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Dealing in FX involves far more than monitoring the prevailing spot rate in each currency pair. Below, we offer a concise overview of FX rates that together offer a consistent, holistic framework for managing FX risk.

Spot Rate – The price for buying a currency and selling another today, for settlement in two days’ time. Simple.

Forward Rate – The price for buy a currency and selling another today, for settlement at any day in the future beyond two days’ time.

Budget Rate – Typically set by Finance and Treasury teams ahead of an upcoming financial year or reporting period, this is the FX rate used to convert international budgeted forecasts back into the company’s reporting currency.

This is often a static rate that is not updated rapidly enough as market or commercial conditions change throughout a year. Also, not every company’s treasury or finance teams have a consistent or robust budgeting process, making this rate unavailable. For this reason, we also consider Target Rates.

Target Rate – The expected rate that international cash will be converted into the company’s reporting currency. This rate is more flexible than a budget rate, e.g., it can be set by week or by month and it can change as needed to reflect dynamic changes in a company’s operating environment. For example, if a company had a AUD/USD budget rate of 0.7200 at the start of 2020, they may have reduced their target rate to 0.6500 by mid-year to reflect the reality of AUD/USD’s drastic depreciation.

This rate acts as an important tool for converting forecasted FX exposures and as an anchor to compare against Average Hedge Rates and Achievable Rates.

Average Hedge Rate – In each currency pair, the average rate of all hedges in each period, e.g., average monthly hedge rate or average annual hedge rate. This one is fairly self-explanatory.

Achievable Rate – If we hedged 100% of remaining unhedged exposures at prevailing forward rates and blended this with current hedging and hedge rates, this would give us the average hedge rate for an exposure that is now 100% hedged. In other words, this would be the achieved rate we would transact at. We can theoretically secure this rate today, so we say it is the Achievable Rate.

This can be a highly valuable metric when we compare our Achievable Rate to our Target Rate because we can easily monitor both in cash terms and as a percent how far above or below our Target Rate we are today, which may help signal whether more or less hedging is appropriate.

This is all driven in large part by the accuracy of cash flow forecasts, so these values must be taken with a grain of salt if forecasting processes are inconsistent or unreliable.

Synthetic Rate – Best introduced with what sounds like a riddle – If your company reports in AUD, has revenue in GBP and costs in USD, so is using Sell GBP/Buy USD forward contracts to fund USD costs, what is your AUD/USD-equivalent average hedge rate, including these GBP/USD forward contracts?

It is incomplete to assess Achievable AUD outcomes of USD cash flows if we are not including the impacts these GBP contracts. As such, Equip converts GBP/USD hedging rates into an AUD/USD equivalent rate so that it can be blended with the more straightforward AUD/USD hedging. This keeps all comparisons in a clean ‘apples to apples’ framework to assess whether more or less hedging might be required.

Costing Rate –The rate a sales team uses to set a price for an FX sales contract. In a highly mature FX rates regime, this value can be based on considerations of Budget, Target, and Achievable Rates, however it is highly variable how each company would apply this to their own operations.

Piecing this together conceptually for a company can be a challenge on its own, let alone implementing and then managing and monitoring it on an ongoing basis. Achieving this quickly and consistently is at the heart of the Equip platform’s FX Risk workflows.

We also provide strategic consulting and operational support services for managing this framework. If you think your company could benefit from a more robust rates regime, we would love to hear from you so please get in touch today!

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