by Real Business - Thursday, 30th August 2007

I t’s white-knuckle time for firms whose livelihoods depend on exporting to the US. If you signed a contract a year ago with Uncle Sam Inc, currency translation will have killed off 14 per cent of its value today. That’s a big hit on profits if you can’t increase your prices.

So what has turned the Almighty Dollar into the American Peso? Well, a $521bn US budget deficit for starters, plus a huge US trade imbalance. But with a weak dollar helping US firms to narrow the trade gap, things won’t change much in an election year. This leaves UK exporters in a fix. “If you haven’t hedged your position, you really ought to start looking at risk protection measures now,” says David Johnson, dealing manager at Moneycorp.

Many are predicting they’ll actually get worse. Says James Madsen, head of international business at HSBC Bank: “Avoid being complacent. It is tempting to think that the dollar has fallen as far as it can go. There are compelling reasons for the dollar to slip further.”

“Hedging is like trying to insure your premises against burglary,” says Andrew McLaughlin, deputy chief economist at the Royal Bank of Scotland. The two main types – forward contracts and options – can help reduce your losses. Banks offer the widest range of hedging products but foreign exchange dealers are often cheaper (and will tell you they offer a more personalised service).

Forward contracts are a binding obligation to buy or sell a certain amount of foreign currency at a pre-agreed rate of exchange, on or before a certain date. Say you’re selling trading systems software to Wall Street and are expecting a $100,000 payment in six months. The forward exchange rate you receive will be based on the current spot market rate, adjusted for the six-month differential between US and UK interest rates. Currently, with a spot market rate of $1.90 you could expect a forward exchange rate of $1.94. There are no set-up costs or commissions – it’s all built into the transaction. So, for a £1,000, you’re protected against a further drop in the dollar’s value.

If you need flexibility, or where cash-flows are less certain, think about options. These allow you the right (without the obligation) to take up a currency deal. Using our previous example, an option would ensure you an exchange rate of no worse than $1.95 for $100,000 in six months time. But if the dollar strengthened to $1.85 over that period, you could take advantage of it. Neil Parker of RBOS Financial Markets, says a typical premium for a six-month $100,000 option might cost around £2,500.

An accrual is a more complex option used by firms who need to buy dollars at a more attractive exchange rate. Currently, banks are offering an accrual rate of $1.90 on a range from $1.78 to $1.96. If the dollar weakens further, you lose your agreed rate. And if the dollar strengthens to below $1.90, you’re stuffed.

Other options are: open a foreign exchange account or try and bill your clients or distributors in pounds and let them carry the burden. Or move your cost base to the US. Or rethink your export markets. The euro is also looking good against sterling.

And what if you don’t hedge? Steve Pearson of HBOS Treasury Services says that by not taking out a forward contract one year ago on $10m revenue, you’re now nearly £1m worse off. Focuses the mind, doesn’t it?

WHERE NEXT?
www.hbosplc.com
www.hsbc.com
www.moneycorp.com
www.rbs.co.uk

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