20 November 2008
The Convertible Forward For Importers
The convertible forward enables clients to fix a worst case rate for the currency that they are looking to purchase on a pre-determined date in the future. However, clients can benefit 100% in any favourable move up to a pre-determined best case exchange rate. If the best case rate is hit or exceeded at any time during the life of the trade, clients are obliged to deal at the protected 'worst case' rate. Therefore, this strategy may be suitable for you only if you believe that the spot exchange rate will not hit or exceed the best case rate during the life of the trade.
How does a convertible forward work?
For example, a client imports electronic equipment from China and has to pay his supplier US$1 million in six months' time.
The forward rate for six months is 2.0000. He would like to take advantage of this forward rate but he feels that GBP/USD might continue to push a little higher. Therefore, he accepts a reduction in the forward rate down to 1.9600. This enables him to fully benefit from an upwards move up to the best case rate of 2.1200. If the exchange rate of 2.1200 is hit or exceeded at any time before the contract matures, the rate that he achieves reverts back down to 1.9600, regardless of subsequent movements in the spot exchange rate.
Possible scenarios:
Scenario 1: GBP/USD weakens to 1.9000. On the settlement date, he achieves his worst case rate of 1.9600
Scenario 2: GBP/USD strengthens, and trades at or above 2.1200 at any time during the life of the contract. He is obliged to buy dollars at 1.9600
Scenario 3: GBP/USD strengthens and at maturity the exchange rate is 2.0750 (2.1200 has not traded during the life of the contract). He can buy dollars at maturity in the spot market at 2.0750
Please note that this graph and any figures and terms cited are for illustrative purposes only.
Advantages
Disadvantages
The Convertible Forward - Exporter
The convertible forward enables clients to fix a worst case rate for the currency that they are looking to sell on a pre-determined date in the future. However, they can benefit 100% in any favourable move down to a pre-determined best case exchange rate. If the best case rate is hit or exceeded at any time during the life of the trade, they are obliged to deal at the protected 'worst case' rate. Therefore this strategy may be suitable for you only if you believe that the spot exchange rate will not hit or exceed the best case rate during the life of the trade.
How does a convertible forward work?
For example, a client exports shower curtains to America and she forecasts having to repatriate US$1 million in six months' time.
The forward rate for six months is 2.0000. She would like to take advantage of this forward rate but she feels that GBP/USD might move slightly lower over the next six months. Therefore, she accepts a worse case rate of 2.0400. This enables the client to benefit from a favourable move in 100% of their exposure down to the best case rate of 1.8500. If the exchange rate of 1.8500 is hit at any time before the contract matures, the rate that the client achieves reverts back up to 2.0400, regardless of subsequent movements in the spot exchange rate.
Possible scenarios:
Scenario 1: GBP/USD strengthens up to 2.2000. On the settlement date, the client achieves the worst case rate of 2.0400
Scenario 2: GBP/USD weakens, and trades at or below 1.8500 at any time during the life of the contract. The client is obliged to sell dollars at 2.0400
Scenario 3: GBP/USD weakens and at maturity the exchange rate is 1.9250 (1.8500 has not traded during the life of the contract). The client can sell dollars at maturity in the spot market at 1.9250
Please note that this graph and any figures and terms cited are for illustrative purposes only.
Advantages
Disadvantages
World First Markets Limited is authorised and regulated by the Financial Services Authority. Our Firm Reference Number is 477561
