Now things are moving and we're getting firm pricing, it's time to start thinking about currency exchange. Here's some background, hope it's useful:
Why Bother with Currency Hedging?
Currency Hedging is all about mitigating the risk from exchange rate fluctuations. Imagine you were buying at Alkudia Smir for E100,000. At the moment the Euro/£ rate is 1.48. So E100,000 will cost you £67,567 of your hard earned pounds. You pay 40% (E40,000) now as a deposit and then you have to pay 60% of this when your apartment is ready, i.e. £60,000.
So, at today's rate your deposit will cost you £27,027.
Let's say building work takes 18 months and by that time the exchange rate has dropped back to what it was in June - 1.37. When you pay your E60,000 final payment this will actually cost you £43,795 in pounds. So, in total you will have paid £43,795 plus £27,027 or £70,822. That's £3,255 more than the £67,567 you thought you had to pay!!!
Hedging is where you remove the risk of this fluctuation in currency. You invest a small amount in contract fees to avoid the risk of the value of the £ against the Euro falling. What if the value of the £ rises? Well in this case you lose out. If you're prepared to take the gamble you may win, but you could also lose allot of money. Would you bet £3,255 on a horse? Then why gamble the same amount on buying Euros?
There are different types of contract you can get with a broker to buy your currency. Here are some examples.
The Spot Contract
This is what you do when you buy your holiday Euros at the airport. Basically you buy currency at the prevailing rate and you get it now. You could buy your Euros to buy your apartment now and bank it in a Euro account. But any change in the exchange rate will change the value of your pot... You'd also have the extra headache of setting up an account to deposit your Euros in and the interest rate might not be as good as a UK savings account for your £s.
Forward Contract
Think of this as buy now, pay later. You can fix a rate for a period of time (usually upto 2 years). Some brokers allow you to fix the rate others will just give you a fixed rate. Think of it like a fixed mortgage rate. It protects you against any movement in the market.
You pay a small deposit (£100-500 depending on terms and how much you need). You can then put your pounds in a high-interest account in the UK and earn interest on it until you need to buy the rest of your currency....
Time Forward Contract
When you have to be more flexible with when you buy your funds (i.e. you don't know the dates when instalments have to be paid on your apartment) you can go for a time option.
Some contracts are very flexible in that you can buy Euros at any time during the 2 years, at your fixed rate, ideal where you have to make a number of instalments on your apartment purchase. Generally though you will negotiate the level of flexibility at the time of taking the contract out. Most will allow you to draw funds upto 3 months before the maturity date agreed. You can buy several contract with different maturity dates to give you more flexibility (i.e. one for each during-building instalment, one for the final payment).
Limit Orders
This is where you specify an exchange rate and once that rate is reached in the market, the broker will buy the Euros for you. You can also set 'lower level' or 'stop' limits to protect you should the rate fall. For example, you ask for a limit order rate of 1.60. If the rate then rises to 1.60, the broker will buy your Euros there and then. If you set a stop rate of 1.40 and the rate drops to this level, the broker will buy at that amount. This allows you to take some risk on currency fluctuation and possibly get a better rate than the fixed contract whilst limiting your potential risks of loss. You can play the markets within your defined budget.