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Why hedge foreign capital transfers

Many people have offshore interests and subsequently need to bring significant capital into Australia. Possible scenarios are:


  • Investing offshore – shares, bonds, term deposits to access the high quality investment opportunities outside of Australia

  • Property purchase - bringing in capital to buy a property in Australia.

  • Inheritance – receiving funds from overseas or sending money overseas.

  • Consolidating wealth in Australia after working abroad.


Converting large sums of foreign currency into Australian dollars (AUD) can be done through your normal travel money services however they often don’t provide any way of protecting you against adverse currency movements. The AUD is a very volatile currency and can move dramatically in short periods.


For example in the last 12 months, the AUD has fluctuated between 0.6170 USD and 0.7661 USD.


AUD/USD 12 months to 22 Feb 2023. Source: Bloomberg


The difference between converting $1m USD to AUD at the high of 0.7661 compared to the low of 0.6170 is AUD 315,432.92. This could significantly impact plans for the use of those funds. Eg. Buying a home.


It is possible to remove this risk and set your currency conversion rate ahead of time giving peace of mind and no last-minute changes to financing. It is called hedging and it isn’t just for the big boys.


What is Foreigh Exchange (FX) Hedging?

Hedging is taking out a contract that is expected to behave in the opposite direction to an asset you already hold. If the asset goes up in value, the hedge contract is expected to go down in value and vice versa.


Example


Let’s say that the AUD/USD is currently 0.70 and we wish to buy a USD bond worth USD700,000 with one year left to maturity paying 5% interest. The bond will return a total of USD735,000 on maturity.


The cost of this bond was AUD1,000,000 (USD700,000 / 0.7000). Without any hedging, the following scenarios may occur at maturity based on the AUD/USD

- If AUD/USD remains at 0.70

USD735,000 / 0.7000 = AUD1,050,000

+ 5% return as planned.

- If AUD/USD falls to 0.60

USD735,000 / 0.6000 = AUD1,225,000

+ 22.5% return = AUD $225,000 currency uplift.

- If AUD/USD rises to 0.80

USD735,000 / 0.8000 = AUD918,750

– 8.125% return = AUD $81,250 currency loss.




To mitigate the risk from the above example, we would enter into a FX Forward contract to sell USD735,000, maturing in one year. This would be executed at the same time as we purchase the bond so the exchange rate will also be 0.70.

NB: We’re assuming equal interest rates in Australia and the US.


Impact of FX hedging on net returns

- If AUD/USD remains at 0.70

Bond returns AUD1,050,000

FX contract has no gain or loss

Net proceeds of AUD1,050,000 for a +5% return

- If AUD/USD falls to 0.60

Bond returns AUD1,225,000

FX contract loss of AUD175,000 (735,000 / 0.70 – 735,000 / 0.60)

Net proceeds of AUD1,050,000 for a +5% return

- If AUD/USD rises to 0.80

Bond returns AUD918,750

FX contract gain of AUD131,250 (735,000 / 0.70 – 735,000 / 0.80)

Net proceeds of AUD1,050,000 for a +5% return




As you can see, when hedged the currency movement has zero impact on the return of interest and capital of the bond. We can do the same for transactions around house purchases, inheritances and business funding.


Depending on your appetite for risk, you can hedge all, part, or none of the currency conversion. How much you hedge might relate to your view on the currency direction, the time frame you are working with and the purpose of the funds. We can assist you to create the strategy and structure of your currency conversion to suit your needs and circumstances providing peace of mind and risk reduction.


Currencies


Although our examples above are in AUD/USD we can convert any currency you may require especially the popular ones of Pound Sterling, Yuan and the Euro.


Fee


The next question is usually price related: How much does this cost? As this is our area of expertise, we have established processes that enable us to look after these ‘smaller’ transactions at a competitive price vs the larger providers. Our clients have found that they have been better off using us versus trying to go it alone with the banks or other conversion services. If our clients wish to stay with their bank for currency conversion services because it is convenient (e.g. they are providing other banking services such as mortgages) we are often able to negotiate better pricing for them with their bank due to our experience and contacts.


If you are planning to convert any foreign capital into Australian dollars now or in the future, please contact us to chat about how we may be of service to you.


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