Question

11.2   Your rich uncle in France has decided to give you an annuity of €2,000 per month. Because you live in Canada, you’re concerned about the effect of foreign currency fluctuations on your new income. You heard a finance guy on the radio talking about how “foreign currency exchange rate could move against you, if you’re not properly prepared.”                                                                                              

a.    What does it mean for the currency exchange rate to move against you?

b.    Would moving to France mitigate some of the risk? If so, how? If not, why not?

c.     Assume you want to stay in Canada. Your grandparents, who have retired to Provence (France), each receive a Canadian pension of C$1100 monthly. What could you do to reduce the risk for all of you?

Answer 1

a]

A currency exchange rate moving against you means that the exchange rate changes in a manner that decreases the cash flow you receive in your domestic currency.

For a person receiving payments in a foreign currency, an appreciation of the domestic currency relative to the domestic currency will decrease the net cash received in domestic currency.

For example, in this case, if the Canadian dollar appreciates relative to the Euro, the net amount received in Canadian dollars will be lower

b]

Yes, moving to France will mitigate the risk.

This is because if you are living in France, your expenses will be denominated in Euros, and the annuity does not need to be converted into Canadian dollars. In such a case, the foreign currency fluctuation risk is mitigated.

c]

To reduce the risk for all, the payments could be swapped.

For example, you could collect the pension of your grandparents and your grandparents could collect the annuity from your uncle.

In such a case, the foreign currency fluctuation risk is reduced for everyone as the requirement to convert one currency to the other is reduced.