Ensure you don't lose money when exchange rates vary or interest rates on your loans rise. If your company buys and sells products internationally, it is likely to be impacted to a degree by foreign exchange rates. Indeed, you will have to buy foreign currencies to pay for products and services bought abroad, and you will likely be paid in a foreign currency for the products and services your company sells in another country, which you will have to change back to your local currency.
This is done at the current exchange rate between the two countries, repeated for every transaction, and replicated for each country with which you conduct business in a different currency to yours. There is therefore a risk that the exchange rate or rates will change between the time you agree on an amount and the time payment is actually made, in a way that impacts your accounts negatively.
Say, for example, that you are a Qatar-based company and you sell a product to a client in the UK for GBP 10,000. At the time of invoicing, this may amount to QAR 61,400. If the rate changes before you receive the payment, when you exchange those pounds for riyals you may end up with only QAR 55,000.
The opposite can also happen between the time when you receive an invoice from a supplier abroad and the time you pay them, forcing you to pay more money than you had budgeted. Repeated several times over the course of a year, it might cause your firm to lose a significant amount of money. Hedging is a way to minimize or eliminate those types of risk.
"If your company trades in several markets where you have no significant operations or staff," explains Mark Hobson, Financial Director at Advent Software EMEA, "that is when you need to hedge against volatility in those markets' currencies versus your own. "
"If you have some assets in those markets, then you benefit from some natural hedging. The treasury manager will assess your total exposure and how much is naturally hedged, how volatile the currencies are, and what the duration of the exposure is likely to be. They will look at the different hedging options available, like buying currencies on deposit or, if necessary for a long-term exposure, buying assets locally. Their role is then to make the best decision to protect the business from foreign exchange volatility."
INTEREST-BASED PRODUCTS
Meanwhile, variations in interest rates present a similar kind of danger on interest-based products such as loans or bonds. If interest rates go up and you are paying off a variable-rate loan, it can drive your costs up significantly, while if you have invested spare cash and interest rates go down, you may get less from your investment than you had counted on.
"Some loans track to central bank rates, so the interest may present volatility," specifies Hobson. "Depending on your exposure and on the stability of central bank rates, you may want to hedge against that, to ensure you can continue to meet your obligations."
If you want to hedge either your loans or your investments against interest rate risk, there are a number of products to choose from, such as futures, swaps or options. As they are all relatively complex tools, you or your treasury manager should discuss with your bank to determine the best course of action to cover your specific type of exposure to interest rate risk.
Of course, hedging foreign exchange or interest rate risks always comes at a price. There is a cost to setting up a hedge and, if you do decide to hedge your risks, it also means you won't make an extra profit if the movement in the exchange or interest rate turns out to be favorable. However, if you have a high exposure to either or both risks, one that is putting your company in danger of losing important sums, it is probably a price worth paying.
© Zawya BusinessPulse QATAR 2014
This is done at the current exchange rate between the two countries, repeated for every transaction, and replicated for each country with which you conduct business in a different currency to yours. There is therefore a risk that the exchange rate or rates will change between the time you agree on an amount and the time payment is actually made, in a way that impacts your accounts negatively.
Say, for example, that you are a Qatar-based company and you sell a product to a client in the UK for GBP 10,000. At the time of invoicing, this may amount to QAR 61,400. If the rate changes before you receive the payment, when you exchange those pounds for riyals you may end up with only QAR 55,000.
The opposite can also happen between the time when you receive an invoice from a supplier abroad and the time you pay them, forcing you to pay more money than you had budgeted. Repeated several times over the course of a year, it might cause your firm to lose a significant amount of money. Hedging is a way to minimize or eliminate those types of risk.
"If your company trades in several markets where you have no significant operations or staff," explains Mark Hobson, Financial Director at Advent Software EMEA, "that is when you need to hedge against volatility in those markets' currencies versus your own. "
"If you have some assets in those markets, then you benefit from some natural hedging. The treasury manager will assess your total exposure and how much is naturally hedged, how volatile the currencies are, and what the duration of the exposure is likely to be. They will look at the different hedging options available, like buying currencies on deposit or, if necessary for a long-term exposure, buying assets locally. Their role is then to make the best decision to protect the business from foreign exchange volatility."
INTEREST-BASED PRODUCTS
Meanwhile, variations in interest rates present a similar kind of danger on interest-based products such as loans or bonds. If interest rates go up and you are paying off a variable-rate loan, it can drive your costs up significantly, while if you have invested spare cash and interest rates go down, you may get less from your investment than you had counted on.
"Some loans track to central bank rates, so the interest may present volatility," specifies Hobson. "Depending on your exposure and on the stability of central bank rates, you may want to hedge against that, to ensure you can continue to meet your obligations."
If you want to hedge either your loans or your investments against interest rate risk, there are a number of products to choose from, such as futures, swaps or options. As they are all relatively complex tools, you or your treasury manager should discuss with your bank to determine the best course of action to cover your specific type of exposure to interest rate risk.
Of course, hedging foreign exchange or interest rate risks always comes at a price. There is a cost to setting up a hedge and, if you do decide to hedge your risks, it also means you won't make an extra profit if the movement in the exchange or interest rate turns out to be favorable. However, if you have a high exposure to either or both risks, one that is putting your company in danger of losing important sums, it is probably a price worth paying.
© Zawya BusinessPulse QATAR 2014
