Hedging SME Foreign Currency Receivables
Companies involved with international trade often want to reduce their exposure to foreign exchange rate variations and potential foreign currency losses by selling their accounts receivables denominated in foreign currency for delivery at a future date, but at today’s market rate for future delivery. Until recently, such hedging and risk reduction was available only to big companies with large contracts. AsiaMart now makes this service available to Small & Medium Enterprises by arranging the packaging of SME receivable forward exchange contracts as small as $10,000 and transferring them to major banks on a daily basis.
This approach minimizes SME’s risk of financial losses (including financial surprises) resulting from currency exchange movements affecting their balance sheet and income statement, along with their revenue backlog. Regarding possible hedging, companies need to forecast the time periods in which revenue is expected to be collected.
Big company treasury groups often calculate foreign currency exposure at each subsidiary monthly and hedge that balance sheet exposure with a forward exchange contract at the most favorable price quoted by the big banks. Revenue backlog has typically not been hedged by US companies due to US accounting (Financial Accounting Standards Board) requirements. This financial service is now available worldwide to SMEs via AsiaMart.
The minimum contract available from a big international bank would typically be approximately $250,000. Forward contracts can go out two years. However, there is a very thin market for forward contracts going out more than one year. A lot of companies hedge weak currencies like the depreciating South African rand, for example. Implied interest rates are up in the 20% range because of high short term rand interest rates in South Africa. (Short term rand interest rates have currently risen to well over 20 percent.
A Hypothetical Big Bank Hedge Transaction
A big international bank might quote a price on selling $500,000 dollars worth of rand forward at six months. On a given day, the spot rand rate might be 6.40 and the forward would add .4 to that, making the forward rate 6.80 six months out. This forward rate takes into account the substantial difference in interest rates and bank’s costs and profits. For example, with the current 20% rand interest rate and say 5% for the dollar, the expected value in six months of $100,000 (640,000 rand) would be 704,000 rand (ignoring compounding) and $102,500 (again ignoring compounding), or an exchange rate at six months of 6.87. The banks would actually give companies a worse rate than this so as to cover their costs, profits and risk. (Forward rates are quoted over the phone on a competitive basis by the different banks. Customers then choose the bank with the most favorable rate.)
However, if a company is not earning the 20% interest on its rand receivables, unfortunately its
$100,000 rand receivable above would provide them with only $93,158 after the six month contract becomes due (640,000 rand /6.87= $ 93,158), a loss of $ 6,841 on every $100,000 worth of rand receivables hedged. A real issue to be addressed is how to manage its rand receivables in a period of high interest rates in excess of 20%.
A key issue would be to ensure that the high rand interest rates are either factored into pricing either explicitly or implicitly. Should major contracts are won and the locally high interest rates cannot be factored into the pricing, it makes a lot of sense for SMEs to examine the possibility of selling the foreign currency receivables via forward exchange contracts, as do the large companies.
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