Currency risk for mid-market companies: the complete guide for a finance director
Identify your exposure, choose a hedge ratio, select the instruments, measure the real cost: the full method for steering currency risk without reading a trading-floor manual.
Most of what is written about currency risk stops at a definition and a list of instruments. It answers the question « what is a forward contract ». It does not answer the one a finance director actually asks: how much should I hedge, when, with which product, and how do I know the price I am being quoted is fair.
This guide takes the question in that order. It is written for a finance team in a mid-market company that handles FX alongside everything else, with no trading desk, no dedicated treasurer, and which has to justify its decisions to a managing director and a statutory auditor.
1. What « currency risk » actually means
A company is exposed to currency risk as soon as there is a gap in time between the moment a price is fixed in a currency and the moment the money is actually received or paid. It is not a question of size, it is a question of delay.
Three exposures coexist, and confusing them is the first source of error we meet on assignment.
| Type of exposure | What is at stake | Horizon | Hedged with |
|---|---|---|---|
| Transaction | An invoice issued or received in a currency, settled later | 0 to 24 months | Forward, option, spot FX |
| Economic (or competitive) | Your selling price against a competitor producing in another currency | 1 to 5 years | Pricing, sourcing, location — rarely a financial product |
| Translation | The accounts of a foreign subsidiary converted into group accounts | At every closing | Debt in the currency, balance-sheet forward — a group decision |
The classic trap: a company invoices 100 % in euros, believes it is safe, and finds it is losing tenders to a Turkish or Chinese competitor as soon as the euro strengthens. That is not transaction risk, it is economic risk. No forward contract fixes it.
2. Measure your exposure before talking about products
A hedge can never be better than the data that triggers it. Before calling a bank, you need a schedule: by currency, by month, expected receipts and expected payments.
- 1Collect the certain flows
Signed order book, invoices issued and not yet settled, firm supplier orders. These flows are contractual: their amount and their date are known.
- 2Add the highly probable flows
Recurring commercial budget, framework contracts with indicative volumes, subscriptions. They are not certain, but their likelihood justifies partial hedging.
- 3Separate out the conditional flows
Tenders in progress, commercial options. These do not belong in a firm forward — a forward on a contract you have not won creates a speculative position the day you lose the tender.
- 4Net off
If you receive USD 400,000 and pay USD 250,000 in the same month, your exposure is not USD 650,000: it is USD 150,000 net. Hedging both legs separately means paying the bid-offer spread twice.
That last step is the one that pays off fastest. In a group where each subsidiary hedges on its own side, it is common for a substantial share of the volume traded to cancel out internally — and for the group to pay a bank margin on all of it.
3. Choose a hedge ratio, not a market view
The question « should we hedge now or wait for the euro to fall » has no good answer, because it assumes a forecasting ability nobody sustains. The useful question is different: what share of my margin am I willing to leave floating.
A hedging policy is expressed in three numbers, not in a market call:
- A ratio per horizon: for example 90 % of certain flows at 3 months, 70 % at 6 months, 40 % at 12 months. The further out, the less reliable the forecast, the less you hedge.
- A tolerance band: a range (say ± 10 ratio points) within which the treasurer can adjust without going back to committee.
- A minimum threshold: the amount below which you do not hedge, because the cost of processing exceeds the risk covered.
Written down once, those three numbers remove 90 % of internal debate and give your statutory auditor the reference framework they need to validate your transactions.
4. The instruments, ranked by what they really cost you
| Instrument | What it guarantees | Visible cost | Hidden cost to watch |
|---|---|---|---|
| Spot FX | Nothing — it executes | Bid-offer spread | Margin built into the rate, with no line on the confirmation |
| Forward contract | A firm rate at a date | No premium | Margin inside the forward points; margin calls possible |
| Vanilla option (call / put) | A floor rate, keeping the upside | Premium paid | Volatility overpriced inside the premium |
| Participating forward | A guaranteed rate + partial participation | No premium | Margin hidden in the shift of the guaranteed rate |
| Barrier option (knock-in / knock-out) | An improved rate, conditionally | No premium, or a reduced one | Protection disappears at the worst moment; margin very hard to read |
| Accumulator / TARF | A very attractive headline rate | « Free » | Downside leverage, margin calls, unbounded loss |
A product with no premium is not a product with no cost. It is a product whose cost has been moved into the guaranteed rate, where you cannot read it without recomputing the theoretical price. That is exactly what our pricer is for.
5. Knowing whether the price quoted is fair
This is the blind spot of almost everything available online. You are told what a forward contract is; you are never told how to check that the rate quoted is in line with the market.
The principle is simple enough. A forward rate is not a forecast: it is anchored on the spot rate and the interest-rate differential between the two currencies, and it can be recomputed. The difference between that calculation and the rate you are quoted is, for the most part, your bank's remuneration — the remainder going to the market's own bid-offer on forward points and to the cross-currency basis.
On a plain forward, the margin stays contained and is negotiable once it is measured. On constructed products — participating forwards, barrier options, accumulators — it can become very significant and exceed 2 % of notional. The logic is constant: the harder a product is for the client to reprice, the wider the remuneration that can sit inside the rate. That is why a product presented as « free » is the one that deserves the closest check.
Applied to an annual hedging programme of several million euros, a margin of that order represents an amount that very often exceeds the full cost of outside advice. It still has to be measurable: it appears on no invoice, and only recomputing the reference price brings it to light.
6. Accounting: keep your hedges out of your P&L swings
Without hedge documentation, the change in value of your instruments goes through financial income at each closing, while the commercial flow it protects has not yet been recognised. You end up with earnings that yo-yo while your business is stable.
Hedge accounting — IFRS 9, or the French ANC 2015-05 regulation — exists precisely to avoid that: it lets the recognition of the hedge coincide with that of the hedged flow. It requires written documentation, put in place before the transaction, not after.
7. Where to start from scratch
- Build the schedule by currency over a rolling 12 months. A spreadsheet is enough to begin.
- Net off opposite flows, by currency and by month.
- Write a one-page policy: ratios per horizon, tolerance band, minimum threshold, who decides, who checks.
- On the next transaction, systematically ask for two quotes and recompute the margin before signing.
- Put your positions under monthly mark-to-market review, so you always know where you stand.
Check what your bank is really taking
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Frequently asked questions
The questions finance departments ask most often on this topic
At what volume should a mid-market company start hedging currency risk?
There is no threshold in volume, but there is one in margin. The useful rule: if a 10 % move in the currency absorbs more than a third of the net margin on the contract concerned, the exposure deserves a hedge. A company with EUR 300,000 of dollar flows and a 4 % net margin is more exposed than one with EUR 3 million of flows and a 25 % margin.
Should you hedge 100 % of your exposure?
No, except on certain short-dated flows. Hedging 100 % of a 12-month forecast turns a forecasting error into a speculative position: if the flow does not materialise, the hedge becomes an open position. Declining ratios by horizon — say 90 % at 3 months, 40 % at 12 months — answer that problem.
Does a forward contract cost anything, since there is no premium?
Yes. The bank's remuneration is built into the forward rate quoted, as the gap between that rate and the reference rate computable from spot and the interest-rate differential — part of that gap going to the market itself, through the bid-offer on forward points and the cross-currency basis.
Can you hedge without going through your bank?
Yes. Specialist payment institutions offer forwards and limit orders, often with clearer margins than commercial banks. The point to examine then is the counterparty's soundness, client-fund segregation and margin-call terms, which differ markedly from one provider to the next.
What is the difference between hedging and speculating?
A hedge reduces an existing exposure. A position with no underlying commercial flow, or larger than the flow to be hedged, is a speculative position — whatever the product used. The test is not the instrument, it is the existence and size of the flow behind it.
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