Currency Exchange – Order types, managing your exposure
The current global economic slowdown has had a huge effect on the currency markets and amongst the majors we have certainly seen evidence of this with the exchange rate between EUR/USD and GBP/USD in particular and most other major pairs. This volatility can make a huge difference to companies who import or export.
Let’s assume that you agreed to purchase $250,000.00 worth of stock from your US supplier on 21st September. The rate of exchange you would have achieved would have been around 1.6307 so you would have spent £153,308.39 and been rather pleased!
Now, to illustrate just how much market volatility can adversely affect your business let’s assume that rather than pay for your dollars on the 21st of September that you decided to wait until you received an invoice ( none of us likes to pay immediately!). You duly receive your invoice on the 24th September and decide to buy your dollars. The bad news is that the market has dropped and the exchange rate you actually buy at is 1.6127 which means that your purchase price for the same goods is now £155.019.53… a difference of £1711.14.
It is unexpected losses like those illustrated which can make the difference between profit and loss.
Utilising the services of a dedicated currency provider can help you to minimize your losses. Currency specialists can monitor the market on behalf of clients and can therefore inform clients of market movement and price fluctuation.
You can utilise various order types depending on your actual requirement;
A trade is agreed based on the current market rate in the live market. A client can call their account manager and book the exchange rate instantly. The delivery of a spot transaction is normally two days.
Forward contracts allow the client to agree an exchange rate for their currency and fix it for up to 24 months. Clients are asked for an agreed deposit to secure the rate. The client then has access to their funds at the fixed rate given on entry at any time. Forward contracts are also a great way for companies to accurately plan for the future and minimize their exposure to fluctuating currency prices.
If you only wish to exchange your funds at a specified rate, your account manager can monitor the market and buy the currency at the level agreed. Limit orders are generally left in the market until cancelled and if your target price isn’t achieved then nothing happens!
Stop orders can be used to protect against the exchange rate moving adversely. It can also be used to allow clients to lock in a worst case scenario while holding out for a better rate. If , for example , the GBP/USD rate was trading around 1.62 but you wanted to wait for a better rate you would place a stop order at your worst acceptable rate of exchange. You would need to place your stop order below the current price so you would use 1.61 as worst case scenario! As with a limit order , nothing happens unless your stop price is hit.
An OCO order essentially combines a Limit order and a Stop order. You would place a Stop at your worst case rate and a Limit at your best case…. whichever is achieved first will be the rate at which your order is booked.
Topics: Currency Exchange, Export Planning, Finance, and Payments