CHAPTER 9
CURRENCY EXPOSURE RISK
| Most of us getting paid in the US never give a second thought to the
value of the currency we receive on pay day. Compensation is in US dollars from a US bank and is most likely to be spent in the US. What is happening to other world currencies is not of much concern in our day-to-day lives. Expect this to change drastically when you move abroad. If you're working for a company offshore and being paid in a foreign currency, what you pay for dinner tonight or for gas to drive to work in the morning will be directly affected by how much |
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| that currency is worth on the global currency market. The value of your currency may change significantly on a day-to-day basis. Consequently, to maximize your purchasing power and to minimize losses due to shifts in the value of the currency you are paid, you will need to become familiar with the forces at work in world currency markets and learn ways to both take advantage of these swings and protect yourself from them. As Reinard Nigl, who works in the currency markets of London, comments: "Dramatic changes in currency rates can have severe consequences not only for big international corporations and central banks, but also for private individuals. You do not have to own millions to make profits or incur losses." | ||
THE GLOBAL PICTURE
Currency is bought and sold on global foreign exchange (forex) markets.
The value of a freely convertible currency is determined on these
markets in much the same way the value of consumable goods is determined
in their markets. To put it simply: if there are more buyers than
sellers of a particular currency, its value (price one must pay for it)
goes up. If there are more sellers, the price goes down.
Simple enough in concept, the forex markets on which money is traded are
massive and extremely complex. Every day astronomical sums (trillions!)
change hands. Due to modern information technology, news travels around
the globe within seconds, and markets are open 24 hours a day.
Market participants include both central banks and big commercial
banks. All trading is done on an over-the-counter (OTC) basis in the
interbank market. The participants buy and sell currencies with the aim
of making money from their trades. When the banks' own money is
involved (called "proprietary trading"), the persons involved are
normally under enormous pressure to perform well. Apart from trading
for purely speculative reasons, these traders might also hedge their
currency portfolios or trade on behalf of big international
corporations, who are exposed to currency risks.
Like the oceans, these markets cannot be tamed by anyone. The markets
are made up of individuals (the forex traders), who normally follow the
herd. Generally there is very little time for these traders to make
their decisions, often resulting in actions that sometimes appear to be
based more on intuition or herd behavior than on a clear or informed
strategy. Often something as tenuous as the release of economic data
(trade deficit figures, unemployment rates, consumer spending, tax
increases, changes of government or in interest rates, etc.) can have an
enormous effect on the price of a particular currency.
With regard to central banks, it should be pointed out that their power
through trading currencies is rather limited. If all major central
banks in the industrialized world would fully co-operate to support one
single currency, it would take less than one hour for all their foreign
reserves to be exhausted. For example, the events during the fall of
1992, when New York-based George Soros with his hedge funds forced the
British pound out of the European Exchange Rate Mechanism (ERM) give a
clear picture of the overwhelming power of these markets. In this case,
the British government on its own could not support the British pound.
The pound was driven and valued solely by the markets.
How does all of this affect international trade? Let's take a big US
multinational company which sells its products all over the world. The
currency used for production costs and the balance sheet are logically
in US dollars. However, receipts from international sales come in all
sorts of currencies. In order to remain competitive, the products must
be sold in each country at prices which cannot change every day.
Unfortunately the currency rates do. If the US dollar gets stronger,
this US multinational company will take a loss, as the Yen,
Deutschmarks, etc. in which receipts are paid will buy fewer dollars
(used to pay personnel and production costs Stateside). It is not
uncommon for international sales profits to be wiped out by adverse
currency moves.
On the other hand, if the US dollar weakens and the currencies in which
the company is paid get stronger, our US multinational will make a
profit. Sometimes these profits enable producers to bring their sales
prices down, so they can undercut their international competitors. That
is why exporters want a weak (in their eyes, competitive) currency,
whereas central banks favor a strong currency in order to achieve
monetary stability. Treasury departments in large corporations and
central banks have the task of keeping these problems under control.
They can buy and sell currencies in the spot and forward markets and
they can use various hedging instruments, such as swaps and options.
Furthermore they can go long ("betting" on a strengthening currency) or
go short ("betting" on a depreciating currency). The ultimate success
of these strategies is very difficult to predict.
HOW CURRENCY EXCHANGE RATES AFFECT YOUR COST
OF LIVING AND QUALITY OF LIFESTYLE
What applies to our big US company, also applies to you living abroad.
If your employer sends you out to work in a different part of the world
for a prolonged time, fluctuations in currency value could have severe
implications for your financial well-being. You have been used to using
greenbacks. But now, if you want to buy a meal in Tokyo, you have to
pay in yen. If the yen is strong relative to US dollars and you are
paid in yen, your dinner will be a bargain. However, if you are paid in
dollars and must pay for your meal in yen, you can only hope that your
expensive meal is a good one.
You will need to consider the implications of relative currency values
and their fluctuations when you negotiate your compensation and plan
your finances for your stay abroad. First, look at the exchange rate
over the last few years to get a clear picture of the host currency
relative to the US dollar. Then establish the real buying power in this
country. For example, food, cars, and accommodation in Europe and Japan
are normally twice as expensive as in the US. For an American now
working in Zurich, an attractive annual salary in the US converted into
Swiss Francs might prove to be just average by local standards and may
not ensure the previously enjoyed life style. This shortfall, of
course, can be offset by a good expat compensation package. Inquire how
much of your net wages will actually be available for spending.
PERSONAL INVESTMENTS, PLANS FOR RETIREMENT, AND
OPTIMUM CURRENCY
One important factor to consider when arranging your finances for your
overseas assignment is where and when you will be spending the money you
earn abroad. Chances are good that some portion of it will be spent on
living and traveling abroad (though this may be minimal if your company
is paying for these), and the rest will be invested or otherwise saved
for future use. Think about what you intend to do upon your return.
Whether it will be retirement or working for the head-office in the US
again, you need to decide what your base currency will be. In other
words, what exactly will be the color of the money you intend to spend
in years to come? Going back to our US person working in Switzerland:
she intends to retire after her foreign assignment. She and her husband
will buy a home in Arizona with US dollars and all living expenses will
be paid in US dollars. Obviously, they were wise to have kept all their
investments in US dollars. Currency swings between the Swiss franc and
the US dollar are of minor importance and affect only the amount spent
in Switzerland.
Keeping all this in mind, the currency you are to be paid in might be a
negotiating point with your company. If you are working in a country
with a relatively weak currency and your company, for its own financial
reasons, insists on paying your salary in that currency, it would be to
your advantage to negotiate a compensation package with a salary just
adequate to cover your overseas expenses, perhaps with your living
expenses covered by the company so you need very little money in the
host currency, and with compensation more heavily weighted in other
forms more useful to you later (such as pension plan, stock options,
etc.). Conversely, if you are going to a country with a currency
generally stronger than the dollar, you might want to maximize the
amount of money you collect in that currency, as it will buy you more
dollars later when you need them.
In the process of gathering information and considering your financial
options, you might find the advice of a private banker or other
financial advisor who is familiar with international currency and
investment issues very valuable. The time and money you invest upfront
arranging your finances will pay dividends in both money and peace of
mind.
SUMMARY: SOME QUESTIONS TO ASK
· Will I be paid in US dollars, in the local currency, or both?
Determine for yourself what is most advantageous to you and see how much
your company can accommodate you.
· What is the real buying power and subsequent cost of living in the
host country?
· How much money will I have to spend in this foreign country and how
much local tax will I have to pay?
· Can I have a split employment contract, whereby a certain percentage
will be paid offshore and in US dollars?
· Can I save money and can this amount be paid in US dollars?
· Where do I wish to spend most of my money at a later stage (e.g.
retirement)?
· Are my investments denominated in US dollars?
