Explore the Zero Sum Game of FX Gains & Losses Hedging foreign exchange risk can be viewed as a zero sum game, meaning that when one side of the hedge gains the other side loses. The degree by which those gains and losses do or do not perfectly offset depends on the derivative instrument, hedge coverage level, and strategy used. The FX hedge game isn't about winning or losing, it's about making the outcome more certain. Balance sheet hedging is the most common practice among multinational corporations, and the goal is often to reduce foreign exchange gains and losses on the income statement to zero. The most effective way to largely achieve this goal is to hedge using a forward contract, which has a symmetrical payoff profile relative to the spot exchange rate, and to hedge 100% of the underlying exposure. However, even under this perfect scenario, there will still be residual FX gains and losses reported in earnings. When companies hedge near 100% of their balance sheet exposures using forward contracts, controllers and treasurers often wonder why they are never able to achieve that zero sum outcome entirely. This is due to the forward point component of the forward rate on the derivative contract, and the fact that forward contracts are revalued based on forward rates compared to the underlying spot exposure, which is revalued based on spot exchange rates. As a result, there will almost always be a difference in the "mark-to-market" accounting of a forward contract hedge and an underlying spot exposure. The only time this would not be the case is if interest rates were exactly equal for the countries or regions associated with the two currencies in the pair, which is highly uncommon. This is a typical area of frustration global corporations struggle with, and it highlights that understanding the accounting for underlying exposures and derivatives can clarify why there is a residual impact in earnings. Furthermore, it helps set realistic expectations as to what can be achieved when trying to play the zero sum game of FX hedging. FX Initiative's Currency Risk Management Training covers balance sheet hedging in detail using Apple as an example to show how multinational corporations can hedge common exposures such as receivables and payables with forward contracts to mitigate foreign exchange gains and losses on the income statement. Our focus is on both the cash flow and financial reporting aspects of the hedge strategy, and we reinforce our teaching with visual displays of the economic and accounting ramifications. If you are interested in learning how to hedge FX balance sheet exposures, forecasted transactions, and net investments in foreign subsidiaries, start your training today and explore our real world examples of all three scenarios. Furthermore, you can use our FX Transaction Simulator and Foreign Subsidiary Consolidator to customize your own risk model using company specific variables that reflect your actual exposures. Our video based curriculum puts academic theory into practice, and can help you and your team deliver more effective bottom line results in a time efficient manner. Take the FX Initiative for your organization by subscribing here. Click here to subscribe > Cheers, The FX Initiative Team support@fxinitiative.com August 27, 2018By FX Initiative FX Transaction Simulator, Hedging FX Transactions Accounting, Apple, Balance Sheet, Best Practice, Continuing Professional Education, Controller, CPE, Credit, CUrrency, Derivatives, Earnings, Economics, Forward Contract, FX, Gains, Hedge, Income Statement, Losses, Management, Risk, Traning, Treasurer, Zero Sum Game, Foreign Exchange 0 0 Comment
Check Your FX Knowledge: Take Our Pre-Test Evaluation Are you a foreign exchange expert? Take the FX pre-test evaluation to see how you perform using our scoring brackets! 100% Excellent Job! Ready to earn your certification? 90% Good Start! Complete your FX Risk Management Training! 80% About Average. Let’s close your FX knowledge gaps! <70% Room for Improvement! It’s time to take the FX Initiative! Whether you’re an experienced professional or brand new to foreign exchange, FX Initiative’s Currency Risk Management Training helps you learn currency risk management best practices using a video based on-demand format with real-world examples. Complete your FX training today in 4 simple steps: Select Your FX Risk Management Training Program Complete Your FX Risk Management Training Education Track Your FX Risk Management Training Progress Download Your Certificate of Completion Ready to take the FX Initiative? Click here to get started! Cheers, The FX Initiative Team support@fxinitiative.com June 26, 2017By FX Initiative General Collars, Continuing Professional Education, CPE, Currency, Economics, Evaluation, Financial Reporting, Forwards, Hedging, Options, Policy, Qualitative, Quantitative, Risk Management, Spot, Strategy, Trading, Treasury, Derivatives, FX, Pre-Test 0 0 Comment