FAQ Part 3 of 4 : How do we know whether our treasury function requires basic or complex solutions and oversight?
WellCapital can help you – we use a structured approach with defined criteria to provide insight and guidance on the requirements.
Four of the WellCapital Treasury Rubik focus areas are used to support the analyses and requirements of a complex, intermediate and basic treasury operations and structure. The six WellCapital Treasury Rubik focus areas include :
i) Treasury structure and systems;
ii) Liquidity Risk~I;
iii) Foreign Exchange Risk~I;
iv) Commodity Risk~I;
v) Governance~I; and
vi) Strategic impact and value added
Part 3 of 4 : CURRENCY AND COMMODITY RISK MANAGEMENT
Transactional Foreign Exchange (FX) Risk arises from future currency receipts or payments, the ZAR values of which will vary in line with exchange rate movements.
Transactional Risk is the risk of
i) Additional cost due to the movement in exchange rates affecting any payments (weakening of reporting currency)
ii) Lower inflow/collections due to the movement in exchange rates affecting any receipts (strengthening of reporting currency)
Both of the above scenarios will result in a negative impact on the organisation’s income. This will only be applicable where payments are due to or receipts are to be received from third parties.
Economic Foreign Exchange Risk exposures results in a change in the longer term competitive position of a company, resulting from the effects of exchange rate movements on its cost base, products, competitors and customers.
Economic FX Risk is the risk of
i) Loss in the value of inventory or
ii) Loss in margin or
iii) Negative impact on the organisation’s competitive position
due to fluctuations in the rate of exchange between the reporting currency and the various currencies in which the organisation purchases, sells and values its inventory”
Even when obligations are paid in local currency, the price of the goods could be linked to an international price in a different currency which will result in economic foreign exchange risk.
When the performance of the organisation is negatively affected by consumer behaviour and the ability of the organisation to reprice its goods in a volatile FX market, it is worthwhile to determine whether the organisation has economic foreign exchange risk which is embedded in its service and goods. Economic foreign exchange risk is quantified in analysing the business model, transaction- and cash-flows, including the cost of sales and turnover over time.
The ability to risk manage Economic FX risk depends on the ability to unpack and analyse the underlying business models and customer behaviour. Without this capability and precision, the organisation may create Transactional FX risk or render existing hedges ineffective as Economic and Transactional FX risk usually transition from the one to the other over the transaction timeline in the organisation. Since both transactional and economic foreign exchange risk can be mitigated and hedged, support is provided in the development and execution of suitable hedging models and strategies.
Commodity risk exposure can be complicated and difficult to quantify when the pricing is done in a foreign exchange currency. Commodity risk is often found in other consumables such as fuel which can also be addressed through the use of quantification models and hedging strategies. Correlation between expense and/or income items with other financial market hedging products can be used in the hedging strategies.
