I just buy currency when I need it, why would I change?
Two of the great unanswerable questions asked by Finance Directors, CFO’s and CEO’s are should I hedge my FX exposure, and how do I judge what is the best exchange rate?
Account managers, in answer to the first question, would be expected to answer that “your business is making widgets so why would you expect to be successful as a foreign exchange speculator?”
That is a dangerous game and provides a great deal of uncertainty. For example, you are importing from the U.S. and will be invoiced in dollars throughout your financial year and the current rate is 1.3000 dollars to the pound. If you could guarantee that you could buy all the dollars you need at 1.2750 would you accept? If you did, you could provide certainty to your entire business about the costs over the whole year. If you chose not to accept you may, of course be able to buy your dollars at 1.3200 but that is not certain, and you would have no idea what your profit margins would be. This leaves open the possibility that you would be buying at an average of 1.2500.
To compare exchange rates, it does not pay to look at absolutes. Since the market is constantly changing the only way perform a currency exchange comparison is to understand how much your provider is charging for the same service.
For example, if you contact two providers ten minutes apart and one quotes a rate of 1.1250 to buy euros versus sterling and the other quotes you 1.1235, you will, naturally, assume that the first provider is giving you the best currency rates.
But consider this, since it is a constantly moving market with several drivers that are constantly changing, without knowing what the underlying market price was, it is impossible to judge.
In the first case. The market may have been trading at 1.1265 and the provider took fifteen points “spread” (margin) from the price (i.e 1.1265 minus 0.0015), while the second provider may have been pricing following a market move with underlying market price of 1.1240 and only taken five pips spread. (1.1240 minus 0.0005)
To perform a foreign currency exchange comparison, it is vital that the provider tells you their margin or mark-up and can prove it. Receiving the best currency exchange can be difficult to prove but it can be even more difficult to find.
There is an argument which says it is a time-consuming process to hedge currency exposure and it is not always successful, so buying when needed is the way to go. The counter to that is that if you don’t look after every aspect of your cost base you cannot expect to always receive premium service from your suppliers.
About Alan Hill
Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”