Forex Forecast Management

If your company has decided to hedge future forex transactions, you must be aware of the potential for forecasting errors. Senior personnel must validate any forecast transactions (to ensure they are reasonable and they reflect future corporate directions). Further, you may wish to limit the amount you hedge to a percentage of long-term forecast transactions. Hedging a smaller amount may reduce your exposure, particularly if you are unsure about future sales, future market stability, or the reliability of your long-range forecasts.
If you hedge future transactions that do not actually occur, the hedge is exposing your company to currency movements with no offset transactions—effectively, your company is speculating or betting on foreign exchange movements.
One solution for reducing the risk of uncertain future forecasts is to reduce the hedging amount. Another solution is to segregate future forecast hedges into smaller tranches (amounts) and apply different hedging products to each tranch. As an example, if you are concerned with the forecast purchase amount, 50 per cent of your future foreign currency product purchases might be hedged with a carry spot trade (a cheaper solution provided the future transaction actually takes place), while another 25 percent might use a currency option with a higher strike price. While the option may be more expensive and result in higher product costs, it would help you avoid the costs of extreme currency movements when your forecasting confidence levels are too low.
For companies following US GAAP or IFRS GAAP, the FAS 133 and IAS 39 standards require accuracy in future forecasts to obtain favorable accounting treatment. When setting up your management accounts, consider how to manage the P&L impact of forecast errors. If local units are charged the P&L impact of forecast errors, then they will have a better incentive to produce reliable forecasts.