Question

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A US importer who owes and Belgian company 500,000 Euros payable in 30 days from today expects that the US Dollar will weaken during this period. What would you advise the importer to do? What would happen if the imported took your advice yet instead of the dollar weakening, the dollar actually strengthened?

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Answer 1

Before we jump in to answer this question, lets take a look at the impact of currency weaking and strengthening on the currency exchange rate.

Currency Strengthening :

When we say currency strengthening, its not in isolation but with refernece to extenal currencies. When a currency strangthens we can always buy more for the same $ value as compared to before. Currency, goods , services etc all can be bought more as compared to earlier. ALso, when people travel or plan to buy something from abroad, the most ideal situation would be if the currency is strong during that time.

This is a good situation when you are suppose to pay-up to companies/people etc outside of US/home country,as this may lead to unexpected profits/gains.

Currency Weakening :

Currency weakening essentially means that we can now buy less in the same $ value as compared to earlier.

This is a good situation when you are suppose to recieve payments from people outside of US and vic-e-versa not a good situation for making payments.

Problem Statement : US exporter is suppose to pay Euro 500,000 in 30 days from now with an expectation of currency weakening in this duration.

Solution :

Case 1 : We arent able to estimate the %age currency weakening , in this case it would make sense to make immediate payment to the Belgian company as the outflow would other wise increase

Case 2 : We are able to estimate the %age currency weakening

2.1 %age  Currnecy weakening is less then monthly Cost of Capital : To be paid after 30 days, as the Interest earned would be more than the depreciation/weekening in the currency

2.2 %age  Currnecy weakening is more then monthly Cost of Capital : To be paid immediately

In case, the currency strengthens that this would mean that the Exporter could have paid less to settle the 500,000 euro bill as 1$ now can buy less Euros as compared to 30 days before.

Alternatively, Exporter can look at the hedging the curency and associated cost with it. If its lesser then the potential loss then Hedging is advisable.