Currency Hedging

You don't be at the mercy of the currency market. Our risk management solutions offer hedging for businesses and organizations of every size.

With a variety of forex solutions available from our strategic partners, our dedicated forex desk will help you hedge your forex risks and advise you on currency movements to help you anticipate your business costs. Example. 1. Know your risk : Gain visibility into currency exposures and forecast cash flow. 2.Minimize costs :Avoid unnecessary currency conversion and costs using cross-currency payments. 3.Hold money in foreign currencies : Hold money in over 40 currencies for up to 90 days. No foreign bank accounts needed. 4. Make the most of your money: Strategically trigger foreign payments to happen when exchange rates are favorable. 5.Pay invoices in foreign currencies:Quickly buy or sell foreign currency online to settle invoices around the world. 6. Protect against currency volatility :Lock-in a currency rate for up to 12 months to protect against adverse currency changes. 7.Currency protection:Use our currency protection options to manage risk and capitalize on favorable exchange rate.
Understanding Currency Hedging

When the Canadian dollar fluctuates against foreign currencies, all Canadians impacted one way or another. For instance, if you are buying a television from the U.S. and the Canadian dollar moves higher relative to the U.S. dollar, it will take fewer Canadian dollars to buy that television. If the Canadian dollar declines, then it will cost you more Canadian dollars to buy that same TV. This principle applies to any financial transaction or investment where foreign currency valuations involved, including exchange traded funds (ETFs).

The change in value of a foreign currency relative to the Canadian dollar (referred to as currency risk or exchange rate risk) is an important factor to consider before investing in an ETF that invests in non-Canadian assets. For example, if the underlying investments of the ETF bought in U.S. dollars (i.e., U.S. companies listed on a U.S. stock exchange), the appreciation or depreciation of the U.S. dollar against the Canadian dollar has the potential to either add or detract from the investment return.

Essentially, there are two options available to an investor: 1) be exposed to currency fluctuations (i.e., stay unhedged); or 2) be currency hedged. The objective of currency hedging is to reduce or eliminate the effects of foreign exchange movements over the life of the investment, such that a Canadian investor receives a return solely based on the change in value of the underlying assets, without the effect of changes in currency values.

Return on Foreign Assets +/- Change in Foreign Exchange Rate = Total Return on Investment.

To reduce or eliminate the impact of changes in foreign exchange rates, ETFs that invest in non-Canadian assets are currency hedged.

HOW CURRENCY HEDGING WORKS

To initiate the currency hedge, the ETF enters into an agreement with one or more investment dealers to sell the foreign currency forward (“forward agreement”). If the foreign currency drops in value relative to the Canadian dollar, the ETF will realize a gain in the value of the forward agreement, offsetting the foreign exchange loss. Alternately, if the foreign currency appreciates in value relative to the Canadian dollar, the ETF would realize a loss in the value of the forward agreement, offsetting the foreign exchange gain. In either case, the impact of the change in foreign exchange rate is eliminated.

 

SHOULD AN INVESTOR CURRENCY HEDGE?

It’s important for investors to consider their appetite for currency exposure prior to investing in an ETF with a foreign investment mandate, rather than after they’ve owned it and have found themselves wondering why their experience is different than what they had expected (given the performance of the market). Some argue that over the long-term, currency fluctuations balance out, so there’s no need to hedge. Those who support currency hedging argue that most investors don’t hold an investment long enough to mitigate the effects of currency volatility.

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Case Study 1

Suppose Company A gets 80% of its revenue in USD. However, they are local and pay liabilities (rent, salary, local loans etc.) in SGD.

If the USD weakens against the SGD, the company will thus end up having less SGD to cover their local liabilities. For ease of example, assume that their local liabilities come up to SGD $8 million, their SGD revenue is SGD $2 million, their USD revenue is USD $8 million and the USD to SGD exchange rate is 1.25.

This would mean that they are currently making (SGD $2 million + SGD $(8x1.25)million) = SGD $12 million, earning them a net profit of SGD $4 million after liabilities. But if the exchange rate weakens to 1.15, they would instead be making (SGD $2 million + SGD $(8x1.15)million) = SGD $11.2 million, reducing their profit by $800k due to forex movements against their favour.

To protect against this, the company could buy currency forwards that lock in the SGD/USD conversion at a certain rate. For instance, if they lock it in at 1.25 exchange rate, assuming a similar weakening of the USD and a cost of $100k for the currency forwards, they would reduce their overall loss from $800k to just that $100k.


Case Study 2

Suppose Company B would like to expand overseas and do business in Kuala Lumpur. They need to buy buildings, infrastructure, and set up a team there in 6 – 9 months, which they estimate to cost around RM $5 million. The current exchange rate is 2.5, which means that the company needs SGD $2 million to fund the business.

However, forward currency contracts and the forward curve implies that the exchange rate in 6 months could worsen against them and become 2.3. This means that in 6 months' time, the company would need to fork out SGD $2.17 miilion, which is more than they budgeted for.
Since they need the cash, they cannot exchange at today’s rate and keep ringgit in the bank. But they can buy a ringgit forward contract, which would lock in the exchange rate at higher than 2.3 – say, something like 2.46, including costs. As such, the company would be able to fund the expansion business with only a slightly higher cost – SGD $2.03 miilion – compared to what they would have otherwise needed to pay if they exchanged at spot rate in 6 months' time

 



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