The global economy becomes more intertwined each day and more companies are finding themselves faced with the difficult decision of how and when to hedge foreign exchange (FX) exposure.
Global exposure and currency risk, once limited to the Fortune 500, have found their way into middle market companies and even into mom-and-pop enterprises that are now balancing suppliers in Asia, middlemen in South America, or clients in Europe, says Garry Duncan, CAIA, managing director, PNC Capital Markets, Foreign Exchange.
“FX risk, if not properly monitored and managed, can negatively impact margins and potentially erode competitive advantages, so finding the right hedging solution is an imperative,” says Duncan.
Smart Business spoke with Duncan about Rolling FX hedges and how to approach hedging decisions.
What is prompting companies to employ Rolling FX hedge strategies?
Economic uncertainty continues to dominate the headlines and global foreign exchange markets remain volatile, making any hedging decision even more challenging. For example, the fiscal crisis brewing in Greece has prompted a nearly 10 percent decline in the euro since mid-December 2009. While this might elicit cheers from importers enjoying a decline in the cost of goods purchased from European suppliers, it would no doubt prompt tears from exporters lamenting the decline in the U.S. dollar value of their European sales efforts.
This relatively simple hedging program helps to take the guesswork out of how and when to hedge and smooth volatility while retaining the flexibility to respond to changes in the business environment.
How do Rolling FX hedges work?
Rolling FX hedges are similar in concept to dollar cost averaging. Both are based upon taking multiple observations over the course of the investment, or hedging period. Rolling FX hedges produce an average, or blended, FX rate that will reflect activity over a defined period rather than a one-and-done approach that locks in a lone FX observation for a quarter or an entire year. This blended rate, derived over time, will also be consistent with the underlying exposure being hedged. In other words, if all your revenue or costs can be boiled down to one day, then perhaps the one-and-done approach works. However, the more traditional course of business suggests that these types of exposures are generated over time, which would be consistent with a blended FX rate constructed over the hedging period.