Do You Know your Average Rate vs. Your Budget Rate?

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Calculating an average exchange rate for all your payments and comparing it to your budget rate or your break-even exchange rate, can help you determine how well your Foreign Exchange Risk Policy (or your FX advisor) is working for you. Here’s a tip that I give clients when I sit down with them to perform a Currency Risk Analysis. 

When you have a lot of payments, it’s easy to lose track of your overall exchange rate cost for purchasing overseas. Calculating an average rate for all your foreign currency transactions can help you determine whether you’re in line with your budget rate. If you don’t use a budget rate, what’s your threshold-of-pain? In other words, where does the exchange rate need go where you start to say: “We can can’t handle this.” or where your profit margins start to get uncomfortably thinner.  By calculating an average rate for your past transactions, you can make adjustments to your risk management policy as the market fluctuates; and therefore, have better control of market risk.

To calculate your average rate, you’ll first need to get a list of all your foreign payments and the subsequent U.S. dollar equivalents for each payment.

Next, total all of your foreign currency amounts in one column and total all of your U.S. equivalent amounts in another column.

Next, divide the two total amounts to give you your average exchange rate for that period.

*Please note, don’t simply calculate the average using only the exchange rates (without factoring in the notional amounts).  This will not give you an accurate result, since you have different notional amounts for your payments at different exchange rates.

A larger payment’s exchange rate will carry a higher weighting in your average exchange rate for all your transactions.

Remember, you want to find your true cost for all your foreign payments and then compare that average rate to your budget rate to determine how well your risk management policy is working.

Below is a chart showing a result of this process where I compared the average exchange rate vs. the budget rate for each quarter.  I then calculated the percentage variance from the budget rate.

Please let me know if you have any questions and good luck.

Click on the image for a closer look.


budget vs avd rate chart

Comparing your currency budget rate to your overall weighted average exchange rate.



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