Currency Concerns

[romablade1889]

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.

[ScottieDog]

I've got an account with a foreign exchange company that does what romablade1889 suggests. The other benefit is that they don't charge transfer fees (can be up to £25 per transaction for a bank) or commission. It does cost me £23 per CHAPS transaction from my bank, but I could send a cheque if time allows. The terms for a Time Forward contract is 10% of the payment price up front. You've got to consider whether the cost of borrowing the 10% say 12 months in advance is cheaper than the potential risk of the currency fluctation.....

[romablade1889]

Hi all,

Just a quick reminder to get your currency sorted.

When I started considering Alkudia Smir a few months ago, the Euro/£ rate was 1.37. It's currently 1.49.

So, my 2 bed apartment is going to cost me about £56,995. If the rate drops as rapidly as it has risen and went back to 1.37 I would have to pay £62,199 - an extra £5,124....

Watch this space for a currency risk tool I'm working on, specifically for Alkudia which takes into account the payment schedule and forecasts the overall risk...

[romablade1889]

I've quickly pulled together a calculator for estimating the possible losses/gains from currency fluctuations (I need to make a few tweaks then will post here later).

Basically the Sterling/Euro exchange rate is at a high at the moment due mainly to an expected hike in the UK base rates in November. This is attracting investors into the UK as they can expect a bigger return than in Europe or the US where the base rates are much lower (basically they can charge more interest for their investments/loans).

This means we're getting a great deal at the moment on our property purchases with xe.com quoting a rate of 1.49 Euros for each £.

However, RBS and others are predicting that the exchange rate will start to drop as another base rate rise in the UK is unlikely. They expect the rate to be as low as 1.33 in the next two years.

The tool will allow you to enter the Euros price of your property and then makes some assumptions on when payments are due. It then identifies the risk on those payments that are to be made in Euros.

Basically, for my 2 bed 1st floor apartment (costing E85,000) , I could see an additional £3,100 in extra costs due to exchange rate fluctuation by the time I get my keys...

When I've posted the tool, input your own data and see what the tool comes up with. This is basically the amount you're gambling with at the mercy of the exchange rate. Personally, I'm not prepared to gamble 3 grand so I'll be buying a forward contract....

I'm happy to receive any feedback on the tool, or if you need help running it give me a shout via PM...

[fandango]

Hi RB1889,
Really useful post, thankyou. Can you recommend a broker so that I can look into buying a forward contract?

Many thanks, Fandango

[Pinky]

Im using Moneycorp if I ever get these contracts sorted with Fadesa

[ScottieDog]

I use Sterling Exchange

[mcneilee]

i was thinking of using currenciesdirect Time Option
but can't do anything until fadesa pull their finger out of their asses

[romablade1889]

I've used Hifx in the past and been pleased. It's a case of shopping around to get the best deal on commission and Forward Exchange Rate.

[mcneilee]

SEE THE POUND IS WEAKENING

[romablade1889]

As predicted (smug grin on face).

Now that the interest rate rise is out of the way, the pound will weaken. It may rise again if speculation about another rise in 2 months time is true. Forecasts suggest it will drop to around 1.34 Euros eventually, which is why you should buy your Euros now on a forward contract... As soon as I'm sure I'll be buying (contract pending) I will buy mine. I'm not in the money market so why would I take the risk..?

[mcneilee]

i thought a Time Forward Contract would be more suitable since their are instament to pay & "incase they finish it quiker allthogh that would be unlikey as history has shown"

[romablade1889]

Correct. Most forward contracts allow you to "withdraw" curency form your account at any time or you can fix the dates for lower commission if you know them.

[kenz]

Just looking to sort out another payment, WTF has happened to the pound against the dirham!!!!
I looked at these different options of hedging a year ago & decided to ignore them, doh!