Key points
- Common instruments: forward FX settlement and sale (locking the rate for future conversion of receipts or purchase of currency), FX swaps (adjusting the timing of receipts and payments), and FX options and option structures (keeping room to benefit from favourable moves).
- Exporters worried about the foreign currency weakening usually sell forward; importers worried about it strengthening usually buy forward.
- At maturity, a hedge can be delivered in full or in part, extended or delivered early, and must be matched to actual receipts and payments.
In practice
For importers and exporters, currency risk begins when the contract is signed: contracts are priced in US dollars, and payment often comes months later. The hard part of FX hedging is not placing the deal but deciding how much to hedge and for how long. Receipt and payment dates can move because of shipping delays, discrepancies under a letter of credit or late payment by customers; if the hedge maturity and the actual cash flow fall out of step, the result is extension costs or forced delivery.
FX hedging therefore needs to work alongside contracts and the cash plan: aggregate exposure by currency and month from contract payment schedules, hedge according to the policy ratio, adjust when receipt or payment dates change, and at delivery allocate the locked-in rate back to the relevant contracts to calculate exchange gains and losses. Where the criteria are met, a company may also designate an FX hedge as a cash flow hedge and apply hedge accounting.
How Tranexio supports it
Tranexio provides management of FX exposure, forwards, options and FX hedges, exchange rate maintenance and calculation of exchange gains and losses, with hedges allocable to contracts. Bank-side data can be connected via the integration hub. See Treasury, settlement and credit and Hedging and hedge accounting.