a fully functioning local market, such as Brazil, Russia, India and China, amongst others. Alternatively, these contracts can also be employed with major currencies where there is an underlying commercial foreign currency risk, but no impending foreign currency payment. At their core, NDFs offer the ability to hedge against foreign currency risk, without obligating you to a principal payment at the contracts conclusion. In this sense, they can be regarded as a pure currency hedge.
Global currency markets trade 24 hours a day, 6 days a week. Cambridge’s market orders provide you with access to foreign currency markets around the clock, thereby allowing you to take advantage of favorable trading conditions outside of normal office hours. Our traders and systems monitor currency markets across all active trading sessions, meaning that we can monitor the market for you, even while you’re asleep.
Commonly referred to as a “bid,” or a standing order, a take profit order allows you to specify an exchange rate and an amount of foreign currency that you would like to buy or sell via a spot, forward or option trade, and if the market moves favorably to your desired price level, it is automatically executed. Take profit orders can be placed on either an overnight basis, or “good-til-cancelled,” which means that the order will remain in force until it is either executed in the marketplace or canceled by you.
A stop loss can simply be viewed as the opposite of a take profit order. In its simplest form, a stop loss allows you to set a worst case exchange rate at which you would like to execute your spot, forward or option trade, thereby protecting yourself in the event of a sudden and violent unfavorable market movement. If the market trades to your worst case level, your trade will be automatically executed. Again, stop loss orders can be placed on either an overnight or “good-til-cancelled” basis.
Order Cancels Other (OCO)
An OCO is effectively a combination of both a take profit and stop order, whereby you set an exchange rate level at which you would ideally like to execute your trade as well as a worst case price level in the event that the market moves against you. If the market then moves such that one of the two orders is executed, the second order is automatically cancelled so that there is no risk of your order being double booked. As with our other market orders at Cambridge, OCO’s can be placed on either an overnight or “good-til-canceled” basis and can be placed for spot, forward or option trades.
Options are not available to or suitable for all parties and may be restricted to certain geographic regions. In certain circumstances, fx options can be provided to qualified parties. To discuss your circumstances, and to determine whether you meet the requirements of a “qualified party”, please ask to consult with a Cambridge Options Specialist.
For more information on these, or any other hedging structure available from our risk management specialists at Cambridge, contact us today.