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Member question: “When deciding on whether to hedge a currency, do you take into account whether the currency is cyclical or not?
- “I think that there is a stronger case to hedge a monetary asset in a cyclical currency, such as the Brazilian real (BRL), that tends to appreciate when the economy is doing well and tends to depreciate more when the economy is doing poorly than if we had a liability in BRL.”
Peer answer 1: “No, my current and previous companies all hedged 100% of material net monetary asset/liability positions. I know some companies factor in hedging cost, e.g., model how much volatility reduction they get per dollar.
- “We have not considered a currency’s beta or cyclicality in balance sheet hedging decisions. With the BRL example, USD/BRL is flat to the end of April 2020, but there has been some large volatility month-to-month that we wouldn’t have the stomach for. If you had a BRL liability, you could hedge that and get paid for hedging.”
Peer answer 2: “We don’t, as we wouldn’t want to risk an unpleasant surprise.”
NeuGroup peer group leader Anne Friberg responded that “hedging is to reduce risk and reduce volatility in either earnings, cash flows or both. Most companies do not have the stomach for the negative surprises that might ensue if they assume some sort of cyclicality.
- “However, if they have a view on the currency’s future direction based on observed cyclicality in the past, they could potentially adjust the choice of instrument to preserve upside (with an option) vs. locking in a fixed/no-upside result with a forward,” she said. “To some extent, corporates could also adjust the hedge ratio to reflect a view—within policy flexibility.”
- In accord with Ms. Friberg’s point, she said that most of Chatham’s clients design their balance sheet hedging programs to reduce volatility “with an eye towards operational simplicity, setting hedging triggers and ratios that can be broadly applied and consistently executed, rather than isolating specific currencies.”
- Ms. Breslin added that “exceptions are most often seen due to material transaction costs related to liquidity, companies that have a strong bias towards using forward points as a proxy for hedging costs and/or currencies that represent a relatively high or low proportion of the aggregate risk in the portfolio.”