The eurozone crisis has created a lot of volatility on the currency exchange markets, posing a serious and immediate risk to any British company that trades across markets.
Even on a good day, the currency markets can be choppy, but the persistent doubts about the future of the Eurozone mean they are now more volatile than ever.
Last week the Pound fell by 1.2% against the euro in a couple of days, and last November it rose by a breathtaking 2.6% in just one day. The eurozone is by far Britain’s biggest trading partner, but other key currencies have been infected by the volatility too.
In the current economic climate, margins are so tight for many companies that such sudden swings can be the difference between making a profit and barely breaking even on a sale.
In the most extreme cases, falling foul of exchange rate volatility can tip a struggling business over the edge.
Whatever you’re doing — importing or exporting, paying staff in a local currency or buying a new factory or plot of land overseas — you need to hedge your risk.
But too few companies properly account for the volatility of the currency markets — and fewer still make use of the various strategies that exist to hedge against risk. These include:
- Forward Contracts. With forward contracts, you buy a currency now with a small deposit – typically 10% - that enables you to lock into a specific rate. However, you only pay the remainder when you actually need the money. The fixed rate protects you against a sharp move against you when you eventually make the payment. Forward contracts can usually be fixed for up to two years.
- Limit Orders. This is where you set a target exchange rate, at which, if achieved in the markets, you will buy (or sell) your currency. Limit Orders are useful if you have upcoming payments but you are not restricted by tight deadlines and therefore have time to try and achieve a better exchange rate than available at the current time. This tool provides assurance to businesses that should the ultimate exchange rate be achieved, even if that occurs in the middle of the night, their trade will be triggered automatically.
- Stop Loss Orders. This is where you set a minimum exchange rate, which, if achieved in the markets, you will buy (or sell) your currency. Stop Loss Orders are often used where there is a high risk or concern of adverse movement in exchange rates, enabling clients to protect their bottom line and reduce the risk of exposure to such negative movements.
Stop Loss and Limit Orders are often run together, effectively ‘ring fencing’ the desired exchange rate. In this instance, the realised order will cancel the other automatically. This enables businesses to aim for a favourable exchange rate, while also ensuring that, should the markets run against them, they don’t lose out.
Earlier this year the government appointed an "Export Czar", Kelly Hoppen, to encourage more companies to export and expand overseas in our global economy. This is all very encouraging, but companies need to ensure that when they do expose themselves to overseas markets, they’re not exposing themselves to unnecessary currency risks.
Mark Deans is corporate clients dealing manager at the foreign exchange specialists Moneycorp