What is the impact of volatile foreign exchange rates on the media technology industry? How do suppliers and manufacturers protect against volatile exchange rates?
Situation - “The classic hedging with currency forward contracts is not sufficient any more these days”, said Stefan Bender, Head of Foreign Exchange Trade, Deutsche Bank in the Handelsblatt on the 6th February 2009. Significant changes in the international financial and economic landscape have led to uncertainty regarding the direction of foreign exchange rates. The economic turmoil, with its insecurity, has led to highly volatile exchange rates and therefore an increase of risk. The Euro against the Dollar, the UK Pound Sterling and the Japanese Yen have all shown record levels of volatility in the last year of up to 20%. In the last crisis of 2001 the implied volatility was about 15% and in the years between 2002 and 2007 about 10% (Handelsblatt, 6th February 2009). This volatile risk situation has major impact on profit and margins for the media and technology industry, and is therefore a substantial factor in international trade.
Solution - The foreign exchange rate risk requires an effective hedging strategy to ensure a stable future financial position for a technology enterprise. Companies can achieve some degree of immunisation by hedging against exchange rate movements. If companies hedge with options they must take 5-7% of the trade value into account. It can be justified to pay these increased premiums because “after what has happened in the last year, there is a lot more at risk”, according to Tim Graft, Forex Strategy, at Credit Suisse. (Handelsblatt, 6th February 2009)
Hedging against long term exposure is different from hedging in the short term. Long term exposure is not part of this work. Short term hedging can be done in different ways. Companies have to take into account that the higher the volatility in the forex market is, the higher is the amount at risk. For this reason there are higher costs of hedging for some instruments. Apart from simply passing the risk to another party there are hedge instruments such as Currency Forward Contracts and Futures Contracts, Currency Options and Carry Spot Trades.
While the first products are classic hedge instruments and handled through the High Street commercial banks, Carry Spot trading is a relatively new tool enabled through internet technologies. High Street banks are relatively easy to use for foreign currency transactions; however they could be expensive. An alternative could be an online Carry Spot trading.
There are basically two positions in derivative trading: Long and Short Position (Buying and Selling). Long hedges are bought in the anticipation of an increased exchange rate and are therefore important in the export position. This is an insurance against a home based currency becoming stronger (e.g. hedge of 1€/$1.3 against increase towards $1.4). Short hedges are bought in the anticipation of an exchange rate decrease. This is important in an import position in the country base currency. However long and short positions work in import and export.
Recommendation- Companies should hedge under the current circumstances. In an international business they should request an offer from the company’s commercial bank. Since the bank knows the company’s current situation this may has advantages.
However they should also try to get an alternative competitive offer from specialized services such as www.save-your-rate.com. Specialized services require no margin account, as for this reason no permanent cash is utilized.