A contract priced in the supplier's currency is an open foreign exchange position for the whole term, and it can be priced three ways on the same scenario.
Convert the supplier-currency spend at the base rate and at each plausible rate, and the difference is what the currency clause costs you. On an illustrative contract priced at USD 6,000,000 a year for a euro buyer, a euro that weakens 3 and then 5 per cent over three years adds 464,219 euros of cost, against 416,667 for a 2.5 per cent premium to have the supplier quote in euros, and 403,931 under an adjustment clause with a 3 per cent band and half the excess shared.
Worked in full in Contract Management by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The currency of a supply contract is usually decided in the definitions, in a few words, and priced by nobody. If the contract is in the supplier's currency, the buyer holds an open foreign exchange position for the whole term whether or not treasury is told. There are three ways to carry it: leave it open, pay the supplier to take it, or share it through an adjustment clause. Each can be priced on the same scenario.
| Input | Value |
|---|---|
| Annual spend, priced in USD | 6,000,000 |
| Base rate at signature, USD per EUR | 1.0800 |
| Annual spend in EUR at the base rate | 5,555,556 |
| Euro movement against the base: year 1 / 2 / 3 | 0.0% / −3.0% / −5.0% |
| Supplier's premium to quote a fixed price in EUR | 2.5% |
| Adjustment clause: band around the base rate | ±3.0% |
| Share of movement beyond the band borne by the supplier | 50.0% |
EUR cost = USD spend ÷ (base rate × (1 + movement))
Cost of the open position = EUR cost at the new rate − EUR cost at the base rate
Band clause: buyer bears the movement up to the band in full, and (1 − supplier share) of the excess
In Excel, with USD spend in B1, base rate in B2 and the movement in B3: =B1/(B2*(1+B3))-B1/B2. For the band, compute the same at the band edge, =B1/(B2*(1-Band))-B1/B2, and add half the difference between the two.
Step 1, year 2: the rate falls 3.0 per cent to 1.0476, and USD 6,000,000 now costs 5,727,377 euros, 171,821 more than at signature. Step 2, year 3: at 1.0260 it costs 5,847,953, an extra 292,398. A 5 per cent fall in the euro raises the euro cost by 5.26 per cent, because the cost is spend divided by the rate. Step 3, the open position over the term: 0 + 171,821 + 292,398 = 464,219, 2.79 per cent of three years' spend.
Step 4, the premium: 2.5 per cent of 5,555,556 is 138,889 a year, 416,667 over three years, paid whatever the currency does. Step 5, the band clause: year 2 sits on the edge of the band, so the buyer bears all 171,821. In year 3 the first 3 per cent costs 171,821 and the remaining 120,576 is split, so the buyer bears 232,109. Over the term, 403,931.
| Arrangement | Year 1 | Year 2 | Year 3 | Total |
|---|---|---|---|---|
| Open position, priced in USD | 0 | 171,821 | 292,398 | 464,219 |
| Supplier quotes in EUR, 2.5% premium | 138,889 | 138,889 | 138,889 | 416,667 |
| USD price with ±3.0% band, 50.0% shared beyond | 0 | 171,821 | 232,109 | 403,931 |
On this path the three arrangements land within 60,288 of each other. That is the point: none of them is free, and the question is not which is cheapest on one scenario but which risk the business is equipped to carry. The premium buys certainty at a known price; it is cheaper than the open position whenever the euro falls by more than 2.44 per cent, to below 1.0537. The open position is cheaper if the euro holds or strengthens. The band clause halves the movement beyond the band, in both directions, and costs nothing up front. A treasury forward would be a fourth route, priced off the interest differential; how that rate is derived is in how to calculate an FX forward rate.
| Euro movement | Rate | Open position | Band clause | EUR quote, premium |
|---|---|---|---|---|
| −10.0% | 0.9720 | 617,284 | 394,553 | 138,889 |
| −5.0% | 1.0260 | 292,398 | 232,109 | 138,889 |
| −3.0% | 1.0476 | 171,821 | 171,821 | 138,889 |
| 0.0% | 1.0800 | 0 | 0 | 138,889 |
| +5.0% | 1.1340 | −264,550 | −213,181 | 138,889 |
| +10.0% | 1.1880 | −505,051 | −333,431 | 138,889 |
The open position is asymmetric: a 10 per cent fall costs 617,284 and a 10 per cent rise saves 505,051. The band clause trims both sides. A clause that shares losses but not gains is not a band; check that the drafting is symmetrical before treating it as one.
Price the currency clause by converting the spend at the base rate and at each scenario rate: 464,219 open, 416,667 for the premium, 403,931 with a shared band on this path. Then tell treasury, because the exposure exists from the day of signature. The free workbook for this case prices the currency clause alongside the other clauses of a signed agreement, each against what the rejected bid offered.
A clause that changes the contract price when the exchange rate moves beyond an agreed band from a base rate, usually sharing the excess between buyer and supplier. With a 3.0 per cent band and 50.0 per cent sharing, a 5 per cent fall in the euro on USD 6,000,000 of annual spend costs the buyer 232,109 euros instead of 292,398 unshared.
It depends on how far your currency moves. A 2.5 per cent premium on 5,555,556 euros of spend costs 138,889 a year whatever happens. Leaving the price in dollars costs more than that only if the euro falls by more than 2.44 per cent, and saves money if the euro holds or strengthens. The premium buys certainty, not a lower expected cost.
Because the cost in your currency is the foreign spend divided by the exchange rate. When the euro falls 5 per cent against the dollar, USD 6,000,000 rises from 5,555,556 to 5,847,953 euros, an increase of 5.26 per cent or 292,398, not the 277,778 that multiplying spend by 5 per cent suggests.
This article is one calculation from Contract Management. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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