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Limit Orders and Forwards

(and other essential strategies for going into new markets)

Limit Orders and Forwards | HCFX

Scenario

For experienced treasurers, nothing that follows in the case study below will be too surprising.



But for companies confronting new markets and unfamiliar situations, the approaches described here are more than just tips and tricks: they’re essential survival strategies.

Our client is a long-established company based in the UK that sells used farming equipment on both sides of the Channel.

When EU trading relationships changed, they looked for ways to smooth out the bumps in the road for their customers. One way they did this was to invoice their European clients in euros, rather than just pounds.

So, after taking an order on the Continent, they would deliver the goods and receive the euros.

In doing so however, they suddenly found themselves in the world of currency trading and were quickly confronted with the challenges presented by adverse market moves when they sold euros back into pounds.

Banks weren’t about to offer the best rates, but the real issue for them was stability and forecasting.

If currency markets were quiet, their cashflow and profits were predictable. But when the exchange rate moved, their model broke down.

This was because short term currency moves could hinder margins and, ultimately profitability.

Longer term currency moves could also cause problems. Continued movements in a currency would render a price-list redundant and risk the client becoming uncompetitive or facing outright losses.

Both were giving the business too much to worry about.

Solution

Limit Orders for the short term.



Limit orders are a way using a wider window of time to target a better rate. You target the stronger rate by triggering a sale at the higher limits of your profit aspiration. So, you make the market work for you rather than being its servant.

Limit orders work even when you’re not paying attention to the trading screens, and that’s part of what makes them a finance director’s friend. (They work when the markets work, so even though they are machine based, the limit orders take the weekend off too.)

So much for the short-term issue. But there was still the problem of the trend of an appreciating pound making equipment sourced in the UK more expensive. How could our client insure against that?

Forward contract for the longer term.

This required a different style of solution to the short-term currency movements.

Here we used a forward contract to cover 50% of their forecast sales. This would lock in a price for sterling that would guarantee the smooth operation of the business for the next 12 months.

If sales were quiet, they wouldn’t be overcommitted because they were only covering half the amount.

Better still, the forward contract was structured so you could draw down on it as and when it was needed. So, if they sold their equipment in fits and starts, reflecting the agricultural seasons, it was no problem.

Implementation

Hamilton Court could see there would be a series of measures for both the immediate and long term. But we didn’t want to overwhelm with complexity, so we took things step by step, starting with the short-term issues.

Outcome

Together with some more limit orders for the other 50% of sales, they were now ready for pretty much anything the market could throw at it.

The business is doing well and can look ahead to the next year knowing that we have given them several less things to worry about.

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