The volatility and uncertainty of the Australian Dollar against other currencies impacts on the profit and loss of many Australian companies. Managing this risk has become an essential part of successful importing or exporting. When deciding on a strategy the following factors must be considered:
- What is the size and nature of my risk?
- How much risk am I prepared to undertake?
- What is the lowest currency level I am prepared to tolerate?
- How much flexibility do I need to incorporate?
A successful strategy can incorporate any or all of the following tools and methods:
- Forward contracts
- Spot transaction
- Rolling hedging
- Standing orders
- Consignment (holding) accounts
A forward contract is an agreement between you and your currency provider in which the institute agrees to buy or sell to you a pre-agreed amount of money at a fixed exchange rate on a pre-determined date in the future. A FEC is used to negate exposure to currency market movements between now and the date at which you will need to pay or receive a foreign currency.
A spot transaction is the standard form of foreign exchange transaction. With any spot transaction there is a 'value date' i.e. the date at which the cash flow occurs and a 'contract date' i.e. the date on which the transaction is contracted. The spot value date usually takes place two working days after the contract date. Choosing to simply buy spot is still considered to be a strategy however it does involve the maximum risk. This method leaves the organisation with the greatest exposure to market movements and therefore the greatest potential for losses or gains.
Rolling hedging is the most common form of risk management and usually consists of a combination of forward and spot. A choice is usually made as to what percentage of each is desired. A 50/50 split of forward cover and spot leaves half the exposure covered, while leaving the remaining 50 per cent open to market movements. Alternatively an 80/20 split might be undertaken by a more risk adverse organisation.
Standing Orders (Overnight Market Orders) take advantage of Australia's unusual situation - over 70 percent of all the movements involving the AUD occur overnight, i.e. outside of Australian trading hours. Traditionally this was a wasted opportunity to achieve better rates that were often only seen outside of our trading time. These days, by using the 24 hour trading capabilities of currency specialists, you can access the tools to capitalise on these movements. A standing order authorises your currency provider to automatically purchase the desired amount of currency at a pre-selected rate. The more time that an organisation has before payment is required, the greater or more optimistic the rate may be away from the current spot rate.
A consignment or ‘holding account' is a non-interest bearing account used by companies to temporarily store foreign denominated funds. These accounts are an ideal facility to be used in conjunction with standing orders or incoming foreign currency. A target rate can be set and funds can be bought at the desired target rate even when there isn’t actually a bill to be paid. The funds are simply stored on a short-term basis until they are needed. This facility helps a company to take control of the market movements as opposed to the traditional method of having rates dictated to you.
Thus there are a number of techniques that allow a company to actively take control of its financial risk. Becoming aware of exactly where these risks lie, then developing a comprehensive strategy for alleviating these risks, is a necessity for any company involved in international commerce. By utilising the services of a currency specialist to assist in these transactions, exporters and importers can make the decisions necessary to minimize the risks.
The Chamber of Commerce and Industry of Western Australia has formed an alliance with non-bank currency specialist, AFEX-Associated Foreign Exchange Pty Ltd, and invites members to contact AFEX for any foreign exchange needs.
For more information contact: Daniel Cunneen, Corporate Account Manager, AFEX - Associated Foreign Exchange Pty Ltd, dcunneen@afex.com or visit www.afex.com.