The CFOs Comprehensive Guide

To Understanding Foreign
Exchange For Business

Bettering Your Business FX Operations

By Timothy Woods and Antonio Rami










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Contents


Introduction

Page 4
FX explained

Page 5
FX explained infographic

Page 6
Exchange rates explained

Page 8
Business foreign exchange explained

Page 10
Effects of home currency strength and how to act

Page 13
Effects of a weak home currency and of increased volatility

Page 14
Choosing an FX provider

Page 15
Advice for effective FX risk management

Page 17
The takeaway: bettering your business FX operations

Page 18





#









As 2 billion people are now online, exporting has never been easier. With
research now pointing to a 34% productivity increase for businesses that
export, it is further proof that it is now absolutely essential to do so.
Companies must if they are to stay ahead of the curve, or their
competitors will beat them to it.
Philippe Gelis, Co-Founder and CEO of Kantox



$
Introduction
As business becomes increasingly international, more CFOs need to
educate themselves in foreign exchange for the good of their
companies. Many CFOs and finance leaders are not yet experienced
in the FX market. For that reason, we have written this guide, where
we explain the fundamentals of foreign exchange applied to
businesses.

For CFOs experienced in FX: please visit our Benchmark
solution for access to live (updated in real-time) mid-market rates.
This service is free of charge for unlimited access, and there is no
obligation to trade whatsoever. Here you can compare your bank or
broker on your FX rates. We also hope that the last section in this
guide, Advice for effective FX risk management, will be particularly
useful for you.

For CFOs new to FX or keen to refresh knowledge base: In this
guide we analyse the basics of FX, exchange rates, the numerous
ways FX can affect businesses, and we offer some key advice on
how businesses can improve and effectively manage FX risk. We
aim to educate you on the fundamentals of foreign exchange,
provide actionable advice and ultimately, better your business
approach to FX.

Business is now more reliant than ever on international trade.
Furthermore, if a company is eager to explore importing/exporting in
order to improve their bottom line, they must become well educated
with foreign exchange in order to maximise their opportunities for
success abroad. In the modern business climate, suppliers and
customers are increasingly sought abroad and international markets
are developed. Such increased international trade for companies
means an increased exposure to the foreign exchange market in
order to pay for and receive payment for goods and services abroad.
Many businesses, however, are still not fully aware of how to best
protect their profit margins from exchange rate fluctuation, assuming
that the only way to go about FX operations is still through paying a
bank or broker, at the same time paying a sizeable fee to do so.

FX risk management makes a huge difference to company cash flow.
For instance, Hornby, the maker of model trains, posted a loss of 1.2
million pounds recently due to exchange rate fluctuation, in what is a
perfect example of why it is fundamental to hedge foreign exchange
risk. A company exposed significantly to FX fluctuation
underestimates the importance of investing time and capital in an FX
risk management strategy at their peril.



A company
underestimates the
importance of an FX risk
management strategy at
their peril


%
FX explained
Foreign exchange (Also known as FX, forex, currency exchange) is
the trading of one currency for another. Domestic exchange involves
the exchange of money for goods or services. Abroad, the same is
true, but foreign currencies are involved (with the exception of the
Eurozone, in which the 18 Member States all use the same currency,
the euro). Therefore, in order to be able to transact in these foreign
currencies, a foreign exchange market is necessary.

The foreign exchange market is the largest in the world, at $5.3
trillion a day, or USD 1,378,000 billion a year, compared to global
GDP of USD 71,670 billion.. It is simply a colossus, unrivalled in size
by any other market. Foreign exchange underpins the modern global
economy, and without it, we wouldnt have access to the everyday
things we take for granted, from computers, to types of food, to the
energy that powers our homes and buildings.

There are two main functions of the FX market: speculation and real
economy. Speculation is the trading of currencies simply to turn a
profit, based on which direction the trader thinks the currency value
will go, up or down. Different to gambling, speculation is based on
calculated risk, at least in theory, and often involves complex
systems of forecast generation. Real economy refers to non-
speculative purposes, such as international transactions that take
place to exchange goods or services in order to do business. For
example, a European company may need to buy a product from a
supplier in the United States. This would involve the exchange of
euro and the US dollar. Another example is in exchanging money
before going on holiday.



The FX market is the
largest in the world, at $5.3
trillion traded a day


&
FX explained infographic
The Kantox FX infographic, below split into three parts, explains
some essential facts and figures about the FX market.





As illustrated in the infographic, the FX market is much bigger than
both the equity market and the global manufacturing sector. It is an
incredible 28 times bigger than the equity market.
Speculation accounts for the vast majority of all transactions in the
global FX market. Although it is difficult to know the exact
percentage, it is widely agreed that over 90% of all traded volumes
globally are speculation, leaving less than 10% for real economy
transactions. This is in contrast to 1975, when around 80% of all
global FX transactions were to conduct business in the real economy.











Part 1 of our
infographic, left,
illustrates the
incredible size of the
global FX market.
Shown in the graphic
are details on some
other markets, global
GDP and some large
cap companies, all
which, as shown, are
easily dwarfed by
global FX.



'



Foreign exchange is more necessary than ever before, as the world
becomes even more interconnected through globalisation and cross-
border trade. Though global foreign exchange involves hundreds of
currencies, the overwhelming majority of transactions involve a
select few. In order, the top five are the US dollar, Euro, Japanese
yen, British pound and the Australian dollar.

Far and away the number 1 FX trading hub is London, where 40% of
global trades occur. In second place is the US, at 18.9%. One of the
reasons why London is so formidable is its geographical position, as
its time zone is among the most suited to global communication. US
dollar is by far the most traded currency, as shown on the left,
followed in second place by the Euro.















(



Top 5 trading currencies (2013 data, total = 200%)
1. US dollar with 87% of share of average volume
2. Euro / 33.4%
3. Japanese yen / 23%
4. British pound sterling / 11.8%
5. Australian dollar / 8.6%

Interestingly, coming in at ninth place was the Chinese Yuan, up
from 17
th
in 2010. It could feasibly reach number one, two or three at
some point in the future, particularly now as China is loosening its
banking regulations, with ambitions to become a major player in the
FX market an increasing priority.


Exchange rates explained
What is an exchange rate?
An exchange rate is the amount of one currency that is needed to
buy one unit of another currency. For example, the Euro/US dollar
exchange rate, also written as EURUSD, may be 1.38. This means
that it takes 1.38 dollars to buy 1 Euro. For instance, you need to
buy a foreign currency often when you go on holiday, or if a
company wishes to purchase supplies from abroad, they often have
to exchange their own currency for that of the supplier in order to in
order to conclude payment. The exchange rate comes directly into


The last part of our
infographic, left, shows the
explosive growth of the FX
market since 1998. We
have illustrated this growth
by showing the main type
of FX transaction,
including swaps, options,
forwards and spot trades.

Since 2010 the FX market
has increased in size by
33%


)
play to decide the quantity of the home currency that is necessary to
meet the price of the supplier currency.

Types of exchange rate: (1) floating and (2) fixed

Floating exchange rates
In stark contrast to fixed exchange rates, floating exchange rates are
currency pairings whose price constantly changes. They are are
used almost everywhere in the developed world. Floating exchange
rates can change by the second, as a result of the constantly
changing variable factors that influence a currencys strength. The
strength of a currency is measured in its comparison to other
currencies through exchange rates. They fluctuate as currency value
is determined by a series of supply and demand factors, including
trade flows, tourism, interest rates, rates of inflation, political stability
and speculation. For instance, if interest rates are increased
substantially, in the UK, demand for pound sterling will increase as
people will invest money to the British currency to take advantage of
the interest rate increase and make money. If interest rates fall, the
opposite consequence is highly likely to occur. Therefore,
governments attempt to control various factors to ensure exchange
rates are at a level that will help their respective economies grow. A
delicate balance often has to be struck.

Fixed exchanged rates
A fixed exchange rate is where a currency of one country is pegged
to a stronger currency, whose purpose is to maintain the weaker
currencys value within a tight range, thereby protecting it
significantly from the risk of fluctuation. Fixed exchange rates protect
the valuation of a weaker currency by providing less uncertainty
regarding importing and exporting prices, and assisting a
government in maintaining low interest rates and thus, low inflation
rates. This is intended to lead to increased trade and economic
stimulation. Many African nations have pegged their currencies to
the Euro for instance, while many Latin American countries are
pegged to the US dollar. They are traditionally pegged to the
currency of a larger trading partner.


China is loosening its
banking regulations, with
ambitions to become a
major player in the FX
market an increasing
priority


*+
Business foreign exchange explained
Businesses small, medium and large are increasingly turning to
foreign markets, due mainly to increased competition from home and
abroad and because of reduced local demand. To execute
successful business strategy abroad, a company must master how
to optimise their foreign exchange transactions.

Why do businesses need to exchange currencies?
Businesses need FX more than ever before for various reasons. The
management of foreign exchange transactions is of critical
importance in order to maximise profits and minimise loss through
rate fluctuation. Incorrect management of foreign exchange
transactions can have far-reaching consequences, including lower
profit margins, lack of capital for reinvestment in the company or
even worse, bankruptcy. Therefore, it is pivotal that a company is
fully aware of its exposure to FX and how to best protect itself from
said exposure.

1. Paying foreign suppliers
Most businesses pay suppliers in the local currency of the supplier.
Although one may also see suppliers who accept payment in the
currency of their customer, it is highly advised to pay in local
currency to get more competitive prices, even if this means
supporting FX risk, particularly when paying in exotic currencies.

Example: A wine supplier in Europe who sells Californian wine
needs a Californian wine supplier. Whether it is bought directly from
the supplier, or through a middleman in Europe, an FX operation is
essential.

2. Paying employees/contractors in foreign countries
Companies often pay their employees in different countries from
their headquarters. This requires the company to exchange a certain
amount of home currency to meet the salary of the employee in the
foreign currency.

Example: A US-based company with 10 employees in the UK, each
earning 50,000 pounds annually, would have to transfer the required
amount of US dollars into pound sterling to pay the UK employees.
Subject to the fluctuating exchange rate, they are likely to have to
pay different amounts of dollars each time, though the pound sterling
amount will remain the same.

3. Funding foreign market operations
Subsidiaries in foreign countries often need operating capital from
the parent company, for various reasons. These can include market
expansion; setting up in a new country; unexpected costs from
exterior events, such as political and economic developments, as
To execute successful
business strategy abroad, a
company must master how
to optimise their foreign
exchange operation


**
well as natural disasters; and in staving off bankruptcy in some
cases if a subsidiary goes through a period of struggle.
Example: Topshop, the UK high street clothing store, expanded its
operations into various foreign markets. In order to do so, the UK
company had to purchase foreign currencies with pound sterling.
When opening in Spain, in order to set up, the company had to pay
in Euro, and in the US, with Dollar, almost certainly requiring
repeated exposure to the FX market in order to exchange from
pound sterling.

4. Repatriating profits from subsidiaries into the company head
office home currency
Companies periodically repatriate profits from offices abroad into the
company home currency. Depending on the number of offices
involved, this can potentially mean a large number of currencies.
Operating in more countries means access to more customers and
thus, greater sales and profits. However, without correct
management of risk, these profits can quickly dissipate, lost in the
exchange rate once repatriating.

Example: The Japanese carmaker, Nissan, repatriates profits made
across the globe into Japanese yen. As the carmaker sells its cars
all over the world, they are very much exposed to FX market risk. In
May of this year, Nissan reported inflated fiscal year profits, which
came in large part as a reversal of the yens appreciation against the
US dollar the previous fiscal year. Japans second biggest carmaker
earned $3.8 billion in the fiscal year to March 2014. This is an
example of how the fluctuation inherent in the FX market can be
positive, though equally, it can be devastatingly negative should
there be a loss.

5. One-off asset sales/purchases
This can include the takeover of other companies, sale/purchase of
company assets, and any purchases for operating purposes from
abroad. The exchange rate of course, has its part to play in how
much it costs the buyer. If the home currency is weak at the time of
purchase, a company will pay a lot more for the product.

Example: International takeovers can often see the exchange of
currencies in order to complete the deal. For instance, earlier this
year, when the British firm, Vodafone, sold its 45% stake in Verizon
Wireless to back to Verizon Communications for $130 billion, it
involved the exchange of funds from US dollar into a number of
currencies. Chiefly, these included British pound, euro, Japanese
yen and also Swiss francs. Such hige takeover deals are nearly
always pre-hedged to protect the deal in the exchange rates.



Forward contracts fix in
todays rate for an agreed
trading date in future


*"
Risks for businesses when exchanging currencies
A currencys value strength is deduced by how much of another
currency can be bought with it at any given moment. Rate
fluctuations often mean the gain or loss of huge sums of capital for
companies trading in large volumes. Even the slightest change can
make a significant difference when a large transaction takes place.
For this reason, risk-management solutions are in place, such as
forward contracts, which fix in todays rate for an agreed trading date
in future. This, for instance, is one way parties to a trade are
protected by the risk of loss through rate fluctuation. It also means
that any gains that may have been received are also lost. However,
once a companys cash flow is on the line, it is a dangerously risky
strategy to gamble on a positive exchange rate movement. Such a
strategy has turned what would be many profitable international
trades into debts, and even plunged companies into insolvency.

The following table shows 8 different examples of negative FX
impact as a result of neglect or mismanagement regarding FX risk
strategy:


COMPANY / GROUP TIME PERIOD NEGATIVE IMPACT
Group of 800
multinationals
2013 Q2 USD 4 billion FX loss
XL Axiata 2013
63% fall in profits due to FX
loss (Rp 1.03 trillion ($84
million) in 2013 from Rp 2.77
trillion a year earlier)
US Fortune 2000 2012 / Q3 USD 22.7 billion FX loss
Proctor and Gamble 2012 USD 3 billion FX loss
US Fortune 500 2010 USD 100 billion FX loss
Turkish Airlines 2010
TRY 774,9 million FX loss
(and increased financial costs
of TRY77.8 million)
South Africa Airways 2003/04
FX mismanagement plunged
the company into insolvency
SMEs in the UK 2010
More than 55% of SMEs did
not hedge against FX
risk,representing an estimated
potential risk of 20.4 billion
pounds




*#
Effects of home currency strength and how
to act

When a companys home currency goes through a sustained period
of strength, they may wish to change strategy to protect their profit
margins. While home currency strength may be good news for
holidaymakers, many companies that export overseas will be hit by
losses from the negative impact on foreign exchange rates as they
convert money from international customers and subsidiaries to their
home currency. A good example is Europes Airbus Group. Airbus
costs are nearly all in euro, as they are based in Europe. However,
their client payments are predominantly completed in US dollar.
Airbus therefore have to convert their profits into euro, which is a
costly process.

Exporting
Exporters will likely be hit hardest, and must face a choice of either
absorbing a probable loss of custom or adapting their business by
lowering their prices. After all, as far as the customer is concerned,
they are paying a lot more for the exact same product as they did
before the currencys gains. It is advisable to lower prices in the
short term, preparing for shorter profit margins, rather than lose a
client altogether by demanding the same GBP price. Long-term
relations are what matter to a business. Furthermore, clients will
appreciate UK exporters efforts to accommodate their clients in
challenging circumstances. Relationship-building is what makes a
business thrive in the long-term.

It is also an opportune time for businesses to channel energies away
from focus on price, and instead on improving product, timeliness
and client relations. If trust and rapport with a client is built up over
time, the client will likely stick with a company even if it means
paying a little more on their product.





*$

A time for importing
As the home currency has greater buying power when strong,
companies that import to the currencys home country will see
increased savings on orders, or may choose to take advantage of
the currencys strength in order to bulk-buy, in case the market
moves against them in future.

Exporters can also take advantage of the strength of the home
currency. They can use its buying power to improve business by
investing capital in foreign services or products. Who knows when
the currency will be so strong again? Now is an opportune time for
businesses to improve technologies, facilities or in foreign market
expansion investment, for instance.

The strength of a home currency often sounds the alarm bells for
exporters. However, in taking a long-term view, rather than micro-
managing each period of currency fluctuation, a business will be
much better off. Retaining customers in such challenging times is
paramount for a businesss long-term future. Such a time should also
be taken advantage of where possible, in optimising import
operations and focusing elsewhere on business improvement.


Effects of a weak home currency and of
increased volatility

With a weak home currency, essentially inverting what one would do
with a strong home currency is advised. It is a time to maximise
sales abroad and take full advantage of your selling power to
international customers. If importing, first of all ask your suppliers if
they would consider amending their price as your home currency is
weakening your buying power and affecting your profit margins. If
this is not successful, you could then consider changing suppliers or,
if possible, consider focusing your efforts on areas of your business
that do not require importing.

With increased volatility in exchange rates that you operate in,
increased hedging is especially crucial. Hedging will take away the
risk of volatility in the exchange rate. There are businesses that take
a risk on the exchange rate, as it may very well rise. However, such
a strategy for an SME is dangerous and foolish. If the rate were to
plummet unexpectedly and your business did not hedge through a
forward contract, for instance, what would be the impact on your
business? In many cases, it would mean profit margins being wiped
out, debt accumulation and possible layoffs.

While home currency
strength may be good news
for holidaymakers, many
companies that export
overseas will be hit by
losses


*%
Choosing an FX provider

Traditionally a business first opts to go with their bank. If a change is
instigated, it has normally been to change to using a specialised
broker. Now you can choose between your bank, FX broker services
and now, what the alternative finance sector offers in the form of FX
service provision. So you have 3 options, of which it is advised you
take your time while considering all options.

Points to remember:

Price comparison
Comparing FX services is crucial. Do not take 0% commission
claims at face value. Find out the exact charges applied to FX
transactions. This can include a transaction fee, spread in the
exchange rate and a delivery fee. Some providers even add
administrative fees, so caution is advised and getting fully informed
before committing. Also, many businesses have been duped by the
common dumping practice where unbeatable initial rates are
offered in order to snare the customer, before loading charges into
subsequent trades. This requires a stonewall attitude when it comes
to questioning the potential FX provider. Ask, ask and ask again to
ensure all doubts are clarified.

Many FX providers are also really unfair, charging their clients huge
spread, when using stop-loss or automatic orders. In that case, they
usually widen their spread given that the client is unable to track the
order and check the timing and spread applied.

Clarification of your business FX needs
If you only need a simple enough service, such as spot trades or
forwards, regular care is advised not to get sold complex financial
products that are not needed. Many businesses buy financial
products that they either do not need, or use sparingly at best,
unnecessarily increasing costs. Banks are adept at selling these
products, promoting unique features to the client, which may be
impressive, but for many customers, they are irrelevant. Such a
product is an accumulator, a type of financial derivative, where if a
strike price is met, both the buyer and seller are obliged to complete
the trade, having previously reached a binding agreement. Banks
and other FX service providers are known for promoting their more
complex financial products more, as they are simply much more
profitable for them.

Ease of use of trading portal
Is the platform understandable and efficient? Will you have any
issues with understanding exactly how much you are being
charged? Do you have access to live mid-market rates to know
Reputable service
providers are authorised
and regulated. In the UK,
for instance, look for
Financial Conduct
Authority


*&
exactly what spread you are charged? These are the questions that
will be important once you start trading, as your businesss time and
money is in play.

Regulatory compliance
Reputable service providers are authorised and regulated. In the UK,
for instance, look for Financial Conduct Authority (FCA, formerly the
FSA) regulation. Other countries have regulatory or supervisory
bodies. Clarifying regulation procedures and requesting proof if in
doubt is pivotal, no matter how professional a providers website
looks.

Customer service and treatment of current clients
Being able to contact your FX account manager or another
representative from your FX company will be an important factor in
your considerations. Do they accommodate your requests in full and
promptly? Is there a proper complaints system in place? Do they
focus on their current clients as much as they do in winning new
clients? These are just some of the questions that should be
considered.






Before any transaction,
prepare your business for
all possible outcomes, good
and bad


*'
Advice for effective FX risk management

With the right risk management techniques, small businesses can
avoid significant financial losses and unnecessary costs.

Know your risk
Analyse exactly where your business is at risk from foreign
exchange fluctuation. Before any transaction, prepare your business
for all possible outcomes, good and bad. Imagine that you sell to an
American client who pays you in USD, but there is a 60 day period
between the date of the sale and the payment date. If the USD/GBP
exchange rate falls 20 per cent during that period, your revenue will
also fall 20 per cent!

Stay one step ahead
Consider using hedging products like forward contracts. A forward
gives you an agreed fixed rate to be paid at a later date, thereby
protecting you from rate fluctuation (60 days in the example above).
Depending on your product or service and their profitability, some
products may be more suitable than others and the percentage of
market exposure you hedge may vary from 0 per cent to 100 per
cent. Market exposure represents the amount an investor can lose
from the risks on a particular investment. The greater the market
exposure, the greater the market risk. For example, a business
involved in raw material trading may hedge close to 100 per cent of
their exposure.

Shop around
Beware of hidden fees in the exchange rates offered by banks and
brokers. Additionally, keep your eyes peeled for high commission
rates and delivery fees. They are all essentially one and the same:
ways for the banks to make a profit on your transaction. With this in
mind, the profitability of your company also depends on your ability
to find a competitive FX provider. Full understanding is crucial to
ensure you know exactly what you are being charged. Its your
money; demand transparency! Paying a large spread simply
because you dont have access to market prices is unjust.

Be careful, avoid complacency
Dont choose products that you dont perfectly understand. Unlike
forwards, options are normally clouded by a lack of understanding
due to their intricacy and pricing structure. Long contracts that tend
to be very complex are best avoided. Negotiate hard but always
make sure you understand what you are buying.

Ask smart questions
Brokers are known for what is called dumping- offering an
unusually low initial exchange rate in order to snare new clients, only
Dont choose products that
you dont perfectly
understand. Negotiate
hard, but always make sure
you understand what you
are buying


*(
to then steadily increase the price through hiding fees in the
exchange rate. This maximises their gains at your expense. If rates
seem to be going up, dont be afraid to ask questions and move to a
more transparent provider.

Prepare prudently
Your business, your sector and the FX market all inevitably go
through changes. Plan a regular review of foreign exchange
practices with your financial director/CFO. Ensure your company is
up to date with FX market services and updates, and that your FX
transactions are as financially profitable for your company as
possible.

Avoid exotic currencies
Currencies outside the mainstream U.S dollar, euro, sterling,
Canadian dollar, and the Japanese yen, among others, are best
avoided. The exchange rates tend to be acutely unfavourable, as
exotic currencies are infrequently traded and are lower in demand.
These include the Chilean peso, Indian rupee and Thai baht, for
example.


The takeaway: bettering your business FX
operations

With this guide, we hope that you are a little more knowledgeable
now with foreign exchange, and can take away some actionable
advice with your FX strategy. No matter the size of your company,
whether you are a sole trader with a small percentage of your
custom abroad, a medium-sized business or a mid-cap, FX
management is increasingly crucial in todays marketplace. If, for
instance, you have a small foreign market operation, perhaps now is
the time to explore further expansion, given the unprecedented ease
of entering new markets. If larger, a review might be in order to
streamline your procedure. A prudent, well-informed FX
management strategy is fundamental to maximise profits and protect
your business from FX risk. You dont want to go the way of Hornby,
posting a loss of 1.2 million pounds through FX fluctuation. Cutting
corners on FX or not preparing sufficiently can be costly. It is
advised to invest the time and capital required. It will save your
company on both commodities in the long run.


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About Kantox

Kantox is a pioneering firm in the FX industry, bringing light and
providing fresh air in an obscure, static market. Expertise and
passion result in an efficient and transparent solution to serve real
economy clients.


Trust and Security

We are regulated by the Financial Conduct Authority (FRN 580343)
and the HMRC (12641987). All client funds are held in segregated
bank accounts at leading banks.


Transparency

We clearly display the mid-market rates and the fees we charge.
There is absolutely no hidden commission or fee. In other words, we
are fair.


Savings in 25+ Currencies

78% of our clients are saving more than 80% compared to their
banks or brokers .







Start Trading with Kantox


"+











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