Identify the 5 Stages of the FX Trade Lifecycle

Foreign exchange trading is a critical element of currency risk management, and understanding the trade lifecycle can help organizations plan their hedging activities more efficiently and effectively. The foreign exchange trade lifecycle, as discussed in the FX Risk Management course, can be enhanced with automated resources and typically includes the following 5 stages:

1. The first stage involves identifying and evaluating exposures. To aid in the exposure identification and evaluation process, best practices relate to investment in quality automated resources such as an enterprise resource planning (ERP) system or treasury software application that can be set up to extract data across the enterprise to identify and evaluate foreign exchange exposures rather than manual analysis, which can be time consuming and limited in scope.
2. The second stage involves collecting and quantifying exposure details. These tasks can be automated through software modules such as a netting system for matching foreign currency inflows and outflows or a cash flow forecasting module for determining future exposures based on historical trends in comparison to manual collection and quantification processes through spreadsheets, which can be vulnerable to human errors and oversight.
3. The third stage involves developing and analyzing hedging strategies. This analysis process can be streamlined and structured with automated software that performs value at risk analyses and simulates hedge strategies such that scenarios can be modeled prior to trading in order to save significant time and costs down the road, whereas performing this analysis manually can limit the ability to compare economic and accounting strategies in a comparable format and in a time efficient manner.
4. The fourth stage involves the administration and execution of hedge strategies. This is increasingly facilitated through the integration of electronic trading platforms, where multi-provider execution platforms can be integrated for optimal rate bidding across numerous FX service providers in real time, coupled with automated straight though processing of trades with back office systems to handle transaction reporting, confirmation matching, and payments between counterparties rather than manually performing these critical tasks.
5. The fifth and final stage of the foreign exchange trade lifecycle is financial & managerial reporting. This communication and recordkeeping can be automated through the integration of accounting systems to enable seamless financial reporting for both internal and external audiences rather than manual reporting and compliance processes.

Overall, the 5 stages of the foreign exchange trade lifecycle include (1) identifying and evaluating exposures, (2) collecting and quantifying exposure details, (3) developing and analyzing hedging strategies, (4) administering and executing hedging strategies, and (5) financial accounting & managerial reporting. Each of these stages is essential when implementing foreign exchange trading best practices, and understanding the lifecylce can help organizations plan their hedging activities more efficiently and effectively.

To learn more about foreign exchange best practices and to observe how world class organizations such as Apple employ each stage of the FX trade lifecycle, sign up for FX Initiative’s currency risk management training. Our educational videos, interactive examples and webinar events can help you and your team better mitigate FX risk and deliver measurable results to the bottom line, so get started today by taking the FX Initiative!

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How to Forecast Foreign Exchange Rates

Forecasting foreign exchange rates is a challenging but necessary aspect of currency risk management. There is no single prescribed method for FX forecasting, and it is a difficult task particularly for those who are not engaged in the market on a daily basis. FX forecasting has a relatively low predictive power as uncertainty always remains a factor, but nonetheless each market participant is responsible for developing an educated guess about what direction exchange rates will move in the short, medium, and long term. The following two techniques are used most commonly to generate an FX forecast.

1. Technical Analysis – Technical analysis uses historical market data to predict shorter and longer-term future exchange rate movements, whereby past prices and volume helps serve as a guide for the future.
2. Fundamental Analysis – Fundamental analysis uses current economic indicators to predict future exchange rates, and considers factors such as interest rates, earnings, employment, GDP, housing, and manufacturing among other areas to assess the present state of the economy and help guide the future.

Many market participants use a combination of both technical and fundamental analysis to develop a forecast. Applying these techniques using the euro as an example, a forecaster could use technical analysis by looking at the historical data provided by the Federal Reserve for the Euro/US dollar exchange rate since the introduction of the euro in 1999 to the present day. The forecaster can then observe the range of values, and identify that the high was 1.5759 in July of 2008 and the low was 0.8525 in October of 2000. Given the current euro exchange rate of 1.1800, the forecaster can conclude that the present valuation is towards the lower end of the trading range between 0.8525 and 1.5759 and perhaps is undervalued.

Building upon that premise, a forecaster can then use fundamental analysis to assess the current state of the economy in the Eurozone where the euro is used. If the forecaster anticipates a slowdown in economic growth, sluggish earnings, weaker employment, a decline in housing, manufacturing, and GDP, and a low interest rate environment, then there might be more room for the euro to depreciate. Conversely, if the forecaster expected strong growth in economic activity, healthy earnings, rising employment, positive trends in housing, manufacturing, and GDP, and a corresponding rise in interest rates, then perhaps the euro will appreciate in value.

All forecasts need to be scaled to a specific time frame, and each market participant must use their best judgment to assess how supply and demand factors will impact foreign exchange rates. There are various views and perspectives among market participants that can differ for good and substantive reasons, and the interpretation of how supply and demand factors determine exchange rates and the generation of a FX forecast is more of an art than a science. A sound foreign exchange market forecast can be challenging to develop in house, so some organizations rely on the consensus forecast among experts or research and insight shared by their banking partners or financial institution to help guide them.

To learn more about forecasting foreign exchange rates, sign up for FX Initiative’s currency risk management training for complete access to our educational videos, interactive examples, and live webinar events. We walk you through real-world scenarios and simulated strategies from leading global organization such as Apple to illustrate key learning concepts in a practical and easy to understand format. Foreign exchange is a key component of international business, and FX Initiative can help you mitigate risk and maximize opportunity abroad.

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How to Compare Currency Derivatives & Credit Considerations

Foreign exchange risk management involves the use of currency derivatives, which are financial contracts between two parties whose value is derived from the exchange rate of one or more underlying currencies. In order to use currency derivatives to achieve foreign exchange risk management objectives, companies must be able to deal or trade with a credit worthy counterparty such as a bank or financial institution.

Counterparty credit risk is the risk that the counterparty to a contract does not perform, and is involved in any banking activity, including trading currency derivatives. Therefore, both parties in the transaction need to consider the financial condition of their counterparty by quantifying their creditworthiness. It can be helpful to compare key credit considerations between the three most common currency derivatives, which include forward contracts, vanilla options, and zero cost collars.

Forward contracts involve the exchange of two currencies at an agreed upon rate on the date of the contract for settlement on a date more than two business days in the future. A forward contract will almost always finish in either an asset or liability position at maturity depending on the ending spot rate. From a credit perspective, forward contracts usually do not require an upfront exchange of funds, but almost always requires a payment at maturity to settle the asset or liability position of the contract.

Option contracts are financial contracts that give the buyer the right, not the obligation, to buy or sell a quantity of a particular currency at a specific exchange rate, called the strike rate, on or before a pre-arranged date. A purchased option begins its life as an asset in the amount of the option premium paid to the counterparty at inception, and will expire with either a positive value or zero fair value. In other words, options require an upfront payment, but do not require the option holder to make a payment at maturity.

A zero cost collar is a combination of two vanilla options, whereby the premium paid on the purchased option is offset by the premium received from the sold option to create a zero cash outlay. This structure enables the holder to buy or sell a quantity of a particular currency within a specified range of exchange rates between the two option strikes on or before a pre-arranged date. In turn, collars do not require an upfront exchange of funds, but may require payment at maturity if the structure finishes in an asset or liability position.

The two key credit variables to consider are (1) the upfront exchanges of funds and (2) the obligation to make a payment at maturity. Since a forward contract is a firm obligation for a future settlement to be made with no upfront exchange of funds, this derivative has a higher credit risk than a purchased option where upfront premium is paid and there is no obligation for the option holder to make a payment at maturity. Similarly, since a collar may require a payment at maturity to settle the contract, collars are more credit intensive than vanilla options.

Conterparty credit risk became a prominent headline during the financial crisis of 2007–2008, and remains an important factor to consider as credit limits may prohibit a firm or entity from entering into a derivative transaction, particularly in a tight credit economy. When credit constraints inhibit business decisions, firms may need to consider alternative means to transact such as posting collateral. When trading FX derivatives, the acronym KYC, which traditionally stands for Know Your Customer, can be modified to Know Your Counterparty.

If you are interested in learning more about foreign exchange derivatives, credit considerations, and how to hedge using financial instruments, sign up for FX Initiative’s Currency Risk Management Training today. Our educational videos, interactive examples, and webinar events use real world companies such as Apple, Inc. to illustrate aspects of their world class foreign exchange risk management policies and procedures. Mitigating currency risk is a top priority for global businesses, and you can benefit your firm’s bottom line by taking the FX Initiative!

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How to Implement Internal Controls for FX Risk Management

Internal control (IC) involves everything that controls risks to an organization. IC relates to operational effectiveness and efficiency, reliable financial reporting, and compliance with laws, regulations and policies. When it comes to hedging foreign exchange risk and Sarbanes-Oxley (SOX), management should be able to understand, assess, and conclude on the adequacy of internal controls over financial reporting as it relates to currency risk management.

In general, a minimum of three personnel are required for sufficient internal controls since the trading, accounting, and confirmation duties should be segregated. For example, the Chief Financial Officer (CFO) could be responsible for confirmation and authorization, the controller could be responsible for accounting and record keeping, the treasurer could be responsible for trading and custody. Furthermore, the Board of Directors could be responsible for oversight and approval, and in the event that an exception to the Policy is warranted, the CFO could be responsible for approving any exceptions.

While specific internal controls will need to be tailored to the specific needs of an organization, some key questions that should be addressed include:

1. Who has the authority to execute trades?
2. How will trades be executed and what process should be followed?
3. How and when are trades confirmed and compared?
4. Are the trading, accounting, and confirmation duties segregated sufficiently?
5. Who has the authority to authorize policy exceptions, and trade ticket or accounting discrepancies?

It is critical to include internal controls as an essential component of an effective Foreign Exchange Risk Management Policy because it outlines in detail the specific processes to be followed. The Internal Controls section of a Policy should address the key questions above by stating internal controls have been set forth to segregate the trading, accounting, and confirmation processes. Continuing the example using the CFO, controller, and treasurer, internal controls could apply to the following FX Risk Management related tasks:

• The Treasurer will be responsible for recommending hedging strategies, and the Controller and Chief Financial Officer will be responsible for approving the proposed strategies prior to trade execution.
• The Treasurer will be responsible for selecting counterparty foreign exchange service providers in accordance with 'Counterparty Guidelines', and the Controller is responsible for approving the selected counterparty prior to trade execution.
• The Treasurer is responsible for executing approved hedging strategies and subsequently recording the transaction in the appropriate general ledger account within 24 hours. The Controller is responsible for confirming that the financial reporting surrounding trade execution matches the trade confirmation received by the counterparty service provider within 72 hours. If a trade confirmation is not received within 72 hours, the Controller is responsible for obtaining the confirmation directly from the counterparty service provider, mediating any disputes between the Treasurer and the counterparty service provider, and alerting the Chief Financial Officer of any pertinent issues.
• The Treasurer will prepare a cash reconciliation at each month end related to all underlying positions and derivative transactions, both inflows and outflows, that occurred throughout the period. The Controller will cross check the cash reconciliation with all trade confirmations to ensure cash balances reflected on the accounting records match the economics of the underlying positions and derivative transactions settled throughout the period.

These are just some of the many ways organizations engaged in foreign exchange risk management should be considering internal controls as part of their currency hedging program and formal Policy. Keep in mind that policies and procedures are never perfect, and should be viewed as a process that is responsive to change and capable of continuous enhancement. By starting sooner rather than later, practice, experience, and results will contribute better information to the internal control process allowing for changes to be made to the foreign exchange risk management program in the future.

If you are interested in learning how internal controls are integrated into a foreign exchange risk management policy, FX Initiative's currency risk management training has a course on FX Risk Management that walks you through a real-world scenario using the Foreign Exchange Risk Policy Drafter to illustrate step-by-step the process of segregation of duties and how it relates to personnel and reporting. World class organizations know that proactive prevention is the best approach to long-term compliance and sustainability, so take the FX Initiative and improve your internal control process by subscribing today!

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Discover the Details of FX Hedge Documentation

When accounting for FX derivatives, firms have a choice between the “default” and “elective” accounting treatment. Elective accounting treatment is not required and involves extra preparation and utilization of resources, but for forecasted transactions and hedges of net investments in foreign operations, the benefits can outweigh the costs particularly for publicly traded firms most concerned with mitigating periodic earnings volatility.

The “elective” accounting treatment permits special accounting for items designated as being hedged and offers 2 main financial reporting benefits; Timing & Geography: (1) timing refers to reducing periodic earnings volatility by deferring derivative mark-to-market gains and losses in equity and (2) geography refers to accounting for the derivative gain or loss in the same geographic area of the financial statements as the hedged exposure.

It is important to emphasize that elective hedge accounting never changes the economics of a hedge, only the financial reporting. The choice of whether or not to use “elective” accounting treatment will depend on the foreign exchange risk management objectives of each organization, and part of the strategic decision making process involves determining if the financial reporting benefits outweigh the administrative and compliance costs.

To satisfy the requirement for elective accounting treatment, companies must prepare formal contemporaneous hedge documentation at the inception of the hedge. The hedge documentation outlines the hedging relationship, and the entity's risk management objective and strategy for undertaking the hedge, including identification of following 5 components:

1. The hedging instrument
2. The hedged item or transaction
3. The nature of the risk being hedged
4. The method that will be used to retrospectively and prospectively assess the hedging instrument's effectiveness
5. The method that will be used to measure ineffectiveness

Effectiveness is an assessment of the degree by which the derivative offsets the hedged transactions changes in cash flows that are attributable to foreign exchange risk. While hedge documentation and effectiveness testing can range significantly in detail and complexity, two simplified examples of hedge documentation are addressed in FX Initiative’s currency risk management training.

Our Hedging FX Transactions and Hedging Foreign Subsidiaries courses walk you through real world scenarios using Apple, Inc. as an example, and show you the required documentation as well as the timing and geography benefits using our FX Transaction Simulator and Foreign Subsidiary Consolidator. Hedging documentation can be daunting, but our training makes preparation practical so you can achieve for your foreign exchange risk management goals.

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Learn Best Practice Accounting for FX Derivatives

Foreign exchange accounting is a complex area of financial reporting that many global organizations struggle with. Adding to that complexity, companies engaged in foreign exchange risk management must also learn how to account for currency derivatives. While the specific accounting rules differ between generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS), the fundamental concepts are essential to understand when implementing foreign exchange risk management best practices for your international business.

Companies that hedge foreign exchange risk often have two main objectives: (1) To minimize the Income Statement impact of fluctuating foreign exchange rates, and (2) to reduce the variability in functional currency equivalent cash flows resulting from foreign currency transactions. In order to achieve the objective of minimizing the Income Statement impact of fluctuating foreign exchange rates, it is important to first consider the accounting treatment for the underlying position, and then to align the accounting treatment for the FX derivative accordingly.

At the highest level, companies can account for FX derivatives using “default” accounting treatment or “elective” accounting treatment. The “default accounting treatment requires that derivative gains and losses should be recorded in earnings on a current basis based on changes in their fair market value. The “elective” accounting treatment permits special accounting that results in changes in the fair value of the derivative to be recorded in the equity section of the balance sheet (rather than earnings) as part of other comprehensive income and then reclassified from the balance sheet to the income statement in the period or periods in which the underlying hedged item impacts consolidated earnings.

While the rules of elective accounting treatment can get quite complex, the key take away is that elective accounting treatment provides financial reporting benefits when hedging underlying exposures that do not impact the income statement on a current basis, such as forecasted transactions. Therefore, firms have a choice between the “default” and “elective” accounting treatment. FX Initiative’s currency risk management training addresses several variables to consider when choosing the most appropriate course of action for FX derivative accounting.

If you are interested in learning more about accounting for FX derivatives, FX Initiative’s currency risk management training walks you through real-world scenarios using Apple as an example. Specifically, we cover hedging forecasted revenue transactions, booked receivable transactions, and net investments in foreign subsidiaries using both elective and default accounting treatment. Learning how to account for FX derivatives is critical in order to achieve your foreign exchange risk management objectives. Start learning today by taking the FX Initiative!

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Download the PDF Brochure to learn about FX Initiative!

Are you curious how FX Initiative can help you with currency risk management? Download the PDF brochure and learn why Fortune 500 companies, small and medium sized enterprises (SME), and sales teams of financial institutions trust FX Initiative to learn foreign exchange best practices.

For over a decade, we’ve been training Fortune 500 companies, global businesses, treasury professionals, and FX sales teams on foreign exchange risk management best practices. While all client’s had different objectives and challenges, all benefited from the unparalleled foreign exchange (FX) and continuing professional education (CPE) resources FX Initiative’s currency risk management training provides created by industry expert & trainer Evan Mahoney, CPA. Whether you’re new to foreign exchange or a seasoned professional, your questions will be answered, your challenges will be addressed, and you will leave with an actionable plan for managing currency risk.

Download the PDF Brochure

Self-Study currency risk management training with Evan Mahoney is the gold standard for meeting your organization’s professional development needs. Live webinar sessions that are fully customized can be added to enhance your learning experience and address and solve company specific challenges. Evan has a passion for teaching that shines through in his recorded presentations and live events alike. Evan’s training is so effective that over 90% of trainees went from scoring less than <70% on the Pre-Training Evaluation to earning a perfect 100% score post-training. Not only does this show the growth in knowledge each student experiences, but it leaves a lasting foundation of information to access daily. Our best source of new clients comes from satisfied customers that have benefited directly from our Currency Risk Management Training. You can take full advantage by combining self-study training and customized live webinars to ensure your organization has the resources needed to optimize and mitigate FX risk. Our training is accessible globally and available around the clock to meet your needs.

Evan Mahoney has over a decade of foreign exchange experience, and has helped hundreds of companies identify, assess, and mitigate foreign exchange risk. Evan’s strong finance and accounting background offers a unique skill set for solving technical strategy, policy, and financial reporting challenges in a manner that allows clients to understand and address their currency risk management issues at hand. Evan is an experienced practitioner and established thought leader available to service your organizations’ ongoing currency risk management training and professional development needs. Want to discuss Currency Risk Management Training with Evan Mahoney? Call 312-566-7475 or email evan.mahoney@fxinitiative.com today!

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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!

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:

1. Select Your FX Risk Management Training Program
2. Complete Your FX Risk Management Training Education
3. Track Your FX Risk Management Training Progress
4. Download Your Certificate of Completion

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The Art & Science of FX Risk Management

FX risk management can be viewed as both an art and science. This means that the results of currency risk management practices can be measured quantitively like a science, but determining what constitutes good or bad results requires qualitative analysis like an art. There is no single prescription for managing foreign exchange risk, and each organization must decide their risk management objectives, as well as the best approach towards achieving those objectives.

An excellent example of this concept is a Foreign Exchange (FX) Risk Management Policy. A formal written FX Risk Management Policy lays out a plan with clear parameters and guidelines for managing foreign exchange risk across the enterprise. However, the specific strategies for hedging specific exposures often requires subjective day-to-day judgment that falls outside the scope of the master Policy. As a result, treasury staff of multinational corporations typically know what they are trying to achieve, but struggle with how to achieve it.

FX Initiative's Currency Risk Management Training addresses both the quantitive science and qualitative art of FX risk management. From drafting a formal Policy using our FX Risk Policy Drafter to modeling real world scenarios using our FX Transaction Simulator, our training walks you through common approaches to goal setting and then shows you how to achieve those goals using derivative insturments. The ideas that are discussed will help you see how a world-class organization such as Apple is able to set high level objectives as evidenced in their 10-K, and then accomplish those objectives using the judgement of their highly trained personnel.

If you are interested in learning the benefits of training your personnel on both the high level objective goal setting and day-to-day subjective decision making involved in foreign exchange risk management, sign up and take the FX Initiative today. You can use our FX Risk Policy Drafter to create a formal written policy, and then leverage our FX Transaction Simulator to customize specific variables that reflect your actual exposures to determine if you are able to achieve the FX hedging objectives you desire. Our video based curriculum puts academic theory into practice, and can help you and your team excel at both the art and science of managing foreign exchange risk. Take the FX Initiative for your organization by subscribing here.

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Focus First on FX Fundamentals

Foreign exchange risk management is referred to as a topic that’s “an inch wide and a mile deep.” This phrase means that one can easily cover the surface of the topic, but once you delve deeper there is a plethora of nuances and subtleties multinational corporations need to know to succeed.

The concept of “meta-learning” relates to an awareness and understanding of “how” you are learning not just “what” you are learning. In order for companies to solve more complex FX risk management issues, it is essential to look at “how” you are learning the fundamentals of FX risk management first.

For example, many companies struggle with accounting for currency derivatives. However, before a firm can truly grasp derivative accounting, it is essential to first build a foundation of knowledge on how to account for underlying foreign exchange exposures. Taking a step back can lead to a leap forward.

FX Initiative’s Currency Risk Management Training provides an incremental approach on both “how” and “what” to learn as it relates to foreign exchange exchange risk management. Whether you are brand new to FX or have prior experience, the training program can start where you currently are.

Our series of 6 training modules begins by focusing on the fundamentals of the Foreign Exchange Market and concludes with more advanced topics on Hedging FX Transactions & Foreign Subsidiaries. In between, we cover FX Risk Exposures, Risk Management, and Spot & Derivatives. This framework is designed to help the learner jump right into the curriculum at any point to elicit the most critical knowledge for their personal development. The key is that the learner has an awareness of where they are on the learning curve, and that is where the "how" of meta-learning comes into the equation.

FX Initiative's currency risk management training includes the following 6 video modules:

1. Foreign Exchange (FX) Market Overview
2. FX Risk Exposures
3. FX Risk Management
4. FX Spot & Derivatives
5. Hedging FX Transactions
6. Hedging Foreign Subsidiaries

You can watch the free introductions for each program to get an idea of the learning objectives covered, and then begin with the video you want to learn more about. For example, if you already know how to read currency quotations in the newspaper and how supply and demand impacts FX forecasting, then you may be ready to start learning where to look for FX Risk Exposures or how to create a FX Risk Management Policy. Investing the time up-front in learning foreign exchange fundamentals can help you solve more complex issues later on.

If you are ready to enahce your learning experience, become a FX Initiative subscriber today and access our complete suite of foreign exchange (FX) continuing professional education (CPE), examples and events at FXCPE.com. Managing FX risk has become a higher priority for many firms recently, and it is now easier than ever to learn the fundamentals of currency risk management. Take the FX Initiative for your international business today!

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