Currency Risk on Saudi Returns for a Euro Investor: A Worked Example

An illustrative calculation of how euro-dollar movements change a European investor's return on a Saudi project, with and without a simple forward hedge.

A euro-based investor in a Saudi business earns returns in riyals, which track the dollar, so the euro value of those returns moves with the euro-dollar rate. A move of a few per cent can wipe out the difference between a good and an average year. The example below uses illustrative figures to show how large that effect is and what a simple forward hedge does to it.

The situation

A European company invests in a Saudi subsidiary and expects a distribution of SAR 4,000,000 in twelve months. It measures performance in euros and wants to know how much the euro value of that distribution could vary, and whether hedging is worth the cost.

Assumptions (illustrative)

• Expected distribution in twelve months: SAR 4,000,000.
• Assumed spot rate today: 1 euro buys SAR 4.00 (illustrative, not a market quote).
• Assumed spot rate in twelve months, scenario A: 1 euro buys SAR 4.40 (euro strengthens 10 per cent).
• Assumed spot rate in twelve months, scenario B: 1 euro buys SAR 3.60 (euro weakens 10 per cent).
• Assumed twelve-month forward rate available today: 1 euro buys SAR 4.06, reflecting an assumed interest rate gap.
• Distribution amount assumed certain, to isolate the currency effect.

Step 1: Euro value at today's rate

SAR 4,000,000 divided by 4.00 equals EUR 1,000,000.

This is the figure the investor has in its budget. It assumes the exchange rate does not move, which is the one outcome that almost never happens exactly.

Step 2: Unhedged, euro strengthens

SAR 4,000,000 divided by 4.40 equals approximately EUR 909,091.

The Saudi business performed exactly to plan, yet the investor receives about EUR 90,909 less than budgeted.

Step 3: Unhedged, euro weakens

SAR 4,000,000 divided by 3.60 equals approximately EUR 1,111,111.

The same distribution is worth about EUR 111,111 more. The range between the two scenarios is roughly EUR 202,020, about 20 per cent of the budget.

Step 4: Hedged with a forward

SAR 4,000,000 divided by the forward rate of 4.06 equals approximately EUR 985,222.

The investor locks in this amount whatever happens to spot rates, giving up the upside in scenario B to remove the downside in scenario A.

Step 5: Cost of certainty

EUR 1,000,000 minus EUR 985,222 equals approximately EUR 14,778.

Measured against today's spot value, the hedge costs about 1.5 per cent in this illustration. The real figure depends on the interest rate gap between the currencies when the forward is priced.

Step 6: Half hedge

Hedging SAR 2,000,000 at 4.06 gives about EUR 492,611; in scenario A the other SAR 2,000,000 at 4.40 gives about EUR 454,545, total about EUR 947,156.

A partial hedge narrows the range without removing it. Many investors hedge a proportion of expected cash flows and leave the rest open because the distribution itself is uncertain.

What changes the answer

• If the distribution is smaller than expected, a full hedge leaves the investor over-hedged and settling the difference.
• A wider interest rate gap between euro and dollar makes the forward more or less favourable, changing the cost of certainty.
• Hedging with a euro-dollar forward instead of a euro-riyal forward is common because it is more liquid; the residual risk is a change in the SAR peg.
• Longer horizons, such as a five-year project exit, involve larger possible moves and different hedge instruments.
• Borrowing in riyals against the Saudi asset reduces the net exposure without a derivative.

What the numbers tell you

• For non-dollar investors, currency can matter as much as operating performance over one year.
• Hedge expected cash flows in proportion to how certain they are.
• Compare the cost of the hedge with the size of the range it removes, not with zero.
• Design hedges with a regulated bank or treasury adviser who can price real instruments.

Limits of this example

Every figure above is an illustrative assumption used to show the method, not a quote, valuation or market rate. Costs, rates, fees and regulations change and must be confirmed with the relevant authority, lender or supplier before you commit.

Domira works with foreign investors on the property side of entering Saudi Arabia: finding land or premises, due diligence, design, construction and asset management. For licensing, tax and legal steps, work with a licensed adviser; we coordinate with yours so the property decision fits the structure you choose.