| Friday, September 4th, 2015

Managing Currency Risk for Future International Payments and Receipts

Companies making and receiving regular international transfers are naturally exposed to currency movement. This is a risk that can be mitigated with careful planning and the right products, to minimise revenue loss, reduce uncertainty and preserve margins. With multiple types of payment being made or received for goods, services, products, materials and international personnel, a variety of products can be deployed for several eventualities:

  1. Locking in a future minimum and maximum range for a future transfer - Limit orders or stop-loss orders
  2. Fixing a future rate for actual payment or receipt - Forward contracts
  3. Setting a specified rate for a potential future payment or receipt – Option contracts

A wide range of tools are available from specialist currency brokers, which help reduce exposure to rate movements by increasing the predictability of the rates that a company will pay. Here are some case studies for three main scenarios:

Business Issue: Lock in a minimum and maximum exchange rate for future payments or receipts

Product: Limit orders or stop-loss orders

Solution: Where the timing of a currency transfer is not critical, these orders are ideal for setting parameters to manage the currency risk, by specifying the highest and lowest exchange rate levels at which the company is willing to execute a transaction, and therefore determining the range of funds to be paid or received. By using both limit orders and stop-loss orders, a company can set a stable cost range for regular currency transfers.

managing currency risk

Case Study: Buying commercial property overseas on a flexible timeline

Business Goal: Ensure the transaction occurred within a defined price range

Biltong Chew Industries (BCI), a South African business, was planning to set up a new distribution centre outside Barcelona after having rented space for their Spanish employees for over a year. BCI had set aside 12,000,000 South African rand (ZAR) for the purchase of this property, but since they still had a lease on the rental space, they did not want to make an immediate purchase of a new property and have one of the spaces lie empty, so they decided to wait before making the transaction.

At the time the exchange rate was 8.765 ZAR for each Euro.

Aware that the rate might move in the other direction, BCI arranged a limit order, which allowed them to buy euros when the exchange rate reached a level they were comfortable with. They also arranged a stop-loss order that would prevent them from losing money if the rate moved in the opposite direction.

BCI placed a limit order to make the currency exchange at a rate of 8.630. If this rate was reached, BCI’s 12,000,000 ZAR would automatically be exchanged into euros. This is the best case scenario for BCI.

A stop-loss order was also placed at a rate of 8.850. To prevent BCI from having to pay too much on the transaction, if this rate is reached, the 12,000,000 ZAR would be exchanged for euros automatically.

By setting these two limits, BCI established a certain level of predictability, since they guaranteed the minimum and maximum amounts they would pay on this transfer. If the exchange was made at the stop-loss rate of 8.850, BCI would have received EUR €1,355,932. In the end, the exchange was made at limit rate of 8.630, so BCI’s 12,000,000 ZAR were worth EUR €1,390,498 when the transaction was made.

To find a provider who offers stop-loss and limit orders, simply conduct our comparison search on our site and then select a broker who deals in the two currencies you wish to manage. Typically the online only providers do not offer these products.

Business Issue: Locking in a set future exchange rate

Product: Forward contract

Solution: A forward contract aims to take advantage of a favourable exchange rate by locking it in at a lower point now, with execution to follow at a later date. There is of course the potential for an exchange rate to improve further, in which case any benefit will be lost as the customer is locked into the agreed rate. However, uncertainty is at least removed from the equation.

manage future exchange rates

Case Study:
A company wants to set a fixed now price to buy products from overseas in the future

Business Goal: Reduce future currency risk

Memphis Royal Football Club (MRFC) agreed to buy two new players from a British club for a transfer fee of £10,000,000 (GBP) each but did not need to make the payment for three months. MRFC was concerned that the USD to GBP exchange rate might move against them during that time, and decided to fix the exchange rate in advance using a forward contract.

This allowed MRFC to know exactly how much the players would cost on the day they needed to pay for them. MRFC fixed a rate of exactly 1.5 USD to GBP to buy $30,000,000 worth of players. In the three months before the payment was due the exchange rate moved between 1.47 and 1.54. On the day the payment was due the rate was 1.53.

If MRFC had waited until the day the payment was due and exchanged pounds to dollars at the prevailing rate, the players would have cost an extra USD $60,000.

To find a provider who offers forwards, simply conduct our comparison search on our site and then select a broker who deals in the two currencies you wish to manage. Typically the online only providers do not offer these products.

Business Issue: If a company plans to make or receive a foreign currency payment in the future, but is not certain the payment will happen or how large it will be.

Product: Currency options

Solution: Option contracts give a buyer or seller the right, but not the obligation, to execute an exchange of a particular currency, at a predetermined rate, at or by a future date. Option contracts cost money whether executed or not, but can provide additional benefits compared limit and stop-loss orders and forwards contracts.

currency options

Case Study:
Selling a film prop to an overseas client

Business Goal: Protect against a currency decline

An Australian special effects company, OZeffects (OZE), agreed to build a new film prop in three months’ time for EUR €500,000 for a movie being shot in France. Worried about possible exchange rate moves against the Australian dollar (AUS), OZE decided to enter into a currency option called a ‘protection option’ and paid a small premium. This allowed OZE to set a worst-case rate to protect the company from the rate declining, but also allowed OZE to benefit if the rate improved. OZE was able to fix a worst-case AUS to EUR rate of 0.6901. Without the protection of an ‘option’, if the rate had moved to 0.6766, OZE would have received AUS $6,750 less for their prop. However, on the settlement date, the rate had moved to 0.6886, increasing OZE’s sale amount by a further AUS $6,000.

Benefits of managing currency risk on future international payments

Currency risk management products can reduce exchange rate volatility and increase predictability for any company that makes or receives payments in other currencies. By using and if necessary combining limit and stop-loss orders, forward and option contracts, a company may benefit in several ways:

  • Managing and reducing forex risk: Currency risk typically grows in proportion to the time elapsed between agreement and execution. Fixing a more favourable and known exchange rate beforehand allows for more accurate financial forecasting and potentially improves transaction margins.
  • Reducing fees: By planning ahead with a specialist broker to develop tailored currency solutions, companies can agree lower fees, and sometimes it may be waived altogether, for their international transfers. Certainly the overall cost will be substantially lowered in comparison to typical rates and fees charged by the banks for such transactions.
  • Gaining competitive advantage: As discussed in other “how to” guides, more favourable pricing can be achieved by using the currency of the counter-party, and managing the currency risk using the tools described, instead of effectively obliging the other party to do so.

Risks and issues of future currency payment tools

As outlined above, an element of risk is unavoidable in any forex transaction, especially when dealing with a future exchange with its unknown rates. A specialist currency broker can assist a company to manoeuvre through these currency movements and build in risk mitigation solutions via limit and stop-loss orders, forward contracts and options.

Businesses must, however, bear in mind there are risks associated with these techniques. With forward contracts, any upside from an improvement in the exchange rate prior to the execution of the contract may be lost. Options involve a fixed up-front cost, which cannot be recovered in the event that the option is not taken up, whilst mitigating downside risk.

Be sure to talk through any of these products with a specialist currency provider before making any decisions and finalising a product. The providers listed on our site who offer these products are happy to go through any questions you may have. You can register for free with one today and begin the conversation as to how to manage your currency risk.

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