15 February 2017

New FX hedging instruments within Hedgebook

See how Hedgebook provides greater comfort for importers and exporters entering more complex FX structures and new FX hedging instruments including one-for-one or leveraged collars and participating forwards.

Traditionally, the typical Hedgebook user has focused their foreign exchange hedging activity at the vanilla end of the spectrum. Forwards, purchased options and options that are in one-for-one collar relationships have been the staple diet of importers and exporters. To be honest, even purchased options are not particularly common as there is a distinct unwillingness to write out the cheque for the premium. However, we have seen an increase in new FX hedging instruments across Hedgebook users that are using non-bank FX providers for their hedging and, as a result, an increase in “structured option” hedging products.

Structured options can allow the importer or exporter to achieve enhanced outcomes while still retaining an element of protection against adverse currency movements.

When entering structured options it is crucial that the importer/exporter understands what the outcomes may be. For example, a knock-out option may leave the importer/exporter without any hedging cover at exactly the time they need it most.

At Hedgebook we have recently expanded the FX hedging universe to include two of the more common structured options – participating forwards and leveraged collars – as well as improving the functionality to capture one-for-one collars.

New FX hedging instruments: One-for-one collars

The most common form of a one-for-one collar is the zero cost collar (“ZCC”). So-called as they are structured such that the importer/exporter has no premium to pay.

They are created by buying an option for a pre-determined amount of foreign currency at the protection rate and at the same time selling an option for the same amount of foreign currency at the participation rate. The premium received from the sold option offsets the premium paid for the purchased option.

Effectively you lock in a range of outcomes, a best case (participation rate) whereby the sold option is exercised by the counterparty, a worst case (protection rate) whereby you exercise the option that you have bought, or, if the exchange rate is between the ranges at expiry, neither option is exercised and you are free to do a spot FX deal at the current exchange rate.

Until recently users had to enter the two options individually into Hedgebook, then link them in a collar relationship. This is no longer the case.

New fx hedging instruments: leveraged collars

A leveraged collar differs from a one-for-one collar in that the amount of foreign currency is different for the protection rate than for the participation rate.

The benefit of a leveraged collar is the ability to achieve more favourable protection/ participation rates than a standard collar.

An example is a 2:1 leveraged collar that gives you a nominated amount of foreign currency hedging at the protection rate (say USD1 million) and twice the amount of hedging cover at the participation rate (USD2 million).

Entering leveraged collars in Hedgebook is easy!

New fx hedging instruments: participating forwards

A participating forward allows the importer/exporter to have protection at a known worst case rate (the protection rate) but participate in favourable movements in exchange rates for a portion of the foreign currency amount.

A participating forward is structured with two options. The purchased option gives the importer/exporter protection for a pre-agreed amount of foreign currency at the protection rate. The sold option is for a percentage (“obligation percentage”) of the purchased option notional.

If the spot rate is less favourable than the protection rate at the expiry date then the importer/exporter will exercise the option for the full notional.

If the spot rate is less favourable than the protection rate then the importer/exporter will be exercised upon by the counterparty and be obligated to transact the obligation percentage at the protection rate and have the choice to transact the balance of the notional at the more favourable market rate.

See how to enter a participating forward in Hedgebook

Hedgebook provides greater comfort for importers and exporters entering more complex FX structures. Part of the challenge of taking advantage of the benefits on offer from the more exotic end of the hedging product spectrum is having the ability to easily record, value and report the instruments. Hedgebook endeavors to take these obstacles away. Like to learn more? Get a short online demo from one of our experts: Request a Demo

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