Dynamic Export

Setting a foreign exchange rate for the future could make a huge difference to your profitability. Learn how foreign currency can work for you and how you might benefit from securing a forward exchange contract.

If you’re the kind of exporter who watches exchange rate movements with a little trepidation, maybe it’s time to consider ways of managing your money beyond the daily rate.

Fluctuations in the foreign currency market occur for various reasons, but are mostly in tune with traders’ appetite for risk. But the perception of risk changes daily—even hour-by-hour—as political announcements occur, company information comes to light and global events unfold.

To avoid the whims of traders, exporters dealing in foreign currency for business transactions are advised to lock in a forward exchange contract.

Put simply, a forward exchange contract is an agreement between you and your provider to exchange a specified amount of one currency for another currency on a particular date, using a set rate calculated at the point of making the contract.

The aspect that you need to remove from your thinking is that the forward rate is a prediction of the exchange rate at that future date—it is not.

“A forward exchange contract is made up of two components: the spot component, which is effectively the rate of the two currencies on the day, and the forward component, which is a reflection of the interest rate differential, the difference between the interest rate in one country versus another over that time period,” explains Tim Keith, head of Treasury Management at the National Australia Bank. “At the end of the day there is no other mathematically correct way to do it.”

Anyone with foreign currency transaction in their business should consider setting up a forward exchange arrangement with their financial institution; most providers will offer this once they understand the foreign exchange requirements of your business.

“Any business that has exposure to a currency through importing, exporting or trade of some sort should consider the use of forward exchange contracts. It doesn’t matter if you’re big, small or in between,” says Keith.

He suggests that a forward exchange contract should centre on existing supply contracts you have with customers.

“In some markets that’s just from month-to-month,” he says. “Meat is a classic example where there are no long-term supply contracts, they tend to have much smaller tenure forward exchange contracts or they just use the spot market, whereas there are other businesses that have contracts to supply 12 months or two years out. That will obviously increase the tenure of their contract.”

Forward exchange contracts can be negotiated for up to 10 years into the future, though this length of tenure is understandably rare. “It’s really uncommon because no one has [supply] contracts out for 10 years. What they’re saying is that they don’t consider that their business model will change dramatically in a 10-year period and therefore they’re willing to lock in their cash flow,” Keith explains.

Your relationship with your exchange provider will help you decide what’s appropriate for your business, so be open about what you want to achieve and what you want out of the contract.

“They might say ‘I want to lock in a rate for 12 months’ and then after we talk to them and understand their business, we find out they’re actually going to be paid the currency in six months we’ll say ‘Why are you going for 12 months out?’” says Keith. “That’s simplistic case but that’s the process followed.”

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