Five tips to manage foreign exchange risk

Whether you’re considering a one-off purchase from overseas or importing hundreds of containers a year, there are some real financial savings to be had when dealing in foreign currency.

In recent times the Australian dollar has been very volatile, with many people caught out by the drop from above parity. To put it into perspective, if you bought a flat in the UK priced at £450,000 in the middle of October last year, then by the time settlement arrived some six weeks later the property would have cost almost $70,000 Australian dollars more.

Or for an importer paying $US50,000 a month to China over the last year, costs have risen some $A90,000 in the last 12 months. This is extra money paid that could have been avoided following some simple risk reducing strategies.

Do some research

As well as the hours of background work done searching for overseas property or sourcing the right supplier, do some research on the currency volatility. The world of foreign exchange can be very complex, so if this is the case for you then it’s best you talk to someone who is not only in touch with the market but can talk to you in plain English.

Minimise fees and charges

Sounds obvious but the real transaction costs on international money transfers are not always that apparent. Apart from the upfront fee often referred to as a Telegraphic Transfer (TT), which can be avoided, there is also a hidden cost in the exchange rate itself. This is known as the margin, which varies from one provider to the other and could add an extra 5% to your transaction costs without even knowing.

Set a trading range

Work out your best and worst case scenario. That is, how far would the currency have to fall before it becomes too costly to go ahead with the transaction? At what exchange rate would it be more worthwhile? Once you have done this exercise you will have upper and lower exchange rate limits in place. Now you can keep an eye on the rate and either take advantage of a favourable move or minimise the risk of costs blowing out, but ensure you are realistic with your trading range.

Use free tools

There are a lot of tools out there to help you keep an eye on the exchange rate. Many websites or apps come with free email or SMS rate alerts plus daily or weekly emails with FX research for those that like to dig a little deeper. One of the most useful, however, is the ability to place a Limit Order. So you can set orders at your trading range, which will automatically be executed if the market gets there. This takes the stress, time and effort out of the process.

Consider hedging

Whilst this may sound complicated, hedging is actually quite easy to do and can provide some certainty in your costs. By taking out either a Forward Exchange Contract (FEC) or an Option you can fix the purchase price to give you piece of mind and remove the exchange rate variation. Now this doesn’t necessarily mean you will get the best exchange rate when it comes time to make your transfer, but it does protect you from higher costs in the future.

Some people argue that hedging has cost them money in the past, as they could have transacted at a more favourable exchange rate if they had not entered into a FEC. This should be considered as an opportunity cost and comes with the risk of loss. If you would like to have your cake and eat it too then perhaps options are more suitable.

Jim Vrondas is chief currency and payment strategist, Asia-Pacific at OzForex, Australia’s leading international money transfer service. OzForex’s cutting edge technology powers foreign exchange services for 100,000 private and institutional clients across six continents, and the company is a key provider of forex news.