How to hedge on currency |
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| Finance | |
| Written by Robin McEwen, managing director at Foremost Currency | |
| Monday, 24 August 2009 | |
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Gaining Currency: Advice on how to take the sting out of currency fluctuation. Robin McEwen, managing director at Foremost Currency, a specialist foreign exchange broker for businesses making international payments offers advice on how to mitigate the impact of negative movements in the money markets. Any business that has a regular requirement to make international payments needs to be aware of currency fluctuations. Whether you’re an importer, an exporter or both, if the money markets move against you the profitability of a deal can be negatively affected and that’s money that comes straight off the bottom line. There’s no use in pulling out all the stops to seal a deal, only to see your profit margin quickly wiped out by a disadvantageous currency swing. And the value of overseas contracts, payments and receipts are also subject to the vagaries of the money market, meaning that the best-laid business plans of any company that carries out cross-border trades can be significantly disrupted.Companies dealing into USD for example have experienced wild swings of 20% and beyond in little more than a six-month period, while companies dealing into NZD would have seen the value of sterling plummet by over 10% over recent weeks. With international trade now key to the growth of many companies developing a comprehensive understanding of FX markets is becoming more of a necessity than a chore, especially when it comes to the negotiating of contracts. In the past 12 months any company involved in worldwide trade would have seen the value of sterling drop by over 25% against a basket of currencies and this can have dire consequences if the underlying exposure is not accounted for. Example A UK company has employed the services of a European IT firm and at the outset of the contract a fee of €250,000.00 is agreed with 20 % payable at outset balance on completion of work 6 months later. At the outset the FD of the UK company has used a £/EUR exchange rate of 1.30, and priced the contract at €250,000/ 1.30 = £192,307.69 However at the end of the contract the rate of £/EUR has dropped to 1.10, meaning the remaining 80 % balance (€200,000) will now cost £181,818.18. So the total cost of the project that was originally priced at £192,307.69 has now risen to: £220,279.72. Currency movements are an accepted risk when making international payments and can have a real and significant impact on profitability and cash flow. These risks necessitate pro-active management, which in turn requires a certain level of expertise. The largest institutions have the scale to employ their own economists, analysts and dealers, and resources to invest heavily in market information, data, and risk management systems. However, it is unrealistic to expect SMEs to have access to such resources and this is where the knowledge and expertise of a foreign exchange specialist comes in to play – allowing SMEs to concentrate on their core business. Free specialist services such as the ‘forward contract’ can protect against a company’s exposure to foreign exchange risk however. The ‘forward contract’ ensures that a rate is agreed at the time of the contract for a delivery date in the future, as stipulated by the client, effectively protecting against fluctuations that could seriously impinge on the profitability of an otherwise successful overseas deal. Whilst it is possible to agree a rate option with your bank to fix an exchange rate it can be a costly service, with charges of anything up to £20,000 being the norm. For example, one high-street bank charges 2 per cent of the transfer sum for three-month currency protection and lets customers choose between the guaranteed rate and the daily rate. However, most exchange specialists do not charge a fee to fix a rate meaning huge savings for traders still feeling the pinch of the economic downturn. By looking beyond the banks businesses can benefit from a proactive service and the provision of a dedicated currency specialist, who will watch the markets on your behalf, advising of advantageous rates and currency movements that might work against you. While not the only concern for banks, international payments are the sole focus for specialists in this field. At a time when businesses are feeling the dual squeeze of the credit crunch and rising costs, many are under increased pressure to examine every option to manage costs whilst increasing profit. In this respect the pricing of international payments is of paramount importance, as they have a direct bearing on the bottom line profits of a company. Pro-actively managing risk and protecting against the vagaries of the currency market has never been more relevant in today’s economic climate. So make sure that when the transaction is finally undertaken, you secure an exchange rate that will have you laughing all the way to the bank. Robin McEwen is managing director of Foremost Currency, a specialist foreign exchange provider that helps businesses manage foreign exchange exposure.
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