Managing forex risk: a toolbox

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Have you read The World Is Flat by Thomas Friedman? It’s full of examples of the way modern communication technology has torn down the barriers between countries and people, levelling the playing field
Issue date 17 August 2007

Have you read The World Is Flat by Thomas Friedman? It’s full of examples of the way modern communication technology has torn down the barriers between countries and people, levelling the playing field. The United States Inland Revenue Service has their income tax returns assessed in India, and radiographers in Britain send x-rays by e-mail to China for analysis and interpretation overnight, with the reports delivered to their desks the following morning. Can you imagine what technology has done to flatten the foreign currency market? It’s by far the biggest financial market in the world, with average daily trade of about US,5 trillion per day – 10 times that of all the world’s stock markets.

And because it’s primarily an over-the-counter market, without the intervention of a central exchange or clearing house, deals are instantaneous and done at the click of a mouse. At any one moment, 24/7, thousands upon thousands of currency traders from banks, commercial companies, investment management firms and hedge funds are sitting at their desks absorbing and assessing news from all over the world, and electronically shifting money around in response. The market is like a huge melting pot into which an ever-changing mix of currencies is being poured, together with world events such as country budgets, surpluses and deficits, inflation, interest rates, economic growth, politics and market psychology. Comprising less than 1% of the global trade in currencies, the rand is a minnow swimming with much larger fish. The flick of a passing shark’s tail throws it off course, giving us an extremely volatile currency. What’s this got to do with farming? Everything.

If you export, it impacts on your rand revenue. It affects the prices of the imported products with which you compete. Not to mention the impact it has on input costs such as fuel, agro-chemicals and machinery. E xchange rates are vitally significant to your business, and a volatile currency does it no good. But what’s to be done? Forex risk management, that’s what, and it’s really not that difficult. Any number of businesses specialise in managing forex risk. First stop is your banker, but if you don’t get the necessary attention, look elsewhere. They all use the same five tools: Spot: This is a direct exchange of two currencies. Forward transaction: Where a buyer and seller set a specified future date for a sale. No cash changes hands until the deal date. Futures: A deal for a fixed amount of currency in the future. Swaps: The most common type of forward transaction. Options: The exchange of one currency for another at a future date. In the hands of an expert, any one or more of these tools may be used to manage your currency risk. Let’s look at each of them in more detail next time.

Contact agribusiness consultant Peter Hughes on (013) 745 7303 or e-mail [email protected].