Managing FX in a Volatile Environment

Judging from the earnings statements coming out of corporate America during the last half of the year, more than a few companies were hit by unfavorable foreign currency fluctuations. Amazon.com, Inc.; Lennox International, Inc.; and Pfizer, Inc., among many others, all reported a negative impact to earnings from foreign exchange rates. "Companies that thought their foreign exchange exposures weren't material got hit with large losses," says John Herrick, principal with Treasury Strategies, Inc., New York City.

Several factors converged to bruise companies' top and bottom lines. For starters, the volatility, or the pace of change in the exchange rate between currency pairs, shot up. During the past 12 months, volatility between the U.S. dollar and the Canadian dollar was 15.3 percent, compared to a 3-year volatility rate of 12.17 percent, according to RatesFX.com. Similarly, the volatility between the U.S. dollar and the euro hit 13.20 percent over the past year, vs. 10.25 percent over the past 3 years.

Moreover, volatility ramped up just as sales were falling off at many companies. Strong revenue increases can obscure the negative impact from currency fluctuations, says Joseph Neu, president of The NeuGroup, Katonah, N.Y. "If you're generating huge growth when you're not managing foreign exchange optimally, the results won't show up," he says. When growth slows, however, unprotected exposures come to light.

At the same time, the increasingly global economy means that many firms are doing more business internationally. The average daily volume in the foreign exchange markets hit U.S. $3.2 trillion in April 2007, estimates the Bank for International Settlements in its Triennial Central Bank Survey. That's a jump of 60 percent from 2004.

More companies also are working in smaller and emerging markets. "Volatility is largest in the non--G-10 currencies," notes Wolfgang Koester, chief executive officer with FiREApps, a Scottsdale, Ariz.-based provider of solutions to manage foreign exchange risk. The three most volatile currencies against the U.S. dollar over the past year were the Hungarian forint, the Polish zloty, and the South African rand, again according to RatesFX.com.

In another shift, a growing number of businesses outside the U.S. are requesting payment in their local currencies, says Chuck Bernstein, chief financial officer with Ladas & Parry, an international law firm focused on intellectual property.