Cash Flow Hedging in Eruptive Currency Markets

This summer my family visited Yellowstone National Park. At Mammoth Hot Springs Historic District, near the north entrance of Yellowstone, I learned about the park’s history. This was the first national park ever established, with a vast coverage area (3,472 square miles or 8,992 kilometers), limited financial resources, and very harsh winter conditions. Despite these challenges, the administrative and conservation policies developed greatly influenced the success of the National Parks program nationwide, which continues to this day.

Because I work as the Global Director of Marketing at GPS, I couldn’t help but draw parallels between the determination and preparation that went into creating Yellowstone and the business feats I see GPS help clients achieve daily. Just as Yellowstone’s early planners had to assess their goals and resources, companies looking to streamline treasury processes or establish hedging programs begin by determining their objectives and considering the specific financial risks they aim to mitigate.

Bracing For and Responding to Volatility

Each day, businesses brace for geopolitical events that can trigger market volatility, while visiting the park, we saw how the Park Service responds to out-of-the-blue events. During our trip, the Biscuit Basin, located about two miles from the famous Old Faithful Geiser, experienced a rare hydrothermal explosion. It was an unpredictable, relatively rare event and the park rangers responded by closing the area to mitigate the danger to visitors.

Scientists employ monitoring equipment to track the geothermal activity of the area but cannot forecast with certainty the exact timing or location of the next event.

Similar to how geysers’ schedules can be forecasted within certain windows of time but are still susceptible to unpredictable explosions, currency trends can be somewhat predictable within range. However, pressures on currency markets over the past few years have brought unexpected currency movements. Such is the case with the recent elections in Mexico. Following the election, the peso lost 12.5% of its value in one week. Another example is the recent market meltdown, when a combination of factors including weak US job reports and rising Japanese interest rates, combined to cause a global market shakeup.

Adaptions for Different Types of Risk

Yellowstone’s uniqueness lies in its diverse wildlife, numerous geothermal features, and the high concentration of active geysers within its volcanic hot spot. Since its establishment in 1872, the National Park Service has been committed to safeguarding this fragile ecosystem, initially from poachers and more recently from the pressures of increased visitor use.

Their risk mitigation strategies have adapted to the evolving threats they encounter. Similarly, companies are exposed to many types of exchange rate risk: most commonly transaction, translation, and economic. Transaction risk is the potential financial loss due to exchange rate fluctuations between the initiation and settlement of a transaction. Translation risk occurs when a company’s financial statements consolidate foreign subsidiaries’ values into the parent company’s currency, potentially affecting financial reports. Economic risk involves the impact of changing currency rates on a company’s market value, creating inequities between them and foreign competitors and influencing future cash flows and market strategy.

The most common financial strategy to offset the risks associated with dealing in more than one currency is hedging.

Where to begin?

Cash flow hedging protects a company’s future expenses and revenues from currency exposure. For example, if your company has a set payroll amount in a foreign currency they forecast to pay for the next 12 months, a cash flow hedging program can lock the amount of that future cash flow to ensure their payroll costs remain stable throughout the year.

Every company is unique and has needs that are specific to them. In creating plans to mitigate risks you need to not only look at your unique situation but remain flexible enough to act when outlying events happen in the market.

Just as no one in Yellowstone anticipated the eruption of Biscuit Basin, the Park Service had prepared by creating walking paths outside of the main area of destruction and had contingency plans in place to shut down and evacuate people immediately if necessary. Likewise, many of our clients took advantage of the weak MXN to lock in more risk for the coming year. It’s essential you have insurance in place, and contingency plans in case the worst happens.

You can learn more about establishing a successful cash flow hedging program and how hedge accounting comes into play at the upcoming webinar FX Bootcamp: The Ultimate Guide to Cash Flow Hedging.

A Cash Flow Hedging Success Story

Not every organization will benefit from a cash flow hedging program but those that do attain greater financial predictability to make informed, confident decisions for sustained growth.

One of GPS’ cash flow hedging clients, an industry-leading entertainment company with annual revenues of $900 million with operations in over 20 countries and dealing in five different currencies recently commented:

“GPS saves our team time, as our dedicated advisors run models and manage with deep analysis, which allows us to assess our exposure in FX and actively manage our cash flow program in a timely manner. Their accounting services support us and save us a good deal of time and money with their care and attention.” (VP, European Financial Controller)

Learn about their success story: International Entertainment Company Substantially Reduces FX Risk with GPS Cash Flow Hedging Expertise

Access to Expert Consultants

GPS Capital Markets has been advising international companies for over 20 years on their FX risk management strategies and helping them exchange funds from one currency to another at exchange rates more favorable than traditional banks. If you wish to learn more about our free FX advisory services and currency treasury management tools please reach out to us at GPSFX.com.