Savvy Directors and Boards are Asking Questions

A recent article in Directors and Boards Magazine highlights the need for stakeholders to ask questions about currency risk. While the direction and strength of the U. S. dollar is seldom a sure thing, you can bet that currency exchange rates (sometimes called "foreign exchange rates" or "FX") will continue to be volatile. 


The article is entitled "Foreign Currency Volatility: 3 Questions Directors Should Ask" and it appears in the online at Directors and Boards Magazine. Click here to read more. 


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Managing Hidden Risks in Currency Exchange: Key Pitfalls CFOs Should Avoid

Corporations face a wide range of different kinds of risk today. Cybersecurity, fraud and business interruption due to a disaster (whether natural or man-made) are just a few that keep many CEOs awake at night.

But there’s another risk faced by companies conducting business internationally that tends to fly under the radar: currency exchange risk.

Also known as foreign exchange or FX risk, this type of risk exists when a financial transaction is determined in a currency other than that of the base currency in which a company operates. An estimated 80 percent of mid-sized U.S. businesses export or import products, services or supplies, and these businesses must deal with FX risk one way or the other — even if they don’t realize it.

FX Risk Can Impact Profit

When negotiating a financial contract, U.S. companies that do business with overseas customers and vendors can designate payments in either U.S. dollars or the base currency of the country in which their customer or vendor is located. If payments are denominated in a currency other than U.S. dollars, the U.S.-based company will face currency exchange risk due to the daily fluctuations in currency exchange rates.

These fluctuations can have a significant impact on a company’s revenue, expenses and bottom line. For example, a 10 percent move in currency value can wipe out 50 percent of a company’s earnings due to lower-than-expected sales revenue or higher-than-expected raw material or inventory costs.

Currency exchange risk isn’t new — it has been around for as long as businesses in different countries have conducted international trade. But it is now more pronounced due to the interconnectedness of businesses all over the world and the volatility of the global economy and marketplace. Today, almost every business is affected either directly or indirectly by global events, whether it’s a neighborhood mom-and-pop laundry service or a billion- dollar multinational corporation.

The good news is that currency exchange risk can be identified, quantified and managed within a systematic framework.

The goal, in FX risk management, isn’t to predict in which direction currency exchange rates will move — or in other words, to speculate on foreign currency exchange. Instead, FX risk management is designed to ensure a certain level of financial performance regardless of exchange rate fluctuations.

Many large international corporations have entire departments devoted to managing currency exchange risk,  but most small and mid-sized businesses don’t have the resources to devote to this full-time. The challenging accounting,  tax, regulatory, analytical, and capital markets domains relating to currency exchange risk require sophisticated expertise that most small and mid-sized companies simply do not possess.

Managing FX risk effectively requires in- depth experience and expertise in foreign currency exchange, which isn’t a core competency for most firms. That’s why it usually makes sense for smaller and mid- sized firms to outsource currency exchange risk to a competent and trustworthy third party that specializes in this, while establishing clear lines of accountability and reporting.

Two FX Risk Management Scenarios Reveal Real-time Vulnerability

There are two main scenarios in which small and mid-sized firms could benefit by taking steps to manage their currency exchange risk:

1. A one-time overseas event: 

In this scenario, a particular event occurring overseas presents a company with FX risk. A good example is the construction of a new building or manufacturing plant, in an overseas country. Since this is a long-term project, the currency exchange rate could fluctuate considerably between the start and completion dates of the project, which will impact the final cost. In general, the longer the timeframe of the event, the greater the potential currency exchange risk.

2. An ongoing overseas customer or supplier: 

Here, a domestic company does business on a regular basis with a customer or supplier located overseas. If payment is denominated in the overseas customer’s or supplier’s currency, the domestic company will face FX risk each time a payment is received from a customer or made to a supplier.

In deciding whether or not to take steps to manage this FX risk, businesses must determine how significant the risk is to their organization. Companies differ in their definition of what is and isn’t “significant,” but anything that impacts earnings by more than 0.01 per share during a quarterly reporting period (or the equivalent for a non-public company) will be visible and thus likely to be considered  significant. 

FX Risk for Manufacturers

There is inherent currency exchange risk facing any U.S. manufacturer doing business overseas. As an example, ABC Manufacturing Corporation, located in Detroit, Mich., lands a big contract to manufacture customized heavy equipment for a new customer in Germany. The contract stipulates that payment to the company will be made in euros, not U.S. dollars. It will take ABC Manufacturing six months from the date the contract is signed to deliver the equipment. During this six-month window, the exchange rate between the euro and the U.S. dollar will fluctuate — perhaps considerably — and these fluctuations could work for or against the manufacturer.

If the value of the dollar declines against the euro, ABC Manufacturing will benefit and pocket more dollars when it converts euros to U.S. dollars. But if the value of the dollar rises against the euro, ABC Manufacturing will pocket fewer dollars when it converts euros to U.S. dollars.

Ultimately the manufacturer must make a decision: It can choose to “roll the dice,” so to speak, and hope that the exchange rate between the euro and the dollar moves in its favor over the next six months. If it does, the company will earn more revenue and profit. But if it does not, the company could see its entire profit vanish simply due to changing currency exchange rates.

Gambling in foreign currency exchange isn’t usually a risk that small or mid-sized businesses should be taking. Instead, a better strategy is to identify, quantify and manage FX risk than take the chance that currency fluctuations could wipe out the profits on overseas sales. The best way for most small and mid-sized companies to reduce or manage this risk, is to outsource currency exchange risk management to a trusted third-party that specializes in FX risk.

FX Risk for Service Businesses and Firms Importing Supplies

Manufacturing businesses are not the only companies facing potential currency exchange risk by contracting with companies overseas. Consulting and service based organizations also face FX risk. For example, a marketing company contracts with an overseas business to provide a monthly service. The overseas company stipulates the contract will be paid in Yen, the home currency of the overseas company based in Japan. Every month of the contract the U.S. based marketing firm risks potential loss due to currency exchange risk.

So how does FX risk affect domestic companies that purchase raw materials or inventory from overseas suppliers? Let’s look at ABC Manufacturing again, which purchases materials used in the manufacture of heavy equipment from a supplier located in China. Its contract with the supplier stipulates that payment will be made in Yuan, not U.S. dollars. Fluctuations in the exchange rate between the Chinese Yuan and the dollar will impact the price the manufacturer pays for these materials, which in turn will affect its costs and profitability. The company can protect its bottom line by taking steps to manage this currency exchange risk.

Different types of industries (like manufacturers, retailers and service businesses) experience currency exchange risks with varying characteristics. For example, the main FX risk exposure variables for manufacturers are the length of the production cycle, the players in the supply chain, the customers’ ability to place orders well in advance of delivery, and the relationships between supply, production and sales.

These variables will impact both the magnitude and timing of a manufacturer’s currency exchange risk exposure. The longer the production cycle, the greater the company’s FX risk exposure. So a manufacturer of customized heavy equipment, like the one in the example above, may experience more currency exchange risk than a manufacturer that sells commodity parts that can be produced and shipped within a week.

Direct vs. Indirect FX Risk

At this point, a fairly obvious question is: Why not just insist that overseas customers and vendors make payment in U.S. dollars instead of a foreign currency? Wouldn’t this shift the currency exchange risk to them?

The short answer is “yes,” but there are potential trade-offs that present an indirect FX risk to a domestic company. The biggest trade-off is that the overseas company will likely factor this risk into their cost and pricing decisions, so a domestic business may have to charge less for their products or services or pay more for materials and supplies. Another trade- off is that this could make a business less competitive if its competitors are willing to designate transactions in a foreign currency, which could result in lost sales and revenue. 

The Challenges of Forecasted Transactions

Even companies that recognize and plan for FX risk mitigation sometimes fail to identify the largest contributor to currency exchange risk exposure: forecasted transactions. While some fluctuations in currency exchange rates show up on the income statement — such as translation of accounts receivable in a company’s non-functional currency — forecasted transactions do not.

The first step in managing this type of risk exposure is to identify which areas of the revenue cycle and supply chain expose a company to currency fluctuations. The next step is to quantify this risk, which can be a time-consuming process that involves more than just a cursory look at an Excel spreadsheet.

Often, derivatives are used to manage this type of FX risk. While capital markets desks at large banks are good at showing different derivative structures, the hard part is choosing the best derivatives for a company’s unique situation. The best structure will match each element of a company’s exposure, adjust for future cash flow visibility, avoid needless complexity and allow for consistency and benchmarking over time.

The Role of ERM: Is it Enough? 

Risk management is integral to everything a company does, which is why some corporations have created a new role: the Chief Risk Officer, or CRO. A CRO is usually tasked with managing operational risk across the enterprise and may utilize Enterprise Risk Management (ERM) software to help accomplish this.

While ERM can help corporations identify and manage many different types of risk, it often misses the nuances of currency exchange risk. FX risk is typically given little more than a cursory nod within the context of a broad ERM framework, so it falls through the cracks. But this isn’t to say that ERM can’t be a valuable tool in managing currency exchange risk.

Cutting-edge international firms use the capabilities of their ERM software to support their FX risk management framework and centralize FX risk management. For example, ERM’s performance measurement capabilities and the data gathering that’s required, create better visibility into activities that can expose a company to currency exchange risk.

Keep in mind that decentralized management of currency exchange risk at the business unit level can be costly and merely provides a temporary fix. Conversely, centralizing FX risk management creates a systematic framework for currency exchange risk management that helps ensure buy-in and engagement across the entire organization.

With or without the help of ERM software,  proactive and forward-looking international businesses are implementing an organization-wide framework for managing currency exchange risk. Such a framework takes a holistic approach to identifying, measuring and managing FX risk, as well as reporting this risk to the board of directors and other corporate stakeholders.


Currency exchange risk is real for any firm that conducts business internationally. As a result, CEOs, COOs and CROs must first quantify the level of FX risk exposure within their organization. Then, they must make a decision how to manage it — whether within a systematic FX risk management framework, or to absorb the risk internally.


About Grayline Partners

Specialists in risk management, regulatory compliance and business analytics, Grayline Partners and its founder Mark Henderson have more than 25 years of experience in helping companies manage a wide range of different types of business risk, including currency exchange risk.

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A Guide to FX Risk Management Tools

Just about every company that has conducted business outside its home country has experienced the pain of losing money due to fluctuations in currency exchange rates. These losses don't just happen at the moment of cash conversion. There's also an economic cost of forecasted transactions, which is when exchange rates move during the time elapsed between the forecast and the purchase or sale of product. In addition, companies may experience losses due to foreign currency translation adjustments. These stem from line items on the balance sheet or income statement. Finally, a company may experience an opportunity cost if they choose against pricing in the local currency when buying or selling goods in another country. While company managers may think think they are avoiding currency risk by pricing in their home country currency instead of a local currency, in reality this places them at a competitive disadvantage, and comes with an inherent risk premium that benefits the other party in the transaction. 

Plan Ahead to Manage Risk

Companies of all sizes need a plan that includes identifying and quantifying the foreign currency risk, determining organizational risk tolerances, writing policies and procedures for foreign exchange, execution parameters and counterparty relationships, establishing effective reporting and accounting practices, and ongoing reevaluation and assessment. 

Companies need an executable plan to identify, quantify and manage their foreign currency risk.

Companies need an executable plan to identify, quantify and manage their foreign currency risk.

What Tools Are Involved?

A word of warning: company managers might be tempted jump the gun and move right into questions of execution parameters. They can be quick to ask, “What tools should we use to mitigate the risk?” without first building a comprehensive risk management plan. But without a holistic plan in place, foreign currency management tools will only take a company so far, no matter the tools' level of sophistication. That being said, once managers effectively build a comprehensive strategy, they will find a variety of good tools at their disposal to execute their plan. Small to mid-sized companies in particular may use the following tools to control currency exposure.

Natural hedging

In this context, a natural hedge is a method of reducing foreign exchange risk—for example, the risk of losing money due to movements in the currency exchange rate—by offsetting revenue generated with costs incurred in the same currency. While natural hedging is seldom a perfect solution, it does not require the use of sophisticated financial products such as derivatives. For a practical look at natural hedging, see our article entitled, A Non-Hedging FX Risk Management Strategy.

Spot exchange

A spot exchange rate is the price to exchange one currency for another for immediate delivery. The spot rates represent the prices buyers pay in one currency to purchase a second currency. Although the spot exchange rate is for delivery on the earliest value date, the standard settlement date for most spot transactions is two business days after the transaction date. The most common exception to the rule is the U.S. dollar vs. the Canadian dollar, which settles on the next business day. Weekends and holidays mean that "two business days" is often far more than two calendar days, especially during the Christmas and Easter holiday season. For more information on the spot rate of exchange, see ISDA Definitions at

On the transaction date, the two parties to the transaction agree on the price, which is the number of units of currency A that will be exchanged for currency B. The parties also agree on the value of the transaction in both currencies and the settlement date. If both currencies are to be delivered, the parties also exchange bank information. Speculators often buy and sell multiple times for the same settlement date, in which case the transactions are netted and only the gain or loss is settled.

Swap Contract

A swap is a derivative contract through which two parties exchange cash flows based on some notional amount and an “underlying.” The underlying can be almost anything. Currency swaps involve cash flows based on a notional principal amount and a currency pair that both parties agree to in the swap contract.

Swaps are generally not exchange-traded instruments, unlike most standardized options and futures contracts. Instead, swaps are customized contracts that are traded in the over-the-counter (OTC) market between private parties. Firms and financial institutions dominate the swaps market, with few (if any) individuals ever participating. Because swaps occur on the OTC market, there is always the risk of a counterparty defaulting on the swap. To read more about swap agreements, see An Introduction To Swaps on Investopedia.

Option Contract

The owner of a currency option has the right, but not the obligation, to exchange a specified amount of one currency for another currency at an agreed-upon rate of exchange. In the OTC market for currency options, for example, one party may purchase an option to exchange an amount of currency A for a specified amount of currency B. The purchaser of the option then has the right, but not the obligation, to make the exchange at the specified time in the future.

The key benefit of the option contract is that exercise is entirely at the owner’s discretion. At the time of exercise, the owner may elect the most favorable of the spot exchange rate and the exchange rate specified in the option contract. The option premium is usually paid upfront, reflecting the value of this beneficial asymmetry.

There are numerous types of options (e.g. European, American, Burmudan, to name the most popular) that differ in the terms of exercise (what the contract states about when the owner may settle the specified transaction). For more information on the spot rate of exchange, see ISDA Definitions at

Forward Contract

A currency forward contract is an agreement to exchange a set amount of one currency for another at at a specified price for settlement a predetermined time in the future. There are several types of currency forward contracts that differ in the terms of settlement. A Deliverable Forward requires the actual currency to be exchanged at settlement. A Non-Deliverable Forward allows the contract to be settled without exchanging currency. The “net settlement” is calculated based on the difference between the prevailing spot exchange rate and the exchange rate specified in the contract. A Window Forward allows the settlement over a period (window) of time rather than one specific date, allowing more flexibility. For more information on the spot rate of exchange, see ISDA Definitions at

Which is best?

So which tool is the best to use? Well, the answer depends on the company’s objectives and constraints and which instrument (or combination of instruments) will satisfy its objectives and constraints most optimally.

ABC Distribution Case Study

Let’s consider a company with thin profit margins and short periods of exposure throughout the year. Management has determined that its revenue in Europe must come with an average exchange rate of 1.06 U.S. dollars per one Euro. A lower exchange rate is unacceptable, but the company must capture some upside if the exchange rate goes higher. The company has ample cash on hand. In this simple scenario, a series of option contracts seem to be the appropriate choice. A purchased option requires upfront payment of a premium, but preserves the upside potential given a rise in the rate of exchange (EURUSD). It also ensures that the company’s effective exchange rate stays above a certain level (a floor). Over-the-counter (OTC) options can start and end at any time in the future, depending on the company’s forecasted cash flow.

XYZ Manufacturing Case Study

Another situation is XYZ, a manufacturer of goods with a six-month production cycle and relatively high profit margins. With this long lead-time, the company has good visibility into the future, but long periods of currency exposure once the purchase orders have been placed. Past earnings volatility have led XYZ’s stakeholders to question management’s understanding of the business, even though management’s volume and pricing forecasts have been accurate (the timing and magnitude of currency exchange rates has caused the volatility). Finally, XYZ’s working capital is in high demand, with no excess cash available. In XYZ’s case, a series of forward contracts seems most practical.

For a more in-depth look at a case study, see Grayline’s article entitled, Effective FX Risk Management Strategy, a case study of currency risk in Brazilian telecom equipment manufacturer.

More Questions…

In this article, we’ve addressed questions of specific instruments available to companies wishing to control the negative impact of currency movements on earnings and performance. While it is crucial to understand the tactical alternatives available to manage currency exposure, these instruments must be utilized responsibly within a solid framework for currency risk management, including these key elements:

  • Established Organizational Risk Tolerances
  • Corporate Polices and Procedures for Approaching FX Risk
  • Identification and Quantification of Currency Risk
  • Approved Execution Parameters and Counterparty Relationships
  • Accepted Reporting and Accounting Practices
  • Regular (periodic) Evaluation and Assessment of FX Risk Management 

Interested in more insights into Currency Risk Management? Refer to and contact us at

About Grayline Partners

Specialists in risk management, regulatory compliance and business analytics, Grayline Partners and its founder Mark Henderson have more than 25 years of experience in helping companies manage a wide range of different types of business risk, including currency exchange risk.


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4 Ways to Budget For Exchange-Rate Volatility

Now is the time to implement a budgeting and planning process that embraces, rather than ignores, uncertainty and volatility.

In December 2015, when most companies were finishing their 2016 budgets, the pound (GBP) was worth $1.52. With the precipitous drop after Brexit in July, the pound is ending the third quarter around $1.26, a decline few could have predicted. As the 2017 budget season draws to a close, companies doing business outside the US are taking lessons from Brexit and asking what the dollar price will be in 2017. The answer is really anybody’s guess, and that’s the point — we live in a world of uncertainty and unpredictability.

The chart below shows that one pound could be converted to 1.52 US dollars at the beginning of 2016. At the close of the year, that amount had dropped to 1.26 US dollars per one British Pound, a decline of 17%. 

Similarly, CFOs have experienced volatility in their earnings forecasts in years past. As they prepare for 2017, the level of uncertainty will be on the rise again and perhaps more so than ever. Companies are not only dealing with unusually low oil prices, a tumultuous transition to a new governing administration, and an uncertain U.S. interest rate environment. They’re also coping with continued exchange-rate volatility, which is becoming a much more significant factor as companies increasingly globalize their operations. So how should CFOs approach the challenge of budgeting for 2017? Here are four suggestions to put a solid foundation in place:

1.     Understand Your Company’s Risk Tolerance

CFOs have known for years that very detailed annual budgets, predicated on a static set of assumptions, are useless at predicting future business performance — never mind serving as a rational basis for allocating resources. Now more than ever before is the time to acknowledge this reality and move to implement a set planning and budgeting process that embraces, rather than ignores, uncertainty and volatility. By acknowledging that uncertainty and volatility in today’s business environment is the “norm,” you can plan accordingly.

One way to uncover your company’s risk tolerance is to ask, “How much of an adverse effect is your company willing to tolerate?”

The two most common ways to quantify the answer are 1) pennies per share of earnings or 2) dollars of net income.

Consider, for example, ABC Company.  At the beginning of 2016 they forecasted a steady-state of $500 million in revenue and $100 million in net income, a 20% net margin. Based in the US, ABC expected to generate 40% of its revenue in British Pound. As the chart above shows, the GBPUSD exchange rate moved 17% in 2016. In that period, currency movement caused ABC’s revenue to decline by USD 34 million from its forecast, even though its pricing and volume were forecasted accurately. Further, net income declined by USD 22.1 million or 22 percent, despite expenses staying steady as forecasted.

An unexpected decline of that magnitude affects every stakeholder: Employees, management, and the Board. At a minimum, cash flow for bonuses, dividends, and investment are diminished. If ABC Company is like most, the Board and senior management would be quite concerned by a decline of that magnitude. In order to protect against a repeat poor performance going forward, ABC Company’s Risk Committee would likely recommend that the Board adopt a currency risk limit somewhere in the conservative realm of 10%. Senior management would then implement a framework to manage currency risk proactively. If ABC’s measured earnings at risk exceeded 10% due to currency exchange rate movement, senior management could then take action to manage its currency exposure within the organization’s agreed upon currency risk limit of 10%. 

2.     Measure Potential Impact

Companies must look at the impact of the previous year’s currency exchange rate movement to explain current financial performance. But the company’s business activities in the coming year may be entirely different. Furthermore, the relative movement of exchange rates may be quite different going forward. It is not enough, therefore, to assess risk tolerances “post-mortem.”

A full description of the best potential impact measurement techniques is outside the scope of this discussion, but outlined below is a short list of metrics. In each case, a path of exchange rates is simulated. Using forecasted pricing, volume, and costs, the company’s financial performance is calculated and compared to the results, assuming a “static” simulation in which exchange rates stay constant.

  • Forward Curve – Exchange rates track the forecast implied by currency forward rate contracts.
  • Single Historical Period – Exchange rates mimic the relative movement in a single historical period.
  • Exchange Rate Shocks  – Paths of exchange rates are generated that represent instantaneous shocks of 10%, 20%, 30%, 40% up and down.
  • Exchange Rate Cones – Paths of exchange rates are generated that represent movements within designated standard deviation cones (ranging from +/- 0.5 to +/- 2.5 standard deviation movements).
  • Monte Carlo simulation – Multiple random paths (usually 10,000 or more) of simulated exchange rates.
  • Historical Monte Carlo simulation – Exchange rates mimic the relative movement during every historical period.

By measuring the potential impact of currency exchange rates and comparing this to the company’s agreed upon risk limits, senior management can assess how much currency risk must be mitigated. Having a framework for measuring potential impact gives a company greater control over performance, thereby reducing risk and saving money. 

A risk management framework gives senior managers sound metrics for measuring overall financial performance.

A risk management framework gives senior managers sound metrics for measuring overall financial performance.

3.     Assess Alternatives and Implement a Strategy

Armed with clearly-defined and articulated risk tolerances and an assessment of a company’s current risk posture, CFOs can evaluate the plethora of risk management or hedging alternatives. Some of the alternative solutions may involve financial derivatives like forward exchange rate agreements, currency options, or swaps. 

A risk management framework that uses derivatives to hedge can employ a variety of hedging strategies that include:

  • Static Hedging – Hedging once at the start of a forecasting period (e.g. once a year in January).
  • Rolling Strategy – Hedging periodically throughout the period (e.g. each month, extending the hedge as the period progresses).
  • Layering Strategy – Hedging varying proportions of forecasts based on visibility (e.g. hedging 100% of amounts forecast to occur in one month and 75% of amounts forecasted to occur in six months. 

Other alternative solutions may require operational changes. By combining alternative solutions, often very little expenditure is required in order to make substantial reductions in a company’s exposure. 

4.     Monitor and Report Key Performance Indicators

This fourth step brings the first three steps together for the stakeholders. It involves a “report card” on past performance and a look into the future. With an understanding of the company’s ability to tolerate the impact of currency movements, consistent measurement of the company’s current exposure, and thoughtful implementation of the right strategy, senior management and the Board need simple performance indicators that will tell the story of currency risk management within approved limits.

Exchange-rate volatility is not a new phenomenon. But its impact is increasing as companies make, sell, and serve global markets. As CFOs lock down plans for what could prove to be a turbulent 2017, the only certainty is that their hypotheses about the direction of currency exchange rates may prove to be merely guesses. A willingness to accept this reality, plan for it, identify when their planning assumptions no longer make sense, and then act rapidly and with confidence will distinguish the winners from the losers. The good news is that CFOs have better data and more sophisticated tools than ever before to effectively manage uncertainty. 


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Effective FX Risk Management Strategy

Effective FX Risk Management Strategy

A Brazilian telecomm equipment manufacturer struggled with its exposure to the changing currency exchange rates. An assessment revealed that the volatility affected its revenue by 22% and its net income by even more. 

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A Framework for Interest Rate Risk Management

Banks are often unknowingly exposed to risk due to balance sheet structure, and they often seek to change that composition through pricing and customer incentives. While this approach can be effective, it takes a long time and tends to be costly.

The key to avoiding this risk is to accurately quantify your exposure to interest rate movements.

  • Determine your strategy: Specify your risk appetite in relation to your annual objectives. What limits exist and what is their impact on your net interest income? Map the relevant policy statements to OCC-defined risk categories, and develop procedures to implement the policy statements.
  • Measure and monitor: Measure interest rate sensitivity and analyze potential hedge structures to move towards your objective.
  • Implement and execute: Recommend potential hedge structures and strategies. Simplify needless complexity, and compare the impact of alternate hedging strategies on net interest income.
  • Evaluate and assess: Address the regulatory, governance, credit accounting, and educational requirements of each recommendation and create a plan to execute.

By using these strategies, Grayline can optimize you institution’s unique objectives and constraints relative to profitability, liquidity, cash flow and income at risk, as well as operational, regulatory, and accounting considerations. A successful framework for interest rate risk management must combine leading practices with regulatory and accounting guidance, with specific attention paid to an institution’s unique risk appetite and strategic objectives.

To learn more about how Grayline can help with managing interest rate risk, contact us.

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The Impact of BREXIT on U.S. Corporations

The Impact of BREXIT on U.S. Corporations

Insight on the recent impact of Britain's exit from the EU.

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Measuring Risk to Hedge CVAs

The market volatility experienced during the 2008 financial crisis has driven many firms to review their methods of accounting for counterparty credit risk.

The traditional approach of controlling counterparty credit risk has been to set limits against future exposures and verify potential trades against these limits. Credit Value Adjustment (CVA) offers an opportunity for banks to move beyond the control mindset of limits by dynamically pricing counterparty credit risk directly into new trades.

Many banks already measure CVA in their accounting statements, but the financial crisis has led pioneering banks to invest in systems that more accurately assess CVA, and integrate CVA into pre-deal pricing and structuring. Their expected return on investment is the ability to support future growth by freeing up more capital and minimizing earnings volatility.

But how do you quantify these risks? How, for example, do you measure reputation risk?

In Douglas W. Hubbard’s book, "How to Measure Anything," he defines risks like these and lays out helpful ways to think about quantification. Without that, trying to manage these risks is impractical at best. At worst, it’s a foolish waste of time that does no more than check a box.

Beyond the Box

Arguably, going “outside the box” may not be required in order to employ leading practices in the realm of risk management and regulatory compliance. It is almost certain, however, that managers move beyond the mentality of simply “checking the box.” That is, merely doing anything just to “get it done” will leave the company in an undesirable state. At the very least, managers and employees will be without direction; more than likely, they will go astray and incur even risk without benefit.

Using a proprietary assessment tool, Grayline helps companies evaluate and rank the state of their internal risk measurement and reporting. Contact us today for a complimentary assessment.

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A Non-Hedging FX Risk Management Strategy

Exporters can avoid foreign exchange exposure by using the simplest non-hedging technique: Price the sale in a foreign currency, and then demand cash in advance. The current spot market rate will determine the U.S. dollar value of the foreign proceeds. A spot transaction is when the exporter and the importer agree to pay using today’s exchange rate and are willing to settle within two business days.

Another non-hedging technique is to net out foreign currency receipts with foreign currency expenditures. For example, the U.S. exporter who exports in pesos to a buyer in Mexico may want to purchase supplies in pesos from a different Mexican trading partner. If the company’s export and import transactions with Mexico are comparable in value, pesos are rarely converted into dollars, and FX risk is minimized. The risk is further reduced if those peso-denominated export and import transactions are conducted on a regular basis.

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How Smart Companies Prepare for Rising Rates

With every anticipated interest rate adjustment, we notice an increase of jitters among our clients. If the Fed raises interest rates, will that put a drag on GDP growth or even crush it altogether? They could opt to wait, but such a holding pattern seems unlikely as it could lead to inflation with easy money and “runaway” expansion.

In one article, "What to Expect as the Federal Reserve Decision Nears," author Jeffrey Moore asks the burning question: which way will the Fed lean in order to do the “wrong” thing?

The implications for global business are huge. An increased demand for the greenback will widen the already appreciable gap between the USD and other currencies. As other currencies continue to weaken, this will threaten the earnings of domestic companies generating business abroad.

But before the dust settles, smart companies must decide how to position themselves for rising rates. It’s a matter of when, not if.

How Smart Managers and Board Members Respond to a Potential Interest Rate Hike

“Smart” companies—no matter what size—are doing at least three things to prepare. They always have, to varying degrees. But now they’re doing them with stepped-up urgency and energy:

  • Evaluate their company’s debt service and capital structure
  • Optimize capital structure around goals and limits
  • Take action early

Smart companies also respond to events in the economy by continually reevaluating their position in light of new information. They ask key questions early — and often.

  • How is my company servicing its debt today?
  • What portion is fixed or floating?
  • Will that change if we do nothing? Are there covenants that may take effect under certain conditions? Will those conditions get triggered in a rising rate environment?
  • What about my company’s debt/equity mix?
  • Have I considered financial instruments that may improve the capital structure?

And smart companies don’t wait until all of the uncertainty is taken out of the equation (that is, after rates rise or after the dollar strengthens or weakens). They know that by then, it’s too late. Instead, they assess their current position, determine the optimal positioning, and act early. Smart companies build risk management into their operations, and the process of assessing, optimizing, and acting is ingrained in the company’s DNA.

The Benefits of a Good Assessment

After assessing its strengths and vulnerabilities, a company must determine the optimal positioning to benefit from (or avoid the downside of) potential events. If the economic context never changed, companies would never need to adjust their balance sheets or capital structure. It is precisely because economic conditions are uncertain–and constantly in flux–that smart companies position themselves to benefit optimally.

Nobody knows exactly what will happen, but every company can be prepared for changes in the economy whether or not they’ve forecast correctly.

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The Difference Between Hedging and Speculating

Derivatives are the preeminent tool for laying off or taking on risk. Because of this dual purpose, the general public (and even some finance professionals) confuses their risky – and risk-averse – role.

Speculation is rightfully compared to making a bet. It may be an “educated” bet because the speculator is forecasting rather than simply gambling. The speculator does not have underlying risk that is being offset. Rather, s/he is taking a “naked” position. The position is the whole show.

Hedging differs from speculating in that a change in the value of the hedge position offsets an underlying risk. The position gains value when the hedged item loses value. When the position loses value, the hedged item gains. The net position of the hedger is neutral.

The speculator, however, is always adding risk.

Risk Management Approaches Vary

A risk management framework is more than just reports and algorithms. It has to make sense for a company’s unique business and risk portfolio, so that risk can be managed optimally.

For example, if a company is positioned to lose money when commodity prices rise, then an unhedged position is more risky than a hedged position. By doing nothing, the company is making a bet that commodity prices won’t rise.  But the company may be taking on more risk by doing nothing more than employing a thoughtful hedging strategy, even if it uses derivatives. The company may be exposed to changes in interest rates, energy costs, commodity prices (agricultural or industrial), or foreign currency rates of exchange. Therefore the “doing nothing” approach is the risky course of action – or non-action, as it were.

This simple example may not match your company’s position, but it might prepare you to think differently.

A thoughtful framework for risk management can help identify and quantify exposures, assess alternative solutions, manage, and report. Contact Grayline to learn more.

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A Solid Approach to Currency Risk: A Primer

Foreign exchange is a risk factor that is often overlooked by small and medium-sized enterprises (“SMEs”) that wish to enter, grow, and succeed in the global marketplace. Although most U.S. SME exporters prefer to sell in U.S. dollars, creditworthy foreign buyers are increasingly demanding to pay in their local currencies. For a U.S. exporter who chooses to sell in foreign currencies, FX risk is the exposure to potential financial losses due to devaluation of the foreign currency against the U.S. dollar.


Companies can avoid this exposure by insisting on sales in U.S. dollars. However, that approach may result in losing export opportunities to competitors who are willing to accommodate their foreign buyers by selling in their local currencies. It could also result in the non-payment by a foreign buyer who may find it impossible to meet U.S. dollar-denominated payment obligations due to the devaluation of the local currency against the U.S. dollar. While coverage for non-payment could be covered by export credit insurance, such “what-if” protection is meaningless if export opportunities are lost in the first place because of the “payment in U.S. dollars only” policy.

But when foreign exchange risk is successfully managed, selling (or buying) in foreign currencies can be a profitable alternative for U.S. exporters. And here’s what you need to know:

  • Most foreign buyers generally prefer to trade in their local currencies to avoid exposure to changing currency rates of exchange.
  • U.S. SME exporters who choose to trade in foreign currencies can minimize foreign exchange exposure by using straightforward risk management techniques available in the United States.
  • The volatile nature of the currency markets poses a great risk of sudden and drastic currency movements, which may cause damaging financial losses against otherwise profitable export sales.
  • Solid currency risk management minimizes potential currency losses (not to make a profit from currency movements, which are often sudden and unpredictable).

Since business activities across borders often expose a company to changing currency exchange rates, exposure can be both transparent and non-transparent. That’s why Grayline’s risk analysis process is comprised of the following five step process:

  1. FX Risk Identification

    Understand a business requires uncovering FX risks embedded in tax strategies, supply chain, and product delivery channels. (The impact is often hidden, affecting earnings, cash flows, and balance sheet composition.)
  2. FX Exposure Analysis

    Quantify earnings and cash flow at risk due to changes in currency exchange rates weekly, monthly, quarterly, annually. Measure the uncertainty and opportunity cost of over-hedging or under-hedging.
  3. Hedge Recommendations/Presentations

    Recommend potential hedging strategies and simplify needless complexity. Compare the various degrees of impact on income, cash flow, and balance sheet.
  4. Hedge Execution

    Address the regulatory, governance, credit, accounting, and educational requirements of each recommendation and create a plan to execute.
  5. Valuation, Monitoring, and Analysis

    Value the hedge (and the hedged item, if necessary), provide accounting advice and/or journal entries, and set up a framework for monitoring the effectiveness of the program.

Determine the aspects of your company’s approach that makes it solid, and identify the biggest challenges.

To learn more about how Grayline can help your business manage currency risk, contact us.

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The Real Winners in China’s Upheaval

In her August 2015 Wall Street Journal article “China Economic Upheaval Mints Winners and Losers,” author Laurie Burkitt fails to mention one key winner: Those companies that outsource elements of their supply chain to China. They win because currency exchange rates continue to favor savvy USD buyers.

The statistics about China’s recent explosive economic boom — and subsequent slowdown of growth — were both helpful and eye-opening. That is, many knew China’s economic growth was strong, but many may not have realized exactly how strong.

Throughout the last decade infrastructure companies from all over the world rushed to meet China’s demand which helped spur further growth, peaking in 2011. Since then double-digit growth continued but the numbers have inevitably shrunk.


The Back-Story to China’s Growth

What makes this topic timely is the huge volatility in China’s stock market, which has several proximal causes. While the economic statistics sited in the article aren’t new (they have been closely tracked through the last eighteen months), in retrospect, China’s stock market bubble should have been obvious. But the huge economic declines have been a big surprise and a cause for legitimate concern. What does it mean? Not just for US companies working on infrastructure projects in China, but for the developing economics of the Chinese people. Will they, like the article suggests, continue to be largely unaffected? Personally, I doubt it.

Historically, the stock market is not an isolated factor and, unlike consumer sentiment, it is a leading indicator. The article sounded a lot like the articles written in the wake of the 1987 crash. Those interviewed didn’t feel any different than the week before the sell-off, which is understandable.

Today, consumers continue to spend and the retail sector is strong. That’s exactly what people said in 1987. The reasoning was something like, “Stocks are not as widely owned as they were before the 1929 crash and the subsequent Great Depression.” But that didn’t seem to matter then because the drop in the stock market was a signal of a severe economic pullback that, one way or another, affected every single person. I suggest that the same is true in the case of China’s upheaval.

So, who are the real winners?

As noted previously, the real winners were omitted from Burkitt’s article: Savvy US companies doing business with China’s suppliers. Not every company working with China in its supply chain, however, will benefit, because the determining factor is currency exposure.

Companies purchasing China-made products and services in USD have “managed” currency risk by passing it along to their Chinese suppliers. In that case, the suppliers will be beneficiaries of any weakening in their currency. Those suppliers will convert revenue received in dollars to more yuan than last year, with more profit left over after paying employees in yuan. In contrast, companies that negotiated lower prices because they retained currency exposure instead of passing it along may be poised to benefit from the strengthening dollar.

Managing Currency Risk

The key take-away is not whether a company chooses to bet on currency exchange rates. Instead, the important questions are:

  • What is my firm’s currency exposure?
  • How do we measure (quantify) it and what is my company’s tolerance?
  • What is the best way to manage it?
  • How do we communicate this to our board and other stakeholders?

By spending time to research and answer these questions, an organization can develop a consistent framework for managing its currency risk.

While there are multiple approaches that can be used to achieve this goal, Grayline’s Six-Factor Framework has been successfully deployed with a number of businesses to help them manage currency risk.

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