Foreign Exchange Benchmarking
With foreign exchange benchmarking the business would state where it would like its exposures to reach.
a) The Business will set a benchmark for its exposure management practices inhouse or utilise a company to deal with this.
b) The foreign exchange benchmarking will be set for 6 months periods.
c) The foreign exchange benchmark would be based and incorporate the following principals;
d) The foreign exchange bench-marketing set should be realistic and achievable.
- “Should Exposure Management Practices be conducted on a **Cost Centre** or **Profit Centre** basis?” - Any Forecasts should be discussed and agreed upon at an early stage, where the Benchmark should be the Probabilistic Expectation of the rate in question. - The Forecast risk, Market and Transaction risk, and Systems risk should be discussed and agreed upon at an early stage. - Room for error in keeping with any Stop Loss Margin you have set in place. - Businesses that have trained personnel dealing with exposure could look at a "long-term Capital scenario" where the business is looking to manage them on a **PROFIT** Centre basis, since the exposure are not open to day-to-day business risks. - Businesses whose exposures are of "Short-term Revenue" scenario should manage them on a **COST**Centre basis, since the exposure impact the Profit and Loss Account directly.
Profit Centre Concept
Under a profit centre concept, the Exposure broker is required to generate a NET Profit on the exposure over time. This is an aggressive stance implying a high degree of risk appetite on the part of the broker. A business with a strong position and healthy books and bank balance can afford to take some financial risk and can opt for this concept.
The Benchmarks under a Profit-Centre concept would take the form of “The total cost of a foreign currency loan should be reduced by at least 25 bp over a one year period, from the forecasted rate of x.x% p.a.”
Under a cost centre concept, the Exposure broker would be required to ensure that the cash flows of the business are not adversely affected beyond a certain point. This is a defensive strategy, implying a lower risk appetite. A business whose cash-flows are volatile, or whose underlying business is not on a very sound footing would be advised to adopt this concept.
The Benchmarks under a Cost-Centre concept would take the form of “Foreign Exchange fluctuations should add no more than x% to the cost of Imported Raw Material over and above the budgeted cost.
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