Foreign Exchange (FX) Risk Management & Currency Hedging

A garment exporter lives in two currencies at once. Buyers pay in dollars, euros, or pounds, while most factory costs — wages, rent, electricity, local transport — are paid in taka. Between the day a price is quoted and the day payment arrives, often 60 to 120 days later, the exchange rate can move enough to erase the entire profit on an order. A 5 percent margin, which is common in apparel, disappears if the taka strengthens by 5 percent against the invoicing currency and nothing else changes. That is why foreign exchange risk management belongs in the costing function, not only in the finance department. The costing team sets the price, so the costing team must understand what a rate move does to that price.

The core discipline is simple: know exactly how much foreign currency you are exposed to, know what a rate move does to profit in taka, and decide in advance how much of that exposure to lock with a forward contract. Everything in this lesson builds that discipline step by step.

Exposure is not the value of your orders. It is the difference between what you will receive in a foreign currency and what you must pay in that same currency, in the same period. A factory with USD 500,000 in receivables and USD 150,000 in payables for imported fabric and trims has a net exposure of USD 350,000. If the taka strengthens by 2.00 per dollar, profit falls by 350,000 multiplied by 2.00, which is BDT 700,000. If the taka weakens by the same amount, profit rises by BDT 700,000. The payables cushion the swing, because a stronger taka also makes imported inputs cheaper in taka terms. Factories that hedge their gross receivables instead of net exposure over-hedge, and over-hedging creates a new risk of its own.

Exposure must be mapped by currency and by month. Dollar receivables do not offset euro payables, and a payment expected in March does not offset a payable due in January. The mapping tool is the exposure register: one row per order, with receivable currency and amount, payable currency and amount, expected payment month, and the resulting net exposure. The register is updated weekly, because orders change, shipments slip, and claims reduce receivables.

Consider a merchandising manager maintaining a register with two open orders. Order 1 has a receivable of USD 180,000 and payables of USD 30,000 for imported trims, giving net exposure of USD 150,000. Order 2 has a receivable of USD 120,000 and no foreign currency payables, giving net exposure of USD 120,000. Total net exposure is USD 270,000. The factory policy is to hedge 60 percent of net exposure, which is USD 162,000. At an illustrative forward rate of BDT 119.50 per dollar, the locked taka value is 162,000 multiplied by 119.50, which is BDT 19,359,000. The remaining USD 108,000 stays exposed to whatever spot rate applies when payment arrives. That split is deliberate: the locked portion protects the margin, and the exposed portion preserves flexibility if the order changes.

The register also records the forward contract number, the bank, the contract date, and the settlement date, and it is reconciled against bank confirmations every week. A register that nobody reconciles is a decoration, not a control.

Before hedging, management should see the risk in taka. The sensitivity rule is straightforward: a 1 percent move in the rate moves profit by 1 percent of net exposure converted at the current rate. On net exposure of USD 210,000 at BDT 120.00 per dollar, the taka value of exposure is BDT 25,200,000, so a 1 percent move is worth BDT 252,000. A 5 percent move is worth BDT 1,260,000. Put that number next to the order profit and the decision becomes concrete: on an order earning BDT 3,000,000, a 5 percent adverse move wipes out 42 percent of profit. That is the number that justifies a hedging policy to senior management, far better than any abstract warning about volatility.

Work through the full sensitivity for the Gazipur shirt order used in the factory example. At a spot rate of 120.00, revenue on USD 250,000 is BDT 30,000,000 and profit is BDT 3,000,000. At 114.00, revenue falls to BDT 28,500,000, but the trim cost also falls from BDT 4,800,000 to BDT 4,560,000, so profit is BDT 1,740,000 — a fall of BDT 1,260,000, which is exactly the 6.00 move multiplied by net exposure of USD 210,000. At 126.00, profit rises to BDT 4,260,000, a rise of the same BDT 1,260,000. The symmetry is the point: exposure cuts both ways, and hedging gives up upside to remove downside.

The cheapest hedge costs nothing. If a factory imports fabric worth USD 40,000 for the same order it exports for USD 250,000, part of the exposure is already matched: dollars earned pay for dollars spent, and only the net USD 210,000 is at risk. Other natural hedges include negotiating to pay freight and bank charges in the invoicing currency, holding a foreign currency account and timing conversions to match payment cycles, and shortening payment terms so less time passes between quotation and receipt. A factory should exhaust natural hedges before buying forward contracts, because every forward contract carries bank charges, documentation, and settlement risk.

Pricing is also a hedge. A quotation can include an explicit currency buffer, for example pricing at a rate 1 to 2 percent below the current spot rate, so that a modest adverse move is absorbed by the buffer rather than by profit. The buffer must be disclosed internally as a costing assumption, not hidden, so that the commercial team knows the true margin at the quoted rate.

A forward contract is an agreement with a bank to exchange a fixed amount of currency at a fixed rate on a fixed future date. If the factory books a forward to sell USD 150,000 at BDT 119.50 in 90 days, then in 90 days the bank pays BDT 17,925,000 for those dollars regardless of the spot rate that day. If spot is 114.00, the factory gains 150,000 multiplied by 5.50, which is BDT 825,000, relative to converting at spot. If spot is 126.00, the factory gives up 150,000 multiplied by 6.50, which is BDT 975,000, relative to spot. The contract removes uncertainty in both directions, which is exactly what a margin-protection tool should do.

The forward rate differs from spot by the forward premium or discount, which reflects the interest rate difference between the two currencies over the contract period. If spot is 120.00 and the 90 day forward is 119.50, the dollar trades at a forward discount of 0.50. As a percentage for the period, that is 0.50 divided by 120.00, which is 0.42 percent. Annualised, multiply by 360 divided by 90, which is 4, giving about 1.67 percent. Understanding this calculation stops a common confusion: a forward rate below spot is not a bank penalty, it is arithmetic driven by interest differentials.

A full hedge sounds safest, but it creates its own danger. Orders change after confirmation: buyers cut quantities, shipments split across months, quality claims reduce the amount actually received, and payments arrive late. If a factory hedges 100 percent of a forecast receivable and the buyer ultimately pays 20 percent less, the factory must still deliver the full hedged amount to the bank, buying the shortfall in the market at whatever spot rate applies. That forced purchase can lose more than the original exposure would have.

A partial hedge of 50 to 70 percent of net exposure is therefore standard practice in apparel export factories. It protects the majority of the margin while leaving room for order changes. The exact ratio is a board-level policy decision, not a trader decision: it should be written down, approved by senior management, and applied consistently, so that hedging does not become speculation disguised as risk management. Any departure from the policy, such as hedging 90 percent because someone feels the currency will fall, must require written approval and must be recorded as a deliberate view, not hidden in the register.

Forward contracts fix the conversion rate. They do not fix the underlying commercial risks. A buyer who cancels an order leaves the factory with a forward contract and no receivable. A quality claim that reduces payment by 10 percent leaves the factory over-hedged by that amount. A shipment delayed by a month leaves the forward maturing before the money arrives, forcing a rollover. For these reasons, forward contract dates should include a buffer of two to four weeks after the expected payment date, and the exposure register must be updated immediately when an order changes, so that excess hedges can be unwound early while the cost is still small.

Documentation discipline matters too. Every forward booking needs a written confirmation from the bank stating the amount, rate, and settlement date, filed with the order documents. Disputes about forward contracts are rare but expensive, and they are always lost by the party without paperwork.

Once a month, the costing head and the finance head should sit together for thirty minutes and work through a fixed checklist. First, reconcile the exposure register against bank confirmations and open order files. Second, compare hedged outcomes against what spot would have given, and record the difference without blame — hedging is insurance, and insurance sometimes costs money. Third, update the hedge ratio if order patterns have changed, for example if a new buyer pays in euros rather than dollars. Fourth, confirm that no forward contract matures before its matching payment is expected. Fifth, report the open exposure and the hedged percentage to senior management in one page. A factory that follows this checklist every month will never be surprised by a currency move, because the size of every possible surprise is already written down in taka.

Currency risk is a costing problem before it is a treasury problem, because the price is set at quotation and the margin is earned or lost by settlement. Build the register, measure net exposure, show management the taka at risk, hedge a prudent portion with contracts matched to payment dates, and review monthly. Factories that do this protect their margins quietly, quarter after quarter, while factories that ignore currency risk keep discovering it in their profit and loss account after the damage is done.