Foreign Exchange Risk Hedging

Any company that does business internationally is exposed to risk due to fluctuating currency exchange rates. Protecting your profit margins is vital, and National Bank can help.

 

 

Simplify your operations and reduce risk

When you issue or receive a payment in a foreign currency, the exchange rate may be very different from the rate you expected when you signed the contract with the other party. Make sure you have the products you need to protect your interests.

 

Fictional exporter example

BNC_Chart_EN

1. International sales contract

You sign a contract stipulating that you will be paid in a foreign currency. At the current exchange rate, your sales revenue will be $200,000. When you factor in $150,000 for manufacturing costs, your profit margin will total $50,000, or 25%.

2. Currency decline (unfavorable)

You're worried your profit margin will disappear.

3. Currency increase (favorable)

The situation is reversed: the value of your sales converted into CAD increases.

4. Delivery

You deliver your product to a foreign company. Although the currency has declined slightly, your profit margin remains satisfactory.

5. Receipt of payment

The currency has plummeted since you delivered the product. After currency conversion, your sales revenue is just $180,000, bringing your final profit down to $30,000, or 15%. The value of the currency could also have increased and profited your company. A hedging strategy can prevent this uncertainty.

Types of FX hedging

Forward contract

The original exchange rate is 100% locked in.

Zero-cost range forward

The final exchange rate is locked in, but within a range rather than a single rate.

Currency option

Provides 100% protection against a rate drop, but lets you benefit from a rate increase (a premium is charged)2.

Fictional importer example

BNC_Chart_EN

1. Buying materials abroad

You have signed a major contract that requires you to buy production materials in foreign currency. Your sales revenue will be $200,000 CAD, and your sourcing costs at the current exchange rate will be $150,000 CAD, resulting in profits totaling $50,000 CAD or 25%.

2. Currency decrease (favorable)

The materials will cost you less in Canadian dollars if you buy them now.

3. Currency increase (unfavorable)

The value of the materials in Canadian dollars has increased. You worry that this increase will reduce your total profits.

4. Approaching payment due date

Production is going well, but the value of the currency continues to rise, and the payment due date is approaching.

5. Payment due

Your materials will cost 15% more than expected. After currency conversion, your sourcing costs are $180,000, leaving you with total profits of just $30,000, or 15%. The value of the currency could also have decreased and profited your company. A hedging strategy can prevent this uncertainty.

Types of FX hedging

Forward contract

The original exchange rate is 100% locked in.

Zero-cost range forward

The final exchange rate is locked in, but within a range rather than a single rate.

Currency option

Provides 100% protection against a rate increase, but lets you benefit from a rate decrease (a premium is charged)2

Main foreign exchange risk solutions

Spot contract

  • Allows you to exchange currency at the market rate in effect.
  • Spot currency trades settle within two business days.
  • These transactions can be carried out online via Internet Banking Solutions.

Forward contract

  • Allows you to set an exchange rate in advance, eliminating uncertainty relating to currency fluctuations.
  • The exchange rate for a future date is based on the spot rate at the time of the transaction, adjusted (upwards or downwards) to reflect the current forward rates
  • The maximum term allowed depends on your needs and the credit arrangements made with the bank.
  • The contract can be settled on a set date, or left open for a period of 30 days (up to 180 days in some cases).
  • You can carry out the transaction online using our Internet Banking Solutions for Businesses.

Range forward

  • Negociate a range in which the exchange rate will be allowed to fluctuate, rather than a single rate.  Allows you to benefit from a favorable market variation up to a pre-determined level; if the market rate moves in the wrong direction, the collar will offer you a safety net. 
  • Maximum and minimum rates are based on the market rates for the selected dates, as well as the exchange rates you have used in your budget.
  • Maximum term of the collar depends on your business needs and the credit limit authorized.  

Average-rate forward contracts

This transaction provides the same benefits as the forward and the range forward, but over a longer period; very useful to protect recurring transactions.  

  • Perform your currency conversions at the spot rate throughout the period of the contract.
  • We calculate the Bank of Canada's average noon rate for the same period.
  • We then make a cash settlement based on the difference between this average and the rate negotiated on your contract for the amount covered.
  • This settlement offsets the spot rate obtained during the period.

Currency option

  • A currency option allows you to secure an exchange rate and protect yourself from undesirable fluctuations while benefiting from fluctuations in your favour. This product is very useful when you respond to a call for tenders involving currency risk.
  • The premium you pay for this product depends on a number of factors, including the term, amount, domestic interest rate, current exchange rate and volatility of the exchange rate.

Other FX solutions

  • Currency swap for businesses with payables and receivables in a single currency, but with different inflow and outflow dates.
  • Cap/floor sales enable you to wait for the market to reach a certain level before implementing a hedging strategy.
  • Participating forwards provide full protection against adverse market movements, while allowing partial participation in favourable market movements.

 

Disclosure statement on over-the-counter (“OTC”) derivative transactions

National Bank of Canada wishes to inform you of the regulation governing the trading and reporting of swaps and other OTC derivative instruments in Canada (the “Reporting Regulations”).

Since October 31, 2014, market participants must report their transactions to provincial regulation entities in Quebec, Ontario and Manitoba.  Regulation has been extended to all provinces and territories since July 29, 2016.

Since May 1st 2017, new information has been required by regulatory authorities.

Summary of regulations concerning the reporting obligation

Frequently Asked Questions

 

Obtaining a Legal Entity Identifier ( “LEI“)

All participants in the OTC derivatives markets in Canada must obtain a LEI (Legal Entity Identifier) in order to comply with the Reporting Requirements. You will therefore be required to obtain a LEI in order to maintain your trading activities with National Bank.

To obtain your LEI, you must follow three easy steps:

Please note that the processing time of your LEI request may take five (5) to ten (10) business days. National Bank of Canada will ask for your LEI and other factual information through the trade facility opening or renewal process.

Check out our directory of resources for reference websites

You can contact GMEI by email at CustomerService@GMEIutility.org

You can contact Bloomberg LEI by email at lei-support@bloomberg.net

Since their system does not allow you to answer to their replies, we recommend that you write all your questions in your initial email.

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1 This image does not reflect actual values and is intended as an example.

2 Prices for this service may vary. Please contact your Account Manager for more information.

TM BUSINESS CENTRAL is a trademark of National Bank of Canada.