How using a forward contract can protect your money
Hope isn't stategy when managing your exposure to currency risk. Be proactive by locking in a current rate for future payments using a forward contract.
Whether you’re making regular pension payments to fund your retirement in France or buying a holiday home in Spain, you’ll want to shield the value of your international payments from fluctuating exchange rates.
Managing your exposure to this currency risk doesn’t have to be overwhelming. A forward contract can help you gain control of your finances.
What is a forward contract?
This legal contract allows you to fix a price (a forward rate) based on the current market rate to buy a certain amount of currency in the future – insulating your international payments against currency risk. You benefit from the security of knowing how much future expenses will cost because you know the exact rate you’ll be using to exchange your currency.
How do forward contracts work?
The overseas property buying process is a good example of how a forward contract can be used to guard against adverse exchange rate movements.
The protracted nature of this process means a buyer typically agrees to purchase a property overseas at one price but won’t have to transfer the funds required to complete the purchase for weeks or even months. During this period even small exchange rate fluctuations could cause the price of their property to rise beyond their budget.
Here’s a quick example of how a forward contract can protect an overseas property budget from currency market volatility:
- Having found their dream holiday home in France, Mr and Mrs Kirk are aware that unfavourable rate fluctuations could cause the price of their property to soar between paying their deposit and completing – so they seek the services of a currency specialist.
- When they lay down the deposit the exchange rate is £1=€1.15, meaning their €300,000 property will cost around £260,000 – but they won’t have to transfer the funds to complete the purchase until an unspecified point in the future.
- The account manager they’ve been assigned informs them that the pound is currently subject to heightened volatility, so advises them to secure today’s €1.15 rate for the future payment using a forward contract – providing them with the security of knowing that the price of their property is protected against currency fluctuations.
- Fast-forward six months and the Kirk’s are ready to complete their purchase, during which time the GBP-EUR rate has slumped four cents to €1.11. If they hadn’t been proactive and locked in their forward rate at €1.15, the property would have cost them £270,000 at the current rate – an eye-watering £10,000 more.
When can a forward contract be used?
A range of international payment requirements benefit from locking in a forward rate, including:
- Overseas property purchase
- Overseas land purchase
- Regular payments to cover ongoing property costs overseas
- Regular payments to cover overseas living costs
- Repatriating funds from an overseas property sale
- Regular pension transfers
- Purchasing luxury items from overseas, such as a boat or art
A currency specialist can help you harness the peace of mind that a forward contract offers by monitoring the market on your behalf and helping you lock in a favourable exchange rate.