The COVID-19 pandemic has unleashed tremendous volatility in currency markets. All major currencies have been affected by the global “black swan” event.
Two prominent examples: Volatility in the U.S. dollar/British pound rate reached its highest levels since the Brexit referendum’s passage in 2016, and the euro moved from a three-low against the dollar in March to a two-year high on September 1st.
Whether you’re an importer or exporter, such currency volatility can have direct bottom-line impacts. Since the pandemic began, we’ve seen companies filing for bankruptcies because of credit exposure and a margin clause that couldn’t be met.
Protecting balance sheets and the bottom line is always important. But in abnormal times like the present, maintaining stability by understanding and addressing your business’ FX risk profile is critical.
Strategies for managing risk
The risks of currency market volatility can be managed, but doing so isn’t as easy as just buying one hedging instrument. You need a tailored strategy and insights into your particular risk profile so you can understand how to best time-specific ‘buy’ and ‘sell’ activities, and use the full array of tools available.
Managing volatility requires the deployment of a variety of hedging strategies hooked to specific needs in highly dynamic environments. Hedging isn’t speculative—it’s conservative. Think of it as an insurance policy. Key hedging solutions include:
- Forward contracts. This is probably the most popular and efficient hedging tool. It allows profits to be protected from unfavorable market moves. Here’s how it works, in a nutshell: If you think the dollar’s value will weaken in the future and you like the current exchange rate, you lock in today’s rate with a forward contract to avoid paying more during a specified period—up to two years. Learn more here.
- Market orders. This tool allows you to automatically execute currency transactions when the market hits your target price. It’s available around-the-clock, 24/7, so purchases happen even if you’re not watching the market. Learn more here.
- Multi-currency accounts. This tool allows businesses to hold up to 30 foreign currencies in one account. This means you can hold foreign currencies without having to open international bank accounts and you can avoid converting foreign funds into U.S. dollars. That saves time and money. You can also take advantage of market conditions by buying directly into an account and converting certain currency at opportune times. Learn more here.
Shelter From the Storms
Consistently following a smart risk management strategy geared to your company’s specific risk profile provides shelter from market storms.
As an illustration of this, consider a U.S. confectionary company that imports a lot of chocolate and other ingredients from Europe. Years ago, the business adopted a strategy of hedging 75% of its expected need for euros to 1) give the company a little flexibility if business falls off in a quarter, and 2) give it the opportunity to seize on market moves—to buy extra currency if the exchange works in its favor.
Then the COVID pandemic arrived early this year, and it hurt the company’s business and its need for euros. But the hit to its business was substantially mitigated through its hedging strategy. How? Because this TEMPUS client had purchased forward contracts at the end of 2019, when the dollar was stronger, it was able to sell its contracts back to the market at a profit—the market had moved their way. The company was able to add $60,000 back onto its books.
This is what a consistent FX risk management strategy can accomplish in a genuine crisis: It can turn volatility into value.
