INTERNATIONAL PAYMENTS
Hedging &
Risk Management
Common risk tools
Protecting gross margins
Mitigating market volatility
Not hedging known future payables in an alternate currency is speculating (rolling the dice) your gross margins from unknown future exchange rates.
COMMON RISK TOOLS
FORWARD EXCHANGE CONTRACTS
FX SWAPS
FX OPTIONS
AVOIDING RISK MANAGEMENT
Currency volatility in cross-border transactions can weigh heavily on the bottom line. Yet, businesses often choose to not manage certain risk and roll the dice on related costs.
Why?
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1. PROSPECT THEORY
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Prospect theory studies show that people generally take more risk to avoid a loss and take less risk to protect a gain.
As a result, businesses will risk budget/cost uncertainty, just to avoid potentially ‘losing’ against better spot rates.
This natural tendency can lead to inconsistent and costly decisions.
Risk management is about protecting gross margin.
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2. BUSINESS FINANCIAL HEALTH
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Firms with limited funds avoid risk management with collateral requirements.
Similarly, households with financial difficulty may reduce certain insurance policies to reduce expenses.
The puzzle, firms with limited funds should actually be more concerned about budget certainty.
Evidence shows firms with stronger balance sheets and capitalisation hedge a lot more often.