Margins required to cover credit risk
A business operating internationally faces many financial risks, not least currency risk. A common derivative to hedge (protect) this risk is a forward contract.
Whilst a forward contract can provide simple and effective protection against the future adverse movement of the currency, it is likely to come at a cost to the business - cashflow.
The counterparty might require an upfront payment from the company in case it defaults on its obligation to pay future currency under the forward contract. Further margin payments might be required from the company (more cash outflow) if the exchange rate moves adversely.
It is important therefore for businesses trying to manage their currency risks that upfront and interim cash payouts might be required by their counterparties and they should therefore ensure they can withstand such outflows in the period up to the currency cashflow being hedged.
In managing one risk (currency), another risk (liquidity) can be created.
To discuss your currency risks, and how to hedge them with forwards or other instruments, contact me for a free no-obligation discussion.