Based on my experience of managing over 1000 clients over the last 2 decades, here are the "9 common mistakes to avoid as a treasurer"
1) Your risk appetite is linked to your OPM (operating profit margin). Never let FX losses erode your operating margins.
2) Always document your hedging/risk management strategy i.e. minimum hedge ratios, percentage to be hedged through each hedging instrument, whether to hedge on gross or net basis. Consistency is the key. Avoid impulsive decisions. It is important to develop a MIS as it helps in risk monitoring. Anything that cannot be monitored cannot be controlled.
3) If you are taking an active call on a currency make sure you always do so with a stop loss and ensure you strictly adhere to the same. Importers saving carry in a benign environment can lose it all and more in the event of vol explosion. Remember that realized volatility usually undershoots implied volatility for prolonged periods and by smaller amounts but during brief spells when it does overshoot implied volatility, it does so by a huge margin, obliterating all carry gains made during the low vol period. In other words, gains made over 2-3 years can be eroded in 3 months. A benign carry environment causes complacency to creep in and results in anchoring and confirmation bias which causes one to ignore the warning signs of an imminent breakout.
4) Ensure you do not hedge the same exposure twice i.e. take PCFC and also book a forward for the same. Mark to Market (MTM) impact on your hedge book may require you to post additional collateral as margin, the unavailability of which could compel you to unwind positions at a loss or may constrain you from entering into hedges when levels are really attractive. Hedges based on past performance should be entered into considering business visibility. Therefore it is prudent not to overhedge if you see the business slowing down during recessions
5) Make sure your team understands the payoffs and risks associated with option structures thoroughly before executing them. While options impart a lot of flexibility, if risks are not evaluated properly they can be brutal. We have seen how leveraged option structures and exotic options have proven to be the nemesis for several companies in the past. Also there is a general aversion to entering into premium paid options i.e. an obsession for zero cost option structures. Premium paid options can be used equally effectively. Think of the option cost as an insurance premium.
6) If you are hedging USDINR and Cross/Dollar separately always know the correlation risk. This is especially relevant in case of borrowing in lower yielding currencies eg JPY, CHF, EUR. During times of risk aversion JPY appreciates and INR depreciates i.e. USD/INR and USD/JPY move in opposite directions resulting in a double whammy. Such types of correlation breakdowns are typical during times of crisis eg. Asian financial crisis of 1997 and Subprime mortgage crisis of 2007, Removal of the EUR/CHF floor by SNB in 2015.
7) Optimize Cash and Investment management. Liquidity management and cash flow forecasting are crucial. They help manage ALM risk and augment ROI. While investing in liquid mutual funds, do keep a close watch on the portfolio composition from time to time to check exposure to dubious credits. Exposure to a few dubious credits for a few basis points of additional yield pick up can prove disastrous in the event of a default.
8) It is important to understand the term structure of annualized forward curve, especially for longer tenor hedges. Even forwards these days are extremely volatile and therefore basis risk is high.
9) Do not act on hearsay. Crowded trades generally do not end well. There is no free lunch. Always do your own due diligence and objective research before executing any strategy.
Would be happy to receive your comments, feedback on the same at:
We put together our take on the major domestic and global factors driving risk sentiment over the medium term with special emphasis on political developments, monetary policy outlook and fiscal policy implications.
We may see some volatility on account of domestic election results in the sh...
Quant based FX Advice.Subscribe for exclusive access.