Article series – Part 2 of 2
Mike Smith, derivatives lawyer, Montreal, QC, CYBF mentor
Whether you plan to manufacture or sell internationally, or buy large quantities of raw materials, exchange rates will be an important factor in the decisions you make. The world markets are liquid, flexible and highly complex, so to protect your business, be sure to manage foreign currency exposure. If the overall transactions are over a certain size, derivative strategies can be useful tools to hedge against foreign exchange risk.
Securities laws (which vary by country and in Canada, by province) dictate different criteria that must be met before a company can enter into a derivative trading strategy. Among other things, these criteria include having base corporate assets of at least 5 or 10 million (depending on jurisdiction) and a credit/margin account with a member institution (e.g. bank) of a forex market which are reserved for mid-to-large corporations.
Common forex derivatives include:
To learn how contractual agreements can be used to protect your company from foreign exchange exposure, see Managing foreign currency exposure: Contractual agreements (part 1).
Please note that this is only a cursory overview, so if you plan to use some of these hedging strategies, make sure you seek proper advice from your banker/derivatives trader, accountant, finance department, or derivatives lawyer. Used properly, these strategies can allow for some stability in prices, despite market fluctuations. If they are used improperly, your business could face large losses, which have bankrupted many companies and municipalities in the past.