A currency exchange insurance for imports is a financial product that protects the buyer from the risks associated with currency exchange in their international commercial operations. When signing the contract with any banking institution, a price is set to buy or sell a currency for a specific amount and on a certain date.
This way, the importer is not affected by potential fluctuations in the currency exchange rate, something common in international markets where transactions are frequently conducted in dollars and euros.
There are basically two types of exchange insurance, depending on whether the client wants to buy or sell:
- Purchase or Import: With this insurance, the client commits to buying the currency at the agreed price with their bank to use it in their purchase operations. It is, therefore, the option of currency exchange insurance for imports.
- Sale or Export: Through this exchange insurance, the client commits to selling the currency at the agreed price and on a specific date. It is used for sales transactions in that currency.
Contracting a currency exchange insurance for international trade guarantees the importer that they will be safe from fluctuations in the euro and dollar exchange rates. During the term of the contract, the agreed price with the bank remains unchanged even if circumstances change.
How does currency exchange insurance for imports work?
Importers purchase a certain amount of dollars from their bank with which they can operate until the expiration date. During the insurance period, changes in currency prices will not affect the importer, as they are guaranteed a fixed purchase price by their bank.
At the end of the agreed period, the established nominal amount will be bought at the fixed rate. This way, losses are avoided, but it is also not possible to benefit if market fluctuations are favorable.
The settlement can be made in full or partially before maturity, always maintaining the exchange rate.
Example of currency exchange insurance calculation
The currency exchange rate set for the expiration date depends on several factors: the currency exchange rate on the contracting day, the interest rate differential between both currencies, and the coverage period.
The price calculation is done by applying a financial formula. For example, let’s assume that the contracted amount is 100,000 dollars for one year and that at the time of contracting, the spot exchange rate is 1.2600. If the dollar interest rate at 365 days is 3.19% and the euro interest rate at 365 days is 3.29%, the price of the currency exchange insurance would be the result of applying the following formula:
1.2600 x (1+3.19% * 365/360) / (1+3.29% * 365/360) = 1.2588
In a normal currency exchange insurance, this price is valid until the operation’s maturity date. Some institutions offer a flexible currency exchange insurance. It differs from the normal one because the price is set for a period of time instead of for a specific date. Thus, the price remains the same throughout the period, although its cost is slightly higher due to the flexibility it offers to the client.
If you need advice on currency exchange insurance and the conditions of different banking institutions, do not hesitate to contact Bull Importer. Our staff will be happy to provide you with all the assistance you need to start your import business.
