The 5 Most Common Mistakes Companies Have When Managing FX Risk
Minneapolis, MN |November 21, 2024 | By: John Trefethen, Director and Co-Founder
Companies are exposed to FX (foreign currency) risk in several ways when they operate internationally or deal in multiple currencies. FX risk arises primarily from fluctuations in exchange rates, which can impact a company’s profitability, cash flows, and overall financial health. Managing this risk is critical in a company’s effort to meet its financial goals. Below are five common mistakes companies make when managing FX risk.
The Top 5 FX Risk Management Mistakes
Mistake #1: Ignoring RX Risk Exposure
By failing to acknowledge the impact of currency fluctuations on a company’s financial performance, businesses can face unexpected losses. Companies should actively track and assess FX exposures, even if they seem minor, as they can become material over time.
Mistake #2: Poorly Defined Risk Management Policies
Without a structured plan outlining exposure thresholds, hedging strategies, and decision making processes, businesses may make decisions driven by emotion rather than a developed and agreed upon strategy. An effective policy will put guardrails in place that cover objectives, risk tolerance, and specific strategies designed to dictate risk management decisions that are aligned with the overall objectives of the company.
Mistake #3: Inadequate Forecasting and Scenario Planning
Failure to consider “what if” scenarios with different currency rates can leave companies unprepared and exposed to greater risk if sudden fluctuations occur. This is often done by “shocking” currency rates in scenarios where rates are increased and decreased by certain amounts (i.e. plus and minus 10, 20 and 30 basis points). Regularly performing accurate cash flow forecasts and scenario analysis will help establish effective FX strategies.
Mistake #4: Failure to Monitor and Adjust Strategy
It is a common mistake for companies to set an FX risk strategy and not periodically revisit it, especially when market conditions and business circumstances change. Regularly reviewing hedged positions, market conditions, business forecasts, etc. is essential to effectively adapt to evolving risks.
Mistake #5: Choosing Not to Use Hedge Accounting When Hedging Risk with Derivatives
When a company does not apply hedge accounting to its FX hedging activities it faces increased volatility in reported earnings, reduced transparency in FX risk management activities, and negative perception from key stakeholders. Hedge accounting provides a mechanism to match the timing of hedging gains and losses with the transaction they are intended to protect.
Actively avoiding these common mistakes will help companies with exposure to FX reach their financial objectives.
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Author: John Trefethen, Director and Co-Founder
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Email: jtrefethen@hedgestar.com
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