The Currency of a Contract Matters

Feb 5, 2008 by

Recently, Bloomberg reported that the supermodel Giselle Bundchen wanted her contracts to be denominated in any currency but the dollar, as she feared that the value of her dollar-denominated contracts would shrink due to the depreciation of the dollar. Ms. Bundchen is one smart model.

 In July 2007, I created a contract with an outsourcing company based in China. While at the time all of the payments specified in the contract were denominated in both Renminbi (the currency of the People’s Republic of China), and U.S. Dollars, we made the official currency of the contract the Renminbi. Although it is fortunate that our developers have not been harmed by the weakening of the dollar, the contract has become more expensive for us over time. In July, a Dollar bought 7.6 Renminbi, while now it only buys about 7.2 Renminbi. As a result, the cost of our contract has grown by nearly 5.5% due to the weakening of the dollar.

 What can someone do if they hold a contract denominated in a foreign currency and face a weakening exchange rate? The simple solution is to convert money to the stronger currency at the beginning of the contract, and pay from the previously converted currency, rather than to convert domestic currency as payments are due. In the event that the domestic currency strengthens, it may be wise to convert the money back. However, as there is often a conversion fee in the form of a spread, it is best to not convert money back and forth if it is unnecessary. While it is sensible to convert money at the onset of a contract, it is likely not sensible to convert the money back and forth whenever there is a slight strengthening or weakening of the dollar.

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