Source: Wealth Creator Magazine May/June 2006

When the AUD depreciates, importers will pay more for their goods.

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Hedging And Trading the Aussie

Source: Wealth Creator Magazine May/June 2006

Hedging And Trading the Aussie

The recent drop in the Australian dollar is a concern for importers and exporters but this should not be the case due to opportunities to hedge their currency exposure. These facilities have been previously available only through banks but now with the advent of private companies and their Foreign Exchange trading platforms there is another alternative.

The recent drop in the AUD.

Importers and Exporters have been relatively comfortable with the Aussie being range bound over the last couple of years. Therefore the recent drop over the past few weeks has caused some concern. This drop has been due to several factors. Firstly, there has been Japanese investors liquidating their Australian bond port-folios. The result of which is a sell off of the Australian dollar in order to convert to other currencies for investments offshore.

Secondly, there have been revisions to the outlook of monetary policy in Australia and Australian rates are predicted to be steady for next six months while the US looks to raise their rates by at least another half a percent causing interest rates differential rates to narrow making investment in Australia less attractive.

The final trigger was of a technical nature with a break of 0.7300 attracting large technical sellers who were targeting the move towards 0.6800/0.6900 cents.

These three factors coupled with fund managers’ switching out of the Australian dollar to other currencies has seen the Aussie fall from 0.7480 to 0.7065.

So how do importers/exporters protect themselves from such large fluctuations?

When the AUD depreciates, importers will pay more for their goods and when it appreciates they will pay less. Obviously, these rises and falls cannot be passed on to the consumer in a competitive environment. By hedging these currency fluctuations, importers can save money and can better plan their budgetary needs.

Let’s assume that XYZ Pty Ltd is an importer of toys from Taiwan. They need to make a payment of US$100,000 in 30 days for a shipment of soft toys. If the spot rate was AUD/USD 0.7300 (at the time the company placed the order) it would cost XYZ Pty Ltd AU$136,986.30 (USD$100,000 / 0.7300).

Let’s assume that in 30 days the AUD has fallen to 0.7100 (we have already seen this move in less than 30 days!). Then the new cost to XYZ Pty Ltd is now $140,845.07. Given that XYZ Pty has not hedged their currency position, this is an additional cost of AU$3,858.77.

So how does XYZ Pty Ltd hedge their currency position? They do so by taking out a forward contract in the AUD/USD market for the period of 30 days. Because XYZ wants to hedge against a fall in the AUD, he would sell the AUD at the time they he agreed to purchase the toys. Should the AUD fall over the 30 day period then any loss he would incur from the increase in conversion charge for his payment of US$100,000 would be off set by the profit he would make from his sold AUD position.

Foreign Exchange trading platforms.

With the introduction of the Internet and the use of leverage, importers/exporters (and for that matter currency speculators) can now take advantage of currency movements with minimum capital outlay. Using the example above, an importer can now hedge his US$100,000 with a deposit of as little as AU$1,000. However, he or she may be required to deposit further funds to keep the position open over the 30 day period should the market rise rather than fall.

These foreign exchange trading platforms allow individuals to trade Spot, Forwards or Currency Options. Clients can now open, close and manage their positions online and have 24 hour access to the worlds markets via their home or work computer.

There is no longer a need to rely on banks to hedge your currency exposure and this ‘do it yourself method’, like share trading, is becoming a popular means of hedging and trading currencies.

Written by:

Robert Francis is the General Manager of Easy Forex, Sydney.Mr Francis held a key position at one of Australia’s leading online retail broking firms, Commonwealth Securities, managing the International and Exchange Traded Options trading desks. Email:robert@easy-forex.com