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Hedging Primer: How to Mitigate Financial Risk

Many companies do not understand the scope of their interest rate, currency, and commodity price risks. That knowledge gap has the potential to blow up corporate planning processes.

By Rich Aidala | April 07, 2022 at 11:05 PM

In a complex and interconnected world, risks are everywhere. Companies that fail to effectively mitigate the highest-impact risks may find they wreak havoc on financial projections, budgets, and the company’s ability to meet stakeholder expectations. A recent Citizens Commercial Bank Risk Management Study of 350 U.S. publicly listed companies revealed how widespread these risks are: 78 percent of respondents said their organization is exposed to interest rate risk, 74 percent to foreign exchange (FX) risk, and just under 50 percent to commodity risk. Yet only about half of these companies are adequately managing their risk exposures, which hurts their planning processes.

Risk exposures vary by industry. For example, companies in the healthcare, industrials, and materials sectors are capital-intensive and are traditionally heavier borrowers, relatively speaking. As a result, companies in these sectors are much more exposed to changes in interest rates over time. (See Figure 1.)

The size of a company’s exposure to FX risk generally depends on how much of its business is transacted overseas vs. domestically. But other factors can come into play. The U.S. energy sector, for example, is protected from FX risk because international oil and refined products, such as gasoline and diesel, are traded in U.S. dollars at the wholesale level.

 

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