cheapest way to lock in strong AUD in USD?

[TheStudent]

I am no financial expert, but ill try to tell you what I know.

If you wish to lock in your rate, for when you travel, with no exposure to either upside or downside, you want a forward or futures contract, which will both give you the set price in the future. The difference between the two is that in a forward contract you can specialize it to your needs, for example you sign an agreement with the banks that at x date you will convert your set amount of AUD into USD at the date agreed on now. On the other hand, a futures contract is less flexible, as it has a set expiry date (usually around six months, maybe??) and is for a set amount of money, and thus, while having the same effects as a forward, it can be easily traded on the market (If you were to do this - you would buy contracts from the ASX through a broker).

If you want the possibility of taking advantage of favorable movements, you then look at option contracts. There are two common sorts, American options and European options (Australia to the best of my knowledge uses mainly American options). With American options you sign (and pay for) an agreement where you can buy the underlying asset at ANY time in the future, up too and including the expiry date. Thus you get a highly flexible option, but to make it worthwhile for the other person (In the "short" position) to enter into the contract, the initial price you will buy the option for will be extremely steep.

For the European options (If they are available) you will only be able to exercise the option on expiry, and as a result they are a lot cheaper (But still can be up to 10% of the value of the underlying asset in some cases, I am told), but still allow you to take advantage of any favorable movements between the price today and the price at the expiry date. However, again as traded items, option contracts are generally tightly controlled, in the way futures are, to standardize them so that they can be traded.

To sum up - option contracts are expensive, and in order to break even or make a profit, the underlying asset must move to your advantage by at least the initial price of the option.
- Forwards and futures are very cheap or even free to enter into, but do not allow you to take advantage of favorable movements the way options do, but are a very inexpensive way of locking in a future price.

The one thing to remember in all of this is that for all of these so called "derivatives" the person on the other end is making the opposite bet - for every cent you win - he loses, and vice versa. I advise you to talk to a broker or other financial specialist about your hedging options, as it is very easy to lose a LOT of money by making the wrong bets (Think back to Bearings Bank). One final word of caution: some of these derivatives, I do not know which, increase your losses exponentially if the markets move against you, so make sure you know what you are doing, and have professional advice, before you invest.

Also, you said you were going somewhere in South East Asia - have you considered the fact that you still have to convert USD into the local currency?

Good luck, I hope this has answered some of your questions.

 

[cove]

It is possible to strucure a nil cost option to get today's US dollar or UK pound at today's rate in 3 months time provided the current stays inside the option price band.Of course if the Aussie rallies further you are stuck with getting today's rate rather than the better rate.We deal with Bell FX and Westpac FX.I think about 90% of options expire which means if you buy one it can be goodbye option premium!

 

[patient]

Hi Cove,
I am unable to PM you as i only have 4 (now 5 posts- there is a minimum of 15 I have just been informed.

--re real estate:
While i have heard of Zillow and had a play. I really dont know where to start with real estate, i feel it is has good potential returns but it is outside of my abilities. I would need to rely on an expert (is this how you did it or entirely DIY) and to be honest i dont have much faith or confidence in American real estate professionals I will either do a straight hedge or buy US stocks - easier for me via optionsxpress et al.

--re options hedge.
I was unaware of option price band. This sounds like an interesting idea but complicated (at least for me as i am ignorant). I was thinking of a 12 month hedge and treating the cost as an insurance premium. I was hoping about a 2/3% cost/premium (but from TheStudent's post this is unrealistic) which would be cheaper than converting and losing 6.5% interest. something like that. Clearly, I am out of my depth.

I do feel 3 months is too short for me. The general idea was to buy an option that would recover any loses from a drop in AUD. I suspect (warning future prediction here USA stocks will drop due to some event and AUD will drop. I would like to pick up usa stocks with a strong AUD that is part of the rational for the hedge as well as going over seas (SE Asia) indefinitely.

---
TheStudent
Thankyou for your thoughtful comments and suggestions. This was very useful and helpful. I see now options are too expensive. My concern with futures is that the downside can be potentially unlimited. I think i will follow your advice and sit down with a broker. I wish however to minimise trading (transaction costs/risks increase expotentially) and simply hedge.

I believe the USD is the universal currency and likely to remain so for the foreseeable future so happy to hold assets in that currency (or the currency itself). less confident of AUD and SE Asian currencies.

Once again, thankyou for sharing some great insights and ideas. I appreciate it.

cheers to you both!

 

[terrier]

Best and cheapest way to lock in a strong aussie forex rate is to but an ETF {exchange traded fund} , there is one put out by beta shares , it trades on the ASX, you simply buy and sell it when you want, its easy and the spreads are wafer thin, it simply goes up and down according to the forex rate, its code is USD.
By buying now you are betting that the aussie is heading south, the advantages are that if you want to get out of the position, you simply sell the position on mmarket and are payed T3, i.e 3 days.

 

[patient]

Hi Terrier

Thanks for the feedback. I had seen this ETF and noticed the fee of 0.45% fee going in and i believe another 0.45 out . but still may be a good option indeed. Also relatively unlimited. and there is leverage if i recall correctly. It is on my list to review again... thankyou!

 

[TheStudent]

The only thing more that I feel that I can contribute would be too sit down with a bank and ask them for their advice, as they are the professionals - they should give you a range of options that they can provide. However I imagine you will be looking at a forward (To minimize transaction costs) and thus get a set rate, with no potential upside or downside. I would think that they would all offer the same, or at least very similar rates. Indeed the rates will be lower than the spot price, and this will reflect the bank's estimate of where the exchange rate will be in the future minus a slice of profit the bank will want to make. As I get student discounts with my bank I have no idea how much this would cost, but I would expect it to be very cheap, a minuscule fraction of a six figure sum at best.

As to the other options that have been suggested such as the ETF's - i have even less knowledge about how they work and can't offer any opinion.

Best of luck as always.

 

[cove]

You have not said that you are experienced in buying and selling shares. What city are you based in at the moment?Zoopla.co.UK and zillow.com are helpful starters for real estate purchases in England and America. Both of these markets have been crushed during and after the GFC. The other thing is have you done any real estate valuation studies? The idea of talking to Dixons or going ETF route through a recommended financial advisory group/ stockbroker may have some merit but we cannot give financial or taxation advice here.Buying pounds or US dollars and holding them in an almost interest free account does not thrill me as you can earn 7 to 10 per cent in Australia on a reasonable spread of investments without lifting too many fingers to work on it.In 7 years 10 percent compounded doubles your money!

 

[patient]

TheStudent,

Yes i agre banks will promote forward contacts but no harm in having the conversation. I suspect this may not be the best solution but would be a good one regardless.

Cove,

I am in the Eastern Suburbs of Sydney. My past focus has been stocks and shares although mainly cashed up for quite some time now. Main investing these days is via super with cash in my other holdings. But desire to diversfy into non-AUD assets either cash (unattractive due to cost) or derivative investment in cash or stocks or pty. I am no expert on valuation but tend to have basic working understanding and am quite risk averse - i look at the balance sheet first then cash flows for stocks. My problem with property overseas is lack of local knowledge of all the costs involved which seem (at least for USA) very different from here in Oz.

Yes I agree that this thread may have reached its reasonable limit without going down the financial advice route.

cheers guys

 

[cove]

When I deal in foreign exchange the margins are about 12 pips.

 

[Craigie]

I've been hesitant to post in this thread because I don't want to give financial advice or lead anyone up a path they're not prepared for..

Now that's out of the way. If you have a certain amount that you want to lock in then you could use a forex broker that offers leverage at 1:100. I would not advise this though unless you understand the foreign currency market well. I've been dabbling and learning about it for 8 years as a hobby and the amount of people I've seen lose money is mind boggling.

BUT if you understand what you're doing you could for example do this:

Find an Australian forex broker that is basically backed by ASIC. There's not many to choose from so that's easy. Also in your case I'd choose one that doesn't pay/take the interest differential.

Say you had $200,000 you wanted to lock in. Put $10,000 into forex broker and take a short position worth $200,000. Because of leverage, every 1% movement in the currency will be $2,000 to you.

So for simplicities sake we'll say you sold $200,000 at 1.00. If the AUD declined to 0.99, your forex account would be worth $12,000. Adversely if the currency went to 1.01, your account would be $8,000. So with a $10,000 account you're in effect giving yourself a 5% buffer for the currency to go against you. Obviously it's your choice on how much you willing to let it go against you before you cut your losses.

At the same time you can invest the rest ($190,000 or whatever) in a term deposit and get the 6% interest Australia currently has to offer.

An that's my suggestion in a nutshell!

 

[patient]

Hi Craigie

Your reply was the sort of thing i was hoping to find out about; what you have suggested does seem spot on-although i am quite ignorant. Is there a website that lists additional ways to do this type of thing? I went to ASIC website but was unable to find brokers/dealers, are IG Markets and FXCM the type of dealers you were referring too?

many thanks!

 

[cove]

You could call Bill Giffen at Bell Potter Foreign Exchange in Sydney.

 

[patient]

Thanks Cove

I will do that next week. cheers.

 

[cove]

Some folks don't know which way is up in dealing rooms so I thought about it before I gave you Bill's name.

 

[patient]

Cove, I understand and appreciate it. cheers

 

[rechoboam]

You want to engage in the carry trade. Borrow US funds and invest them in Australia, right?Works well until the AUD crashes vs the US. Perhaps this "shouldnt" happen. But it did when the NZD crashed vs the yen, and the JApanese housewives lost a fortune (i suggest tou google that and closely read it).

 

[cove]

Yes foreign exchange dealing is not without risk. It is not a big 4 term deposit that is for sure. There are products that can improve your perceived position. Many exporters from Australia would be crushed right now if they only do a transaction on the day they needed it.Australia is heading for a major economic adjustment if the currency stays where it is today.As an example if Qantas hires staff in the UK or the US they would be paid in local currencies and that would save them quite a bit. That adjustment has started Australia wide and whole units of international companies will move out.In today's case doing nothing can now be as risky as doing something.By the way I can get a full 0.2% interest on an English pound deposit right now!

 

[rechoboam]

Sure...but there is a world of difference between hedging (with professional advice) and attempting to speculate due to interest rate differentials.

 

[cove]

It's ok I am just doing a slow transaction in England that will take 90 days.....I am not racing there for the "high interest rates".

 

[Craigie]

Is there a website that lists additional ways to do this type of thing? I went to ASIC website but was unable to find brokers/dealers, are IG Markets and FXCM the type of dealers you were referring too?

many thanks!

There's many websites that will tell you more about this kinda thing but most of them will promise you wealth beyond your wildest dreams. Cutting through the cough is one of the most difficult things with the forex market. I would recommend getting a good book about the forex market and how it works. Then move from there. Even to do something as simple as what you want, you either need to get someone who knows exactly what they're doing, or be very clear in yourself that you know what you're doing.

To find out whether a broker is regulated by ASIC you just need to do a little digging about them. Forex Trading - CFD Trading - Currency - GFT case in point. On the main page, right down the bottom you'll find their ASIC license number.

Advice: Be. very. careful.