What a difference a referendum makes! Since the UK voted to leave the European Union, sterling has had a pretty difficult time of it. If we compare exchange rates from the just middle of June 2016 with the middle of July 2016 then we see just how much sterling has been hit by the Brexit brouhaha. Over this time it has fallen 9% against the euro, 11% against the US dollar and 8% against the Swiss franc. The year on year picture is more stark still; down 19%, 18% and 14% respectively.
As always, there are two sides to every exchange rate story. Whilst many of us will simply look at those numbers and think our holiday to Spain has just become nearly 17% more expensive or that we'll have 16% less to spend when shopping in New York this Christmas, UK exporters will see it quite differently. In effect, their goods just become a lot cheaper for their overseas customers.
Expats earning abroad and repatriating funds to a UK bank account are also winners for the time being. Whichever side of the equation you are on, you may think that now is either a good time to lock in some gains if the rates have moved in your favour or choose to protect yourself from further losses if rates have moved against you.
Whatever your motivation, forward contracts can be a good way to navigate through currency markets during times of high volatility.
A simple solution
A basic forward contract is a classic currency product and represents a simple, off-the-shelf way of managing and protecting yourself against a foreign currency exposure.
Put very simply, a forward contract allows a company to purchase an amount of currency for a set time in the future. The price will differ from the spot rate as the market calculates a forward rate depending on the difference in the interest rates between the two countries. It is similar to a fixing a rate on a mortgage in that it just means that you know what rate you are getting for a certain period of time so that you can plan ahead and not have to worry about constantly watching the rates in the market.
It's important to say that forward rates do not represent predictions of where the market is expecting exchange rates to be in the future, however; they are merely calculations of future interest rate expectations. These products allow individuals and businesses to hedge themselves against unfavourable currency movements as far as three years into the future
Risks and rewards
The risks with a forward contract are that the market may move in your favour over the lifetime of the contract. In this case the rate you booked at does not change though we may ask for additional deposit to secure your contract. This is only a deposit.
Overall, what businesses find attractive about forward contracts is the certainty they provide, and should your business opt for one, you'll benefit from knowing in advance what you'll pay when striking contracts and deals with suppliers. For example, if you take an order for €100,000 you'll know exactly how much that will be in sterling well in advance.
Our recent survey* found that 78% of UK SMEs recognised that having a proper currency strategy could improve profitability. If you are in that 78% and wish to talk to us about your currency exposure or book a forward contract, get in touch with the World First team.
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