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| 30-11-2020 | Bas Meijer |
Corporate firms have the primary objective to be profitable. From a Treasury perspective, the main goal is to increase cash and add value. Nowadays, an increasing amount of Corporate firms engage in international business. Therefore these firms can be exposed to unrelated business exposure, such as interest rates, FX and commodities pricing depending on the business model pursued.
How do you deal with potential orders with these kind of exposure? I have seen companies going bankrupt because they did not (fully) hedge their potential orders and applied the wrong instruments.
In order to hedge, the distinction must be made between the type of exposure:
- A committed exposure: invoices, signed orders
- An expected exposure: unsigned orders, expected budget
Both types of exposures need different products to be eliminated. Do all exposures need to be hedged? No. Transactional exposures should be fully hedged. Internal loans or hidden equity not always. In general, equity is not hedged. Internal loans depends in the way these are structured. In which currency is the loan granted, what are the cash flows etc. This is tailor made.
Natural Hedge & Holistic Hedges
The Natural hedge myths: there is only a natural hedge if the cash-in and cash-out are in similar currency and at approximately the same time, and applicable to transaction exposure only. This means that there is hardly any natural hedge.
Finally the holistic approach: some providers are selling holistic hedges. In general these are based on statistical studies. Holistic hedge approach adds uncorrelated exposure to the corporates, with the goal to lower the total exposure. In the world of statistics there is always room for error. When using this approach, the corporate firms should be aware of this. Not only the board, but also the auditors. I have seen enormous errors on this approach, resulting in not eliminating the risk but increasing the risk.
Cost of hedging
Is hedging expensive? No. There are many different ways to hedge the exposures, and there are many different providers to do this. Some of these are too expensive. Use a Treasury Specialist to analyse the cost of hedging and come up with alternatives. The Treasury Specialist has a high rate of return and attributes to the bottom for years to come.
More important is to quantify your exposures. The exposures are not limited to the cash flow only, but can also be embedded in your processes. Using a Treasury Specialist will lower your cost of hedging, assures that your organisation hedges the correct exposure with the right instruments, can massively attributes to the bottom line and protect you of becoming tomorrow’s news.
Thanks for reading, comments are welcome!
17-06-2020 | by Aastha Tomar
In her previous post, our Expert Aastha Tomar explained how the forwards work. Lets see the second type of hedge. The second type of hedge contract is futures. Like forwards they also fix the currency rate for a future date. The major difference between a future and a forward is that futures are exchange traded and therefore they are standardized.
Features of Futures
- They have standard sizes, delivery dates and settlement rules. The settlement mechanisms reduces much of the credit risk .
-> Now why do I say that credit risk is reduced ? As mentioned earlier, all settlement takes place through the exchange clearing house and the two parties buyer and seller are not in direct contact with each other. Therefore since it is the responsibility of exchange clearing house to settle the trade, the counter-parties run the credit risk of the exchange clearing house instead on each other.
- They can be cash settled or physically delivered and are legally binding.They trade in one contract size, so corporate must trade in multiples of that
- They move in increments called ticks and each tick has a value. The number of ticks made or lost on a trade determines the loss/profit of the trade
- The counter parties holding the contracts on the expiration date must deliver the currency amount at the specified price on the specified delivery date or they can even close out the position before the expiry date, this can be done by doing an equal and opposite trade in the same futures contract.
- To enter into a future contract an initial deposit into a margin account is required . The contract is then marked to market each day and a company is required to add more funds to the margin account if cumulative losses drain the margin account. If the company does not respond to a margin call, the exchange closes out the contract.
- The contracts are physically delivered four times in a year on the third Wednesday of March, June, September, and December.
Difference between future and forwards
- Futures are traded on an exchange hence standardized therefore a company may not be able to hedge the exact and full amount of underlying transaction. They may have to under-hedge .
- The delivery date in future may not be same as the maturity of underlying transaction which may open the corporate for some market fluctuation.
- The treasures can easily unwind a hedge position earlier than its normal settlement date if needed.
- In a forward contract, the bank includes a transaction fee in the contract. In a futures contract, a broker charges a commission to execute the deal.
Lets understand futures with an example :
Lets take EUR/USD as an example,
One contract size for EURUSD future is $125,000 worth of Euros and one tick size for EURUSD future is .00005. Therefore the price movement will be ($125,000*.00005) =$6.25 per EUR
Now if we purchase one futures contract of the EUR/USD, which is trading $1.0901 . We are hoping that EUR will appreciate , relative to the Dollar. Suppose we are lucky and things go as expected, and the exchange rate rises to $1.09015, We will make $6.25 in profit (per contract). Cool !!! Suppose we are luckier and FED makes some negative announcement on top of that ECB does some tremendous positive changes in their policy due to which EUR shoots up becomes much more stronger and exchange rate rises to $1.09110 (a whooping increase of 20 ticks), then we would make $125.00 in profit per contract ($6.25 x 20 ticks = $125.00).
lets see it more clearly in the following table :
Now why do corporates stay away from Futures ?
- Futures cannot be customized hence there is not always a complete hedge
- Companies don’t want to put initial margin money in the exchange
- They want to stay away from the hassle of mark to market each day and depositing money if the losses erase the deposited margin money
- With forwards there is a human interaction with the banker who enters trade with you and you feel more comfortable with that, you may also negotiate forward premia with the banker and if there is a long standing relationship with the bank, the bank sometimes forego or reduce the fees. In Futures that’s not the case.
Whether its a forward or future contract, nothing is difficult if you have the intent to learn the product . Once you start understanding how hedge market works and start realizing the benefit of it then it will eventually be beneficial for you as a Treasurer and for your corporate which will be saved from unwanted currency fluctuations. In our third and last post in this series we will talk about Options ..keep learning, be safe.. to be continued ….
FX & Derivatives | Debt Capital Markets | MBA Finance
Electrical Engineer | Sustainability
03-06-2020 | by Aastha Tomar
Our financial world has now gone through enough crisis. Some learnt from previous crisis and were braced for the next while some were still in their learning phase. The current crisis took everyone by alteration because this time it was not the financial sector which was responsible for the ordain. The fluctuations seen in equity, bond, commodity and currency markets may have become Achilles heels for Corporate Treasurers in current times.
The incumbent state of affairs was such that Corporates had to protect their bottom line while trying to stay afloat. The entire cash flow projections would have gone for a flip for those who didn’t hedge their foreign currency exposure. One way that would have taken a part of vexation away from corporate treasurers due to currency fluctuation is hedging. It would have attenuated the impact of currency fluctuation on investments, borrowings, assets etc .
Let us have a look at the most used and basic methods of hedging in this article :
So what are forwards? In a simple language its a hedge product between two parties which freezes your cash flow for a future date. That ways whatever the market situation be on the maturity date of the hedge, your cash flows are locked and predetermined. Whether you are an exporter who can know the exact value of future payments or an importer who can anticipate the exact costs of products; a forward will hedge the risk of currency fluctuation for both.
Features of Forwards :
- Specifies the amount, date and rate for a future currency exchange
- Parties involved are banks and businesses with foreign currency exposure
- They are over the counter products
- They can be customized
- They need two parties, one buyer other a seller
- There is no upfront payment
- Determining a currency forward rate depends on interest rate differentials for the currency pair in question
Suppose you are an exporter based in the Netherlands and you want to sell Dollars in an years time. You know due to current euro zone, corona crisis and negative interest rate scenarios Euro may fluctuate sideways and therefore you want to lock in the price of USD today itself so that one year down the line you don’t have to worry about the fluctuating rates. What do you do ? You approach a bank informing them that you have to sell USD (buy EURUSD) for 1st June, 2021. After basic documentation bank enters with an forward agreement with you . Where in today’s spot rate , the currency premium for one year , the amount of hedge and the maturity rate will be mentioned .
Spot EURUSD : 1.08282 (1 EUR = 1.08282 USD )
1 year interest rate for EUR = -.07%
1 year interest rate for USD = 0.7%
So after one year based on interest rate parity :
EUR 1* ( 1+(-.0007))= USD 1.08282 *( 1+ .007)
0.9993 EUR = 1.090 USD
Therefore 1 EUR = 1.0911 USD
Therefore by entering a forward contract today you have fixed your EURUSD rate to 1.0911. Note that because the dollar has a higher interest rate than the EUR, it trades at a forward discount to the EUR.
Let us take a simple scenario analysis to make things clearer :
Here the forward deal amount is : EUR 1mn
Spot rate on the day of deal is : 1.08282
Forward rate fixed for the deal is : 1.0911
We can clearly see above that if the spot is same as the forward rate on the maturity date then there is no loss or gain, but if spot moves to 1.09250 then the corporate saves USD 1400 on the contrary if spot moves to 1.0900 the corporate wont be able to take advantage of the low price and will have to exercise the forward at 1.0911 as fixed earlier thus letting go of USD 1100.
So if forwards are so beneficial why do corporates still do not execute forwards for all of their foreign currency transactions :
- There is some documentation involved and corporates sometimes feel that its time taking and taxing
- At maturity date what so ever the actual spot rate be your forward will be executed at the fixed price , and some corporates feel that they may lose a chance to take advantage of better rates.
- Banks charge a small fee for entering the transactions which corporates want to save.
- Corporates feel the currency wont fluctuate much and hence don’t want to get into forward transaction.
Whatever the reasons be but the main business of corporates is not to use their energies in managing their fx risk but to increase profits by their mainline business hence its always advised for corporates to hedge their fx risk as much as possible to increase efficiency and prevent themselves from unseen shocks.
In our next post in this series we will see a second type of hedge … to be continued. Till then keep learning and be safe .
FX & Derivatives | Debt Capital Markets | MBA Finance
Electrical Engineer | Sustainability
29-01-2020 | Treasurer Search | treasuryXL
The Treasurer Front Office is part of a team of three (Treasury Operations), in this team he will be the medior and take the lead in front office activities such as:
- Support and advise his business colleagues on hedging, cash and bank management strategies (in cooperation with treasury manager)
- Execution and reporting of cash management and hedges
- Ensuring compliance with company and bank policies
- Leading and supporting treasury IT and other projects
- Sparring partner to finance community within his organisation, organize workshops & webinars
Ideal Corporate Treasury Specialist
Remuneration and Process
Our client offers a market level salary, the expected annual base salary will be about €65K. For interested candidates who qualify, a more elaborate job description is available. The Treasurer Test might be part of the recruitment process.
While the role of the treasurer is changing, it becomes increasingly challenging to maintain the current workflows and simultaneously take on new demanding tasks. One of these often manual and time-consuming tasks is risk management. As seen in, among others, this year’s Global Treasury Benchmark Survey of PwC, the registration and management of financial instruments stands among the top 3 challenges on the agenda of the surveyed treasurers. In this article, we take a more in-depth look at possible optimizations in some key treasury workflows.
Example FX management workflow
Hedging your FX exposure risk made easy
A common problem is the lack of visibility on the existing (global/local) FX exposure risk.
In order to calculate the FX transaction risk, transactional data from the TMS & ERP systems need to be consolidated effectively. Typically, this happens to be a (very) painful exercise. With Cashforce, however, using our off-the-shelf connectors (for ERP & TMS) and our full drill-down capabilities, you have all FX exposures at your fingertips.
FX Exposure Management – Current positions & exposures
But there is more to it. Imagine that linked to your FX exposure, an automated proposal of the most relevant FX deal would be generated to properly hedge this risk. A grin from ear to ear you say?
FX Exposure Management – Suggested hedge
And what about forecasting FX exposures? It’s now all within reach!
FX Exposure Management – Future positions & exposures
Whether you choose to take on an intercompany loan, a plain vanilla FX forward or another more exotic derivative product, chosen deals could then be automatically passed on to your deal transaction platform, to effectively execute the deal without any hassle. After execution, deals will automatically flow back into the system. Consequently, a useful summary/overview will be generated to effectively manage all your financial instruments.
Workflow integrated cash forecast
Finally, integrated cash management
New financial instruments / deals will generate a set of related cash flows. Ideally, these are directly integrated in your cash flow forecasts. In Cashforce, this data is automatically integrated within the cash flow forecast module, and will be put into a dedicated cash flow category. Learn more one how to set up an effective cash forecast in this article or this webinar.
Cash flow forecast overview
The analysis possibilities are now limitless, thanks to the ability to drill down to the very transactional-level details. The real number crunchers strike gold here: the analysis features open doors to unlimited in-depth analysis and comparison of various scenarios (E.g. the simulated effects of various exchange rate movements).
Drill-down to the transaction level
Using our big data engine, the delivery of rich and highly flexible reporting is facilitated. It’s fair to say that the typical SQL server (which currently 95% of the TMS systems use) can’t hold a candle to this. Through an advanced ‘self-service’ interface, users can drill down completely into respective amortization tables, historical transactions and effortlessly create customized reports and dashboards. We’ll talk more about why we believe Big Data engines are crucial for any Treasury software in our next blog.
Integration with ERPs & payment platforms
Next to this, Cashforce will automatically generate the accounting entries (in the format of your ERP/accounting system) related to your deals. The appropriate payment files will be generated in a similar fashion.
As might be clear after reading this article, we strongly believe that integrated data flows & a Big Data engine are the foundation of a new type of Treasury Management System that runs like clockwork and can serve effective treasury departments, but also renewed finance/controlling/FP&A departments.
You are curious to hear more about effective treasury management? We’ve recently recorded a webchat on how to set up an efficient cash flow forecast process.
Managing Partner at Cashforce