1. Budget course or objective course: what is the reference course ?
The notion of reference courses can quickly become confusing as we often speak of budget course and objective course, and the terminology can also vary from one company to another.
The budget course underpins an accounting approach and is used, as its name suggests, for the budget course. It is determined at group level and used by each subsidiary. This makes it possible, in particular, to simplify considerably the consolidation calculations.
The objective rate is used to set a management objective in the context of dynamic management of exchange rate risk. In the case of centralized management, it will be determined at group level. If currency risk management is not centralized, each subsidiary may set an objective rate that it must defend as part of its hedging policy.
This rate will be used in reporting for management monitoring.
For the sake of simplification and whenever possible, the budget course and the objective course are identical.
2. How to define the target exchange rate ?.
The target price is determined independently of the budget price according to two main criteria:
– The first criterion is specific to the company: it is the probability of occurrence of the forecasts. On this depends the percentages of hedging to be considered as well as the typology of hedging instruments to be used. The higher the probability of occurrence, the higher the percentage of coverage that can be achieved. If the probability of occurrence is low, optional hedges should be used and option purchases should be preferred whenever possible.
– The second criterion is external to the company: it is the average forward rate corresponding to the forecast net flows. This course allows to know the objective course that it would be possible to defend today if the company decided to cover 100% of its forecast needs. In order to benefit from a possible favorable evolution of the spot price in the future, this price must be downgraded. The greater the chosen downgrade, the more the company will be able to benefit from favourable developments.
Finally, the company may have a management framework defining the minimum and maximum hedging percentages, the hedging instruments to be used and the way to manage any open position (stop-loss and take-profit). These additional criteria are also to be taken into account in the development of the objective price.
Given the volatility of the foreign exchange market, the target price is ideally set when the hedging strategy initially planned has been fully processed.
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Further reading :
AMRAE
Les Echos
Investopedia