When damage control turns a tidy profit
Substantial exposure to rising AUD
With almost all their revenue in USD and all costs in AUD, our client’s financial position was under significant stress thanks to a consistently rising AUD. No hedging arrangements were in place at this stage, so if the AUD continued to go up, the impact on the business would be negative – cost cutting, less funding for development and job losses. Word was spreading around the business about these potential outcomes from currency exposure risks, causing concern and interfering with future plans and the day-to-day running of the business.
A two step solution
There was an immediate need to take action to limit the losses that could be expected from further rises in AUD value and communicate this to stakeholders to reduce anxiety and get back to business as usual. As a short-term measure, Noah’s Rule recommended buying AUD Call Options to limit the impact of any further exchange rate advance over the next 3.5 years (length of current USD pricing previously agreed). This approach removed the immediate threat of currency exposure without losing out on the opportunity to lock in better exchange rates during the option contract period.
With this temporary control of the currency crisis in place, our client’s senior management and Board members had more time on their hands to work with Noah’s Rule to review, analyse and develop strategies for best and worst case scenarios. Together they agreed on a long term approach, intervening with FX Forwards for any major fall in the exchange rate. This strategy came into play three months after buying the AUD Call Options as Noah’s Rule implemented FX Forwards based on their original budget assumptions. The revenue delivered from this approach was a big improvement on the financial position that would have come from striking the original Options, now worth only 30% of the original premium. Even taking into account all option costs, our client’s overall revenues in AUD were significantly higher thanks to the FX Forwards strategy.
Holding fast and reaping rewards
With FX forwards in place the options were no longer required. Rather than selling the options at the lower value, Noah’s Rule suggested monitoring their pricing in the weeks and months to come. As the AUD exchange rate rose again in the next few months, the opportunity came to sell the options for slightly more than their purchase cost. Used as a tool to buy time and certainty when the business was under extraordinary pressure, the call options ended up turning a modest profit in the end. And the client’s reaction? “We felt like we’d been shot up the derriere by a rainbow.”
Options can often be seen as an expensive last resort measure and tend to be rejected as a result. This story demonstrates that buying options is about removing worst case risk and easing the pressure on time and revenue so stakeholders and their advisers can make a cost-effective, longer-term plan for managing currency exposure.