Foreign Exchange Management: Internal Hedging Methods (Part 1 of 4)

GO TO MAIN PAGE FOR ALL TOPICS COVERED UNDER FOREIGN EXCHANGE MANAGEMENT: 

The internal hedging methods are techniques which emanates from within the company. It is an integral part of company’s regulatory treasury to prevent an exposed position arising in the first place.

There are basically four internal hedging methods.
1.       Leading and Lagging Method
2.       Matching Method
3.       Netting Method
4.       Inter-Company Foreign Exchange Contracts

This article describe the first method which is the
1.  Leading and Lagging Method

This is the process of adjusting timing for imports and exports in order to reduce an exposure period or match a particular currency profile and to take advantage of an expected currency depreciation or appreciation.
The success using this approach depends:
·   on your relationship with your suppliers and buyers and
·   the currency’s strength or weakness.
Therefore, leading and lagging is normally commonly applied to intercompany transactions as there would be no conflict with third party suppliers or buyers.Relationship with Suppliers and Buyers:Relationship with the suppliers must be exceptionally good so as to be willing to grant you the extra credit period and if your company regularly leads payment because the import currency is appreciating, you should negotiate for discount for prompt payment. Interest costs incurred may be charged by one subsidiary to another where lagging has caused additional charges. Therefore, there is some costs incurred for these concessions. For this reason, such an approach is usually restricted to arrangements within the company itself. Besides these costs, there is also the administrative costs of monitoring the situation.
Note that if we are dealing with third parties, they may agree to provide additional credit facilities or to clear the account more rapidly if the purchase price is allowed to reflect their additional interest and administration costs.
The currency’s weakness or strength also determines whether you should lead or lag.
If the paying or receiving currency are equally weak or strong, there is no advantage in leading or lagging from a currency exposure viewpoint.
The rules for leading and lagging are summarized as follows:
                                                            Receiving Currency
                                                            Strong               Weak
                                    Strong                   -                      Lag
Paying Currency
                                    Weak                 Lead
The advantages are as follows:
· facilitates the use of netting and matching systems,
· inexpensive in terms of running costs,
· this is a better method of managing group liquidity rather than using intercompany loan,
· it allows fine tuning for group tax management. It’s allow a company to use leading and lagging to take advantage of different tax rates in different countries.
(Please refer next article on Matching Method)