Strategies to protect against global uncertainty: structuring a proper foreign exchange hedging strategy can shield global corporate assets from market volatility, improving the bottom line of any company exposed to FX risk.

• Author: Gibbons, Ryan
• Position: Treasury

Businesses around the globe are grappling with a lot of "what ifs." Worry over Greece and the future of the euro, the possibility of another natural disaster on the scale of the tsunami and earthquake in Japan last year and increasing instability in the Middle East may certainly keep some financial executives up at night, wondering how their international operations might be impacted. With such volatility and uncertainty in global markets, businesses need to protect themselves against mounting exposure and risk.

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In this era of market globalization, most companies find it virtually impossible to avoid being exposed to some form of currency risk. Whether a company is exposed directly, in the form of foreign currency receivables or payables, or indirectly, through an overseas competitor's pricing agreements, identifying and taking steps to manage these risks before they impact the bottom line has become crucial to running an effective business.

Unfortunately, many companies have misconceptions about foreign exchange hedging or haven't explored the possibilities. Those with financial executives who have taken the proper steps for managing global risk and have implemented a proper, responsible hedging strategy find they have a lot less to worry about.

FX Hedging: An 'Insurance' Policy

It's clear that hedging is simply a form of risk management, similar to buying insurance. Life insurance is purchased to protect loved ones in case the wage-earner's life is cut short. When companies hedge, they protect their global assets from volatility in the currency markets.

If there is more than a single country involved, chances are there is currency exposure in some form. And for every form of currency exposure there is a hedge or insurance policy available in some form. For example, consider a company based in the United States that has a manufacturing subsidiary in Mexico, with the financial of that company reported in Mexican pesos. A common hedge involves dealing with the fluctuation of the financials of the Mexican subsidiary during the accounting period. The hedge involves taking an equal and opposite position in response to the underlying FX exposure to protect against adverse currency movements.

The end result is that a gain incurred by one position is offset by an equal loss in the other. In a perfect hedge, all currency risk is taken out of the equation and one is left with the exact numbers...