However, because the volatility that accompanies exchange rates also provides opportunities to realize gains, it is important to find a balance between risk and return, says Todd Blonshine, vice president and foreign exchange manager of global capital markets at Comerica Bank.
“Companies need to differentiate between investing and conducting business internationally,” he says.
Smart Business spoke with Blonshine about the importance of currency risk management in today’s global economy.
How can businesses best strike a balance between risk and return when investing in global markets?
If a business enterprise is United States-based, they quite likely will need to convert U.S. assets into foreign assets in order to maximize the potential for success. This operation, however, involves risks and is quite different from investing solely in the United States. Today, given globalization, it is a rare company that carries on business exclusively within the borders of its domicile. E-commerce, improved technological and transportation systems, in conjunction with the liberalization of trade policies, has led to the explosion of trade possibilities and opportunities. But also, to the corresponding risks that are associated with conducting business internationally. Fortunately, commercial banks, as well as futures markets, offer products and services that businesses can utilize to eliminate these risks with little or no cost.
How often should businesses address their pricing to compensate for fluctuations in exchange rates?
Unfortunately, there’s no definitive or right answer to this question; every company has a slightly different risk profile. I can, however, comment on the factors which should be considered in determining the proper answer on a company-by-company basis.
First and foremost, companies should realize that different currencies exhibit different degrees of volatility. Second, a company should look to the strength of their sales data. A company with better internal reporting will be in better position to tweak their hedge amounts, hence being better able to adapt to a changing economic environment. Third, a company should determine how much time they wish to spend on forecasting and speculating on the future direction of exchange rates. We offer consultation services to help deal with very risk-adverse customers.
What steps can be taken to protect against adverse exchange-rate movements?
The most common way to eliminate exchange-rate risks is by entering into a foreign exchange forward contract with a commercial bank. The contract guarantees that all monies will be exchanged at a prespecified rate at some point in the future, regardless of what the actual exchange rate is. Banks simply make an immediate conversion using their funds and then swap the exposure out until the settlement in order to retrieve dollars. In this manner, a company can not only put an effective hedge in place at no cost, but it also has no cash-flow consequence until settlement or maturity.
Beyond the standard forward contract, companies can derive timing flexibility from a window forward contract, which allows settlement between a window of maturity dates. Of a more advanced nature is a foreign currency option, which gives a company the right, but not the obligation, to change at some point in the future. Unlike a forward contract, a premium is due and payable at the inception, in most cases on an options contract.
What are the most effective ways to repatriate funds from global operations?
Companies should take advantage of the current favorable tax treatment to repatriate proceeds of overseas operations. The favorable tax treatment, however, unless extended, runs out at the end of this year. Companies should consult with their accounting firms immediately if they feel that the reinvestment of foreign proceeds will not be equal to the return they receive by redeploying the assets here in the United States. Companies who have determined that they will repatriate should then lock in an exchange rate contract that guarantees that the proceeds will be converted at the exchange rate that they expect.
For businesses that operate internationally, how do shifting exchange rates directly influence their balance sheets?
In general, fluctuating exchange rates can impact cash flows and can inadvertently increase or decrease expected proceeds and/or costs. Our experience is that shareholders do not like to see a footnote in the financial statements of a corporation which indicate that earnings per share declined due to foreign currency losses. This could have been avoided by virtue of implementing a proper hedge. Companies are typically very good at what they do best, which is providing a specific product or service, and not speculating as to the direction of what exchange rates will be.
How has the introduction of the Euro changed currency risk management?
The introduction of the Euro has simplified the ability to effectively hedge cross-border businesses throughout Europe. Imagine, if you will, California having its own currency and then New York having its own currency. Imagine the problems if all of these currencies are changing in value relative to one another. Now imagine using only one currency. It has greatly simplified business. No longer do companies have to worry about specific politics or economic aspects of country A versus country B.
Todd A. Blonshine is vice president, Western region; foreign exchange manager, Global Capital Markets for Comerica Bank. Reach him at (310) 297-2801 or http://firstname.lastname@example.org.