Monday, April 21, 2008

Foreign Currency - how to secure a favourable exchange rate

One of the most common financial services requested through Expat Focus is that of foreign currency exchange. Some time ago our foreign exchange partner, World First, created a very useful article for anyone looking to save money when exchanging currency and I'm going to reproduce it here in its entirety. I hope you find it useful!

When emigrating, coming home or simply moving money around the world, making sure you secure a favourable exchange rate is one of the most important things you can do. An extra few minutes or so spent researching your options could save you thousands of pounds.

There are three simple ways in which you can save money:

1) Use a Currency broker. Currency brokers will generally provide superior exchange rates to the high street banks. The currency brokers have access to the interbank rate and do not have the high costs that the banks have. This means that they can usually offer better exchange rates.

2) Use a free Market Watch/Order Service: This allows you to tell your currency broker your target or budget exchange rate and they will ring you if that exchange rate level is reached. As the rate moves every few seconds, currency brokers can act as your eyes and ears on the market.

For example, you might ask your currency broker to ring you if they could offer you a Sterling Dollar rate of 1.85 for the date in the future that you want to move the funds.

3) Consider fixing the exchange rate in advance using a Forward Contract. If you know you need to convert/move funds in the future but don't yet have the money you can reserve a rate in advance using a Forward Contract. During this period, you are exposed to exchange rate movements and therefore, a forward contract is ideal if, for example, you have agreed to buy a house and want to fix the rate now but will not be making payment for a couple of months.

A forward contract is when you fix an exchange rate for a pre-agreed date in the future. You can fix a forward exchange rate for any period from 1 week up to 1 year in advance. There's no cost for a forward contract and no payment is made until the settlement date, except for a small deposit of 2% to 10% depending on how far ahead you would like to fix the rate.

A "forward contract" is fixed at the "forward rate" which usually differs slightly from the "spot rate" (the rate for immediate transfer). The difference between the 2 rates are the "forward points". The Sterling Euro forward points, for example, are a straight arithmetic calculation of the difference in the interest rates between the UK and the Euro-zone. When UK interest rates are higher than Euro rates, the rate will go down slightly as you reserve further into the future. If UK rates were to fall below Euro rates, the rate would go up for a forward contract. This is most easily explained with 2 examples.

1) At the end of June 2005, UK interest rates were 4.75% and European rates were 2%. i.e. a difference of 2.75%. You could have fixed an immediate deal with one of the currency brokers, such as World First, at 1.50. If you wanted to book a 1-year forward contract, i.e. fix the exchange rate for 24th June 2006, we would have reduced the exchange rate by approximately 2.75% (i.e. around 1.4588). Although the exchange rate appears worse, you can keep your pounds on deposit in the UK at 4.75% for a year whereas if you had transferred them to Europe immediately you would only receive 2% interest (or less). If you factor back in the extra interest you would be receiving in the UK, you are still converting at an effective rate of 1.50.

2) If you were buying in France, had signed the Compromis at the end of June 2005 and were due to pay the notaire a month later, you could have fixed a rate with World First for the end of July at 1.4950. Although the rate could have gone up from here and you would still have converted at 1.4950, you would have been protected from the rate falling. In fact by the end of July 2005, the rate had fallen to 1.4350. On a EUR295,000 property the forward contract would have meant you paid GBP197,324.41. If you had waited and converted at the end of July, you would have paid GBP206,293.71 - almost GBP9,000 more!

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