Managing foreign exchange risk factsheet

Managing foreign exchange risk does not have to be complicated. HSBC advocates the use of the following four-point plan:
This simple plan lays the foundations for the management of your foreign exchange exposures:

• Understand your exposures
• Understand the products
• Develop a strategy
• Implement it

Point 1 - Understand Your Exposures
There is a raft of factors to take into account when assessing your exposure to foreign exchange rate risk, for example:

• What proportion of your business relates to imports or exports?
• What currencies are involved?
• What are the timings of payments?
• What impact would an adverse rate movement have on your profitability?
• Is the level of overseas business likely to change?
• Do you pay and receive in the same foreign currency - it may be possible to mitigate the exchange risk by using a foreign currency bank account?

Point 2 - Understand the Products
There are only three basic alternative methods to manage foreign exchange risk.

• Do nothing and buy or sell your currency in the spot market.
  You act on the day you want to buy or sell your foreign currency. We will quote you an exchange rate and the transaction will settle two working days later. Whilst simple, this approach means you will not know how much sterling you will need to pay or receive for your foreign currency until the day in question - this can be a high risk strategy as the exchange rate may have moved significantly since you agreed the price with your customer/supplier. If rates have moved the wrong way, your profit will be reduced accordingly.
• Lock in to fixed rates - as soon as you become aware of a need to exchange foreign currency at a future date, you can fix the exchange rate by booking a forward contract. This approach provides certainty but you could suffer an opportunity loss if rates subsequently move in your favour and you are obliged to transact at the forward contract rate.
• Use flexible products - a currency option will offer you the potential for upside benefit if rates move in your favour - like a spot deal, but will provide protection against adverse rate movements - like a forward contract. For this flexibility we will normally charge a premium although there are a range of alternative structured option products available where an up front premium is not required.

Point 3 - Develop a Strategy
It may not always be best to adopt any one of the three alternatives in isolation to manage your foreign exchange risk. Many businesses, reflecting their attitude to risk, their view of the currency markets, preparedness to pay premiums and a host of other factors, will adopt a portfolio approach - using a combination of spot, forward exchange contracts and currency options, HSBC will work with you to develop a strategy that best meets the requirements of your business. For example in an uncertain exchange rate environment, you may decide to transact 25 per cent of your currency in spot, fix 25 per cent with a forward contract and cover 50 per cent with flexible solutions such as an option. This way, if rates move in your favour, you will benefit on 75 per cent of your exposure (spot and options) whilst if rates move against you, you are protected on 75 per cent (forward contracts and options). This is a balanced approach that provides flexibility, and avoids you paying a premium for all of your protection.

Point 4 - Implement it
It is often tempting to defer a decision to implement your foreign exchange risk management strategy, perhaps in the hope that rates may move in your favour in the short term. Historically, currency markets have been extremely volatile and unpredictable - it makes sense therefore, once you have formulated a strategy, to implement it without delay and ensure your profits are protected.

Summary
For many businesses, the impact of exchange rate volatility can be significant. HSBC has a team of specialists available to advise you on developing an appropriate strategy for your business - please contact your HSBC relationship manager for further details.

Important: Please read the disclaimer carefully.