Recently I read several online discussions about the currency risk some translators are forced to take (specifically the risk of exchange rates going against them).
I would like to offer some thoughts and describe a simple process that can be used to mitigate such currency risk, using a fictitious case study.
This is a case where someone has a normal working currency (such as USD) but also has another currency (such as Euro) that she needs to use for some parts of her business or life.
For example, she invoices and gets paid in USD, but she has to pay her student loans in Euro, or perhaps she outsources some of her work and she has to pay her vendors in Euro.
So, even though she sends the invoice in USD (because that's the only currency the client is able or wants to deal with), what she really needs is Euros.
Let’s assume our translator, Jenny, lives in the US and does a translation job for ClientCorp. Jenny agreed to bill the client in USD ($). Further assume she’s outsourced most of the job to a colleague Hans in Europe who requires payment in Euros (€).
Here is the baseline scenario (Scenario A):
Jenny delivers the job to ClientCorp on October 1, and sends an invoice for $150.00. The exchange rate on October 1st, is 1.5 USD per €, so the $150.00 is equal €100.00. This pricing is OK, as Jenny knows she would have to pay € 80.00 to Hans on November 1st, and she still would have €20.00 in her pocket (equivalent of $30.00 at this point).
One month later, on November 1st, ClientCorp pays the invoice, as agreed, $150.00 to Jenny.
By this time the dollar has plummeted against the Euro, and on November 1st the exchange rate is 2 to 1, in other words $150.00 is equal only €75.00. Jenny has to pay Hans €80.00, so she not only loses out on the extra €20.00 profit, but she is short of € 5 to pay Hans. Of course, she pays him, as she promised, but she is very upset about the whole thing.
Could she have done something to prevent this loss?
The answer is yes.
Here is the modified scenario (Scenario B):
Jenny lives in the US, and keeps two bank accounts, one in USD and one in Euro, and she keeps some money in both of them. Let’s say she has 200 in each, so she has $200.00 and €200.00 in her accounts on September 30.
As in Scenario A, Jenny delivers the job to ClientCorp on October 1, and sends an invoice for $150.00. With the exchange rate at $1.50 to €1.00, the pricing is OK as Jenny would net €20.00 after paying Hans €80.00.
In this ideal world, what would her bank accounts look like? After receiving the proceeds from ClientCorp , she expects to have $ 200.00 and € 300.00 in her accounts on November 1st, from which she can pay Hans Euro 80, and be left with € 20.00 profit.
To ensure this, on October 1st, at the same time when she sends the $150.00 invoice, she moves $150.00 out of her USD account, exchanges it to €100.00, and puts it into her Euro account. So now, on October 1st, she has $200.00 - $150.00 = $50.00 in her USD account, and €200.00 + €100.00 = €300.00 in her Euro account.
One month later, on November 1st, ClientCorp pays the invoice, as agreed, $150.00 to Jenny. So, Jenny has $50.00 + $150.00 = $200.00 in her dollar account, and her Euro account is unchanged from October 1st, it still has €300.00. So, she accomplished her goal of having $200.00 and €300.00 in her accounts on November 1st. She pays Hans the €80.00, and she has the extra €20.00, as she expected. Jenny smiles.
By this time the dollar has plummeted against the Euro, and on November 1st the exchange rate was $2.00 to €1.00, in other words $150.00 was equal only €75.00. But this does not matter to Jenny, as she had the Euro funds as she expected, and was able to pay Hans, and did not incur a loss in the course of this deal. Jenny smiles even more.
So, Scenario B is a way to prevent currency loss. To be more precise, this method ensures that Jenny will have the expected funds in the exact same amount, as she originally thought.
Of course, this method also prevents currency gains, as Jenny will not profit from a possible dollar rate rise. If she goes with Scenario A, she is exposed to both directions of the currency risk, so if the rates were in her favor at the end, she would have more Euros than she expected. With Scenario B, she will have exactly the same amount (€100.00), no matter where the rates are going.
Notice that by moving the entire invoice amount out of her USD account and into her EUR account, she has locked in the USD-Euro exchange rate both on the amount owed Hans and on her profit.
In Scenario B, the extra €20.00 at the end worth $40.00 (not $30.00 as she expected, but $10.00 more), so if she wanted to use that profit in USD, she could exchange the €20.00 to $40.00 and realize a dollar gain. However, if the rates went in the other direction, and let’s say on November 1st the dollar and Euro were par (1 to 1), then the extra €20.00 would only worth $20.00, which is $10.00 less than she expected. This presents a problem if Jenny wants to use her profit in the US, in other words, if she wants her profit in USD. As per Scenario B, her profit may decrease, because it is still exposed to currency risk.
However, if she knew at the beginning, that she wanted to use her expected $30.00 profit in USD (because she lives in the US), then she can simply modify Scenario B and at the first step move $30.00 less from her USD account to her Euro account. In other words, she would take out only $120.00, exchange it to €80.00 Euros and put it into her Euro account. This way she is covered for the risk of the payment for Hans, and she kept her $30.00.
A similar two-account strategy can be used if Jenny needs the money in USD, but the client only pays in Euros, except that in that case she would start by moving money from her Euro account to her USD account (reverse direction than in Scenario B above).
The amounts, exchange rates and the extreme fluctuation used in the scenarios above are for illustration purposes. The method makes more sense if bigger amounts are involved, even if the fluctuation is smaller. Of course, currency exchange fees need to be paid, but in Jenny's case, she would have to pay for the USD-Euro conversion once anyway, whether in October or November, when she pays Hans, so for the fees it does not make a difference whether she goes with A or B. For this case, it was also assumed that interest rates for the two accounts are comparable, in other words, it does not make a difference in which account Jenny keeps her money for the time being.
I hope you find these ideas and explanations useful.