Hedging FX Risks: Best Practice and why negative Swap Points are not Hedge Costs.
1. Initial Situation: Quotation and Latent Currency Risk
A Swiss machinery manufacturer is about to submit an offer to a Canadian customer. The client requires pricing in CAD, while the manufacturer’s cost base is diversified:
- 35% in EUR (components from Europe)
- 40% in USD (electronics & semiconductors)
- 25% in INR (inputs from its Indian subsidiary)
Although the functional currency is CHF, the economic FX exposure is a basket of EUR, USD, and INR. Already during the quotation phase, this must be considered: hedging only CAD/CHF is not sufficient, as input costs in foreign currencies significantly determine the margin.
In other words, hedging should not only be from the sales side but also from the purchasing side – shown gross for transparency.
Example: Quotation Calculation
- Sales price in CAD: CAD 30m
- FX Spot (CAD/CHF): 0.66 → equals CHF 19.8m
- Cost base in CHF (synthesized via EUR, USD, INR exposure): CHF 15m
- Target margin: CHF 4.8m
To hedge during the quotation phase, the treasurer simulates the value of a plain vanilla CAD/CHF put option, strike = forward rate in 2 months, maturity = negotiation period.
Result: An implicit offer rate of 0.6580 CAD/CHF is used. This allows the client to receive a fixed CAD quote while the company internally protects itself against FX risk. Whether the option is actually purchased depends on risk appetite. But using the option value as the basis already reflects the “real” FX risk in the calculation.
2. Contract Structuring: Flexibility and Risk Sharing
At contract signing, the price is fixed: CHF 20m (equals CAD 30.3m at spot 0.66). A currency clause is included: ±10% deviation in CAD/CHF triggers renegotiation.
Payment plan
a) Sales Side:
- 15% at signing → CHF 3m
- 15% after 3 months → CHF 3m
- 25% after 6 months → CHF 5m
- Balance after delivery (9 months) → CHF 9m
The treasurer matches these cash flows with forwards at each maturity.
Difference of CHF 0.15m is purely swap point-related (= interest differential).
b) Purchasing side assumptions:
- Total costs = CHF 15m
- 35% EUR = CHF 5.25m → EUR 5.53m (at 0.95)
- 40% USD = CHF 6.00m → USD 6.67m (at 0.90)
- 25% INR = CHF 3.75m → INR 312.5m (at 0.012)
Interpretation:
- EUR & USD payments fall due around 1.5 months → may be hedged as a package (cross-netting). But not recommended due to transparency reasons.
- INR payments fall later (~4 months) → hedge separately with NDF.
Small CHF –0.05m variance again from swap points / NDF premiums = pure interest differential.
3. Delivery Delay and Treasury Adjustment
After two months, delivery is delayed by 4 weeks. The 2nd, 3rd, and final installments are pushed back by 3 weeks each. The treasurer reacts with a forward starting swap:
- Original forwards are closed out.
- New maturities are shifted via swaps.
Hedge remains intact, no open positions arise.
Total additional “cost” from swap points = –CHF 0.013m (= interest differential on 3 weeks).
3a. Accounting View – Operational vs. Financial Component
- Operational FX effect (above EBIT): Spot component of forwards fixes CHF 20m revenue, protecting margin against CAD fluctuations.
- Financial FX effect (below EBIT): Swap points (–0.15m CHF plus –0.013m CHF from shifts) = opportunity cost from lower CHF interest rates.
Interpretation:
If the seller had received the full CAD payments right from the start, they could have been invested at CAD interest rates and, when calculated through to the end, would have produced the exact same effect. Therefore, swap points are not a hedge cost block but merely reflect the time value of money and can thus be presented in the financial result of the income statement. More on this in Section 4.
The same logic applies on the purchasing side: the bank – as the counterparty providing the foreign currencies – funds the required amounts in the money market to hedge its own position, thereby capturing an interest rate advantage, which it passes on to the client minus its spread.
(On a personal note: at the beginning of my career I worked in FX trading at a Swiss universal bank in Zurich and executed exactly these types of transactions. That’s why I know both sides of the business very well: the forward trader hedges the spot component at the spot desk and the forward component at the money market desk.)
3b. CFO/Management View
- Total hedge: CHF 20.0m fixed
- Calculated discount (swap points): –CHF 0.163m
- EBIT impact: unchanged – margin protected
- Financial result impact: –0.163m (interest differential, not “hedge costs”)
4. Interest Differentials and the Illusion of Hedge Costs
CAD yields are higher than CHF yields. Thus, CAD/CHF forwards trade below spot (“negative swap points”).
Example:
- Spot: 0.6600
- 6M forward: 0.6550
- Difference: –0.0050 (–75bp p.a.)
At first glance, this might be interpreted as: “Our hedge is costing us money.” But that impression is not correct.
Why is this not a real cost item?
If the company were to receive the CAD immediately (i.e. if the customer had paid in full at contract inception), the treasurer could have invested those CAD in the market at the higher CAD interest rate. Since the company only receives the CAD gradually, the forward rate simply reflects this interest rate differential.
In other words: the forward is interest-neutral. No value is destroyed; instead, the opportunity costs are simply made transparent.
5. Accounting & EBIT Presentation
FX hedges can be split into:
- Spot component → operating P&L (above EBIT, margin protection).
- Interest differential component (swap points) → financing effect, below EBIT.
This prevents swap points from being misinterpreted as hedge costs.
6. Conclusion
- Global cost exposure must already be considered in the quotation phase.
- Contract clauses reduce extreme FX risk.
- Forwards and swaps efficiently hedge cash flows, even with delays.
- Swap points are not hedge costs but interest differentials.
- Clean separation between operating FX and financing effects ensures CFO/Board/Shareholder transparency.
Message: Professional FX management costs nothing – it protects margins.
Read also our project report where we introduced a FX Risk Report here.