Companies Can Manage Forex Risks

June 11, 2007
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GRAND RAPIDS — Anytime a company pursues a business opportunity in another country, it’s going to be subject to currency fluctuations. That foreign exchange component can significantly impact how profitable the business will be over the long term. 

When manufacturers and service companies consider exporting to or importing from another country or building a factory abroad, they also have to consider how the volatility of a foreign currency is going to impact their bottom line, according to Dan Ryan, vice president of the foreign exchange and denomination sales group at Chase Bank.

Ryan said he always reminds clients that they are pursuing business in another country because of the product or the management team or the customer base — not because they’re hoping that other country’s currency is going to go one way or another.

Few, if any companies, for example, are going to decide to export to Europe simply because they think the euro is going to appreciate over the next six to 12 months, and they might make a gain on it. The point is that clients, especially in the commercial sector and manufacturing sector, are not equipped, not staffed and not capitalized to effectively speculate in the currency markets, Ryan said. But there are tools available to help a company manage the currency implications of its foreign business, such as hedging forecasted transactions.

If a company is going to, say, export to Europe over the next five years, it can hedge the exchange rate risk associated with the forecasted business over that period of time. Ryan and other members of his team work with clients to help them identify where their risks are, and in many cases, try to help them quantify the risks.

“We try to help them figure out how much sales they have in foreign currency, how much expenses they have in foreign currencies, and then figure out what their business could look like under a couple of different scenarios of where the exchange rate might go,” he explained. “Then we develop a risk management program that helps them mitigate the foreign exchange risk.”

As long as a company remains internationally oriented, the foreign exchange risk is something that has to be managed on an ongoing basis. Ryan said Chase has a number of client companies in Michigan that have been pushing south of the border and building manufacturing facilities in Mexico to export product back to the United States. Most of their business is conducted in U.S. dollars because they’re selling to large domestic companies like General Motors or Maytag. Labor costs tend to be their only exposure to the Mexican peso, so on a weekly basis they simply send U.S. dollars and convert the dollars into pesos to pay the payroll, he said.

But a lot of companies conduct all their international business in U.S. dollars and assume they don’t have any foreign exchange risk because all of their transactions are denominated in U.S. dollars. Ryan has found that’s not really the case. If a supplier in Mexico is selling to a U.S. company in U.S. dollar terms, as the peso gets more expensive and the U.S. dollar loses value, it’s going to be worth less to him and his margins are going to get squeezed. When the currency goes the wrong way against the supplier, he’s going to come back and ask for a price concession or he’s going to have to raise his prices, Ryan said.

“It’s not necessarily the case that you need to be managing the foreign exchange risk, but it would be preferable because then you know what’s happening,” he noted. “However, if your supplier or customer has an active foreign exchange management program in place, then that’s OK. The important thing is that somebody in that relationship is protecting that business relationship.”

Ryan helped Ron Townsend, president of Williams Form Engineering of Belmont, put hedges in place for the next three years that allow Williams Form to sell to Chase at a worst-case exchange rate the Canadian dollars it receives from customers every month.

“So he’s able to protect his business in Canada over the next three years because he always knows what his worse-case exchange rate is going to be,” Ryan explained.

Townsend’s company manufactures heavy anchoring devices for the construction industry. His company has two contracts in Canada and each one gets valued on the last business day of every month.

“Basically, depending on what the Canadian dollar is trading at at the end of any given month will determine whether our currency contract is what we call ‘in the money’ or whether we have to exercise on the option.”     

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