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How to prevent the strong NZ dollar hurting you

Fluctuations in foreign exchange rates can have a significant impact on an exporter’s revenue, cash flow and profitability. But while currency risk cannot be eliminated, it can be effectively managed, as Tino Ho at NZForex explains.

Exporters are exposed to many more risks than companies that stick to their domestic markets. The additional risks range from complex documentation to tougher transport logistics, multiplying credit exposures and even political issues. Creating certainty and managing these risks is a constant challenge. The last thing an exporter needs is for an export sale to run smoothly but then to find it is no longer economically viable because of the fluctuation in the exchange rate.

There are several reasons to consider hedging which include smoothing the bumps (reducing P&L volatility and enable more accurate forecasting) as well as maintaining or improving your competitive position.

Effective hedging involves managing risk within known boundaries and is not just about creating certainty but also balancing actual cost with opportunity cost. There are two costs of hedging when using Forward Exchange Contracts and Vanilla Options, one is the opportunity cost that may be a profit forgone on a favourable currency movement (when using FECs), and the other cost is that of paying the interest differential on forward rates or the option premium. The decision to hedge or not to hedge may then come down to an assessment of exchange rate stability and the transaction costs of hedging.

One of the simplest hedging tools is a Forward Exchange Contract (FEC), simply fix the exchange rate for a date in the future. This is a totally fixed solution and with no ability to gain if the NZD moves in your favour. This removes the exchange rate risk and guarantees a profitable transaction.

Currency Options offer more flexibility, think of this tool as simply ‘insurance for you exchange rates’. You pay a premium to enjoy a known worst case rate and flexibility to buy NZD at prevailing spot rates should it move in your favour. Premiums are a function of volatility, term to maturity, forward points and strike rate.

It is the role of management to ensure the ongoing viability of a business and they should be addressing any risks that materially threaten profitability. Depending on the company’s attitude to risk, it may be a dereliction of duty not to hedge financial exposures where it is foreseeable that an adverse currency or price move may undermine profitability. Ultimately it comes down to how much risk the company’s owners want to bear. The important point is to get advice by speaking to your currency broker or specialist at your bank and then put in place a clear policy that is consistent with the company’s strategy, if greater certainty of cash flow is required then hedging can remove some of the major risks that an exporter faces.

NZForex is part of the OzForex Group, which since 1998 has grown to be one of the world’s largest online foreign exchange specialists. With dealing rooms in Sydney, London, and Toronto, NZForex provides international money transfer services to over 100,000 clients around the world.

For more information

Marcus Phillips
NZForex Business Development Manager
(09 410 4975)