16/11/2012
Currency Hedging Strategies for Companies - WSJ.com
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March 1, 2011, 4:01 p.m. ET
Exposed!
As currency volatility rises, companies scramble to avoid being caught with their hedges down
By CHA NA SCHOENBERGER
(Please see Corrections & Amplifications item below.)
These are wild times for corporate financial executives.
Journal Report
Read the full Foreign Exchange report .
Each day, Bob Woodward checks on the forward
currency contracts he's bought, locking in the Canadian
dollar's exchange rate against the U.S. dollar.
"We have to be proactive because we are so exposed that we have to be here every morning
looking at things," says Mr. Woodward, the chief financial officer of Wmode, a Calgary, Alberta,
mobile-software company that gets 95% of its revenue from abroad.
To mitigate the risk that currency moves will wipe out its profits, Wmode buys between $10
million and $20 million of forward contracts annually. In 2010 these hedges saved the company
12% of revenue, money that otherwise would have vanished due to foreign-exchange volatility, he
says.
Companies like Wmode have had to work overtime to protect their bottom lines in recent years
amid a marked pickup in currency volatility. First it was the sharp slide in emerging-markets
currencies during the financial crisis of 2008 and 2009, when the dollar and Japanese yen surged
as safe havens. Then it was the gyrations in the euro, which moved within a range of 12 to 15 cents
in each quarter of 2010 as the eurozone lurched from debt crisis to solution and back again.
A Citigroup Inc. survey of large companies released in December revealed that one-quarter had
changed their risk-management policies as a result of losing money to such currency movements
since the financial crisis began.
"A 2% swing that affects your bottom line could wipe out your profit," says Brendan McGrath,
senior foreign-exchange trader at Western Union Co.'s Western Union Business Solutions in
Victoria, British Columbia, where Wmode does its hedging.
Seeking Certainty
Currency volatility is in the forefront of issues concerning companies around the world, and
hedging has increased recently after a pullback during 2008 and 2009. U.S., European, and
Japanese companies surveyed by J.P. Morgan Chase & Co. in December said they had already
hedged a record 40% of their currency exposure for 2011. Among those, U.S. companies had
hedged 46% of their expected foreign cash flow for 2011. Previous surveys showed that companies
around the world hedged nearly that much in December 2007 for 2008, but then sharply reduced
their hedging during 2008 and 2009.
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J.P. Morgan's December survey showed companies were most
worried about the euro as the sovereign-debt crisis and the
resulting banking turmoil continues to roil the common currency.
Companies that hedge their currency exposure by buying forward
contracts and options through Western Union Business Solutions
are generally trying to protect against exchange-rate fluctuations
of about 8% over the life of a contract, Mr. McGrath says. But since
the crisis of 2008-09, exchange rates can now change in doubledigit increments over those periods, making hedging more difficult
and costly he says. Forwards are agreements to buy or sell a
currency at a specified rate on a certain date. Options give the
right, but not the obligation, for similar transactions.
With companies more careful now about hedging costs, Mr.
McGrath says he's seen an increase in clients using a protective
move known as a collar strategy to bet that the euro's weakness
will continue.
Say a company has euros that it wants to exchange for dollars in
three months and the euro currently is trading at $1.35. The
company wants to lock in its exchange rate within a narrow range.
To achieve this, it arranges two separate options. One option,
which the company buys from a counterparty that's more bullish
on the euro, allows it to sell its euros in exchange for dollars if the
euro reaches $1.37. The other option, which it buys from a eurobearish seller lets it sell those euros at a rate of $1.33. That way,
the company has guaranteed its rate will fall between $1.33 and
$1.37; it won't be hurt if its euros are suddenly worth far less, but
it also won't benefit if its euros become worth far more.
"You can give yourself a very tight protection level," Mr. McGrath says. "But you have to give up
some upside," he adds. "That's one big thing if you're talking about volatility."
How Much to Hedge?
How much a company uses hedging depends on the type of business and how predictable its
foreign-exchange exposures are. Most sectors that do business abroad typically try to eliminate
half of their exposure. Companies with narrows margins, like in agriculture, commodities and
groceries, might hedge 80% of their known foreign-exchange requirements.
Some companies don't hedge at all, either because they can't judge how much money will be
coming in from abroad, or because they have a deliberate strategy of letting currencies balance
each other out around the world.
FM Global, a mutual commercial-property insurer based in Johnston, R.I., does business in about
100 currencies. When it needs to pay out a claim abroad, it builds up deposits in that currency by
halting conversions of the annual premiums it collects in that currency. Otherwise, it regularly
converts its foreign cash into dollars, except where national regulations require it to keep some
money in a particular currency.
"We're not buyers of exotic or pricey FX instruments to manage our risk," says Treasurer William
Mekrut. Because FM Global is privately held, "we manage our company from a long-term
structure, so we don't have to do that."
Even the savviest treasurer avoids purely speculative trades on currencies just to boost profits;
that's an easy way to lose money with disastrous bets. "The evidence is pretty strongly against the
fact that a corporate can forecast how exchange rates are likely to go and make hedging decisions
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to increase profitability by hedging," says Gordon Bodnar, a finance professor at Johns Hopkins
University's School of Advanced International Studies who has researched corporate hedging.
"Increasingly, I think, companies recognize that."
"One way to look at FX is that you're just buying insurance," says Brian Kalish, director, finance
practice, at the Association for Financial Professionals, a trade group in Bethesda, Md., for
treasurers and other financial executives. But, he says, "you never want to overhedge, because
that's just money you're spending right off the bat."
High Costs
Even when currencies are fluctuating dangerously, a prudent hedge policy can still be too pricey
for many companies. Because the more volatile the market, the higher the price for an option.
Treasurers on the message boards of the Association for Financial Professionals website recently
debated how to hedge their exposure to Turkish lira. "You can't," Mr. Kalish says. "You're not
going to buy futures in highly volatile currencies because the cost is too great."
Hedging costs also vary greatly depending on a company's creditworthiness, the currency being
hedged, the type of hedging instrument used, and the length of time the company wants to
maintain the hedge.
According to one adviser to companies on foreign-currency hedging, recently a public U.S.
company with a good credit rating that wanted to convert 100 million euros into dollars in three
months could have used a three-month forward contract to sell euros for $1.3142, compared with
a spot exchange rate of $1.3149. The difference between those two rates represents the difference
in three-month deposit interest rates in euros compared with dollars, or about $70,000. If the two
companies in the transaction put the money into three-month deposits, then the company selling
the euros would earn interest on them for the three months before the exchange takes place, and
the buyer of the euros would earn interest on dollars during the same period. In that scenario, the
interest earned effectively offsets the difference in spot and forward price, and the hedge doesn't
cost the U.S. company anything, aside from the opportunity to put those funds to some other use
during those three months.
At the other end of the spectrum, the adviser says, a privately held company with poor credit that
wants to convert 100 million euros into dollars in five years will likely have to use a put, or sell
option. The company's bad credit would stop most banks from taking a risk on a five-year forward
contract. And that deal could cost as much as $13 million, or close to 10% of the amount hedged.
Corrections & Amplifications
A public U.S. company with a good credit rating wanting to convert €100 million (or about $140
million) into dollars in three months could have used a three-month forward contract recently to
lock in an exchange rate at no effective cost, because of the difference between dollar and euro
interest rates. This article neglects to note the offsetting interest that would make the hedge
effectively free of cost.
Ms. Schoenberger is a reporter for The Wall Street Journal and Dow Jones Newswires in New
York. She can be reached at [email protected].
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