How to deal with FX Risk in practice?

For some 20 years ago, my job as a spot dealer was to buy and sell foreign currencies in spot. During that time, even mid-size companies, which had export business, actively hedged and hold their FX (=foreign exchange) exposures. Some companies even actively took FX position in emerging currencies like Russian rouble and Turkish lira. Our job was to give tight-as-possible buy-and-sell spot market price in moving market, which was nailed by customer. Today, that’s part of the job is done by robotics, but FX risk still remain.

FX transaction risk arises if your customer pays in different currency (like USD) than your bank account (like EUR) is. The greater the time between the payment date and invoicing date, the greater the risk because there is more time for the two exchange rates (EUR against USD) to fluctuate. Fluctuation can be positive or negative — the bigger the upside potential, the bigger the downside potential and the bigger the risk.

In practice, the realized FX gain or loss is the difference between the invoicing amount and payment amount. For example, you send an invoice of USD 10 000 to customer on August 4 at 1,1868 and you receive a payment of USD 10 000 on August 16 at 1,1711. In cash, you receive 8 539 eur and there’s FX gain 112 EUR in book-keeping.

In small amounts, this is non-sense, but when your business grow, this starts to make sense. In addition, bank’s spread, which is the difference between buying price and selling price, is not under your control when you receive FX payments in your nominal currency account.

Goof thumb of rule is, that if your incoming or outgoing FX cash is value of more than USD 100 000 per month, it’s good to open a currency account and start to collect incoming cash in there. In this case, you gather currency and sell those to the FX market.

Also you can do the same than larger companies and build a natural hedge: ask supplier to invoice you in FX currency. This is more cost efficient alternative than to make a FX deal with your bank, because you always loose a spread in deal.

FX hedges is something you should always think twice. If your FX receivables or payables are based on investment or loan, which has strict schedule, that’s OK. Otherwise, if time risk still remain, FX hedges can impact negatively (or positively) your cash, which is the most important funding source of your business.