How To Use Forward Contracts To Fix A Foreign Exchange Rate

Many Brits who buy overseas property don’t think through the implications of exchange rate properly. When paying a typical 10% deposit on a property, the cost in sterling …

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Many Brits who buy overseas property don’t think through the implications of exchange rate properly. When paying a typical 10% deposit on a property, the cost in sterling of a 90% completion payment three months down the road are completely unknown, as the exchange rate could move significantly over that time.

Similarly, a business ordering goods from China might have 30-day terms on an invoice, by which time the exchange rate fluctuation may have eroded their profit margin entirely.

For example a Euro payment in August, would have attracted an exchange rate around 1.28 per GBP. A balance in October would have been at an exchange rate of around 1.22. That represents a 4.7% increase in the price of the Euro – or over £7,000 more on a €200,000 transaction.

Thankfully, a Forward Contract is available from reputable currency brokers to secure an exchange rate in advance for such transactions. It’s a simple process, and a currency specialist will be able to talk you through the mechanism on the phone.

Essentially, exchange rates can be agreed upon up to 2 years in advance for most currency pairs. As a client, you would then pay a 5-10% deposit once a rate has been agreed, with the balance due when the currency is to be sent on.

For example, booking a £100,000 US Dollar rate for delivery in the next 6 months, would attract a deposit payment of £5,000 payable now, and £95,000 payable any time over the next 6 months. The rate is agreed in advance and is based on where the market is now – not on any predictions of what may be around the corner.

In our Euro example above, using a Forward Contract would have saved £7,000 for our fictitious client.

Of course, there are no guaranteed ways to save money, and if the exchange rate goes up during the course of a Forward Contract, you will still be committed to the rate that you booked. But the main reason that many people and businesses use this type of order, is to guarantee the sterling amount of a non-sterling transaction, removing uncertainty and risk from the process. Peace of mind is invaluable in the current volatile climate.

If for any reason a Forward Contract cannot be completed, the 5-10% deposit will be at risk, but only to the extent of any losses made due to exchange rate movement. Speak to a currency specialist to fully understand this, but it would be very unlikely for the whole deposit to be lost – this would only happen if exchange rates have moved more than the deposit amount in one direction. Usually, much or all of the deposit can be returned to the client in the case of non-completion of the contract. The currency sector in the UK is regulated by the FSA, so as long as you use an “Authorised Payment Institution” under FSA regulations, you can be sure of fair treatment and access to the ombudsman if needed – although in most cases FX companies will provide a first class service tailored exactly to your requirements.

In addition, currency companies will be able to beat virtually any bank when it comes to competitive exchange rates for  international payment services required by individuals or businesses.

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