Guest blog by James Boorman, Project and Corporate Finance Advisor and Founder of New African Projects and Business Ltd.
In the second of a series of guest blogs that look at issues around forex financial management for entrepreneurs, this week we get to grips with FX Forwards. We get a better understanding of what it could mean for all those women entrepreneurs trying to balance their import and export ambitions with good foreign exchange risk management.
“...A slump in commodity prices and flight by global investors from risky "frontier" markets has hammered currencies and state budgets across Africa, .... From Nigeria and Ghana in the west to Kenya in the east and South Africa and Zambia in the south, currencies have all fallen against the dollar, and in many cases crashed through historic lows plumbed in the 2008-09 financial crisis...…” --- Reuters
Against the backdrop of all this bad news and uncertain times, what can an Importer and Exporter do to ensure they concentrate on their business and don’t lose sleep over their Foreign Exchange (FX) Risk ?
If I have to pay US$ in 6 months to my supplier in Jakarta, why do I not just buy some US$ today and then hold them until I have to pay? There is no reason why you can’t, except it is not a good use of your money. For 6 months that money will be sitting in a US$ account doing nothing and earning very little, when in fact it could be used to create profits elsewhere or pay your workers and factory lights.
So, how can I protect my profits (I did after all quote my client today having looked at what all my costs (including FX) were going to be)? The answer is to lock in a rate today for 6 months by using Forwards.
Forwards are very simple beasts.
Forward Rate = Spot Rate plus Interest Costs
Interest Costs? There is no way that anyone knows where the US$ will be in 6 months time, but Interest Costs are needed because you could have bought the US$ and put them into a deposit account earning something (not much, but still something). Likewise your home currency could have been sitting in a deposit account, hence the need to consider these in the price.
In 6 months time either the US$ has strengthened and I will be very happy I locked in a lower rate, or the US$ has dropped and I could have bought US$ far cheaper, but I will then think of all those happy, sleep filled nights with no worries about the FX risk. Either way I would have quoted my client 6 months ago on the back of a certainty of FX rate, on the back of certainty of import costs and of course, my added profit margin. So what is the end result? Factory still producing, clients still impressed, employees still happy, job done!
The joy of Forwards is that not only are you locking in a rate today, but you don’t have to pay until the 6 months is up. It is important that you trade through a reputable Bank to ensure that in 6 months your counterparty is still around (you still need your US$ !), likewise your Bank may insist on a deposit to ensure that should the spot FX rate then be cheaper in 6 months that you will still honour the contract.
So what’s the catch? If you have Economic Risk Exposures (Unconfirmed Purchase and Projected Orders), then you will have to guess the amount and delivery date and, of course, sometimes payments come late or containers are delayed. In these situations you can trade out of or add to your position, or if your 6 months is close to your new delivery date just take the US$ (there are more complicated solutions for a later discussion). Either way talk to your bank or advisor so that a plan can be put in place sooner rather than later.
Secondly ensure your Bank gives you a tight Spot FX spread (remember last week’s blog on Foreign Exchange for Lionesses) and that it does not then add another profit to the interest points… They will try - but really, they can’t have their cake and eat it !
Look out for next week’s blog: Having a plan and sticking to it!
James Boorman, 22 years in the Financial Markets in London trading many different products from FX to Interest Rates to Commodities to Futures and Options, before being relocated by Credit Agricole in 2007 to Johannesburg as an Investment Banker, Head of their Financial Institutions Department, sub-Saharan Africa. He now spends his time with his family in South Africa whilst advising on Project and Corporate Finance deals. He adds significant value in the foreign exchange value chain to those companies who do not have the necessity or resources to justify a full time Treasury professional or department, but still need to ensure that their market risks are managed (and their sleep patterns undisturbed). Seen here planting Bamboo in Mozambique.
Read more articles by James
