When you remit money from the U.S. to your home country, the actual amount transferred depends on an exchange rate. The foreign exchange rate is the rate at which a currency can be exchanged for another.
Exchange rates fluctuate constantly, depending on several factors, like inflation rates, interest rates, monetary policies, economic stability, etc. Foreign exchange rate can be of two types – a locked-in exchange rate or an indicative exchange rate.
Locked-in Exchange Rate:
International remittance service providers and banks frequently offer binding contracts to their customers to lock-in exchange rates while remitting funds. Also known as fixed exchange rates, it is an effective tool to hedge conversion risks due to market fluctuations. The exchange rate can be frozen for a specific period through currency futures, forwards, and options contracts.
In currency futures contracts, you enter a binding obligation to buy or sell a defined amount of currency set at a specific rate for a pre-mentioned time-period. Currency forwards are largely used by big corporations and not traded on an exchange. In a currency options contract, the currency value is frozen for a specified time, but you do not have any obligation to buy it when the option expires.
Key Features:
- You will know the exact amount of money that will be received by the recipient
- It prevents risks and eliminates uncertainties in conversion
- There is no loss or gain in remittance
Indicative Exchange Rate:
The indicative exchange rate is based on the live rates that fluctuate every day according to market demand and supply. Also known as the floating rate, it is a reasonable estimate of the current market trend, where the actual sum transferred will depend on the existing rate at the time of transaction.
Indicative exchange rates can be further categorized into free float and managed float. Free float rates are governed entirely by the open market. But in some cases, the central bank of a country may intervene to reduce the extreme volatility of the exchange rates. These are known as managed float exchange rates.
Key Features:
- Fluctuates constantly and has greater risk exposure
- The actual amount remitted may vary according to the current fluctuations in exchange rates
Which exchange rate should you choose while remitting funds internationally?
Your decision to go with either of the two options depends on several factors –
- Which bank/service providers you choose, how transparent and reliable are they?
- What are the service charges levied by your service provider?
- The current market volatility
While some banks offer only locked-in rates for international remittance, others offer both. Generally, banks/service providers also charge a transaction fee over and above your remittance amount. While some banks may take only a fixed amount of money over locked-in rates, others take a fixed percentage over and above the indicative rates.
Most banks offering indicative rates won’t be transparent about the exact conversion rate at the time of remittance. So, if your transaction time takes a couple of days, there is no way to know if you have been charged a higher rate by the bank/service provider. For a falling home currency against the dollar, it might be better to choose indicative exchange rates as you will get a higher value for the same amount of dollars if the rates go up. But this involves a lot of risks due to market fluctuations. Be aware of the potential risk-exposure before taking any decision.
