What a budget rate represents
A budget rate is the exchange rate a business uses in its financial plan to convert foreign currency revenues and costs into its reporting currency. It is the rate at which the plan's prices, margins and cash flows hold. Performance is measured against it.
A budget rate is not a forecast of the market. It is a planning assumption, and its purpose is to make currency a visible, measurable part of the plan. Without one, the plan quietly assumes whatever the spot rate was when it was prepared, and every later variance mixes operating performance with currency movement.
How a budget rate is set
Businesses set budget rates in several ways. The method matters less than writing it down: where the rate came from, on what date, and who approved it.
- Forward rates at the time of budgeting. The rate for each month or quarter is the forward rate for that date when the budget is set. It is achievable at the time, because it could be locked.
- Spot at the time of budgeting. Simple, but it ignores forward points. When the currency being sold trades at a forward discount, a budget at spot cannot be secured with forwards even on the day it is set.
- Existing hedges plus forwards. The rate already secured on the hedged part, blended with forward rates for the rest.
- A rate that delivers a target margin. Useful for testing whether pricing works. If the market cannot deliver it, it is a target rather than a budget, and the gap is a risk to report.
Some businesses also allow a buffer between the budget rate and the forward rate, to leave room for movement before hedges are placed.
Budget rates and operating margins
When prices are set in one currency and costs incurred in another, the budget rate decides the planned margin. A Canadian exporter that prices in US dollars and pays costs in Canadian dollars plans its margin at the budget rate. Every rate below it erodes the margin, and the rate at which revenue in Canadian dollars equals costs is the break even rate. The FX risk fundamentals guide shows how quickly a small move can reach a thin margin.
Achieved rate, blended rate and result against budget
Three different measures are often called "the rate". Keeping them apart avoids most of the confusion in budget reporting.
- The achieved rate on a transaction: the rate on one forward, one spot conversion or one exercised option.
- The blended rate: the average rate across the whole exposure, weighted by amount, combining what is hedged and what is converted later.
- The result against budget: the difference between the blended rate and the budget rate, multiplied by the total exposure, in the reporting currency.
A single forward booked below the budget rate does not mean the budget has been missed. What matters is the blended rate once everything has been converted.
The rate the remaining exposure needs
Once part of the exposure is hedged, the question changes from "what rate do we need?" to "what rate does the rest need?". The answer depends on the budget, the total exposure and what the hedges have already secured.
A Canadian exporter expects $10,000,000 USD of receipts this fiscal year. Its budget rate is 1.3600 USD/CAD. It has hedged $6,000,000 USD with three forwards and $4,000,000 USD remains open.
- Forward 1: $2,000,000 USD at 1.3800$2,760,000 CAD
- Forward 2: $2,000,000 USD at 1.3650$2,730,000 CAD
- Forward 3: $2,000,000 USD at 1.3550$2,710,000 CAD
- Secured on $6,000,000 USD (average 1.3667)$8,200,000 CAD
- Budget: $10,000,000 USD × 1.3600$13,600,000 CAD
- Less already secured$8,200,000 CAD
- Still needed from $4,000,000 USD$5,400,000 CAD
- Target rate on the remainder: $5,400,000 ÷ $4,000,0001.3500
Because the hedges average above the budget, the remaining $4,000,000 USD needs only 1.3500 for the year to blend to 1.3600. The table shows the blended rate for a range of rates on the remainder.
| Remainder converts at | From the remainder (CAD) | Total for the year (CAD) | Blended rate | Result against budget (CAD) |
|---|---|---|---|---|
| 1.3700 | $5,480,000 | $13,680,000 | 1.3680 | +$80,000 |
| 1.3600 (budget rate) | $5,440,000 | $13,640,000 | 1.3640 | +$40,000 |
| 1.3500 (target rate) | $5,400,000 | $13,600,000 | 1.3600 | $0 |
| 1.3400 | $5,360,000 | $13,560,000 | 1.3560 | −$40,000 |
| 1.3300 | $5,320,000 | $13,520,000 | 1.3520 | −$80,000 |
Each 0.0100 on the remainder moves the year's result by $40,000 CAD and the blended rate by 0.0040, because the remainder is 40% of the exposure. The larger the hedged share, the less the remaining rate moves the result.
For a payable, the direction reverses: a business buying foreign currency needs the remainder at or below its target rate.
Reading probabilities against the right rate
Budget analysis often adds a probability: how likely the business is to achieve a given rate. Two different questions sit behind that number, and they are easy to confuse.
- The probability of a market rate is the chance that the rate available when the remainder is converted is at or above a level, for example 1.3500.
- The probability of a blended outcome is the chance that the year as a whole reaches a blended rate, for example the 1.3600 budget.
They are linked through the hedged amount. With $6,000,000 USD fixed at an average of 1.3667, each rate on the remainder produces exactly one blended rate, so the chance of the remainder converting at 1.3500 or better is the chance of blending to the 1.3600 budget or better. They are not interchangeable at the same level: the chance of the market reaching the 1.3600 budget rate is the chance of a 1.3640 blended rate, a different and less likely outcome. Reading a probability against the budget rate instead of the target rate understates the chance of achieving the budget when the hedges sit above it, and overstates it when they sit below.
These probabilities are estimates from a model of possible market outcomes, typically derived from forward rates and option volatilities. They describe the range the market is pricing, not a forecast, and they change as the market moves. If the remainder is converted over several months, the relevant rate is an average of those conversions rather than a single day's rate.
Deciding what to do with the remainder
The target rate turns a market view into a concrete decision. If the forward rate for the remaining dates is above the target, the budget can be secured now. In the example, if the forward for the remaining receipts is 1.3580, hedging the full remainder fixes a blended rate of 1.3632, $32,000 CAD above budget. The business might instead hedge part of it, protect it with an option struck near the target, or leave it open within the limits of its policy. Each choice trades certainty against participation, and the target rate shows what is at stake in each.
When the forecast changes
The target rate depends on the forecast as much as on the market. If the year's receipts are revised down to $8,000,000 USD, the same hedges cover 75% of the exposure and the target rate on the remaining $2,000,000 USD falls to 1.3400. If receipts rise to $12,000,000 USD, the hedges cover 50% and the target on the remaining $6,000,000 USD is about 1.3533. A forecast that falls below the hedged amount turns the excess hedge into an open position of its own, which is why forecasts and hedges need to be reviewed together.
Separating currency from operating performance
At the end of the period, the difference between the plan and the result can be split into an operating part and a currency part. Volume and price differences are measured at the budget rate. The currency variance is the actual foreign currency amount multiplied by the difference between the blended rate achieved and the budget rate. Reporting the two separately shows management what the business did and what the market did, and keeps currency from flattering or obscuring operating results.
Budget rate analysis in Vantry ATI
In Vantry ATI, budget rate analysis is part of portfolio and MTM reporting. For each hedge layer it takes the hedges at their booked rates and the exposure still open, and shows the target rate on the remainder, the probability of the remaining exposure converting at that rate or better, and a sensitivity grid of blended rates and results against budget. Fiscal year views suggest a budget rate for each year, and reports export to PDF and CSV.
This article is general information about managing currency risk. It is not investment advice or a recommendation to use any instrument, and examples use illustrative rates and amounts, not quotations. Products are offered in Canada by Vantry Capital Inc., subject to eligibility and credit approval.