Playing the currency market
Nick Jones looks at the practicalities and implications of navigating the currency markets in the current climate
It’s been a volatile year, to say the least, and fluctuations in the world’s markets are not likely to become any more stable in the short term.
Anyone involved in moving money between countries will need to keep their eyes peeled on exchange rates in the months ahead, or look up one of the companies who are in the position to be able to help individuals control their levels of risk.
As if there isn’t enough to worry about when you are moving abroad or buying overseas, fluctuations in currency rates can make a huge difference to the amount of money you end up dealing with. Buying and selling property overseas almost always involves transferring large amounts of money from one currency to another and moves in the market can make up to as much as 10% difference over the course of just a few days.
It’s worth bearing in mind that this kind of movement will not only mean that the costs of your move or purchase could be affected drastically by this kind of market activity, but in the worse possible scenario it could also put the house of your dreams financially out of reach. Fortunately, there are ways of protecting against this kind of outcome and ensuring that you know exactly what you’re dealing with by minimising your risk in advance.
If you live or work in France and need to move money overseas, it’s highly likely that at some stage you will have to deal with the currency market.
When the exchange rates move, so does the relative cost or value of your goods, deposits and savings. That’s why it’s imperative that absolutely anyone involved in international transfers keeps a very close eye on the comparative value of currencies, to ensure they don’t end up receiving a nasty shock down the line.
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The currency market is the largest financial market in the world, trading more than $4trn around the globe every day. A third of this is traded in London. The market is unique because it’s open 24 hours a day from Sunday evening to Friday evening. During this time, thousands of factors affect each individual currency and its exchange rate, ranging from British politics to American retail sales and the price of oil.
The main players are the banks, which trade the vast majority of the $4trn every day at the interbank rate – literally a rate between the banks. They will usually be transacting for their clients, who might be large companies or institutional investors.
There are, of course, risks to dealing in the world’s financial markets and it can be tough trying to navigate them without specialist help. There are two main things you need to remember. First, getting the best exchange rate (i.e. the rate closest to the interbank rate) is, of course, the central aim. Secondly, you should always do everything you can to make sure that you are not exposed to the ongoing fluctuations in exchange rates which could end up making a serious dent in your pocket.
Securing the best exchange rate
The rate you see on internet sites, the television or in newspapers is normally the interbank rate and you won’t usually be able to get this rate unless you’re transacting millions of pounds.
The banks have a standard day rate for smaller transactions, which can be anything from 0.25% to 2% worse than the interbank rate. This is one of the simplest options, although research suggests it will not be the cheapest or the quickest method. Some banks will insist you go into a branch to fill in paperwork and payment times, which is time consuming and unnecessary.
You should be able to get a better rate by dealing with a foreign currency specialist or broker. The exact rate you receive relative to the interbank rate will depend on the amount you’re transacting, the frequency of your transactions and whether you are booking an immediate transfer or forward contract. However, unless your transactions are small (under �1,000), you should normally expect to be no more than 1% from the interbank rate.
There are many brokers out there to choose from but for additional peace of mind it helps to use a broker that is authorised by the Financial Services Authority (FSA). A major stipulation of this regulation is to safeguard client funds by segregating client money.
The biggest five foreign exchange companies currently trading in the UK are Travelex, Moneycorp, World First, HiFX and Currencies Direct.
Managing your exposure
The currency markets are susceptible to the influence of a whole range of global events, from natural disasters to political upheaval and consumer confidence.
All this adds up to a situation where exchange rates can move by up to 10% in the space of just of a few days. Clearly, if you’re involved in any kind of international transfer this can make a serious impact on the amounts you end up dealing with.
To avoid this, when planning your transactions you have a few options. Firstly, you can just wait until you need to move the money and buy the currency on the date of transfer. This presents a bit of a risk, as there is no way of knowing exactly what the exchange rate will be and you will not be able to budget 100% accurately.
Alternatively, you can book the rate for your transaction in advance – as soon as you know you will definitely need to make the transaction. This is called a forward contract and you can fix the rate for any period from a week up to a few years ahead.
Although the rate could go up or down, it’s considered best practice to lock in your margin in advance. From talking to hundreds of clients we know that it’s more painful if you don’t fix the rate and the exchange rate moves against you than if you do fix it and the rate improves.
Your bank may not offer you a forward contract if you’re just starting out, but should do once you’re established. However, you can also use a foreign exchange broker. A broker will be able to book you a forward contract in return for a small deposit (usually 5-10% of the amount you’re transacting).
By using a foreign exchange broker, you will find yourself presented with a few more options, often methods that the banks reserve for their larger corporate clients. For example, you’ll be able to leave an order for your broker – whereby they’ll call you or book your transactions) if the rate reaches your target level.
A few brokers also offer currency options, which can be very useful. A currency option will allow you to protect yourself by setting a worst-case rate in advance in the same way you can with a forward contract.
However, for a small premium, you will also be in a position to see the financial benefit if the exchange rates subsequently move in your favour in the period leading up to the date of transaction. So there are ways of managing your risk, and making sure that your bottom line doesn’t fall victim to the perils of the currency markets. It is important that you are aware of the options that are out there, and that you go to a company that is properly authorised and, importantly, big enough to ensure your financial security too.
There are better alternatives to the banks: companies that will afford the same kind of service that is usually reserved for only a select few clients. These companies can offer the right solutions for the general business market, securing the best rates and protecting you from the ever-evolving predicament that is the international currency market.
Nick Jones.World First foreign exchange