Can fluctuating foreign exchange rates affect international meeting budgets? Should I pay foreign suppliers in local currency or U.S. dollars? Are forward contracts a good tool for guaranteeing future exchange rates? Where can I get information that will give me an edge in the foreign exchange market? These are questions that will be easier to answer with a basic understanding of foreign exchange markets.
At more than a trillion dollars in daily trading volume, the foreign exchange market is by far the largest capital market in the world--eclipsing the daily trading volume on the New York Stock Exchange several times over. Market participants include governments, banks, nonbank financial institutions, and corporations.
The sheer size of the foreign exchange market, coupled with its lack of a physical presence, often leaves the average bystander with the impression that the market is crazy and unorganized. Although the market can appear this way to the uninitiated, it is clearly an efficient market that reacts very quickly to actual or anticipated changes in economic fundamentals. Some of the economic fundamentals that can impact foreign currency exchange rates are interest rates, inflation, trade balances, and government spending. Market participants also consider noneconomic factors, such as political events, world news, and even rumors, as they try to determine the value of one currency against another.
Obviously, there is a lot to think about if you are a planner faced with setting a U.S. dollar budget for an international meeting or incentive that may not take place for a year or two. You are going to have to decide when and how much currency to buy for the international meeting. At the same time, you will need to make a determination regarding the likelihood of the U.S. dollar losing value against the foreign currency.
Choosing a Strategy One of the first things you need to do is locate a reasonably priced source of foreign currency. Banks are a traditional source for foreign currency, but pricing and service may be better with a nonbank financial institution that specializes in foreign exchange transactions. There are advantages and disadvantages to using either one.You will find that the rate of exchange, the fees charged for international wire transfers, foreign currency drafts, and forward contracts differ from vendor to vendor. Keep in mind that a German mark from one bank is the same as a German mark from the next bank. Your biggest concern is the bottom line, so check your source periodically to ensure you are getting a good exchange rate.
After you find a supplier, you need to decide when to buy. Begin with two assumptions: You can't predict what the value of a currency will be in the future; and the foreign exchange component of your program is a service that you must buy, just like airfares, hotels, and meals. Because you can't predict what the value of a currency will be in the future, planning the U.S. dollar budget for an international meeting or incentive based on a current exchange rate is a gamble. One way to eliminate this gamble is to take steps to hedge the risk that the U.S. dollar may lose value against the foreign currency.
By far the most common way to hedge foreign exchange risk is with a forward contract. A forward contract is an agreement between a foreign currency supplier and a purchaser. It stipulates the amount of a foreign currency to be purchased or sold, the exchange rate, the U.S. dollar total, and the value date--or date in the future when the foreign currency will be delivered.
A forward contract is put into place with an interest-bearing cash deposit. The deposit amount will vary, but is generally 10 to 20 percent of the total U.S. dollar value of the forward contract. Full payment is not due until a few days before the value date. Therefore, during the life of the forward contract, a meeting or incentive planner has a guaranteed exchange rate and a guaranteed U.S. dollar total, but the meeting or incentive planner is able to keep 80 to 90 percent of its funds until a few days prior to the value date.
If you are concerned that the U.S. dollar might increase in value against the foreign currency after you enter into a forward contract, you may want to consider a forward contract "layering" strategy. With this strategy, a meeting or incentive planner would purchase 25 or 50 percent of its organization's foreign currency needs at two or four different points in time, thereby creating a "dollar-cost averaging" effect that would take advantage of any increase in the U.S. dollar's value against the foreign currency.
The downside of this type of dollar-cost averaging is that the U.S. dollar may decline in value. In this scenario, each foreign currency purchase will be more expensive than the previous purchase, and the average cost of the foreign currency will be driven higher.
Negotiating in U.S. Dollars Another popular way to hedge the risk that the U.S. dollar may lose value against a foreign currency is to eliminate the need for a foreign currency by negotiating all contracts in U.S. dollars. Although this can be an effective tactic of hedging risk in some cases, you should be aware that negotiating in U.S. dollars can present some problems. Let's look at some of the problems that arise when meeting and incentive planners pay international suppliers in U.S. dollars.
From your suppliers' viewpoint, checks made out in U.S. dollar create a collection nightmare. Aside from the time it takes for a U.S. dollar check to come back to the U.S. and clear through the U.S. banking system, your supplier will incur a number of additional costs including service charges, transaction fees, and the exchange rate that your supplier's bank uses to convert your U.S. dollar check into the foreign currency.
Suppliers who quote you in U.S. dollars are likely to pad their price to protect themselves from these service charges, collection delays, and the risk that exchange rates will change. It is not uncommon for suppliers to add 10 percent or more to their prices to cover these costs and the associated risks.
There are places where paying in U.S. dollars is not only appropriate but is the preferred method of payment. In places where there are severe currency restrictions, as in Central and Eastern Europe where local currencies are virtually worthless outside the country of origin, it is fine to make payment in the equivalent amount of U.S. dollars. In countries with dramatic inflation rates, such as many South American, African, and Middle Eastern nations, it is also appropriate to pay in U.S. dollars.
Here are a couple of simple rules to follow: If a supplier wants to be paid in his own currency and the currency can be purchased in a forward contract, negotiate in the foreign currency and hedge with a forward contract. It is probably the least expensive alternative. If a supplier asks for U.S. dollars, be careful. Find out how many foreign currency units would be acceptable, then find out how many U.S. dollars it would cost you to buy the currency yourself independently.
On January 1, 1999, the European currency (Euro) will be introduced. Initially, the Euro will be used only by central banks, commercial banks, and some very large global corporations. Smaller companies and consumers probably will not begin using the Euro until Euro bank notes and coins appear around January 1, 2002.
After a short transitional stage, the Euro will become the common currency of the European Union, and the local currencies of member states will disappear.
The primary economic and political objectives of introducing the Euro are to eliminate exchange rate movements, promote trade and investment, reduce costs, and to act as a stepping stone for continued cultural and political integration.
The European Council is determining which countries will participate in the initial introduction of the Euro on January 1, 1999. The core "Euro group" is likely to consist of Germany, France, the Netherlands, Belgium, Luxembourg, Austria, Ireland, and Finland. Portugal, Spain, and Italy also have a good chance of being included in the core Euro group. For various political reasons Denmark, Sweden, and the United Kingdom will not be involved in the initial introduction of the Euro.
The Euro is not likely to have an immediate impact on U.S.-based meeting and incentive planners because most companies in Europe will probably not begin actively using the Euro until Euro bank notes and coins appear around January 2002.
Nevertheless, in the three year period from January 1999 to January 2002, meeting planners should understand: Contracts that are governed by European Union law and denominated in a currency that will disappear will be automatically converted into euros as of January 1, 2002. In addition, when you enter into a contract that is not governed by European Union law and is denominated in a currency that will disappear, you should consider including a clause governing conversion into Euros at the official Euro conversion rate.