FX risk management for companies that pay and get paid abroad

MillTech separates three exposures. Transaction exposure is the risk between agreeing a payment or receivable in a foreign currency and settling it. Translation exposure comes from consolidating foreign subsidiaries into the euro accounts. Economic exposure is the longer-term effect of exchange rates on cash flows and competitiveness, and it reaches a company even when it invoices only in euros, through the prices of its competitors.

Transaction exposure is the one a payments or treasury team can hedge directly, because amount and date are known.

An FX forward fixes the rate for a payment on a future date. An option gives the right but not the obligation to exchange at a strike rate, so the company keeps the gain when the rate moves its way and pays a premium for that. An FX swap combines a spot exchange with its reversal at a forward rate and is used to shift liquidity between currencies. A natural hedge needs no contract at all: costs paid in the same currency as revenue, for example dollar suppliers paid from dollar income on a multi currency account.

A forward is not a forecast. Its price comes from the spot rate and the interest rate difference between the two currencies, and BlueGamma calls the forward market for major currency pairs highly liquid out to around one year.

Some FX risk is created by how payments are set up. Invoicing in euros moves the risk to the customer, who may price it in. Paying a supplier in its own currency, with the conversion done by your bank, shows you the rate; paying in euros leaves the conversion to the supplier's bank, whose margin ends up in your next price. The cost of the conversion itself is covered on the page on B2B cross-border payments, and the settlement risk of a currency trade on FX settlement risk.

A hedging policy answers a short list of questions in writing: which exposures are hedged, what share of forecast flows and over which horizon, with which instruments, with which banks, and who may sign a trade. Many companies hedge firm orders in full and forecast flows in falling layers. The policy also sets how results are reported, so a hedge that lost money against the spot rate is judged against the risk it removed. The page on corporate treasury covers the function that owns it.

The process of measuring how exchange rate moves affect a company's cash flows and results, and reducing that effect with contracts such as forwards and options or with operational measures such as matching currencies of revenue and cost.

For a known payment on a known date, a forward is the usual choice. For an uncertain flow, such as a tender that may not be won, an option fits better because it does not oblige the company to exchange. A natural hedge is the cheapest where revenue and costs can share a currency.

A company with regular foreign currency invoices does. The first step needs no product: list open receivables and payables by currency and date. That list shows whether the exposure is large enough to hedge or small enough to accept.