Identifying and Managing Foreign Exchange Risk Foreign Exchange Management Do not enter into this trade unless you fully understand and are willing to assume the risks associated with it. HSBC Bank provides foreign exchange risk management solutions to customers on a strictly non-advised basis.
This document is a presentation for information purposes only and is not a solicitation of a transaction
Identifying the Risk Businesses that trade internationally or have operations overseas are likely to be exposed to foreign exchange risk arising from volatility in the currency markets. The most common cause of foreign exchange exposure arises from having to make overseas payments for your imports priced in a foreign currency or receiving foreign currency receipts for your exports. However, exposure can also arise from: • Foreign currency borrowing/deposits • Overseas subsidiaries • Assets located overseas The impact that exchange rate fluctuations have on profitability will vary but in many cases it can be significant. FX risk is best explained with an example. Example scenario The following is a simplified extract from a profit and loss account of a UK exporter that regularly receives revenue in US dollars. £000s
Converted at FX Rate - £1.00 = $1.60
In this example, the UK exporter received $2.40 million at a GBP/USD exchange rate of £1.00 = $1.60 which was converted into sales revenue worth £1.5 million, all costs are incurred in Sterling. Consider the impact of, in this case, a c11% adverse movement in the exchange rate to £1.00 = $1.78. After this FX move, the next receipt of $2.4 million will be converted into sales of approximately £1.35 million. This decline in sales revenue puts the company into a loss-making situation. £000s
Converted at FX Rate - £1.00 = $1.60
Impact at FX Rate - £1.00 = $1.78
Response to FX Rate - £1.00 = $1.78
The response column in the table above (3rd column) shows that following an 11% adverse exchange rate movement, all other things unchanged, this company would need to almost double its sales turnover to restore profitability to previous levels! Effective management of FX risk is therefore crucial but does not need to be unnecessarily complicated. At HSBC, we advocate the use of a simple four-point plan to help you adopt a structured approach.
Identifying and Managing Foreign Exchange Risk
The Four Point Plan Point 1 – Understand your exposures There are numerous 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 three alternative methods available 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. While 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 exchange at a future date, you can fix the exchange rate by booking a forward exchange 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 Currency options (where available) 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 exchange 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, depending on their attitude to risk, view of the currency markets, willingness to pay premiums and a host of other factors, will adopt a portfolio approach and use a combination of spot, forward exchange contracts and currency options (where available). HSBC will work with you to help you understand the products available, allowing 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 exchange 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) while if rates move against you, you are protected on 75 per cent (forward exchange 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, therefore once you have formulated a strategy, you may choose to implement it in order to, where possible, protect your profits.
Identifying and Managing Foreign Exchange Risk
Summary For many businesses, the impact of exchange rate volatility can be significant. HSBC has a team of specialists available to help you develop an appropriate strategy for your business – please contact your HSBC relationship manager for further details.
Contact point For further information, please contact your local Global Markets Office.
Important: Please read carefully This document is issued by HSBC Bank plc (“HSBC”). HSBC is authorised by the Prudential Regulation Authority (“PRA”) and regulated by the Financial Conduct Authority (“FCA”) and the Prudential Regulation Authority and is a member of the HSBC Group of companies (“HSBC Group”). Any member of the HSBC Group, together with their directors, officers and employees may have traded for their own account as principal, underwritten an issue within the last 36 months, or have a long or short position in any related instrument mentioned in this material. Spot and forward foreign exchange transactions generally are not ‘designated investments’ as defined in the United Kingdom Financial Services and Markets Act 2000 (the “Act”) and therefore do not benefit from the protections of the Act or the rules of the FCA. Any other product described in this document is a ‘designated investment’ as defined in the Act, even when used to cover a commercial trade position. Hedging instruments, such as caps or options, even when used to cover a commercial position, are investments under the Act. This document is for information and convenient reference, and is not intended as an offer or solicitation of the purchase or sale of any derivative product. HSBC is under no obligation to keep current the information in this document. This document is not intended to provide and should not be relied upon for tax, legal or accounting advice. Prospective investors should consult their tax, legal, accounting or other advisors. Figures included in this document may relate to past performance or simulated past performance. Past performance is not a reliable indicator of future performance. The instruments appearing in this document are not readily realisable investments; it may also be difficult to obtain reliable information about their value or the extent to which they are exposed. Investments can fluctuate in price or value and prices, values or income may fall against an investor’s interests. Changes in rates of exchange and rates of interest may have an adverse effect on the value, price or income of these investments. The levels and bases of taxation can change. Derivatives can be utilised for the management of investment risk, however, derivative instruments may not be suitable for all investors, as they may be contingent liability transactions such as swaps. This means that the investor may not only lose all the amount invested, but may also have to pay an additional sum at a later date. Prospective investors should ensure that they read the applicable standard risk warning in conjunction with this document, and where necessary seek advice. This presentation is a “financial promotion” within the scope of the rules of the FCA. HSBC Bank plc Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority Registered in England No. 14259 Registered Office: 8 Canada Square, London, E14 5HQ, United Kingdom Member HSBC Group DISCRPFS0413
Identifying and Managing Foreign Exchange Risk - HSBC Business ...
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