Market and hedging conditions
For illustration purposes, the strategies presented in this document follow these assumptions:
- Currency pair is GBP/EUR
- You are going to buy EUR 500,000
- You need hedging for a tenor of 180 days
- Reference spot rate is at 1.1400
- Reference forward rate is at 1.1350
Strategy Summary
| Product | Upfront Cost | Protection Rate | Upside Limit | Leverage |
|---|---|---|---|---|
| Outright Forward | — | 1.1350 | — | — |
| Vanilla Option | GBP 13,900 | 1.1400 | Infinite | — |
| Forward Extra | — | 1.1030 | 1.1975 | — |
| Ratio Forward Extra | — | 1.1310 | 1.1975 | 200% |
| Extendible Forward Extra | — | 1.1300 | 1.1975 | 200% |
| Knockout Forward Extra | — | 1.1280* | 1.1975 | — |
| Spread Forward Extra | — | 1.1140** | 1.1975 | — |
| Ratio Forward | — | 1.1420 | — | 200% |
| Extendible Forward | — | 1.1410 | — | 200% |
| Drawdown Ratio Forward | — | 1.1420 | — | 200% |
* You can buy or sell currency at the Protection Rate for as long as the spot market rate does not trade at or beyond a pre-agreed Knockout Rate 1.0250, at which point the contact will immediately terminate.
** If the spot rate is below 1.0825 on expiry, you will receive a reduced rate
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 Protection Rate
- No premium payable / Zero cost
Disadvantages
- You are unable to benefit from an appreciation of the spot rate above the Protection Rate
- You may be Margin Called
How it works
You import goods from Europe and need to pay EUR 500,000 in 6 months’ time to your supplier.
The prevailing spot rate for GBP/EUR is 1.1400, the half year forward rate is 1.1350. You do not want to benefit from favourable market moves. You accept a Protection Rate of 1.1350.
If at expiry, the spot rate is below the Protection Rate then you receive the Protection Rate on 100% of the agreed exposure. If, however, the spot rate is above the Protection Rate, you are obliged to transact at that Protection Rate, although it is worse the prevailing spot market rate.
Graphical Overview
Possible outcomes at expiry
GBP/EUR weakens and, on the expiry date, the spot rate is 1.0975. This is below the Protection Rate. You buy EUR 500,000 from us at the Protection Rate of 1.1350.
GBP/EUR strengthens and at expiry the market rate is 1.1775. This is above the Protection Rate. Nevertheless you are obliged to buy EUR 500,000 from us at the Protection Rate.
Please find a graphical representation of these posible outcomes on the chart below.
On this chart: the Black lines are samples of possible paths of the Spot market during the life of the product, Blue - the Protection Rate, Blue Circle - the rate at which you transact the Notional Amount upon Expiry.
Vanilla Option
Description
A Vanilla Option is a standardised financial instrument that gives the holder the right, but not the obligation, to buy or sell and underlying currency at a predetermined price on a given expiry date.
Hence, this product gives you a worst case rate for your future currency transaction, whilst at the same time allowing you to benefit from any favourable upward movement in the spot market.
There is an upfront Premium payable for this product.
Advantages
- Provides you with full protection against a depreciation of the spot rate below the Protection Rate
- Enables you to fully participate in favourable spot market moves
- Your possible loss is limited by the option Premium, and you will never be Margin Called
Disadvantages
- You pay the option Premium upfront
How it works
You import goods from Europe and need to pay EUR 500,000 in 6 months’ time to your supplier.
You buy a Vanilla Option that provides protection at 1.1400 (known as the “Protection Rate”). You pay a premium upfront GBP 13,900 (in this example). You will never have to pay an additional margin call for the transaction. On the maturity date of the deal (i.e. in six months time), if the rate in the market is more favourable than the Protection Rate 1.1400, you can simply deal at spot at the more favourable rate.
Graphical Overview
Possible outcomes at expiry
GBP/EUR weakens and, on the expiry date, the spot rate is 1.1000. This is below the Protection Rate. You have the right but are not obliged to buy EUR 500,000 from us at the Protection Rate of 1.1400.
GBP/EUR strengthens and at expiry the market rate is 1.1800. This is above the Protection Rate and you may buy any amount of currency in the spot market at the prevailing market rate.
Forward Extra
Description
A Forward Extra provides you with a guaranteed Protection Rate, whilst allowing you to fully participate in favourable exchange rate movements as far as a pre-determined Barrier Rate.
If the spot rate breaches this pre-determined Barrier Rate at any time during the life of the contract, you will be obliged to transact the Notional Amount at the Protection Rate, regardless of where the spot rate is on the expiry of the option.
Advantages
- Provides you with guaranteed hedge against a depreciation of the spot rate below the Protection Rate
- You are able to participate in an appreciation of the spot rate above the Protection Rate
- No premium payable / Zero cost
Disadvantages
- Your hedged rate is lower than the prevailing market forward rate
- If the spot rate hits the Barrier Rate at any time, you have to transact at the Protection Rate
- You may be Margin Called
How it works
You import goods from Europe and need to pay a supplier EUR 500,000 in 6 months’ time.
The prevailing spot rate for GBP/EUR is 1.1400, the half year forward rate is 1.1350. You would like to benefit from favourable market moves but are reluctant to pay a premium for this. You are prepared to accept a hedging Protection Rate of 1.1030. We then calculate the Barrier Rate to be 1.1975 (in this example). This ensures that you are protected at 1.1030 with the ability to participate in favourable market movements up to the Barrier Rate of 1.1975.
Graphical Overview
Possible outcomes at expiry
GBP/EUR weakens and, on the expiry date, the spot rate is 1.0825. This is below the Protection Rate. You have the right but are not obliged to buy EUR 500,000 from us at the Protection Rate of 1.1030.
GBP/EUR strengthens and at expiry the market rate is 1.1500, having never traded at or above the Barrier Rate of 1.1975. This is above the Protection Rate and you may buy any amount of currency in the spot market at the prevailing market rate.
GBP/EUR strengthens and at expiry the market rate is 1.1850, hitting the barrier at 1.1975. You are obliged to buy EUR 500,000 from us at the Protection Rate of 1.1030.
Ratio Forward Extra
Description
A Ratio Forward Extra provides you with an enhanced Protection Rate that is better or very close to the prevailing forward rate, whilst allowing you to fully participate in favourable exchange rate movements as far as a pre-determined Barrier Rate.
Upon expiry If the prevailing spot rate is above the Protection Rate and the spot rate breaches the pre-determined Barrier Rate at any time during the life of the contract you will be obliged to transact the Ratio Amount at the Protection Rate.
Advantages
- The enhanced rate provides protection at better levels relative to the market forward rate at the time of entering into the contract
- You are able to benefit from an appreciation of the spot rate above the Protection Rate
- No premium payable / Zero cost
Disadvantages
- If the spot rate hits the Barrier Rate at any time, you have to transact at the Protection Rate
- Upon expiry you may be obliged to transact the ratio amount, if the spot rate hits the Barrier Rate at any time during the life of the contract
- You may be Margin Called
How it works
You import goods from Europe and need to pay a supplier EUR 500,000 in 6 months’ time.
The prevailing spot rate for GBP/EUR is 1.1400, the half year forward rate is 1.1350. You would like to benefit from favourable market moves but are reluctant to pay a premium for this. You are prepared to accept a hedging Protection Rate of 1.1310 and possible increase in the transaction amount to EUR 1,000,000. We then calculate the Barrier Rate to be 1.1975 (in this example). This ensures that you are protected at 1.1310 with the ability to participate in favourable market movements up to the Barrier Rate of 1.1975.
Graphical Overview
Possible outcomes at expiry
GBP/EUR weakens and, on the expiry date, the spot rate is 1.0950. This is below the Protection Rate. Despite whether the Barrier Rate of 1.1975 has been hit or not, you have the right but are not obliged to buy EUR 500,000 from us at the Protection Rate of 1.1310.
GBP/EUR strengthens and at expiry the market rate is 1.1650, having never traded at or above the Barrier Rate of 1.1975. This is above the Protection Rate and you may buy any amount of currency in the spot market at the prevailing market rate.
GBP/EUR strengthens and at expiry the market rate is 1.1900, hitting the barrier at 1.1975. You are obliged to buy the ratio amount EUR 1,000,000 from us at the Protection Rate of 1.1310.
Please find a graphical representation of these posible outcomes on the chart below.
On this chart: the Black lines are samples of possible paths of the Spot market during the life of the product, Blue - the Protection Rate, Red - the Barrier Rate, Blue Circle - the rate at which you may transact the Notional Amount upon Expiry, Black Circle - the rate at which you may transact any amount upon Expiry, Red Circle - the rate at which you must transact the Ratio Amount upon Expiry.
Extendible Forward Extra
Description
An Extendible Forward Extra provides you with an enhanced Protection Rate that is better of the prevailing forward rate, whilst allowing you to fully participate in favourable exchange rate movements as far as a pre-determined Barrier Rate.
Upon expiry if the prevailing spot rate is above the Protection Rate and the spot rate breaches the pre-determined Barrier Rate at any time during the life of the contract you will be obliged to transact two deals of buying the Notional Amount at the Protection 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
- You are able to benefit from an appreciation of the spot rate above the Protection Rate
- No premium payable / Zero cost
Disadvantages
- If the spot rate hits the Barrier Rate at any time, you have to transact at the Protection Rate
- 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 Europe and have to pay a supplier EUR 500,000 in 6 months’ time.
The prevailing spot rate for GBP/EUR is 1.1400, the half year forward rate is 1.1350. We have informed you that we can offer an enhanced Protection Rate of 1.1300 for delivery in 6 months, after which upon expiry if the market rate is above the Protection Rate and during the life of the contract the proposed Barrier Rate of 1.1975 has been hit, we will, in this example, extend the contract on the following terms: you transact two deals of buying EUR 500,000 at the enhanced Protection Rate of 1.1300 each, one on the spot market, the another by a 3 months flexible forward.
Graphical Overview
Possible outcomes at expiry
GBP/EUR weakens and, on the expiry date, the spot rate is 1.0950. This is below the Protection Rate. You have the right but are not obliged to buy EUR 500,000 from us at the enhanced Protection Rate of 1.1300.
GBP/EUR strengthens and at expiry the market rate is 1.1625, having never traded at or above the Barrier Rate of 1.1975. This is above the Protection Rate and you may buy any amount of currency in the spot market at the prevailing market rate.
GBP/EUR strengthens and at expiry the market rate is 1.1900. You are obliged to transact two deals: to buy EUR 500,000 in the spot market at the Protection Rate of 1.1300, and to buy EUR 500,000 by a 3 months flexible forward at the Protection Rate of 1.1300.
Knockout Forward Extra
Description
A Knockout Forward Extra provides you with a Protection Rate very close to the prevailing forward rate, whilst allowing you to fully participate in favourable exchange rate movements as far as a pre-determined Barrier Rate. If the spot rate breaches this pre-determined Barrier Rate at any time during the life of the contract, you are obliged to transact the Notional Amount at the Protection Rate, regardless of where the spot rate is on the expiry of the option.
Additionally, if the market moves against you, there is a Knockout Rate, at which point the contact will immediately terminate. if the spot rate breaches a pre-determined Knockout Rate at any time during the life of the contract, the product ceases to exist and there are no obligations on either party.
Advantages
- You are protected at a better rate relative to the current market at the time of entering into the contractas as long as the spot market rate remains above the Knockout Rate for the duration of the contract
- You are able to participate in an appreciation of the spot rate above the Protection Rate
- No premium payable / Zero cost
Disadvantages
- If the spot rate hits the Barrier Rate at any time, you will no longer be able to participate in favorable market movements
- If the spot rate breaches the Knockout Rate at any time during the life of the contract, the product will immediately terminate
- You may be Margin Called
How it works
You import goods from Europe and need to pay a supplier EUR 500,000 in 6 months’ time.
The prevailing spot rate for GBP/EUR is 1.1400, the half year forward rate is 1.1350. You would like to benefit from favourable market moves but are reluctant to pay a premium for this. We have informed you that we can offer an Protection Rate of 1.1280 with the ability to participate in favourable market movements up to the Barrier Rate of 1.1975, as long as the Knockout Rate of 1.0250 is never reached during the life of the contract, at which point the contract is terminated.
Graphical Overview
Possible outcomes at expiry
GBP/EUR weakens and, on the expiry date, the spot rate is 1.0775, having never traded at or below the Knockout Rate of 1.0250. You have the right but are not obliged to buy EUR 500,000 from us at the Protection Rate of 1.1280.
GBP/EUR strengthens and at expiry the market rate is 1.1625, having never traded at or above the Barrier Rate of 1.1975. This is above the Protection Rate and you may buy any amount of currency in the spot market at the prevailing market rate.
GBP/EUR strengthens and at expiry the market rate is 1.1900, hitting the barrier at 1.1975. You are obliged to buy EUR 500,000 from us at the Protection Rate of 1.1280.
GBP/EUR weakens to 1.0250 breaching the Knockout Rate of 1.0250. The contract is terminated at that point, leaving no delivery in place.
Spread Forward Extra
Description
A spread forward extra provides you with a Protection Rate very close to the prevailing forward rate, whilst allowing you to fully participate in favourable exchange rate movements as far as a pre-determined barrier rate. If the spot rate breaches this pre-determined barrier rate at any time during the life of the contract, you are obliged to transact the notional amount at the Protection Rate, regardless of where the spot rate is on the expiry of the option.
Additionally, if the market moves against you, there is a reduction rate that caps your transaction level. If spot is beyond this reduction rate on the expiry date, your transaction rate will be adjusted so that you obtain a spot level that is boosted by the difference between the Protection Rate and the reduction rate.
Advantages
- Provides you with some protection against a depreciation of the spot rate below the Protection Rate
- You are able to participate in an appreciation of the spot rate above the Protection Rate
- No premium payable / Zero cost
Disadvantages
- If the spot rate hits the Barrier Rate at any time, you will no longer be able to participate in favorable market movements
- If the spot rate is below the Reduction Rate on expiry you will receive a reduced rate
- You may be Margin Called
How it works
You import goods from Europe and need to pay a supplier EUR 500,000 in 6 months’ time.
The prevailing spot rate for GBP/EUR is 1.1400, the half year forward rate is 1.1350. You would like to benefit from favourable market moves but are reluctant to pay a premium for this. You are prepared to accept a Protection Rate of 1.1140 and a Reduction Rate 1.0825. We then calculate the Barrier Rate to be 1.1975 (in this example). This ensures that you are protected at 1.1140 down to 1.0825 with the ability to participate in favourable market movements up to the Barrier Rate of 1.1975. Upon expiry if the spot rate is below the Reduction Rate, your transaction rate will be improved by 315 basis points from the prevailing spot rate.
Graphical Overview
Possible outcomes at expiry
GBP/EUR weakens and, on the expiry date, the spot rate is 1.0975. This is below the Protection Rate but is above the Reduction Rate. You have the right but are not obliged to buy EUR 500,000 from us at the Protection Rate of 1.1140.
GBP/EUR weakens and, on the expiry date, the spot rate is 1.0700. This is below the Reduction Rate. You are obliged to buy EUR 500,000 from us at the spot rate boosted by 315 basis points. Your hedged rate is 1.1015.
GBP/EUR strengthens and at expiry the market rate is 1.1550, having never traded at or above the Barrier Rate of 1.1975. This is above the Protection Rate and you may buy any amount of currency in the spot market at the prevailing market rate.
GBP/EUR strengthens and at expiry the market rate is 1.1875, hitting the barrier at 1.1975. You are obliged to buy EUR 500,000 from us at the Protection Rate of 1.1140.
Ratio Forward
Description
A Ratio Forward provides you with a Protection 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 Protection Rate. Whilst if the market moves in your favour, you will be obliged to transact the Ratio Amount at the Protection Rate.
Advantages
- Provides you with full protection of the Notional Amount against a depreciation of the spot rate below the Protection Rate
- The Protection 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 Protection Rate on expiry, you will be obliged to trade the Ratio Amount
- You may be Margin Called
How it works
You import goods from Europe and need to pay a supplier EUR 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 Protection Rate of 1.1420 on at least some of your requirement. Based on this, we calculate a pre-agreed Notional Amount. In this example it would be EUR 500,000.
Graphical Overview
Possible outcomes at expiry
GBP/EUR weakens and, on the expiry date, the spot rate is 1.1000. This is below the Protection Rate. You have the right but are not obliged to buy the Notional Amount EUR 500,000 from us at the enhanced Protection Rate of 1.1420.
GBP/EUR strengthens and at expiry the market rate is 1.1800. You are obliged to buy the Ratio Amount EUR 1,000,000 from us at the Protection Rate of 1.1420.
Extendible Forward
Description
An Extendible Forward provides you with an enhanced Protection 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 Protection Rate on the expiry date.
Upon expiry If the prevailing spot rate is above the Protection Rate you will be obliged to transact two deals of buying the Notional Amount at the Protection 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 Europe and have to pay a supplier EUR 500,000 in 6 months’ time.
The prevailing spot rate for GBP/EUR is 1.1400, the half year forward rate is 1.1350. We have informed you that we can offer an enhanced Protection Rate of 1.1410 for delivery in 6 months, after which upon expiry if the market rate is above the Protection Rate we will, in this example, extend the contract on the following terms: you transact two deals of buying EUR 500,000 at the enhanced Protection Rate of 1.1410 each, one on the spot market, the another by a 3 months flexible forward.
Graphical Overview
Possible outcomes at expiry
GBP/EUR weakens and, on the expiry date, the spot rate is 1.1000. This is below the Protection Rate. You have the right but are not obliged to buy EUR 500,000 from us at the enhanced Protection Rate of 1.1410.
GBP/EUR strengthens and at expiry the market rate is 1.1800, hitting the barrier at 1.1975. You are obliged to transact two deals: to buy EUR 500,000 in the spot market at the Protection Rate of 1.1410, and to buy EUR 500,000 by a 3 months flexible forward at the Protection Rate of 1.1410.
Drawdown Ratio Forward
Description
A Drawdown Ratio Forward provides you with an enhanced Protection 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.
You are obligated to buy the Notional Amount, however this product enables you to transact the Notional Amount on any working day from the execution start to the execution end.
Upon expiry If the prevailing spot rate is above the Protection Rate you will be obliged to transact the Ratio Amount (in addition to the Notional Amount already transacted) at the Protection Rate.
Advantages
- Provides you with full protection against a depreciation of the spot rate below the enhanced Protection Rate whilst giving full flexability on transaction date
- The Protection 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 Protection Rate on expiry, you will be obliged to trade the Ratio Amount in addition to the Notional Amount
- You may be Margin Called
How it works
You import goods from Europe and have to make multiple payments to your suppliers, totaling EUR 1,000,000 within 6 months.
You want to get flexible dates of delivery and 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 Protection Rate of 1.1420 on at least some of your requirement. Based on this, we calculate a pre-agreed Notional Amount. In this example it would be EUR 500,000.
Graphical Overview
Possible outcomes at expiry
GBP/EUR weakens and, on the expiry date, the spot rate is 1.1000. This is below the Protection Rate. Suppose, for example, you have already drawn down EUR 400,000 before expiry. You are obliged to buy EUR 100,000, for this example, the remainder of the Notional Amount from us at the enhanced Protection Rate of 1.1420.
GBP/EUR strengthens and at expiry the market rate is 1.1800. Suppose, for example, you have already drawn down EUR 400,000 before expiry. You are obliged to buy EUR 600,000 totaly, for this example, the remainder of the Notional Amount and in addition the Ratio Amount from us at the Protection Rate of 1.1420.
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.
While reasonable care has been taken to ensure that the information contained herein is not untrue or misleading at the time of publication, Currency Solutions Limited makes no representation that it is accurate or complete.
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Past performance is not indicative of future results. Investors should make their own investigations and investment decisions without relying on this report. Only investors with sufficient knowledge and experience in financial matters to evaluate the merits and risks should consider an investment in any issuer or market discussed herein and other persons should not take any action on the basis of this report.
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