Hedging –what’s that all about? (And no, it’s got nothing to dowith gardening) For many years hedging has been considered as something that only City hot shots can possibly understand. But in the current economic climate and with exchange rates a daily news item, it is something that more and more of us should be thinking about. Hedging at home
What can I do? For most companies who want to set up a hedging agreement, the first port of call will be your bank, armed with trading projections and cash flow forecasts for at least the next twelve months. You will need to know your potential exposure to the risk of fluctuations in foreign exchange rates before seeing what the bank may be able to offer. The most commonly used hedges will be: • A natural hedge – If you buy raw materials from Spain and sell finished goods to Germany and all transactions are priced in euros, then, subject to timing and the profit margin, there is a natural hedge in place. There is no cost to you for this, so it is worth considering if you have a business model that is naturally self-hedging. • A forward contract – An agreement to buy a certain amount of foreign currency at a future date at a predetermined rate. So if you are importing timber for example, you can at least fix the future cash outflow which may then assist in setting a sales price in your local currency at a future date. • A cap and collar – An agreement that might limit your exposure to foreign exchange risk, but still leaves you with some exposure. For example if the £/€ rate is £1/€1.25, you might accept the risk down to say a level of €1.20, but will have hedged against the risk of a fall below €1.20. Like all financial decisions, hedging requires careful research and planning before entering into any kind of agreement, but as a protection against unforeseen events, it may well be worth the effort.
Hedging is all about minimising risk by locking in a price to buy or sell a commodity in the future. Without realising it you have probably already entered into a hedging agreement if you have a fixed price agreement with your gas and electricity supplier, who have guaranteed your energy prices for a fixed period. Whilst energy prices are rising then you will be winning compared to your pay-as- you-go neighbour; but be prepared for a nasty surprise when it comes to contract renewal date! Commercial hedging In business, and with the recent fall in the value of the pound, there are companies who are benefitting (exporters) and those who are losing (importers). You can reduce your exposure to winning or losing by, as they say, ‘hedging your bets’. This is why many of the larger listed companies have been in the news recently saying that they are, in the short term at least, protected from the fall in the value of the pound because they have entered into a hedging agreement (for example entering in to a commitment to buy €1million over the next twelve months at a rate of £1/€1.22).
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