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When you need to send money overseas, the exchange rate you receive is a crucial factor in determining the overall cost-effectiveness of your international money transfer. The value of the Australian Dollar relative to other currencies around the world changes all the time and is influenced by a range of factors. This, in turn has an impact on how much of the money you send arrives to your beneficiary.
You can protect yourself against fluctuating exchange rates by placing a forward contract, which allows you to secure the current exchange rate for use in a future international money transfer.
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Forward contracts are an international money transfer tool that allow you to reduce your exchange rate risk. When you place a forward contract you can lock in the current exchange rate for an overseas money transfer that will take place at a later date.
Securing a rate in advance allows you to plan ahead and safeguard your finances against any potential future drops in the value of the Australian Dollar. If you expect the value of the currency you are planning on sending to fall, you can consider placing a forward contract and ensure that you get better value for money on your transfer.
Back to topForward contracts let you enjoy the benefits of a good exchange rate today on a transaction that will take place up to 12 months into the future. To calculate the rate for your forward contract, a money transfer provider will adjust the spot rate (the current market exchange rate) for what are known as ‘forward points’, which factor in the difference in interest rates between your sending and receiving countries and the length of time until your transfer will actually be completed. A standard formula is used across the industry when calculating forward point.
You will usually be required to pay a deposit to secure your exchange rate but will then be able to enjoy protection against any exchange rate fluctuations that may occur until your transfer is placed.
For example, Brian knows that he will need to send a transfer of AUD $5,000 to the United States in two months’ time to pay off an outstanding debt to his brother. The current exchange rate is 1 AUD = 0.70 USD, but financial experts and economists are predicting the value of the Aussie Dollar to drop further in the coming weeks.
Brian doesn’t have all the funds needed to transfer the full amount now, so he places a forward contract with an online money transfer provider and locks in the current exchange rate. He pays a 10% deposit of $500 and, two months later, pays the remaining $4,500 and his transfer is sent. Brian’s brother receives USD $3,500 two days later.
Had Brian not placed a forward contract and simply transferred the money using the best exchange rate he could find, he would have had to settle for an exchange rate of 1 AUD = 0.67 USD. This means his brother would only have received $3,350 - $150 less than he received thanks to Brian’s forward thinking.
Although this article only deals with forward contracts in terms of international money transfers, forward contracts can also be used as a trading tool across a range of other financial assets. These include shares, contracts for difference, commodities and more.
The main issue to be wary of with forward contracts is that the exchange rate could rise after you lock in a forward contract and you could end up losing out. A huge range of factors can affect the value of one currency relative to another, and sometimes it’s not possible to predict exactly which way the value of a currency will go.
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