Insurance for the Wobbly Dollar

It's not fail-safe or free, but doing nothing may be costlier

The euro, pound, and yen are all doing a number on the dollar. That, of course, is a boon for U.S. exporters. But domestic companies buying or making goods and services overseas aren't so lucky. For these companies, hedging currency may be a smart bet. A hedge can protect you from swings in currency value that can add huge costs and compress your profit margins.

Sound risky? It can be. The dollar might appreciate, and you could lose money if the value of the foreign currency you've bet on is suddenly lower than you expected. But in times like these, says Larry Harding, president and founder of High Street Partners, a global advisory and consulting firm in Boston, "not hedging is the risky approach."

You can get a forward contract, futures contract, or foreign currency option from a regional or national bank. Forward contracts are most common among entrepreneurs because they are the simplest and least costly. They allow you to buy currency at a predetermined rate at a fixed date in the future. Say you now pay 10 million euros to produce your goods in Europe. You could use a forward contract to lock in that equivalent cost in dollars until a certain date, thereby protecting you if the dollar continues to plummet. Most contracts are written for a few months to a year in the future. Typically, you'll have to make a deposit of between 5% and 10% of the total value of the contract, and then pay a fee of 1% to 5% when the contract is settled.

By contrast, a futures contract is traded on an exchange and has more stipulations about the size of the order and settlement. Foreign currency options give the buyer an option, rather than an obligation, to buy at a particular price, but you'll pay more for that flexibility.

At Pacific Plastics & Engineering, Chairman and CEO Stephanie Harkness has seen her costs rise 12% in three months. So she's started buying currency contracts to save money and protect against swings in the dollar. It will be three months before she knows how well her move paid off, but she had to do something. Says Harkness: "The effect of the euro was driving us crazy."

Back to BWSmallBiz April/May 2008 Table of Contents

    Before it's here, it's on the Bloomberg Terminal.
    LEARN MORE