What is currency risk? 

Currency risk (or sometimes called “FX risk”) is the risk that changes in the value of one currency relative to another will have a negative impact on a company's financial performance. This risk arises when exchange rates move between the time terms are agreed and the time of the related cash flows. Currency risk can be a significant threat to a company's financial performance. However, there are many strategies and tools companies use to limit the impacts of this risk. 

An example: Let's say a company within the US imports goods from the United Kingom, and the US company agrees to pay 10,000 British pounds for the goods ($12,000 USD). Payment is due in 30 days. During that time the value of the British pound gains against the US dollar. On the day the payment is due, the company buys 10,000 pounds, but because exchange rates have moved, it costs $15,000. Ultimately, the goods cost the company $15,000 although they originally expected the cost to be $12,000. This difference would damage the company's bottom line because the cost of those goods has increased. 

The importance of currency risk management to treasury teams

FX risk management can be important for businesses of all sizes that operate internationally, whether they sell internationally, buy foreign sourced goods or pay foreign service providers. Currency fluctuations can have a significant impact, so it is vital that businesses have a plan in place to manage this risk. When it comes to FX risk management, many companies turn to FX hedging. When a business hedges its currency exposure, they are often entering into a financial contract. The intention is to help mitigate the potential of financial loss. The finer details of risk management depend on the type of currency hedging method. 

FX risk management is especially important for treasurers because they are responsible for overseeing a company's finances. They need to make sure that the company is not exposed to unnecessary risk, and that its financial performance is not adversely affected by currency fluctuations.

Discuss the challenges of managing FX risk manually 

• Inaccurate FX forecasting - It is difficult to predict with certainty how currency values will fluctuate in the future, even with the help of sophisticated models and algorithms. As a result, FX forecasts are often wrong and can lead to costly mistakes. 

• Unforeseen events - These events could be political risks, economic risks and natural disasters.  They can all have a significant impact on foreign exchange rates. 

• Time-consuming - It requires a deep understanding of FX markets and the ability to collect and analyse large amounts of data. This can be a significant burden for businesses that do not have the resources to dedicate to FX forecasting. This can lead to mistakes and may become very difficult and costly for a company to scale.

  
  

What are the different types of risk management tools and software? 

Softwares and platforms 

When looking for FX risk management software and solutions it is essential to look into what features are available to help mitigate risk. Many companies offer currency management solutions with the key selling point being FX payments but do not offer tools which limit FX exposure. When looking for software, treasurers need to ensure they have hedging solutions like forward contracts, options, swaps, NDF’s, averaging and forwarding. Platforms like Bound’s, offer a range of in-platform tools that allow businesses to hedge their risk in a way that suits their needs and business type. 

Risk management tools

Risk management tools are used by CFO’s and treasury teams to identify, assess and manage currency risk exposure. Depending on their requirements, there will be a variety of hedging solutions they should consider.

Forward contract - Exchange rate contracts that companies use to lock in an exchange rate for a future date, protecting them from currency fluctuations.

Options - Currency options allow companies to buy or sell currencies at a future date, without obligation. Options typically have up-front costs but are generally more flexible than forward contracts.

Swaps - Swaps are financial transactions in which two parties exchange currencies, but also pre-agree to exchange them back at a future date.

NDFs - are short-term contracts where two parties agree to exchange the difference between the contracted rate and the future spot price of a currency. The actual currency is not exchanged, which gives it the name "non-deliverable."

Averaging - Averaging allows businesses to automatically spread their risk over as much time as possible, smoothing out short-term volatility. Averaging is aimed at businesses that want to minimise the risk of transacting their currency conversions at an inopportune time. It can help a company to focus on business growth instead of where currencies are moving.

Forwarding - Forwarding is a popular hedging choice for experienced hedgers. Forwarding sets up a series of forward contracts into the future to give the business exchange rate stability in the near-term and high visibility in the medium-term and/or long-term. 

Benefits of using FX risk management software and tools

• Helps to protect against losses from currency fluctuations.

• Improves financial planning and forecasting.

• Reduces volatility in cash flows.

Requirements when looking for FX risk management software?

When it comes to finding the ideal currency risk management software, it's essential businesses know how it is helping limit their exposure. Bound’s currency risk tools allow businesses to recognise, implement and report with ease. 

Discover: Identifying and quantifying currency risk can help treasurers understand how changes in exchange rates could impact their business. 

Manage: Tools that automate the decision-making and execution for treasures. 

• Averaging: With averaging, businesses spread their risk over as much time as possible. They’ll still trend with long-term rate changes, but they’ll smooth out the short-term volatility.

• Forwarding: Forwarding is a popular hedging strategy for large corporations. Forwarding gives businesses good visibility and a high degree of certainty on their future figures, whilst reducing the impact of market volatility.

• In addition to Bound's automated tool, treasures will find a series of self-serve financial products within the Bound platform that customers can use. Some Bound users manage their currency risk in minutes per day using Program Managers.

Generate reports: CFOs and treasurers will want to make life easier when doing month-end reconciliations or when creating quarterly financial statements. Some Bound customers use the platform to integrate their bank account and bookkeeping software to report and reconcile their foreign currency transactions automatically. 

Automation: With Bound’s FX hedging API, businesses can embed our currency hedging tools into their platform. This can be a perfect solution for companies that have high volumes of currency running through their platform, allowing effortless currency risk management.

Conclusion 

Embracing FX risk management tools is vital for limiting the effects of currency fluctuations. As businesses operate internationally, the potential impact of currency risk on financial performance cannot be overlooked. By adopting sophisticated solutions like averaging and forwarding, treasures can proactively shield their companies from losses, enhance financial planning accuracy, and stabilise cash flows. Integrating these tools seamlessly into existing systems not only streamlines reporting and reconciliation but also allows businesses to automate currency risk management.

This publication is provided for general information purposes only and is not intended to cover every aspect of the topics with which it deals. Nothing in this material is, or should be considered to be, financial, investment or other advice on which reliance should be placed and does not take into account your personal circumstances or objectives. You must obtain professional or specialist advice before taking, or refraining from, any action on the basis of this content. No opinion given in the material constitutes a recommendation by Bound Rates Limited or the author that any particular transaction or investment strategy is suitable for any specific person and as such is considered to be a marketing communication.‍