Luis has three friends whose parents want to purchase a Rolex, which is unavailable in Mexico. Each Rolex costs $10,000 or MXP 180,000. The exchange rate is $1=MXP 18. The friends offer to pay him an additional $1,000 or MXP 18,000 for each watch he buys for them.
They give him the total amount in pesos, MXP 594,000, worth $33,000. Luis was going to exchange the Mexican pesos for dollars, but he forgot.
Luis routinely goes to visit his girlfriend Jenny in NYC. He goes to the Rolex store and takes a photo of the Rolex they want, to make sure he will get the correct one (photo below). While at the store. Jenny tries on a necklace. It looks great on her. Luis figures with the $3,000 profit he will make, he would buy Jenny a necklace.
Five weeks later, on his flight to NY, he reads in the newspaper that the Mexican Peso keeps depreciating. He panics. He gets off the plane and exchanges the money at Newark Airport. He gets $20,600. The teller confirms that on Valentine’s Day, February 14th, the rate was 18. Today is April 4th, 2020, and the rate is 26, plus a 10% fee.
What can Luis do? He just lost 58%. What can small businesses procuring goods from foreign countries in foreign currency do, if they have already collected payment in full? Please leave your comments below.
Note: one participant said that Luis should get Jenny the necklace, regardless.
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Small businesses and inflation
If the exchange rate of the dollar to MXP continues to grow, he can exchange more MXP with the current amount of dollars that he has. In this way, he can use MXP again to buy the watches, which is a good opportunity for him to complement his loss. It is wise to keep in hand the strong currency (dollar), instead of MXP.
I think if the MXP is keeps depreciating, it is necessary for him to exchange more MXP with dollars. Since the longer he waits, the more MXP depreciates, the less dollars he can get in exchange, and the more he loses. Also, it is important to avoid exchanging money at airport, and it could be better to use ATM machines to get the best exchange rate available. Another way for him to purchase the Rolex is using credit card.
From my point of view, Luis can exchange the existing US dollars into MXP because of the need to keep value. Then he can use MXD to buy the same watches, in that case the loss will be smaller. For some small companies, it is wise to exchange the received foreign payment into a strong currency, such as USD and GBP. In this way, the value of the profit will be preserved and the loss of exchange rate will be smaller.
Personally, I think Luis made a big mistake first when he didn’t exchange the money on the same day when the exchange rate was $1=MXP 18 and because of that he lost $12,400 because of the change of the exchange rate from 18 to 26 pesos per dollar, the second mistake is that he should have taken the money in dollars from the start and not bearing the responsibility to convert the money from pesos to dollars so he wouldn’t bother with the foreign exchange rate, another solution would have been to hedge fund which a lot of businesses use when making transactions with clients from other countries with the different currencies, this sets the prices and the person won’t bother with the changes on the exchange rate because it will get fixed through the hedge fund contract with the client.
If the USD is stronger, he should exchange all 20,600 USD to MXP. This way, he would get 535,600 MXP. Luis should then avoid exchanging money at the airport and should exchange the currency at the bank or with a prepaid travel card to get a better exchange rate. If he insists on buying watches, he can try looking online and purchasing those watches in MXP instead.
Source: Mastercard Prepaid Travel Mastercard
I would suggest that Luis should ensure he receives the correct payment amount by asking his clients to wire the money in US dollars, similar to my experience with wiring NYU tuition. To address currency fluctuations, particularly with the Mexican Peso, Luis could use a financial service that offers locked-in exchange rates or guaranteed conversion amounts. This way, even if the payment is initially made in another currency, Luis would receive the exact amount he is owed in US dollars. Additionally, it’s important for Luis to be proactive in managing currency exchange and not delay the process, learning from past experiences to safeguard his profitability.
After reading the question I did some research. Honestly there is no right or wrong solution to this now. He definitely made some mistakes. He should have converted the money instantly when he got them since the clients gave him the money seeing the exchange rate for that time. Secondly, exchanging at airport is more expensive usually, so he should have waited and bought it from outside. Thirdly, if this is something he does regularly, he should have someone from a local exchange store to make it easier form him. Right now, what he can do is either pay out of pocket or apologize to his friend’s parents and ask for extra cash and since they know each other they might not be mad at him but disappointed which will be fine if its a one time thing he did for them. However, if this is his business this might hurt his reputation and he may lose those clients.
Luis should ask his friend to convert the currency to US dollars at the beginning. This can avoid many currency conversion fees and currency devaluation from the beginning.In Luis’s case, his options are limited since he has already exchanged the funds and lost a significant portion due to the peso’s depreciation. He may need to have an honest conversation with his friends, explaining the situation and potentially renegotiating the terms or canceling the transaction if they cannot agree on a fair resolution.
From my perspective, Luis should always trade with stable currencies like USD, never trade with unstable currencies like MXP. Luis lost 58% of his money due to the depreciation of the Mexican Peso and high exchange fees when converting the funds to USD after a delay. To avoid such losses, both Luis and small businesses should use strategies like forward contracts or options to lock in exchange rates, adjust pricing for currency changes, and monitor rates closely for timely action. These steps help protect against major financial losses when dealing with foreign currencies.
Luis’s situation reflects the impact of exchange rate fluctuations on foreign currency purchasing decisions for both individuals and small businesses. I think, in his case, he could consider investing in an asset that may appreciate steadily over time, like antiques, to offset his losses, though this also involves risk. For small businesses, exchange rate fluctuations can lead to significant losses, especially when sourcing goods internationally and receiving payments in the local currency. Therefore, I believe strategies like signing contracts to lock in exchange rates can help mitigate currency risks. Another approach could be to reduce settlement cycles and use the prevailing rate for the next investment to limit exposure to fluctuations. Of course, it’s essential to regularly monitor exchange rates as well. These methods, in my opinion, can help reduce overall risk.
Luis could communicate the unforeseen currency depreciation to his friends, as the agreement was based on the assumption of a stable exchange rate. Since they initially entrusted him with the money and he acted in good faith, they might share the financial impact or delay the purchase until a more favorable exchange rate is available. If his friends are committed to the original purchase, he could negotiate with them for an additional financial contribution to cover part of the depreciation, ensuring he isn’t entirely out-of-pocket for this unintended currency loss.
Luis should notify his friends of the currency drop and suggest for them to wait until the next time he visits NYC to buy the watches, which hopefully by then the currency recovers. As Luis regularly visits NYC this should not be too long of a wait. If the currency drop is caused by a serious event that will affect the currency long-term, I would suggest Luis buy the watches locally or in another region where the exchange rate is lower than in the US.
Small businesses can invoice clients in the currency of the goods they are purchasing, so the client bears the currency fluctuation risk.