To Hedge or not to hedge – The Natural hedge mythe

Corporates are in their business to make profit. Or from Treasury perspective: add cash.

More and more corporates are doing international business, and therefore corporates can be exposed to unrelated business exposure. Examples are interest rates, FX and commodities pricing. It all depends on the business model.

And how do you deal with potential orders with these kind of exposure? I have seen companies going bankrupt because they did not hedge their potential orders or fully hedge this using the wrong instruments.

Exposure differentiation

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 type is exposures need different products to eliminate this exposure.

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 mythe: there is only a natural hedge if the cash in and cash out are in the same 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 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 exposure 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.

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