Rates of exchange / Forward exchange contracts

Buying rates of exchange
Selling rates of exchange
Determining what type of exchange you require
Forward exchange contracts
Foreign currency options

Contracts of sale between importers, exporters and local traders for the supply of goods or services, should always specify the currency in which the payment is to be made.

A rate of exchange is the price of one currency in terms of another currency. It is the means by which banks are able to trade foreign currencies in exchange for Australian dollars.

Banks quote prices at which they will buy and sell foreign currency. These prices are based on prices that are quoted in the major wholesale foreign exchange markets and can change constantly throughout the day, depending on market forces.

When an exporter/seller sells goods for payment to a buyer in foreign currency, the foreign currency amount will be paid to the exporter/seller (The method of remittance of the foreign currency by the importer/buyer will depend on the method of payment agreed to in the contract of sale. For further details, see the section titled 'Methods of Payment' on this website.) Once the exporter/seller has been paid in foreign currency, they then may sell that foreign currency to a bank in exchange for Australian dollars or another currency. As rates of exchange are always quoted from a bank's point of view, in this case, the buying rate of exchange will apply, as the bank is buying the foreign currency from the exporter.

Conversely, an importer/buyer who is required to make payment to an exporter in foreign currency (In terms of their contract of sale, and the agreed upon method of payment), will need to purchase foreign currency for the payment of goods or services. The importer/buyer may purchase the foreign currency from a bank, and as the bank is selling the importer/buyer foreign currency, the selling rate of exchange will apply.

Rates of exchange generally quoted in Australia, show the amount of units of foreign currency which is the equivalent of to one unit of Australian currency.

(These rates of exchange are indicative only for use in this example)

Rates of exchange applicable to transactions fall into two categories:

• Spot buying rates and spot selling rates of exchange and
• Forward buying rates and forward selling rates of exchange

Buying rates of exchange

When calculating buying rates of exchange, banks consider any lapse of time between the date of purchasing the foreign currency from a customer in Australia (at which time the customer is paid the Australian dollar equivalent or is paid the equivalent in another foreign currency), and the date on which the foreign currency concerned, is credited to the Bank's foreign currency account held with an overseas Bank.

For example, when an Australian Bank purchases a cheque drawn on an overseas party and payable at a bank in an overseas country, the bank is buying, not the actual currency, but the right to receive the currency stated in the cheque. The actual proceeds of the cheque comes into the possession of the Australian Bank, only after the cheque has reached the bank at which it is payable, is presented and paid, and the amount of foreign currency is credited to the Australian bank's foreign currency account that is maintained at the overseas bank.

Buying rates of exchange fall into two categories:

Telegraphic transfer rates and airmail rates

• The telegraphic transfer buying rate is applied when an Australian bank expects to receive foreign currency in its foreign currency account held with an overseas bank, on the date it pays the Australian equivalent to the beneficiary of the funds. For example, the beneficiary of an inward telegraphic transfer (which is remitted to an Australian bank via SWIFT or telex from an overseas bank) would receive the telegraphic transfer buying rate, as the Australian bank already has or is expected to have the foreign currency credited to their foreign currency account.
  
• Airmail buying rates of exchange are applied to a transaction, when the Australian bank, has to despatch, after purchase, a bill of exchange or cheque, to the country in which the bill or cheque is payable. As there is a time lapse between the date that the Australian beneficiary is paid and the date that the Australian bank finally receives proceeds of the bill or cheque in its foreign currency account, an interest charge for this period is included in the rate of exchange.
  

Selling rates of exchange

As explained earlier, selling rates of exchange are the prices at which banks will sell foreign currency to its customers to meet their obligations to pay foreign currency to an overseas beneficiary.

When an Australian bank sells foreign currency to a customer, it receives Australian currency immediately in payment, therefore at no time is the bank out of pocket. Consequently only one selling rate of exchange exists, and it is the telegraphic transfer sell rate.

Determining what type of exchange you require

It is very easy to become confused when dealing with rates of exchange, and quite often the main mistake is when the incorrect type of rate is requested for converting foreign currency to Australian dollars.

The main principle is 'Am I receiving foreign currency or am I paying foreign currency?'

If you are receiving foreign currency, one of the two buying rates of exchange will apply and if you are paying foreign currency, the selling rate of exchange will apply.

Another area where mistakes are made is in the calculation process. If you obtain the correct rate of exchange (either buying or selling), if you know the amount of foreign currency, you divide the foreign currency amount by the exchange rate quoted to arrive at the Australian dollar equivalent. If you know the Australian dollar amount and have to convert to foreign currency, you multiply the Australian dollar amount by the exchange rate quoted to arrive at the foreign currency amount.

eg. Foreign currency divided by rate of exchange = Australian dollar equivalent

Australian dollars multiplied by rate of exchange = Foreign currency equivalent

For further information regarding rates of exchange, or to make an appointment with a Supply Chain Finance specialist, contact your NAB Business Banker.

Forward exchange contracts

A forward foreign exchange contract is an agreement between an Australian bank and customer. The bank agrees to buy from or sell to the customer, a fixed amount in foreign currency on a fixed future date, or during a period expiring on a fixed future date, at the rate of exchange quoted in the agreement.

This agreement may cover exchange risk between a foreign currency and Australian dollars or between two foreign currencies.

For further information regarding forward foreign exchange contracts, or to make an appointment with a Supply Chain Finance specialist, contact your NAB Business Banker.

Foreign currency options

Foreign currency options can allow you to take advantage of favourable exchange rate movements while protecting you from the effects of adverse movements.

A foreign currency option enables you to buy or sell an amount of foreign currency at an agreed rate for a certain delivery date. They are only available for amounts equal to or in excess of the equivalent of AUD 100,000. If rates move favourably, there is no need to exercise the option. Exchange rate risk can be reduced, or eliminated, for a known upfront cost.

The fee, or 'premium' charged for a currency option varies according to factors such as the strike price, the term, and the volatility of the market.

For further information regarding foreign currency options, or to make an appointment with a Supply Chain Finance specialist, contact your NAB Business Banker.