Currency: Hedging Your Bets

In 1946, my grandfather LW Riley started making pulleys and shackles in Carlton, an area of southern Sydney, and I know that he wouldn’t have envisaged the changes that were going to change the face of the Australian marine industry over the next 65 years. Some of these were as simple as replacing stainless steel pulleys with aluminium rings or going from building wooden skiffs to carbon fibre hulls. However, the biggest change is the breaking down of the largest protector that the industry faced back in the 1940s, ‘50s, ‘60s and even ‘70s - distance.

As the world has become an even smaller place, the need for foreign trade has been and will continue to grow, but will Australia regain the strength it once had when the Australian dollar (AUD) was seen as cheap to foreign consumers against the current view of being expensive, whilst our technical skills and infrastructure remains available.

The rise of the Australian dollar

It was not that long ago that the Australian dollar was down at 0.50 cents (2001) to the United States dollar (USD), with local exporters controlling the global marine market with better manufacturing, ideas and a cheaper currency. However, forward to 2011 the currency is  twice as expensive (over $1.03) to the USD with no end in sight. Competing nations like China or even the USA control their currency via different means, be it quantitative easing (QE) or pegging of the currency. The view of many banking and government economists is that the AUD will remain either near or above parity for the foreseeable future due to rising commodity prices and the strength of the local economy with interest rates remaining significantly above our trading partners.

To hedge or not to hedge?

Australian Importers have grown lazy over the l\past two years with the belief that the currency will continue to rally due to the above reasons, but it would be foolish to think that being unprotected is safe. Everybody knows an importer that suffered greatly or closed when the currency was down at the 0.48 lows or even now with orders decreasing at a rapid rate due to global economic uncertainty, despite the currency being at 29 year record highs.

Exporters on the other hand are facing a much tougher time with global factors and the strong AUD both working against them. It has been clear that exporters, big and small, haven’t hedged, either at all, or enough, with some of the country’s largest corporates blaming the currency strength for reduced margins.

So what should you do? Apart from sourcing better foreign exchange (FX) rates, another way to better manage foreign currency exposures is through effective hedging. In the past, most small to medium businesses were not important enough for the banks to provide the services and information required for these businesses to make informed decisions. However, with the emergence of independent FX providers, that has all changed and they will work closely with you to understand your business and to formulate the most effective strategies to best meet your business objectives.

There are a number of strategies that every importer and exporter must be aware of to effectively manage their currency risk. The strategies available can range from simple forward exchange contracts which provide certainty for future exchange rates and cash flow. Otherwise, option related strategies can be tailored to act like a form of insurance against adverse currency movements. The example we have included here is the most basic form of hedging strategies. Strategies can be tailored to meet various hedging requirements with differing levels of complexity.

Forward Exchange Contract: Forward exchange contracts are used when one requires certainty of exchange rates at which to transact in the future. Below are examples of forward exchange rates.
Regardless of future exchange rate fluctuations you will be dealing at the forward exchange contract rate on the predetermined date specified in the contract. FECs provide certainty of cash flow and protect profit margins against adverse currency moves. They do not provide any flexibility for participation in favourable moves. However, they allow you the time and security to better spend dealing with new or existing clients.

Facts to know

• Know your contract requirements with your suppliers and clients.

• Hedging is not a dangerous word, as it provides security to cash flow.

• Deal with experienced FX professionals.

• Know the security requirements before entering into any forward exchange contract.

• All providers charge a spread, knowing what is fair and reasonable is a must.