Beginner’s guide to currency

Matthew Harris explains currency terms and how currency brokers work to help you save money on your property purchase in France

Currency brokers exist to get you a better exchange rate and to guide you through the market but the language they use can sometimes cause confusion.

Knowing your ‘stops’ from your ‘spots’ could save you a significant sum, and it is essential you get the right type of contract for your individual situation.

These contracts are generally split into four categories: spot contracts, forward contracts, limit orders and stop-loss orders. By selecting the correct type of contract and tweaking it appropriately for your circumstances, you can make your money go that bit further.

SPOT CONTRACTS

The simplest and most common form of currency exchange transaction, a spot contract is where you ask your broker to buy currency for immediate payment and delivery. This means they can arrange a transaction for you; you would then pay them the agreed sum of money and they would send your new currency off to its destination immediately. Settlement times are usually anything from immediate to up to four working days.

FORWARD CONTRACTS

A forward contract is for when you want to arrange your transaction, not for immediate payment and delivery, but for a date in the future. If you want to buy a house for €200,000, that will currently cost around £170,000. If completion is several months away, while the price in euros will remain the same, the price to pay in sterling will move up and down as the exchange rate fluctuates. This means that if the rate drops, your house could cost more than you had originally budgeted.

A forward contract helps you get around this problem by fixing your rate at the current level, so you know how much your house is going to cost in sterling, rather than watching it going up and down every single second.

When your offer is accepted, you can fix your rate at that point, and know that when you come to complete, it is going to cost you the exact same amount in pounds as it did when your offer was accepted.

Forward contracts require a deposit, usually between 5% and 10% depending on the length of contract and the broker providing it. This isn’t a fee or anything like that, it is a security holding deposit and you would pay the remaining percentage as and when you take delivery of the currency further down the line.

If you had agreed to buy your €200,000 house just before last Christmas, the cost would have been around £160,000 but by the end of February this year that would have risen to £175,000. Forward contracts exist to remove this risk completely, and this route is taken by most purchasers. Of course, there is always the risk that rates could move the other way too.

LIMIT ORDERS

Limit orders allow you to set a target level slightly above the market rate, and if it becomes available your currency is automatically secured for you at that rate, rather than the lower levels you may have seen previously. In a volatile market, you can often squeeze out an extra few tenths of a percent by using a limit order; on large volume transfers, this can be several hundred pounds.

The two key benefits of limit orders are that they run 24 hours per day, and they are all placed digitally, so if the market spikes during Asian trading in the middle of the night, or it only lasts for a few seconds, your currency is automatically secured at the higher level.

STOP ORDERS

Stop orders or stop-loss orders are there to prevent you from losing when the market moves against you. While a limit order allows you to target a rate above market, a stop is there to protect you when the market moves adversely. The two can be used together, so you can hope for the best with your limit, but still prepare for the worst with your stop.

You would place your stop below the prevailing market rate, often at your worst-case budgeting scenario, and if the market drops below that level, your currency is automatically bought at that point.

On the basis of our €200,000 scenario, you could imagine that if the cost were to escalate beyond £175,000 then you could use a stop-loss at that level to ensure it didn’t break through that barrier.

With both limits and stops, you can alter them up or down until one of them goes through, and at that point they become binding contracts, either as spot contracts for immediate payment and delivery, or forward contracts for the future.

It’s crucial when it comes to money that you don’t do anything without first thoroughly understanding it. You can ask your broker to explain the details and how they affect you in each of the scenarios, in order to make an informed decision.

Matthew Harris is director of Columbus Currency

Tel: 0203 384 7215 www.columbuscurrency.com