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Currency Risks: Disturbance in the Water

After two years of relative stability, the currency markets may be readying for a year of heightened volatility. Will companies be prepared?

The most dangerous situation companies get into comes from thinking they are hedged when they are not, experts say. For example, in many emerging-market transactions, the foreign supplier is happy to accept payment in U.S. dollars, so the U.S. company may assume it has negotiated away the forex impact, says Schulz. But in reality it has not. “If a [U.S.] company imports manufactured goods from Brazil and sends U.S. dollars, then the Brazilian counterparty is taking on the risk, so it is likely to quote a price structure that is padded,” he says.

In other instances companies may assume they are “naturally” hedged and thus have eliminated forex risk. On its October earnings call, for example, Michelin’s Henry talked about the company’s eventually having “a natural hedge through a balanced geographic portfolio.”

But natural hedges can be deceiving, says Frey. If a U.S. company has $20 million in equity in a foreign currency, it may borrow in that currency to net its forex exposure. In reality, though, the company is just swapping one risk for another. That may be especially true in 2014, when volatility across global markets is likely to come in many forms. “The company may be mitigating a portion of its forex risk but then taking on some kind of cash-flow, liquidity or interest-rate risk by borrowing in the foreign currency,” Frey says. “You have to evaluate: is my cure worse than the original affliction I was trying to treat?”

But assuming that a company is naturally hedged isn’t the biggest sin in forex. The biggest offense? Being reactive. “In many cases we get brought into a conversation when a business has already taken a 10% write-down on a significant position and they want to talk about forex risk management,” Frey says. “CFOs need a plan. Even if they’re making a proactive decision to do nothing, at least they are actively looking at it.”


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