Exchange rate protection strategies

There are a number of alternatives available to protect against adverse movements in the exchange rate. Some can be intrinsic to your existing operations and available at no cost. Others are financial products available from banks and other financial institutions.

Offsets

When considering the extent of your exposure to exchange rate movements, it is important to take offsetting cash flows into account. For instance, any foreign currency expenses will offset your exposure to revenue in that currency.

‘Forward’ exchange contracts

Most people are familiar with the regular currency conversion transaction at the bank, where the bank will make a T/T payment in foreign currency, which will arrive at the receiving bank account in one or two days time, and debit your Australian Dollar account.

It is also possible to arrange to fix the rate for a conversion, but not physically effect the payments until a future date. So while the rate can be fixed today, the foreign currency T/T and the Australian dollar debit may not happen until some pre-arranged date in the future. These ‘forward’ contracts can generally be arranged up to 1 year ahead.

Using these contracts, it is possible to exactly fix the exchange rate that will be used for your currency conversions for a period of time, and remove all exposure to movements in the exchange rate.

Insurance

Financial institutions offer products to insure against adverse exchange rate movements. These provide the purchaser with the potential to benefit from exchange rate movements in their favour while offering protecting against adverse movements.

There is no free lunch of course and this type of insurance comes at the cost of an up-front premium. This can be in the order of 5% of the amount involved for protection against adverse movements for 12 months.

Other strategies

There are many more alternatives available that can be tailored to your specific requirements. An example is a zero cost insurance strategy that allows you to benefit from a certain level of protection against adverse movements by giving up some profit potential from beneficial exchange rate movements.

We would be please to discuss your individual situation with you and work out if we can be of assistance in your organisation.

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