Many expats have to transfer funds to and from the US from time to time. This could be because you make regular payments from abroad to support dependents or pay bills back in the States, or you may be paid in the US and transfer regularly to support your life abroad.
You might also have to transfer larger sums occasionally, such as when buying a car or real estate.
Whenever you transfer money internationally, you are exposed to what is called foreign exchange risk due to the currency value fluctuations between the US dollar and the foreign currency you’re transferring from or to.
Currencies fluctuate all the time, and these fluctuations can make a significant difference to the amount of target currency you receive after your transfer.
Expats have options when it comes to mitigating foreign exchange risk. Strategies such as future contracts, forward contracts, options, and swaps can help you transfer money internationally while reducing both the cost and risk of loss.
In this article, you’ll learn about:
• What is foreign exchange risk?
• Mitigating foreign exchange risk
What is foreign exchange risk?
Whenever you send money internationally, you have to sell one currency and buy another, and the risk that as an expat you will lose out from an unfavorable exchange rate when making these transactions is known as currency exposure, or sometimes FX or foreign exchange risk.
The larger the amount of money you are transferring, the greater the risk. You might for example receive a quote from a broker for a significant transfer for a deposit to buy some real estate abroad, but then if either of the two currencies changes in value you would suddenly find the cost of the transfer changes. If the exchange rate fluctuates significantly, you may even find you can no longer afford the purchase.
Many expats own a business that operates across borders, and there are three different types of foreign exchange risks that businesses that operate internationally can encounter. These are known as transaction risk, translation risk and economic risk.
Transaction risk occurs when a currency fluctuation changes the forecast value of the exchange transaction, exposing you to a possible negative financial outcome. This is the most common risk that individual expats experience.
Translation risk is when a domestic (i.e. US) company has a foreign subsidiary and they report revenue from the subsidiary in the parent company’s currency and so potentially lose out due to currency exchange rate fluctuations.
Economic risk is when a company trades in other countries and its market value is affected by exchange rate fluctuations that alter the reportable value of its overseas revenue.
Many expats have foreign companies with US parent companies due to the tax advantage in paying less US corporate GILTI tax since the 2017 Tax Reform, so some expats will encounter all of these risks.
Mitigating foreign exchange risk
Luckily, there are ways for expats transferring money internationally to mitigate foreign exchange risk.
Future contracts
Future contracts are legal agreements between two parties looking to buy or sell a security or investment at a specified price at a predetermined time in the future. These contracts are bought and sold on a futures market and so have set standard sizes and amounts. When someone buys a future contract, they pay in advance and they agree to receive the asset when the contract expires.
Forward contracts
Like a futures contract, a forward contract is an agreement on a price and future date for the transaction. Where forward contracts differ from future contracts is that a forward contract is privately agreed, customizable and settled at the end of the agreement.
Options
Options are financial derivatives that give buyers the right to purchase an asset such as foreign currency at a predetermined price. As buyers aren’t obligated to exercise these options, this can give expats an added layer of flexibility.
Swaps
Currency swaps are another derivative instrument that let you secure a pre-agreed currency value ahead of time by agreeing an exchange rate with someone looking to transfer in the other direction.
If you need assistance, currency specialists can provide their expertise, so reach out to one if you’re in need of advice.
Winding up
Foreign exchange risk can be a significant factor for American expats transferring funds internationally. Some currencies are more volatile than others, of course, increasing the risks of fluctuations in transfer values. Currency exposure risks can’t be avoided though, and so they will need to be mitigated.
By using strategies like future contracts and options, expats can create a predetermined price and date and so minimize their currency exposure risk.
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