Hedging Foreign Currency Exposure

When I finally pulled the trigger on buying a boat directly from Hallberg-Rassy I became an unwitting currency speculator.

Here's what I learned in the process.

Because Hallberg-Rassy is a Swedish company they price their boats in their home currency: Swedish Kronor (SEK). In early 2006 when I first started looking at HR's the SEK/USD exchange rate was 7.8, by the time I made my first payment it had fallen to 7.3, today in the cash market it's quoted at 6.35. Not using a hedge of some kind would have been disastrous.

Here are the options I evaluated:

1. Pay the full price in advance at the current exchange rate. The downside: All HR boats are built-to-order. The lead time can be anywhere from 9-months to 2-years. Big opportunity cost, even if the cash is just held in a money market account during the build.

2. Convert the purchase price to SEK and hold it in a deposit account until the payments are scheduled. Most commercial banks don't support this but Everbank, an internet bank, specializes in deposit accounts and world currency CDs. I had an account there already. The downside: still some opportunity cost, at the time the "cash rate" in the US was much higher than what was being offered for the SEK. Be warned though, if you want to "trade" the currency and scale-in, Everbank makes it difficult. You call their trading desk and the only exchange rate guarantee you get is that they will complete the trade by the end of the day.

3. Open a futures account and hedge using forward contracts. Futures have the advantage of employing significant leverage. For example the Chicago Mercantile Exchange requires an "initial margin" of just $2,700 to control 2,000,000 SEK. The downside: expensive when the markets are in "contango" (futures trader jargon describing the case when the commodity is expected to increase in value so to lock-in a price in the future you have to pay more than the current market price). Some advice: make sure and open a futures account at a brokerage that gives you access to the NYBOT and not just CME.

4. A few months into the process I read a press release announcing a new ETF (Exchange Traded Fund) designed to track currencies. The ticker symbol is FXS and it typically has a much higher yield than what's offered at Everbank. Also, since it's an ETF you can trade it just like a stock. Understandably the trading volumes are VERY small but the bid/ask spreads were tight when it was listed on the NYSE (Since then the NYSE moved all their ETFs to their electronic trading platform, Arca, I've noticed an increase in the bid/ask spreads). The downside: selling the ETF to wire out the funds triggers a taxable gain or loss. At Everbank you just wire out the SEK held in your account.