Knock-Out Forward - PDF Document

Presentation Transcript

  1. Knock-Out Forward The Knock-Out Forward, a variation on the Converting Forward, provides a form of supplementary cover. It creates a Worst Case Rate (WCR), more attractive than the outright forward, provided the market does not trade at the trigger rate. If the trigger trades, the Converting Forward allows for topside participation, however when the trigger trades under the Knock-Out Forward, the cover ceases to exist. It is therefore, not advisable that this form of structure be used as a primary method of hedging. No premium is payable for this structure. The two structures are compared below: Converting Forward: The hedger is long USD. If the ‘trigger’ rate is reached at any time, the hedger will enjoy unlimited gain potential from any subsequent appreciation of the currency above the WCR. Otherwise the hedge is locked in at the WCR. Trigger Rate WCR Knock-Out Forward: If the ‘trigger’ rate is reached at any time, then the cover ceases to exist. Otherwise the hedger is locked in at the WCR. Trigger Rate WCR Long USD Example: The hedger currently has a portfolio of FX cover at an average rate that is less favourable than current spot. Wishing to improve this rate, the hedger has some capacity to increase the amount of FX cover being held so a 6-month Knock-Out Forward is established with a WCR of 108.04 and a trigger of 95.00. Spot: 105.40 Forward: 102.26 Hedge Rate (WCR): 108.04 Trigger Rate: 95.00 Tenor: 6 months The hedger is locked into the WCR from the outset. However, if the trigger trades at any time the hedger is left with no cover. No premium is payable. Outcomes at expiry: USD trades at 95.00 at any time No cover exists USD never trades at 95.00: 108.04 ANZ makes no representation and gives no warranty as to the accuracy of the information contained in this document and does not accept any responsibility for any errors or inaccuracies in or omissions from this document (whether negligent or otherwise). This document does not purport to be comprehensive or to render advice, recommendation, assurance or guarantee about the expected results of transactions. Recipients should consider whether a transaction is proper or appropriate for it based in their own judgement and, if necessary, upon independent advice. ANZ shall not be liable for any loss or damage arising as a result of any person acting or refraining from acting in reliance on any information contained in this document.