One important aspect of currency hedging for every company is the management of the risks. A high level of flexibility is particularly valuable in the currently uncertain environment. It allows companies to benefit from favorable market movements, while simultaneously providing protection if negative events occur.
"One solution that meets all of these criteria is the participating forward," says Maxime Gineys. "This strategy allows the company to hedge 100% of its exposure, but it only enters into an obligation for 50% of the amount." This means that the company is hedged at the pre-defined level. At the same time, it may benefit as a seller from upward movements in the foreign exchange rate or as a buyer from downward movements.
A second effective strategy is a risk reversal or a so-called collar. In this case, an exchange rate is fixed within a specific range. "We start by defining a floor and cap together with our client," explains the expert. "Then, on the basis of the direction of the transactions, one of the two strike prices is used to hedge the exchange rate. The other price represents an obligation." That gives the company the certainty that the exchange rate will not fall below the lower strike price or rise above the upper strike price.
The optimal hedging strategy for each company is different, but there are three key points that companies should take into consideration when hedging their foreign exchange risks:
Overall, 2021 was characterized by low volatility in the main currencies. That is why a strategy in which future foreign exchange risks are not hedged remain risky, says Maxime Gineys. "In fact, now is the right time for companies to hedge their own exposure. During a phase of low volatility, risk hedging is always cheaper, particularly with foreign exchange structures that combine options." Therefore, it is an attractive opportunity to hedge foreign exchange risks.
In an environment that is calmed by the central banks, the market also anticipates a lower risk of fluctuations. "But that doesn’t mean that there won't be any fluctuations," explains the FX specialist. Furthermore, many central banks may reduce or discontinue their quantitative programs in 2022 and start hiking their interest rates, which would increase volatility. "Therefore, it should be in the company’s interest to hedge its exposure instead of exposing itself to additional risk."