How To Protect Pound Sterling From Further Losses
U.K. Prime Minister
Boris Johnson is among the hundreds of thousands of people worldwide to catch
the coronavirus. His ability to lead the government is at best crippled by
potential flu-like symptoms. Under a worst-case scenario, he may need to resign
due to health reasons and this could result in untold damage to both public
moral and financial markets.
By his own admission, the coronavirus pandemic will “get worse before they get better.” While the government’s response could drastically look different in such a short period of time, one thing has remained consistent: international investors are betting big against the pound sterling. Fortunately, investors can protect their assets through a Pound Sterling Forward contract.
Pound, Stocks Takes A Pounding
The pound is trading
near its lowest levels versus the U.S. dollar since Johnson studied at Oxford
in 1985 at around $1.15. The London Stock Exchange has lost 27% of its value
since the start of 2020 which is worse than its American counterpart, the Dow
Jones Industrial Average which is down around 24% over the same time period.
At the time of
writing, more than 700 people have tragically died from the virus in the U.K.
alone and it is unclear when the world will see some form of progress.
Meanwhile, experts
themselves are scrambling to revise their own research, merely adding to the
confusion and uncertainty.
For example, the
scientist and Imperial College author Neil Ferguson initially predicted the
death toll in the U.K. alone will reach half a million, under a worst-case
scenario. But a revision of his work based on evolving laws, the growing
embrace of “social distancing,” and other assumptions prompted a revision to 20,000 people dying — at the
most.
Scientists Need More Time But The Pound Won’t Wait
At the time of
writing, Oxford scientists are weeks away from starting a trial of up to 510
healthy adults to test a coronavirus vaccine called ChAdOx1 nCoV-19. Experts
highlighted a timeline of 12 to 18 months for any vaccine to be made available
to the public.
U.K. scientists are
joining their peers from across the world in testing the efficiency of existing
treatments, such as therapies for the treatment of malaria, HIV, and other
viruses.
In spite of what
appears to be a step in the right direction in the fight against the
coronavirus, the pound rebounded off its multi-decade lows and traded above
$1.20 versus the U.S. dollar.
To be fair, the
improvement comes at a time where asset classes worldwide showed new signs of
life. But since the pound recently traded at a 35 year low, what’s stopping it
from testing a 40 year low in the coming weeks or months?
Would a 50-year low
be out of the question at a time when global economic activity is grinded to a
near-halt and billions of people worldwide are forced to stay indoors? There is
no way to know for sure, but there is a way to protect against such an event
occurring.
Investors Don’t Have To Wait For Protection
A foreign exchange
forward contract, more commonly known simply as a forward contract, used to be
a tool available for the ultra-wealthy, multinational corporations and global
banks. But thanks to the advancement of fintech and online money exchange
platforms, investors and enterprise owners of all sizes can buy a contract.
A forward contract
allows an individual or an enterprise to buy or sell a currency in the future
at a guaranteed rate with a counterparty. Doing so allows them to essentially
hedge against downside from currency fluctuations but with the caveat they
won’t participate in the event of a favorable movement.
Consider the
following example: a London-based fashion retailer has a contract to sell $1
million worth of goods to a retailer in the United States. As per the terms of
the agreement, the transaction must be conducted and finalized in U.S. dollars.
Based on current
exchange rates, the enterprise owner’s $1M U.S dollar receipt will be converted
to £802,890 and that amount is deposited in their bank account.
If the pound loses
10% in value over the next year, the same $1M receipt implies the enterprise
owner is left with £722,601. The difference of more than £80,000 on a year-over-year
basis is a staggering figure that could be multiplied several times over if
there are many similar contracts on the books with other international clients.
Instead of hoping for
the best and expecting the worst, the enterprise owner purchases a forward
contract through an online exchange platform or other financial services
providers. The enterprise owner agrees today to exchange with someone else the
$1M received from the client for £800,000 in one year. Again, the terms of the
agreement will remain valid regardless of where the currency pair trades it in
12 months.
Conclusion: A Risk Free And Safe Approach
In our previous
example, the enterprise owner took the necessary steps to save themselves from
losing out on tens of thousands of pounds if the currency moves in the wrong
direction. However, if the pound appreciated in value the enterprise owner
won’t see any of those gains.
There are of course
fees attached to a forward contract and approximately 10% of the total amount
is due upfront. Each unique forward contract agreement does not trade on any
exchange and can only be canceled if the two sides agree to do so.
At the end of the
day, the enterprise owner is in the fashion industry and certainly not in the
business of attempting to model or speculate currency fluctuations.