Comparisons of indicators such as profitability or realized gains/losses due to exchange rate movements, based on four simulated scenarios, ensure that the implemented strategy will be effective at the right time.
Is Your Currency Risk Management Strategy Sufficient in Case of Unforeseen Events?
L’incertitude politique et économique actuelle souligne à gros trait qu’il est essentiel pour les entreprises de mettre en œuvre une stratégie de gestion du risque et de pouvoir en évaluer l’efficacité régulièrement pour protéger leurs résultats. Ainsi, la currency risk management est devenue essentielle à la viabilité des entreprises.
Foreign Exchange Market Forecasts
Currency movements are impossible to predict. While financial institutions and specialized organizations periodically publish exchange rate forecasts, significant discrepancies often arise when comparing these predictions to actual market movements.
For companies exposed to currency risk, basing business decisions on these forecasts is not advisable. Exchange rate fluctuations, especially unexpected volatility, can significantly erode profit margins.
A sudden appreciation of the Canadian dollar, for example, may present an excellent opportunity for importing companies, as it reduces foreign currency costs. However, for businesses generating revenue in foreign currencies, this poses a significant challenge, as their earnings in Canadian dollars will decline.
This is why it is essential to develop and implement the right currency risk management strategy and to regularly monitor its effectiveness when conducting international trade. Forecasts can complement an effective currency risk management strategy but should never replace it.
For an Effective Currency Risk Management Strategy, Focus on Margins—Not Market Predictions
As the year begins, are you confident that your current currency risk management strategy will be sufficient if market conditions turn out worse than expected? In the foreign exchange market, drastic changes can occur suddenly.
Comparing key indicators such as profitability or realized gains/losses due to currency movements across four simulated scenarios ensures that your strategy will be effective when needed.
Let's consider an example.
Your company plans to sell USD 767,813 per month in the U.S. Your business cycle is three months, and your budgeted exchange rate is 1.3024 USDCAD. Your target monthly profitability is CAD 190,000.
Currency Risk Management based on your budget [1] , you have determined your target profitability and that, without hedging, a threshold rate of 1.2398 USDCAD—derived from historical volatility—would result in a 25% loss in profitability. Are you comfortable with this first scenario? In a more extreme scenario, a rate of 1.1786 USDCAD would reduce profitability by 50%.
You have implemented your hedging strategy to mitigate this risk by half, using forward contracts to achieve a 50% hedge ratio. These scenarios are summarized in the table below.
Scenario Rate 1 corresponds to the base scenario—the adverse market movement against which you hedge within a predefined tolerance [2] Scenario Rate 2 represents the divergence scenario—your worst-case scenario.
The role of the hedge ratio [3] is to reduce the impact on your margins in case the 1.2398 USDCAD threshold is reached in the market. At the start of your hedging strategy, you are comfortable knowing that if the exchange rate moves six cents against your budget rate (from 1.3024 to 1.2398), you will still achieve 87% of your expected profitability. If the adverse movement extends beyond twelve cents (from 1.3024 to 1.1786), you will still retain 75%.
However, depending on rate fluctuations, your comfort level with these two scenarios may change. For instance, if in a few months the spot rate moves to 1.25 USDCAD, would you still feel as comfortable?
However, depending on rate fluctuations, your comfort level with these two scenarios may change. For instance, if in a few months the spot rate moves to 1.25 USDCAD, would you still feel as comfortable?
Are you still comfortable with the distance between the spot rate and your threshold rates based on your hedge ratio? Should you increase your hedge ratio to further mitigate the impact on your margins before your profitability drops to 75% of your target?
Regular and simple tracking of spot rates versus your threshold rates can save time and money by maintaining the effectiveness of your strategy. On the other hand, long intervals between reviews may reduce the effectiveness of adjustments needed to rebalance risk exposure and risk tolerance.
D-Risk FX simplifies the development of your currency risk management strategy by integrating it into your budgeting process and making real-time tracking accessible. By linking margin realization to exchange rates from the budget planning stage, D-Risk FX enables businesses to take timely action to protect profits and limit losses, ensuring financial objectives are met.
[1] See the article: Currency Risk for SMEs: How to Assess Hidden Risks in Your Budget [2] For more on tolerance levels, see: Currency Hedging Strategy: Is a 70% Hedge Too High or Too Low? [3] See the article Currency Hedging Strategy: Choosing the Right Hedge Ratio
For additional insights on currency risk management, refer to: Currency Risk Management: 5 Tips for Improvement and Bank of Canada – Currency Risk Management.
International Markets: A World of Opportunities
Growing your business abroad can drive growth — but it also comes with risks for SMEs. Tracking the ongoing impact of exchange rates on forecasted performance is complex.
D-Risk FX provides SMEs with performance, risk, and scenario analyses by market, currency, and business line—leading to a tailored hedging strategy and real-time visibility on projected financial performance.
Gain autonomy, automate your processes, and approach foreign markets with the confidence of a clear currency risk strategy and the tracking tools to support your ambitions.