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2024 is set to be another turbulent year for the global economy. More than 2 billion of the world’s population are heading to the polls this year to vote in crucial elections, including for new leaders in the US, EU and here in the UK. This, added to the ongoing geopolitical instability and tense relations between major players, means it’s fair to say that the next 12 months will be difficult to predict.
However, even with an unpredictable future, there’s a strategy to help reduce or eliminate risk that’s often misunderstood: currency hedging.
What is currency hedging?
Currency hedging is a strategy used to reduce the risks associated with fluctuations in exchange rates. If your business deals with multiple currencies, it exposes you to the danger of exchange rates moving against your favour, which can create a lot of unpredictability and impact the overall value of your international transactions. Currency hedging acts as a shield, protecting your business and increasing stability in these dealings.
Many might have hesitations around hedging due to a reluctance to participate in or gamble on the market. In actual fact, without hedging, you open your business up to market movements. With hedging, you mitigate the risk of either an upswing or downswing in the economy by choosing a rate and give yourself room to plan and predict cash flow.
Understanding with an example – forward contracts
Most businesses today operate internationally in one form or another, either through their supply chain or with a cross-border customer base. This often means having to be able to receive and pay out in multiple currencies.
Without any hedging, when it comes to making those payments, you’re forced into paying whatever the current exchange rate is for the currencies you are dealing with. Rates could be more favourable in future than where they are currently, but they could also become less favourable to your market. Not only will this lose your business money, but it also makes forecasting much more difficult, as you can’t be certain how much you’ll have to pay for a future purchase.
With a forward contract, you are locking in the current exchange rate for a period of time, for example for a quarter of a year or even up to two years. That way you know exactly what your outgoings are in that currency and are protected from any future drops during that time.
The benefits and potential risks
While it’s a way to protect against negative downturns, it’s important to understand both the pros and the cons.
Hedging does mean a commitment to the rate you’ve booked, regardless of how It moves after the fact. However, many find the stability and certainty of something like a forward contract outweighs the possibility of a rate moving further in your favour. Without hedging, business open themselves up to more risk, which many can’t afford in the long run.
To effectively hedge, you need to have a solid understanding or seek consultancy on your business’ particular risk exposure and tolerance. You want to put in place a strategy that aligns with your business goals, while taking into account the wider market dynamics that could impact your investments and operations.
Navigating hedging
Financial instruments and hedging are a crucial element in any toolkit to protect against the unexpected. By understanding the basics of hedging and working with knowledgeable advisors, business leaders can manage their financial risks more effectively and protect their companies from unexpected losses.
Equals Money offers a personal service with expert consultancy to help you start. We also provide a briefing every day that you can subscribe to, as a digestible way to stay on top of the market trends.
Our team is on hand to evaluate your risk appetite and talk you through your options so you can focus on your business.
Equals Money can only offer forward contracts to facilitate payments for goods and services.