How to Minimise Currency Risk
The currency markets are exceptionally volatile and with around $4 trillion worth of currency being exchanged every day, you can see how they fluctuate so much. The problem with prices moving so dramatically is that it can be difficult to budget for future foreign exchange requirements.
if you are looking to buy a property in Australia in 12 months’ time, although you know you are going to need around 400,000 AUD, you do not know how much of your currency it is going to cost you to buy those dollars.
Let’s put this into perspective. Nearly ten years ago you could’ve gotten around $2.60 AUD for £1 GBP. At that time, if you were to buy a $400,000 house in Oz, it would have set you back around £154,000. Today GBP/AUD stands at £1/$1.48 meaning the same house would cost you around £270,000 – nearly twice as much!! This example shoes the importance of maximising the rate of exchange you receive and any facilities your broker offers to help do this.
There are a number of options certain brokers offer to help minimise the risk involved with currency rate fluctuations. We will go over each of these in turn:
Updates. If requested, you can ask your dealer to contact you on a regular basis to highlight any significant changes in the environment and any imminent news that could cause a change.
Forward Contracts. Many brokers offer forward contracts that allow you to book a current rate that can be used to exchange at a particular point in the future. This is handy if:
- The currency rate is particularly favourable.
- If you have a budget that cannot be broken.
Flexible forward contracts. These types of contracts are pretty much the same as ‘a forward’ other than the fact you can drawdown all or part of the booked exchange prior to the maturity date.
Stop Loss. A stop loss is a facility that will automatically purchase the currency you require when it reaches a particular level (below the rate it is at now). This level will be the lowest possible rate you are comfortable exchanging at. By taking out a stop loss, you are leaving yourself open to the benefits of a rate going dramatically in your favour while ruling out the chance of it reaching a rate you are not happy with.
Limit order. The limit order is similar to a stop loss other than it works on the other end of the spectrum. You choose a rate that you are happy to exchange at and if the rate goes for you and hits the level you have set, the broker will automatically purchase the currency on your behalf.
A foreign exchange option gives the holder the right – but not the obligation, to purchase a currency at a particular point of time, at a pre-determined rate. The rate of exchange is guaranteed if the client chooses to take up the option but if it isn’t in their best interests to, they are not obligated to do so. Not all brokers offer options and they can be quite expensive although this premium can be well worth the investment considering the potential financial benefit and peace of mind it gives.