Forex:Tohedgeornottohedge?

Global Markets and Foreign Exchange Risk: “To Hedge or Not to Hedge”?

(This is not a gardening question)

By Lesego Osman

Most companies and individuals particularly in Botswana where we import 90% of our goods and services, are exposed directly or indirectly to Foreign Exchange Risk. This risk occurs as a result of most goods and services in Botswana being sold in BWP whilst most imports are paid for in ZAR. Therefore, movements in the BWP/ZAR exchange rate can either positively or adversely impact individuals and businesses alike. Fortunately for our clients we have over several years of tried and tested experience developed products and services that can better assist them in managing their FX Risk. I often use the adage of insurance; we all take out insurance cover over our assets be it home, car, or life and disability cover. It should be no different when it comes to managing a company’s FX Risk. Insurance allows one to sleep at night knowing that should anything happen to their assets they are protected. The same principle is applicable to FX Hedging.

FX Hedging allows firms to focus on their core business whilst allowing their trusted banking partner to ensure their FX risk is adequately mitigated. Much like insurance there are varying degrees of hedging with commensurate costs and benefits. In most businesses the adage high risk, high return holds true. Therefore, it’s important to determine a client’s risk appetite in order to ensure that they are afforded a commensurate FX Hedging solution.

There are several benefits to FX hedging:

1. Predictability of FX Rates - FX Hedging allows clients to lock in pre-determined FX rates removing the uncertainties that are inherent in the volatile FX markers. This allows firms to better plan and focus on improving efficiencies in other parts of their business.
2. Protect Profit Margins When clients determine the price of their goods and services, they use their desired profit margin as a guide. This profit can be eroded by adverse FX movements and therefore FX Hedging enables clients to better protect their profit margins as FX rates are known upfront and can therefore be incorporated into profit margin calculations with a high degree of certainty.
3. Smoothing-Many clients when forecasting use budget rates. FX Hedging allows clients to smooth out FX volatility and therefore increases the probability of clients achieving their FX budget rate. In many instances and depending on the client’s risk appetite hedging solutions can be designed to surpass pre-determined FX budget rates.

Will FX Hedging allow you to eliminate FX risk from your business? “NO”. There are instances when market rates may be better than FX Hedge rates and such is the trade-off.  Much like the insurance analogy it may well and truly hold true that risk insured against does not transpire. Many of us go through the year or years without having been involved in a car accident and in those years if one had no insurance, they may perceive this to mean they have beaten the market. However, the other side of that coin is should one be unfortunate to be involved in an accident they would be grateful for having pro-actively mitigated the risk by taking out insurance cover. At the end of the day each firm and individual needs to do what they believe is in the best interest for themselves or their firm. As Global Markets and as your trusted financial partner we will be alongside to help where we can.

Osman is Head of Global Markets and Custody at RMB Botswana