How can I manage my foreign exchange rate risk?

spanish property forex foreign currency pound euro question

When you sign a contract to buy a property in Spain and take on a Euro liability you become contractually bound to deliver a certain amount of Euros at a specified date (or dates) in the future. If your funds are in another currency like Sterling it then becomes important to manage your exchange rate risk.

At the time of taking on the Euro liability – probably when you sign the private sales contract – you know how much the liability is worth in Pounds because the exchange rate of the day is known. However you cannot be sure of the value in Pounds of this Euro liability in the future. Depending upon how the exchange rate moves your property might cost you more Pounds or less than you have budgeted for. Of course you would be happy if a strengthening Pound were to decrease the value of your debt in Pounds, but you might be devastated if a weakening Pound were to increase the cost and leave you significantly out of pocket. For this reason British buyers of Spanish property general prefer the security of knowing exactly how much they will have to pay in Pounds over the chance that they will end up paying less. Fortunately there are several financial instruments that you can easily purchase to help you manage your exchange rate risk.

Forward contracts allow you to fix the exchange rate that you will pay in the future, be it on one date or on several different dates in the case of stage payments spread over many months. With a forward contract you know exactly how much your property purchase will cost you in Pounds regardless of the what happens to exchange rates. Obviously in a forward contract the currency dealer who sells it to you takes on the risk and therefore has to price this into the exchange rate you are offered. Nevertheless you benefit from the security of knowing how much your property will cost you and the peace of mind that this gives you. Furthermore a good currency broker will be able to offer you a forward contract at a reasonable price.

Although forward contracts are the most common way of managing exchange rate risk there are financial instruments even more exotic than forward contracts. For instance market orders that limit the downside of your exchange rate risk whilst leaving the upside open. This means that if the Pound strengthens against the Euro you will benefit from this but at the same time you are protected against the Pound weakening beyond a certain rate. So you know from the very outset how much your property will cost you in Pounds in the worst case, and can budget for this, whilst leaving the door open for a pleasant surprise if the Pound strengthens in your favour.

These types of financial instruments (and there are others too) might sound too complicated for you. However they are actually quite simple, can be extremely useful and a good broker will be able to advise you on the most suitable instrument given your circumstances and requirements.

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