How to hedge against currency fluctuations when trading overseas
How entrepreneurs can take advantage of the money markets when conducting trade overseas
Glenn Uniacke, senior dealer at Moneycorp, explains how entrepreneurs can take advantage of the money markets when conducting trade overseas.
There has been a lot of turbulence in the foreign exchange (FX) markets recently. Traditionally, traders in international currencies could make fairly strong predictions about the euro, pound and dollar. But since the credit crunch any predictions are far more short-term and littered with caveats. European leaders are busy trying to figure out what to do about Greece and the prospect of a hung parliament in the UK is also having a destabilising effect on currency values. What was once taken for granted in FX markets has now been left open to question. But for entrepreneurs there are opportunities in periods of flux.
The pound is particularly weak at the moment which should be good news for exporters. “At the moment, UK exporters are starting from a position of strength,” Uniacke says. The weak pound can only help exports and Uniacke says he believes the money markets aren’t expecting this situation to dramatically change until at least 2011.
When Uniacke and his colleagues speak to clients, they must refrain from conjecture, provide them with the market’s history and, speaking as an analyst, give a prediction. No-one knows for sure what tomorrow brings, and the further ahead you look the less clear things become.
“The further you go into the future the harder things are to predict. If you are making a deal now for a million euros and you are currently looking at a rate of …1.10 to £1, but you aren’t going to get paid for three months, so there’s no guarantee that the deal will still be profitable when you actually get paid.”
Uniacke says that options (hedges) for exporters fall into two broad categories which, for a small percentage, can shield you if the currency you are trading with takes a big hit:
- Fee-paying options: Known in the business as a ‘vanilla’,this is an option in the truest sense of the word. You pay a premium and have the right to buy money at that price. However, if the market goes the other way, you can discard it – it’s truly optional. “It’s a bit like car insurance, as you pay your money and hope you don’t have to use it,” Uniacke says.
- Zero-cost options: There are many types of these, but one of the more popular ones is a known as a ‘participating forward’. This allows you to profit from half of any upside move. So if, for instance, if you are buying sterling which is priced at 1.10 and then it rises to 1.20 you can still buy it for 1.15.
Entrepreneurs need to be pragmatic about the money markets and see currency as another commodity, which can fall and rise in value. “Businesses should see FX as a business cost,” says Uniacke. “They need to consider what a certain currency is costing their business, what their cost levels are and how that impacts on the bottom line. These are questions businesses need to ask.”