1. Hedging without a defined exposure
- How it arises
- Hedges are booked against a general sense of exposure, a round number, or a view on the market, rather than identified receivables, payables or forecasts.
- Why it matters
- A hedge with no matching exposure is a position in its own right. If the exposure is smaller or later than assumed, the excess gains or loses on its own, and its settlement needs funds the business did not plan for.
- Reducing the risk
- Link each hedge to an exposure or forecast, with an amount and a date, and reconcile hedges against exposures regularly.
2. No budget rate objective
- How it arises
- Plans are built at whatever rate prevailed when they were prepared, with no rate stated, approved or tracked.
- Why it matters
- Without a reference rate, there is no way to judge whether a hedge helps the plan, and currency variance is mixed into operating results.
- Reducing the risk
- Set and document a budget rate, then track the blended rate and the rate still needed on the open exposure.
3. Concentrating all hedges at one market level
- How it arises
- The whole exposure for a period is hedged in one trade, often just after a move that made the rate look attractive or alarming.
- Why it matters
- The result depends on a single day's rate. If the forecast falls later, the whole hedge may be too large.
- Reducing the risk
- Add hedges over time within agreed coverage ranges, increasing cover as forecasts firm up.
4. Ignoring forecast uncertainty
- How it arises
- Forecast flows are hedged as if they were contracted.
- Why it matters
- When volumes fall or timing slips, hedges have to be extended or closed at market rates, which can be costly, and an excess hedge becomes an open position.
- Reducing the risk
- Use lower coverage for less certain horizons, consider options where the amount is uncertain, and review forecasts and hedges together.
5. Not monitoring outstanding hedges
- How it arises
- Hedges are booked and then left on a spreadsheet or a bank statement.
- Why it matters
- Maturities arrive without funds in place, window forwards reach their end undrawn, credit lines fill up, and coverage drifts away from the exposure.
- Reducing the risk
- Keep a maturity calendar and a regular report of coverage, valuation and credit usage, with one person responsible for it.
6. Misunderstanding option obligations
- How it arises
- A structure with no upfront premium is chosen for its protected rate, without the sold side being fully understood.
- Why it matters
- Sold options create obligations: to exchange at a cap, to exchange a larger amount, or to lose protection if a barrier is reached. These can produce outcomes worse than a forward.
- Reducing the risk
- Review the outcome of every structure across a range of rates, including the worst case, before agreeing to it, and require separate approval for structures that can do worse than a forward.
7. Overlooking liquidity
- How it arises
- Hedging decisions consider rates but not cash.
- Why it matters
- A forward settles on its date whether or not the customer has paid. Some credit facilities can call for margin or collateral, and a currency balance held for later is still exposed.
- Reducing the risk
- Include hedge settlements and possible margin in the cash forecast, and agree facility terms before they are needed.
8. Making inconsistent decisions on short term predictions
- How it arises
- Hedging is put off while waiting for a better rate, or rushed after a headline.
- Why it matters
- Results come to depend on timing luck rather than process, and decisions are hard to explain afterwards, whichever way they turn out.
- Reducing the risk
- Agree the rules in calm conditions, such as coverage ranges and review dates, and record the reason for each decision when it is made.
9. Poor communication between treasury, finance and operations
- How it arises
- Sales agree currency and payment terms, operations move delivery dates, and treasury finds out late.
- Why it matters
- Hedges stop matching exposures, and chances to reduce exposure at source, through currency or terms, are missed.
- Reducing the risk
- Run a regular forecast update that covers currency and timing, and involve finance when prices and contract terms are set.
A hedge that shows a loss is not necessarily a mistake
A hedge should be judged together with the exposure it protects. Consider an exporter that sells $400,000 USD forward at 1.3675. If USD/CAD is 1.4000 when the forward settles, the forward on its own shows a loss of $13,000 CAD. But the receivable it hedged is worth $13,000 CAD more than planned, and together they deliver the rate the business chose to fix. The hedge did its job.
A sound decision can also turn out worse than the alternative in hindsight. What matters is whether it was made for the right reasons, within policy, with the information available at the time. Judging every hedge by its standalone value, or by the best outcome available afterwards, encourages exactly the market timing a policy exists to prevent.
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.