Market and hedging conditions
For illustration purposes, the strategies presented in this document follow these assumptions:
- Currency pair is GBP/USD
- You are going to buy USD 500,000
- You need hedging for a tenor of 180 days
- Reference spot rate is at 1.2450
- Reference forward rate is at 1.2508
Strategy Summary
| Product | Upfront Cost | Protected Rate | Upside Limit | Leverage |
|---|---|---|---|---|
| Outright Forward | — | 1.2508 | — | — |
| Ratio Forward | — | 1.2640 | — | 200% |
| Extendible Forward | — | 1.2630 | — | 200% |
Outright Forward
Description
An Outright Forward contract is the straightforward currency hedging tool. It allows you to buy your currency requirement at a rate determined today, whilst delaying the settlement of the contract until a future date.
By entering into an Outright Forward contract you have removed the uncertainty of exchange rate movement. In exchange for the transaction rate certainty, you have lost the opportunity to take advantage of any favourable exchange rate movements between the trade date and the value date.
Advantages
- Provides you with full protection against a depreciation of the spot rate below the Protected Rate
- No premium payable / Zero cost
Disadvantages
- You are unable to benefit from an appreciation of the spot rate above the Protected Rate
- You may be Margin Called
How it works
You import goods from the US and need to pay USD 500,000 in 6 months’ time to your supplier.
The prevailing spot rate for GBP/USD is 1.2450, the half year forward rate is 1.2508. You do not want to benefit from favourable market moves. You accept a Protected Rate of 1.2508.
If at expiry, the spot rate is below the Protected Rate then you receive the Protected Rate on 100% of the agreed exposure. If, however, the spot rate is above the Protected Rate, you are obliged to transact at that Protected Rate, although it is worse the prevailing spot market rate.
Graphical Overview
Possible outcomes at expiry
GBP/USD weakens and, on the expiry date, the spot rate is 1.2050. This is below the Protected Rate. You buy USD 500,000 from us at the Protected Rate of 1.2508.
GBP/USD strengthens and at expiry the market rate is 1.2925. This is above the Protected Rate. Nevertheless you are obliged to buy USD 500,000 from us at the Protected Rate.
Ratio Forward
Description
A Ratio Forward provides you with a Protected Rate that is better than the prevailing forward rate. However, the amount you may be required to exchange is dependent upon where the spot rate is on the expiry date.
If the spot market moves against you, you will be able to transact the Notional Amount at the enhanced Protected Rate. Whilst if the market moves in your favour, you will be obliged to transact the Ratio Amount at the Protected Rate.
Advantages
- Provides you with full protection of the Notional Amount against a depreciation of the spot rate below the Protected Rate
- The Protected Rate is better relative to the market forward rate at the time of entering into the contract
- No premium payable / Zero cost
Disadvantages
- You are unable to benefit from an appreciation of the spot rate above the Protection Rate
- If the spot rate is above the Protected Rate on expiry, you will be obliged to trade the Ratio Amount
- You may be Margin Called
How it works
You import goods from the US and need to pay a supplier USD 1,000,000 in 6 months’ time.
You want to lock in your rate for some of your exposure above the current market rate but you are reluctant to pay a premium for this. You inform us that you are looking to receive an Protected Rate of 1.2640 on at least some of your requirement. Based on this, we calculate a pre-agreed Notional Amount. In this example it would be USD 500,000.
Graphical Overview
Possible outcomes at expiry
GBP/USD weakens and, on the expiry date, the spot rate is 1.2100. This is below the Protected Rate. You have the right but are not obliged to buy the Notional Amount USD 500,000 from us at the enhanced Protected Rate of 1.2640.
GBP/USD strengthens and at expiry the market rate is 1.2975. You are obliged to buy the Ratio Amount USD 1,000,000 from us at the Protected Rate of 1.2640.
Extendible Forward
Description
An Extendible Forward provides you with an enhanced Protected Rate, which will be more favourable than the current market forward rate at the time of entering into the contract. You may have to take further deliveries of currency if the prevailing market rate is at or above the Protected Rate on the expiry date.
Upon expiry If the prevailing spot rate is above the Protected Rate you will be obliged to transact two deals of buying the Notional Amount at the Protected Rate each: the first one on the spot market, the second by a 3 months Flexible Forward.
Advantages
- The enhanced rate provides protection at better levels relative to the market forward rate at the time of entering into the contract
- Can be combined with other deals to improve overall rates
- No premium payable / Zero cost
Disadvantages
- Upon expiry you may be obliged to transact two deals with the Notional Amount each
- You may be Margin Called
How it works
You import goods from the US and have to pay a supplier USD 500,000 in 6 months’ time.
The prevailing spot rate for GBP/USD is 1.2450, the half year forward rate is 1.2508. We have informed you that we can offer an enhanced Protected Rate of 1.2630 for delivery in 6 months, after which upon expiry if the market rate is above the Protected Rate we will, in this example, extend the contract on the following terms: you transact two deals of buying USD 500,000 at the enhanced Protected Rate of 1.2630 each, one on the spot market, the another by a 3 months flexible forward.
Graphical Overview
Possible outcomes at expiry
GBP/USD weakens and, on the expiry date, the spot rate is 1.2100. This is below the Protected Rate. You have the right but are not obliged to buy USD 500,000 from us at the enhanced Protected Rate of 1.2630.
GBP/USD strengthens and at expiry the market rate is 1.2975, hitting the barrier at 1.3075. You are obliged to transact two deals: to buy USD 500,000 in the spot market at the Protected Rate of 1.2630, and to buy USD 500,000 by a 3 months flexible forward at the Protected Rate of 1.2630.
Contact us
If you have any questions or would like any additional information please contact one of our currency risk specialists
+44 (0)207 740 000
Currency Solutions Limited, 2 Jacob Street, London SE1 2BG
Disclaimer and Important Information
This presentation has been prepared on behalf of Currency Solutions Limited for the information of its potential clients. It is not investment advice or an offer or solicitation for the purchase or sale of any financial instrument.
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