What's

What's Foreign Exchange got to do with investing? (Everything.)

4 minute read

FX, Forex, foreign exchange: call it what you want, as long you know what it means to you as an investor in overseas share markets. Foreign exchange is just like it says on the tin: the conversion or exchange of one currency into another currency.

So, why should you care?

Well, when you deposit money into Hatch, we convert your NZD into USD so you can buy shares listed on the US share markets. To use Hatch well, and to be a successful investor, you should know how foreign exchange affects the investing process. Yes, there are risks involved, but the more you know, the better. Let’s roll…

How the foreign exchange market works

The global foreign exchange market is the largest financial market in the world. Yup, larger than the US share markets. We’re talking trillions of dollars worth of transactions every single day of the year and around the clock. These transactions are done in two ways: spot or forward.

Spot

A spot trade is any foreign exchange trade for immediate delivery (you want the money now). In a spot market, the underlying currencies are usually settled in 2 business days. When you exchange money before you travel or deposit money into Hatch, you are participating in the spot market. In liquid markets, where there are a lot of currency buyers and sellers, the spot price may change by the second. This makes the foreign exchange market relatively volatile.

Forward

A forward trade is any foreign exchange trade that settles in the future. A currency buyer and seller agree they will trade foreign exchange on a specified date in the future on a rate decided on today. A forward trade can be entered into to minimise the risk of losses due to adverse changes in an exchange rate (hello hedging!). While the spot market is influenced by supply and demand, the forward market is influenced by future expectations.

Count on fluctuations

Currency fluctuations are normal for major economies. The exchange rate of one currency versus another is based on relative supply and demand of each. This is influenced by a bunch of different factors including economic performance, outlook for inflation, interest rate differentials, and many more.

Currency values fluctuate from one moment to the next because these factors are in a state of perpetual flux. Take a look at XE’s NZD to USD currency chart to see how many changes occur even just over a few hours:

FX chart 24-25 sep.PNG

So what’s the currency that’s most in demand? You guessed it: the US dollar.

The demand for a particular currency depends a lot on what’s happening in that country. For instance, interest rates are a big factor: the higher the interest rate, the more demand for the currency (increasing the value of the currency).

A country's economic growth and financial stability also have a big impact on exchange rates. If a country has a strong, growing economy (like the US right now), investors buy its goods and services, and they'll need more of its currency to do it, thus creating more demand for that currency. On the flipside, if economic growth is looking grim, people are less likely to invest in that particular country.

Why exchange rates matter

Money makes the world go ‘round, however, few pay attention to the impact of exchange rates because we’re busy doing business in our domestic currencies. Fair enough! For most of us, exchange rates are only important when planning a trip abroad or dealing with overseas payments.

We know investing overseas is a good thing for building a diversified portfolio but it does come with risks from exchange rate fluctuations. Fluctuations in both domestic (NZD) and foreign (USD) currency values can either enhance or reduce the returns you can expect from your US investments. For example, if you own shares in the US and the NZ dollar loses value against the US dollar, the NZ dollar value of your shares increases. If the New Zealand dollar gains value against the US then the opposite is true: your shares are worth less in New Zealand dollars.

Reducing risk

Large institutional investors can mitigate the risk of currency fluctuations through hedging... and we’re not talking shrubbery (though we’re huge fans). However this option isn’t easily or readily available to retail investors (that’s you). One trick you have up your sleeve to diversify their portfolio into NZ assets or investments. As always, carefully consider foreign exchange risks, your risk tolerance and keep an eye on the exchange rate before you commit to investing with Hatch.

Hatch’s foreign exchange service

Here’s how Hatch works: You deposit your money into our NZ bank account. We exchange your NZ dollars into US dollars and send them to your Hatch account. Once your money hits your account, you can immediately start buying shares in companies and ETFs listed on the US share markets.

When you deposit your NZD, we always show you an estimated rate. It’s an estimate because the market changes so quickly and your money won’t be exchanged immediately. You could end up with more US dollars, or less, depending on how the rates change between the time you see the rate and the exchange is made.

And this is the crux of the risk: that you don’t get the amount of money you think you should after you’ve done your deposit. For instance, you may deposit your NZD with us at 10am on a Tuesday, but we might not be able to exchange it until 4pm. The rates will definitely change during this time. And to be happy using the platform, you’ve got to be ok with the possibility of this difference.

If you have any further questions, don’t hesitate to get in touch at hello@hatchinvest.nz.



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