15 January Find Out the 4 Ways Firms Manage FX Risk January 15, 2018By FX Initiative FX Risk Management, General Avoid, Best Practices, Booking, Continuing Professional Education, Management, Pricing, Reduce, Retain, Risk, Transfer, CPE, Foreign Exchange 0 Operationally, foreign exchange risk can be managed in four ways: (1) Avoided, (2) Transferred, (3) Retained and (4) Reduced. Each of these four methods can be applied individually or collectively, and there is no standard protocol on which approach to use when conducting international business. Therefore, companies can benefit from defining and exploring examples of how each approach works in practice as follows: First, avoiding foreign exchange risk refers to engaging only in domestic business opportunities where both parties to every transaction use the same functional currency. For example, a company based in the United States that uses the U.S. dollar (USD) as their functional currency would only conduct business with counterparties that also use the U.S. dollar as their functional currency. As a result, neither party to the transaction is exposed to foreign exchange risk, but this approach severly limits business opportunities internationally. Second, transferring foreign exchange risk refers to pricing transactions in the company’s functional currency rather than the customer’s local currency or through risk sharing agreements where a portion of the risk is shared. For example, a company based in the United Kingdom that sells to American consumers could price their goods and services in British pound sterling (GBP). In turn, the foreign exchange risk is transferred to the consumer, but this approach creates a barrier to closing sales in the United States since customers must first acquire GBP to make a purchase. Third, retaining foreign exchange risk refers to accepting the risk associated with foreign exchange transactions and bearing the potential volatility that accompanies market fluctuations. For example, a Canadian company that does business in the United States where transactions are denominated in U.S. dollars is exposed to exchange rate fluctuations. Consequently, the amount of Canadian dollars (CAD) required for the company to settle a transaction varies, which can create uncertainty and volatility in earnings and cash flows. Fourth, reducing foreign exchange risk refers to structuring deals strategically through deliberately denominating transactions in a particular currency and hedging the associated foreign exchange risk. For example, a Japanese company that sells automobiles to the United States that are denominated in U.S. dollars can enter into a currency derivative to hedge the U.S. dollar (USD) / Japanese yen (JPY) exchange rate. Accordingly, this approach ensures that the amount of JPY required to settle a future transaction is predictable and certain. Overall, world-class foreign exchange risk management involves a combination of risk retention and reduction. Risk retention involves controlling the risk and accepting the gain or loss, and risk reduction involves mitigating the risk to an acceptable level by understanding when and how to hedge using financial instruments. FX Initiative’s currency risk management training outlines best practices related to risk retention and risk reduction techniques, including easy to follow guidelines for pricing and booking transactions. Which approaches to managing foreign exchange risk does your global business employ? Our foreign exchange risk management training can help you optimize several important aspects of your program such as accounting booking rate conventions, exchange rate sources, and currency denomination parameters. Start the new quarter with an actionable plan for managing foreign exchange risk by taking the FX Initiative today! Ready to retain and reduce your FX risk exposures? Click here to get started! Cheers, The FX Initiative Team support@fxinitiative.com Related Posts Find Out 4 Ways Firms Manage FX Risk Do you want to find out how firms manage FX risk? FX Initiative’s FX Risk Management course will teach you how to retain and reduce FX risk when conducting business internationally. Get started with our foreign exchange risk management training, which provides 24/7 365 access to our complete suite of foreign exchange (FX) continuing professional education (CPE), examples and events at FXCPE.com. Start Training > Download the PDF FX Risk Management Maturity Model Foreign exchange (FX) risk management involves identifying, analyzing, and prioritizing various foreign currency exposures, and developing and implementing a coordinated and systematic plan that utilizes company resources efficiently and effectively to mitigate FX risk. The degree to which companies implement adequate foreign exchange risk management practices can vary substantially, from not managing the risk at all to engaging in robust hedging activities, and as a result, the impact on the bottom line can vary widely across organizations. This FX Risk Management Maturity Model outlines the 5 stages of a comprehensive currency risk management program. The process involves performing a FX risk assessment, developing a FX risk management policy, and implementing progressive FX hedging strategies. 5 Stage FX Risk Management Maturity Model FX Risk Assessment: Exposure Identification & Measurement FX Risk Management Policy: Hedging Guidelines & Procedures Balance Sheet Hedging: Booked Receivables & Payables Cash Flow Hedging: Forecasted Revenues & Expenses Net Investment Hedging: Subsidiary Earnings & Equity The design and implementation of a FX risk management program must take into account the specific goals and objectives of the firm, the organizational structure and operations, the line of products and/or services, ... FX Risk Management Maturity Model Foreign exchange (FX) risk management involves identifying, analyzing, and prioritizing various foreign currency exposures, and developing and implementing a coordinated and systematic plan that utilizes company resources efficiently and effectively to mitigate FX risk. The degree to which companies implement adequate foreign exchange risk management practices can vary substantially, from not managing the risk at all to engaging in robust hedging activities, and as a result, the impact on the bottom line can vary widely across organizations. This FX Risk Management Maturity Model outlines the 5 stages of a comprehensive currency risk management program. The process involves performing a FX risk assessment, developing a FX risk management policy, and implementing progressive FX hedging strategies. 5 Stage FX Risk Management Maturity Model FX Risk Assessment: Exposure Identification & Measurement FX Risk Management Policy: Hedging Guidelines & Procedures Balance Sheet Hedging: Booked Receivables & Payables Cash Flow Hedging: Forecasted Revenues & Expenses Net Investment Hedging: Subsidiary Earnings & Equity The design and implementation of a FX risk management program must take into account the specific goals and objectives of the firm, the organizational structure and operations, the line of products and/or services, ... FX Risk Management Maturity Model Foreign exchange (FX) risk management involves identifying, analyzing, and prioritizing various foreign currency exposures, and developing and implementing a coordinated and systematic plan that utilizes company resources efficiently and effectively to mitigate FX risk. The degree to which companies implement adequate foreign exchange risk management practices can vary substantially, from not managing the risk at all to engaging in robust hedging activities, and as a result, the impact on the bottom line can vary widely across organizations. This FX Risk Management Maturity Model outlines the 5 stages of a comprehensive currency risk management program. The process involves performing a FX risk assessment, developing a FX risk management policy, and implementing progressive FX hedging strategies. 5 Stage FX Risk Management Maturity Model FX Risk Assessment: Exposure Identification & Measurement FX Risk Management Policy: Hedging Guidelines & Procedures Balance Sheet Hedging: Booked Receivables & Payables Cash Flow Hedging: Forecasted Revenues & Expenses Net Investment Hedging: Subsidiary Earnings & Equity The design and implementation of a FX risk management program must take into account the specific goals and objectives of the firm, the organizational structure and operations, the line of products and/or services, ... FX Risk Management Maturity Model Foreign exchange (FX) risk management involves identifying, analyzing, and prioritizing various foreign currency exposures, and developing and implementing a coordinated and systematic plan that utilizes company resources efficiently and effectively to mitigate FX risk. The degree to which companies implement adequate foreign exchange risk management practices can vary substantially, from not managing the risk at all to engaging in robust hedging activities, and as a result, the impact on the bottom line can vary widely across organizations. This FX Risk Management Maturity Model outlines the 5 stages of a comprehensive currency risk management program. The process involves performing a FX risk assessment, developing a FX risk management policy, and implementing progressive FX hedging strategies. 5 Stage FX Risk Management Maturity Model FX Risk Assessment: Exposure Identification & Measurement FX Risk Management Policy: Hedging Guidelines & Procedures Balance Sheet Hedging: Booked Receivables & Payables Cash Flow Hedging: Forecasted Revenues & Expenses Net Investment Hedging: Subsidiary Earnings & Equity The design and implementation of a FX risk management program must take into account the specific goals and objectives of the firm, the organizational structure and operations, the line of products and/or services, ... Morningstar's Missing FX Risk Management FX Initiative is fascinated with how global companies manage foreign exchange (FX) risk. This analysis focuses on Morningstar, Inc., a leading provider of independent investment research in North America, Europe, Australia, and Asia. Founded by Joe Manseuto in Chicago in 1984, Morningstar’s timeline outlines their expansion into Japan in 1998, Australia, New Zealand and Canada in 1999, and the opening of Morningstar Europe, Morningstar Asia, and Morningstar Korea in 2000. Today, the company has operations in 27 countries as outlined in their 2016 annual report (10-K): The company’s Securities and Exchange Commission (SEC) filings offer 3 interesting highlights from a FX perspective: Morningstar has direct exposure to 23+ currencies through their wholly owned or majority-owned operating subsidiaries. 26% of Morningstar’s 2016 consolidated revenue was generated from operations outside of the United States. Their most recent 10-Q for the second quarter of 2017 states that "approximately 69% of their cash, cash equivalents, and investments balance as of June 30, 2017 was held by their operations outside the United States." The two main goals of a FX risk management program are to (1) minimize ... Comments are closed.