Currency and exchange risk

When buying property in South Africa

Buying property is the biggest financial transaction that most of us will ever make. Due to the large amounts of money involved, small differences in the exchange rate, commissions or payment schedules can make a big difference to your pocket.

If the current and/or future assets you are expecting to use for the property purchase and/or mortgage repayments are held in different currencies, financial planning becomes difficult. The challenges can be split into two main areas:

  1. Exchange rate risk: sudden changes in the currency markets could mean significant movements in the exchange rates between different currencies. Adverse movements may have a consequent impact on bottom-line of your intended purchase or sale.
  2. Price risk: the actual exchange rate you receive, commissions and/or transfer costs all make a difference to the total cost of the transaction to you.

This article will look at both of these areas and explain with some straightforward examples how you can calculate different options and identify the best deal.

Exchange rate risk

Like most markets, the currency market is prone to periods of instability and readjustment. Just because the exchange rate between a pair of different currencies has been stable for many months, there is no reason to assume it will be the case tomorrow. For an idea of the scale of possible movement, just look at the South African Rand expressed in British Pounds below:

Large swings have the most immediate and obvious impact when talking about large sums of money.

For example, you agreed to buy a beautiful beach-side property in a new Cape Town development for 810,000 Rand in mid-2005 with a completion date for the purchase in Jan 2006. It may have cost GBP 64,800 when you agreed to buy the property, but GBP 72,900 when you needed to complete the purchase.

In this example period the Rand strengthened against the Pound. The opposite can take place, and you ‘win’ in the currency movement. However, many people don’t regard themselves to be currency traders and have a preference for less risk and a more certain outcome. So, what options do you have in order to limit these currency movements? :

  1. Transfer the whole amount today. Advantages: you lock in the current exchange rate and get certainty over the exchange rate. Disadvantages: you might not have all of the cash to make the transfer or the interest you earn in the foreign currency may be less than you are currently earning on the money.
  2. Buy a ‘Forward Exchange Contract (FEC)’ to lock in an exchange rate. Advantages: you get a guaranteed rate in the future without having to pay all of money up-front. Disadvantages: there is a principle payment to make and you are obliged to complete on the deal and pay commissions.
  3. Speak to a Foreign Exchange Specialist: Advantages: you may be able to time your purchase or sale better and thus save. Disadvantages: They can’t always predict the future but all information helps make a more informed decision

Price risk

This is the real risk that your bank or another money transfer agent will quote you an uncompetitive exchange rate with an extremely wide spread! It is common practice for bank foreign exchange departments to quote their retail customers exchange rates that are significantly worse than the current spot price in the market.

You will often see an exchange rate price between two currencies on the news and in some exchange rate tables, online services, etc. This will be the mid market ‘Interbank Rate or Spot Price’ and is more or less the indicative level where banks and financial institutions trade the currency. In banks and currency exchange bureau you will see exchange rates quoted with very different buy and sell prices. The (spread) is the difference between the Spot price and the price that they quote to you.

Some people get surprised when they make a calculation on the basis of the rate they find in the newspaper and then find out their transfer has cost them a lot more. Typically, you will get the worst exchange rates in airports and bureaux d’echange in tourist areas. Online money transfer providers, such as PayPal, sometimes have cheap or no costs for making the transfer, but then use an exchange rate with a large spread. High-street banks do not often offer very good deals when it comes to money transfer, often applying less favourable exchange rates to their private individual customers. Usually the best deal you can get will be from a currency exchange specialist, although not all of them deal with small retail transactions.

You can break price risk into three different components:

  1. Spread (Margin) – the difference between the Spot exchange rate and the buy price you are quoted.
  2. Commission – the cost applied for the exchange, this will be a percentage of the transaction or a flat fee.
  3. Transfer costs – the cost applied to make the transfer out of the exchanged currency.

Most providers will not charge all of these elements, but it is important to take into account their impact when making a calculation. Let’s take an example: Willem works in London and is paying R 3,000 monthly to cover the mortgage on a property in Durban. He checks out a couple of providers (exchange rates are for example purposes only):

Provider 1 looks like the best deal as Willem’s monthly cost to cover the R 3,000 payment would be GBP 229. But Provider 1 charges a GBP 10 transfer charge, which Provider 2 does not have, any additional charges. This small difference would make Provider 2 cheaper by GBP 3.

Some tips

By Peter Filmer, Exchange4Free
Specialists in the South African Rand. We offer the best rates, no commissions, no transfer fees and great advice. Get in touch!
Tel. UK: 0845 652 1022
Tel. International: +44 208 150 1941
http://www.exchange4free.co.uk 


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