What it means
The currency was introduced in the late 1990s to replace the several competing currencies circulating at the time. Its name reflects the promise at its core, that holders can always convert it into the anchor currency at a known rate.
That promise is what gave a fragile economy a stable unit of account. The mechanism is a currency board rather than ordinary central banking.
The central bank issues local currency only against foreign reserves it holds, so it cannot fund government deficits by creating money. The trade-off is exchange rate stability in return for giving up an independent interest rate policy.
The fixed rate was inherited from a one-to-one link with the Deutsche Mark and carried over when the euro replaced that currency, which is why the official rate is an awkward figure of about 1.96 marks to one euro rather than a round number. Because the peg is written into law rather than managed day to day, the quoted rate does not drift.
Businesses can therefore treat euro and mark prices as interchangeable after a single conversion. For anyone invoicing into or out of the country, the practical risks are not ordinary exchange rate risks.
They are the risks that come with any peg: a change of policy, banking liquidity problems, or friction in moving larger sums across borders. Finance teams usually invoice in euros where the customer will accept it and keep mark balances small.
The nuance is that a pegged currency moves against everything that is not its anchor. If the euro strengthens against the dollar, the mark strengthens with it, so a United States exporter selling into Bosnia and Herzegovina is carrying euro risk under a different name.
That is the single most useful thing to understand about any pegged currency.
In practice
Real-world examples.
Example
A German machinery exporter quotes a distributor in euros and accepts payment in convertible marks at the official rate. Because the rate is fixed in law, the exporter books no exchange gain or loss on the transaction and treats the conversion purely as a banking cost.
Example
A Canadian mining company with a local subsidiary reports in dollars and must translate mark balances every month. Its treasurer hedges the euro rather than the mark, because the mark simply follows the euro and euro contracts are far cheaper and easier to buy.
Example
A travel business selling package holidays sets its local prices by taking the euro price, multiplying by the fixed rate and rounding to a sensible retail figure. It reviews the rounding once a year rather than each week, because the underlying rate does not move.
Formula
Calculation
Amount in euros = amount in convertible marks / 1.95583, the fixed official rate
Amount in dollars = amount in euros x the euro to dollar market rate
A construction supplier invoices a local customer 195,583 marks. Converting at the fixed rate gives 195,583 / 1.95583 = 100,000 euros exactly, which is the point of a legally fixed peg: the euro figure is certain. If the euro is trading at $1.10 when the money settles, the dollar value is 100,000 x 1.10 = $110,000. Should the euro weaken to $1.05 before the money arrives, the same 195,583 marks are worth 100,000 x 1.05 = $105,000, a fall of $5,000 caused entirely by the euro and not by anything happening in Bosnia and Herzegovina.Case study
Seen in the real world.
Alpenhart Components is an illustrative, fictional Austrian parts maker that opened a small assembly plant in Bosnia and Herzegovina. Its first instinct was to set up a hedging programme for the convertible mark, and its bank quoted an expensive, illiquid product because very little of that currency trades on world markets.
The group treasurer looked again at how the currency actually works. Because the mark is held to the euro by a currency board written into law, the group's real exposure was the euro against its reporting currency, and that market is deep and cheap. Alpenhart cancelled the mark hedge, hedged euros instead and cut its annual hedging cost by about $40,000.
The illustrative lesson is to hedge the anchor rather than the pegged currency, while keeping a written note of what would happen if the peg itself were ever changed. Alpenhart's board reviews that note once a year as part of its treasury policy.
Watch out
Common mistakes.
- Buying expensive hedges against the convertible mark itself, when the real exposure sits in the euro that the mark is pegged to.
- Reading the odd-looking official rate of about 1.96 marks to one euro as a market quote that will move, when it is a figure fixed by law.
- Assuming a pegged currency carries no exchange risk at all, when it carries the full risk of the anchor currency against every other currency.
Questions
People also ask.
Why is the official rate not a round number?
It was inherited from a one-to-one link with the Deutsche Mark, and the awkward figure is simply the rate at which the euro replaced that currency.
What is a currency board?
It is an arrangement under which the central bank may only issue local currency against foreign reserves it actually holds, which keeps the fixed rate credible but removes its freedom to set interest rates.
Can a business just invoice in euros instead?
Often yes, and many exporters do, though local customers and public bodies may require marks, so most firms price in euros and settle in marks at the fixed rate.
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