Pound Sterling Forward contracts 101: How to protect British pounds against downfall.

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.