Background
A New Zealand importer specializes in the seasonal business of importing exotic fruits from South-East Asia and India. Anticipating invoices totaling USD 2,500,000 for fruit imports from South-East Asia in 6 months’ time, the current favorable NZD to USD exchange rate of 0.6500 poses a dilemma. There’s a concern that the NZD might weaken against the USD, potentially increasing the cost of imports.
Strategy: Forward contract
To hedge against this risk, the client opts to enter into a Forward contract with Corporate Alliance FX. By securing the current exchange rate of 0.6500 NZD into USD for the settlement date in 6 months, this strategic move shields against adverse currency movements, providing invaluable financial predictability.
Analysis and Benefits
- Cost Certainty: The Forward contract enables accurate cost forecasting for importing exotic fruits, regardless of potential exchange rate fluctuations. This precision facilitates effective budgeting and prudent financial planning.
- Risk Mitigation: Locking in the exchange rate now proactively mitigates the risk of NZD weakening against the USD in the future. This shields the business from unexpected increases in import costs, ensuring operational stability and profitability.
- Payment Obligations: With the Forward contract, the client gains confidence in fulfilling payment obligations for fruit imports at the agreed-upon rate, irrespective of currency market fluctuations. This certainty eliminates uncertainty and fosters trust in business transactions.
Outcomes
As anticipated, the NZD gradually weakens against the USD leading up to the settlement date.
Without Forward Contract:
The NZD depreciates to 0.6400 against the USD, resulting in higher costs of imports.
- Initial anticipated cost: USD 2,500,000
- Conversion rate at settlement: 0.6400 NZD/USD
- Actual cost without Forward Contract: USD 2,500,000 * 0.6400 = USD 1,600,000
- Additional expenditure: USD 2,500,000 – USD 1,600,000 = USD 900,000
With Forward Contract:
By locking in the rate at 0.6500 NZD/USD, the importer secures their costs, spending USD 1,625,000 in total.
- Conversion rate locked in with Forward Contract: 0.6500 NZD/USD
- Actual cost with Forward Contract: USD 2,500,000 * 0.6500 = USD 1,625,000
By utilizing the Forward contract, the importer saved USD 275,000 compared to not having the contract in place. This strategic move highlights the effectiveness of proactive risk management in mitigating currency fluctuations and maintaining business continuity.
