For businesses with import need, managing foreign exchange (FX) risk is paramount. This risk is typically borne by the buyer. While various solutions exist, the most favorable approach for the buyer is to manage and cover their FX risk themselves.

Let’s explore key considerations and strategies and take the example of a Hungarian company importing from a EU country:

HUF-Based Procurement (Fixed Price in Hungarian Forints)

Many importers choose the most convenient solution for them, and request offers in their own currency. If a buyer requires a fixed HUF-based price, the seller faces currency risk due to exchange rate movements and the duration of the offer. The longer the commitment, the greater the risk for the seller. To mitigate this without incurring losses, sellers often pass this risk on to the buyer.

1. Risk Buffer: Sellers may apply an FX risk buffer, offering a higher HUF price compared to a foreign currency-based quote. The size of this buffer depends on:

1. Offer duration: Longer commitments mean larger buffers.
2. Currency fluctuation (volatility): More volatile currencies require larger buffers.
3. Seller’s risk-bearing capacity: Financially stable large corporations can offer smaller buffers than smaller, more fragile companies.

Example: A one-month EUR/HUF commitment with 3.5% volatility might include at least a 3.5% FX risk buffer. However, a more realistic estimate for this is an FX buffer between 5-10%.

 

1. Hedging with Treasury Transactions: Competitive sellers with sophisticated financial risk management may use treasury transactions to hedge their risk. For a defined offer period, currency options are an effective hedging tool. The seller buys a foreign currency (e.g., EUR) put option and pays a fixed premium. This premium is paid regardless of whether the seller wins the tender (a kind of insurance fee). The cost factored into the offer price accounts for the option cost and the estimated probability of winning the business. This typically results in a lower buffer, estimated at 2-5% for a one-month EUR-based acquisition with similar volatility.

 

Foreign Currency-Based Procurement Without Hedging

If the buyer accepts offers in the seller’s currency (e.g., EUR), the seller eliminates their FX risk and thus does not need to increase the price. However, the FX risk then shifts to the buyer. The buyer can reduce this risk by shortening the offer commitment and decision-making period, as risk generally increases with time. The risk can be lower, but it is not, significant losses can occur, making this a not prudent solution.

Foreign Currency-Based Procurement With Hedging

Foreign currency-based procurement should ideally be accompanied by hedging the FX risk.

• Advantages:
  • Significantly more favorable pricing based on the current exchange rate.
  • The buyer can hedge the risk more favorably and at a lower cost than the seller. This is because the buyer is certain to purchase the asset from someone, eliminating the need to account for the probability of winning a deal. (In treasury lingo, the time value of the option is a significant portion of the premium paid and at the side of the Buyer it is not coming into play.)
• Hedging Method: An FX forward contract is recommended, where the buyer purchases EUR against HUF for a specific future date.
  • Amount: The expected acquisition amount.
  • Maturity: The expected date of the EUR payment obligation.
  • Timing: The day the purchasing decision is made, to secure the exchange rate at that moment.
• Hedging Cost: This depends on
  • the bank’s margin (not an extra cost compared to unhedged spot transactions)
  • and the interest rate differential between the foreign currency and HUF for the period.
  • For a one-month EUR-based acquisition, the hedging cost is estimated at 0.3-0.5%.

Comparative Overview

(Estimated Cost for EU import with 1-month tender duration):

Option	Estimated Cost*
HUF-BASED PROCUREMENT
Seller does not hedge risk	5-10%
Seller hedges risk	2-5%
FOREIGN CURRENCY-BASED PROCUREMENT WITHOUT HEDGING	Unlimited
FOREIGN CURRENCY-BASED PROCUREMENT WITH HEDGING	0.3-0.5%

*Based on a one-month tender commitment and EUR-based import

Understanding these options is crucial for effective risk management in international procurement.