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March 20, 2015
In part one of this article we discussed some things to keep in mind as you expand your business internationally, namely paying attention to exchange rates, researching low cost international money transfer options, and finding the right foreign bank account which offers you great service at a reasonable rate. Today we focus on another aspect of saving money when doing business overseas; hedging.
There are a number of ways you can hedge against the ups and downs in foreign currency exchange rates to ensure you are always getting the value needed for you goods.
Forward Currency Contracts
A forward currency contract lets you lock in a set exchange rate ahead of time. They can be used for protection if you are accepting large payments in a foreign currency and are worried the exchange rate might move against you. Once you purchase a currency forward contract, you get the agreed upon value for your foreign currency when the time comes no matter the current market rate.
The downside of using a forward contract is if you misjudge the market and the exchange rate improves when you are expecting it to plummet, you won’t be privy to the benefits. To learn more about forward currency contracts and how they are used, read “Using Currency Forward Contracts to Save on Large International Money Transfers”
Currency options are more flexible than forward contracts. With a currency option you have the right to buy or sell a particular foreign currency at a set rate on or before a specified date. The main difference with the currency option vs. a forward contract is flexibility. Unlike a forward contract, with an option you can choose not to go ahead with the exchange and keep your money in whatever form you currently hold it.
Because of the added flexibility you get with a currency option, you’ll be paying a higher premium for the deal; usually 1% or 2% over the value of the contract. If the foreign currency exchange rate goes down by 3% or 4% though, you’ll come out smelling like roses.
Currency options are best for large deals that may not ever go through. If you are unsure if the deal is going to work out, a forward currency contract is not a good choice as you’ll be stuck exchanging your cash even if you don’t want or need to. With a currency option you can choose not to exchange your money or use the spot exchange rate instead.
As long as you’ve set up a foreign bank account, you have a third option to hedge against poor exchange rates; holding a currency. This isn’t so much a permanent solution, but rather a temporary option that allows you to hold out until a profitable exchange rate comes around.
If there is a chance you might need the capital to cover operating costs at some time in the near future, holding a currency isn’t really a viable option as you may get stuck with an even worse exchange rate if you find yourself in a pinch and are forced to transfer your money quickly.
On the other hand, if you have staying power and are holding a foreign currency in stable economy that regularly has upswings, it can be beneficial to hold onto it for a couple of weeks or months until the currency increases in value. Holding onto a foreign currency also allows you to use it for paying bills, suppliers, etc in the country where business is being transacted which removes some of the risk involved with transferring and exchanging it. It’s less complicated than purchasing forward contracts or currency options too.