Foreign currency and exchange risks
Buying currency options
There are different ways of hedging your exchange rate exposure and your bank will be best placed to keep you updated with any new alternatives available.
Buying currency options is a more flexible form of hedging than setting up a forward foreign exchange contract - but it's also more expensive.
Currency options give you the right, but not the obligation, to buy or sell a certain amount of currency at a specific exchange rate on or before a specified date. But unlike a forward foreign exchange contract, you're not obliged to buy or sell the currency at the end of the period.
To enjoy this flexibility you'll have to pay a premium, which typically might be a minimum of £500. The exact amount will depend on the amount of currency involved, the exchange rate, the length of the option and may typically be in the region of 1 or 2 per cent of the face value of the contract.
This option suits businesses that:
-
want to protect themselves from unfavourable rate changes while retaining the flexibility to benefit from advantageous ones
-
are entering into a deal but there's a fair chance of it not going ahead eg a tender situation
-
have a foreign exchange exposure in excess of £500,000 per trade, although this may vary between banks
Advantages
-
You're protected from any adverse movements in the exchange rate.
-
Your business can benefit if the exchange rate moves in your favour.
Disadvantages
-
The expense of setting the option up.
-
Only available to companies with large foreign exchange exposures.
The ability to buy currency options is offered by most of the UK clearing banks.
Subjects covered in this guide
- Introduction
- Foreign currency issues when importing or exporting
- Identify foreign exchange risks
- Forward foreign exchange contracts
- Opening foreign currency accounts
- Opening an account with a bank overseas
- Buying currency options
- Foreign currency transactions and your bookkeeping
