07Jun
By: Eric Van Essen On: June 7, 2017 In: Currency, Export Tips Comments: 0

What is “Hedging”?

The vehicle export and import trade business is very efficient and traders work with relatively small margins. The various currencies used (CNY, CAD, USD, and Euro) continue to become more volatile and potential profits can be eliminated quickly if you are not properly protected.  Protecting yourself involves a financial transaction which is profitable when your vehicle transaction is less profitable and vice versa.  This is called “hedging”.  The party involved in the vehicle transaction who is purchasing and selling in different currencies is the one that should be hedging.

Methods of “Hedging”

Hedging can be done by your bank, a foreign exchange specialist like Afex (www.afex.com) or in some cases by the company who you are transacting with such as Techlantic.  There are many types of financial transactions which essentially accomplish a similar result: profit when the exchange rate moves in the negative direction you are protecting against.  Some of the specific transaction types that are commonly used include:

Option Currency Contracts

  • Holder has the right to trade the currency in the future but does not have an obligation
  • Cost to enter the contract

Forward Currency Contracts

  • Binding agreement to trade the currency in the future with specific terms that can control your risk and reward
  • Many types with various degrees of risk and reward to fit your needs (ie. Tunnel Forward, Cable Car, Enhanced Forward, etc.)
  • No cost to enter the contract but have a cost or profit at the end of the agreed time frame
  • Fixed time frame

Future currency contracts

  • A standardized forward contract
  • No cost to enter the contract but have a cost or profit at the end of the agreed time frame
  • Can be rolled over to next future period essentially making the time frame indefinite

 

Cost of “Hedging”

Because the risk exposure of an option is minimal, the contract cost can be high.  It is not uncommon for the cost of an option contract to be over 1%.  Due to the small margins with the vehicle international trade business, this added cost makes it prohibitive.

Forward and future contracts have a comparable cost and is typically related to the difference in current interest rates in the related currencies.  The risk of adverse currency movements can be very significant and can result in a loss on your vehicle trade.  The cost of currency hedging in comparison is small.  Implementing a hedging strategy is strongly advised to ensure your transaction has a predictable profit.  For this reason, Techlantic can offer this service to our clients as part of any transaction.