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7/27/2019 forex6khik

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Forex

Corporate HedgeTools

Compiled by:- CA Sapna

Jain


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HedgingHedging enables you to manage riskand reduce potential risk. If you don'thedge, it's tantamount to speculatingthat the foreign currency rate will

always stay the same, a costlyassumption if the rate ends up movingunfavorably.

A good hedging strategy canhelp eliminate currencyexposure and the attendant risk

associated with currency


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Participating forward

An adaptation of the range forward in whichfewer options must be sold than arepurchased.

Also known as profit-sharing forwards they area type of ratio forward and are usually

structured to be zero premium.So in-the-money put {call} options are sold tofinance the purchase of out-of-the-money call{put} options.

In the FX version of the trade the holder mighthave a long call position twice as large as theshort put.This gives the holder participation in 50% of

the weakening of the underlying currencywhilst retaining full protection on the upside if


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Range forwardThe combination of an anticipated position in the underlying

such as a foreign currency receivables payment in threemonths time with a risk reversal.Unlike a standard forward, which locks in a fixedexchange rate for a forward exchange of currencieseffectively the buyer pays away all upside potentialto the seller in exchange for an equivalent payment ifrates move the other way the range forward givesthe holder exposure to spot rates but only within therange set by the short put and long call position.These floor the downside risk at the cost of capping thepotential upside.The range forward is usually structured so that no premium ispayable upfront.This is the name given by currency markets to whatin the interest rate markets is called a collar (theinterest version entails the purchase of a cap andsale of a floor).

The pos i t ion is also cal led a cyl inder.


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EXOTIC OPTIONAn exotic option is a derivative whichhas features making it more complexthan commonly traded products (vanillaoption). These products are usually

traded over-the-counter (OTC), or areembedded in structured notes.

Consider an equity index. A

straight call or put, eitherAmerican or European wouldbe considered non-exotic

(vanilla).


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Features The payoff at maturity depends notjust on the value of the underlying

index at maturity, but at its value at

several times during the contract's life It could depend on more than one

index

There could be callability andputability rights.

It could involve foreign exchange rates

in various ways, such as composite


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Barrier Options

They let the investorgain from their

expectation of shareprice path movement,

for example, the sharewill first go down and

then Rocket up.


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Types

Binary option

Asian OptionsCompound Option

Chooser option


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Binary option

They are options with

discontinuous payoffs. Another

type of binary option is an assetor nothing call. This payoff nothing

if the underlying asset price ends

up below the strike price and pays

the asset if it ends up above the

strike price.


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Asian OptionsThey are a type of averagingoption. Most common is toaverage the share price. The

pay out is determined bydeducting the average fromthe strike. This option is far

cheaper because the volatilityof anaverage is lower than that of

the price itself.


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Compound Option It is an option on an option. Here, the

holder has an Call option that expires10th March to purchase a Call option

for 2.00 whichwill then give the holder the right topurchase the shares at 12.00 on 31stOctober.

The holder pays less up-front,thuseffectively making this a highly gearedinstrument.


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Chooser optionA chooser option has the featurethat after a specified period of

time the holder can choose

whether the option is a call or a

put .more complex chooser

options can be defined where thecall and the put do not have the

same strike price and the time to

maturity.


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A knock-out option provides a customerwith protection against adverse currencymovements in a similar way to a standard

currency option.In addition to the normal optionvariables, the buyer also selects aknock-out price which is a level atwhich the option lapses and the buyeris left uncovered.If the knock-out price is reached beforethe option matures the buyer must thenchoose between remaining uncovered,dealing in the spot or forward marketsor selecting new option protection.If the knock-out price is not reached, theoption is settled at expiry in the usual way.


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Knockout levels are usually set such thatthe option lapses when it is out of-the-money, i.e.

when the spot price has moved in adirection favourable to the underlyingexposure.The appropriate rate may depend upon

the customer's currency forecasts or maybe related to the relative premium cost ofthe option.

The closer the knock-out level is to the

current spot rate the cheaper the option.Generally knock-out levels are set at apoint where the user will be happy toinitiate spot/forward cover, or at a level

just above/below important

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