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Foreign Exchange Financial Engineering

Hedge Currency Payables with a Participating Forward


Limited Risk of Currency Appreciation Low or Zero Upfront Cost Unlimited Benefit from Currency Depreciation Profile of a Participating Forward to Hedge Currency Payables
Product Description A participating forward is a two-option combination which requires the hedger to buy an out-of-the-money call and to sell an in-the-money put. The call and put strikes are the same and both maturity dates are the same, but the underlying notional amounts differ in order to achieve a zero or low cost. The participating ratio is the percentage difference between the underlying and the notional amount of the sold put. Typically, the ratio ranges between 25% and 75% with 50% being the most common.

Benefit Range

Loss Protection Range

25% Participation

+
P & L

50%Participation
75% Benefit 50% Benefit 25% Benefit

75% Participation

Participating Forward as a Hedge A holder of a currency payable would purchase a participating forward to conservatively hedge against a currencys appreciation while allowing for varying degrees of unlimited benefit from the currencys depreciation.

Purchased Call & Sold Put Strikes

25% Participation 50%Participation 75% Participation

Foreign Currency
Payable & Hedge

+
Currency Payable

Currency View Very Bullish Bullish Neutral Bearish Very Bearish Volatile

Hedge Performance Inferior.......................Superior


A hedger who can tolerate more downside risk can set the call strike farther out-of-the-money. As a result, the sold put is based on a smaller notional amount which allows the hedger to participate in a larger percentage of any currency depreciation. Conversely, a hedger who cant tolerate as much downside risk will set a strike closer to the forward and have a higher level of protection. For this added protection, she will not receive as much benefit as the currency depreciates. In order to achieve a zero cost, the buyer will either specify the participation ratio or the strike price for both options. This strategy allows the buyer the flexibility to set as high or as low a participation rate as desired, depending on risk tolerance. Companies that want a flexible, conservative currency hedge with zero to low cost may find a participating forward attractive. It is particularly suited to protect a maximum payables estimate from currency appreciation while simultaneously allowing some upside potential on a minimum payables estimate.

Currency View Very Bullish Bullish Neutral Bearish Very Bearish Volatile Market Place Frequency Liquidity Hedge Accounting for Transactions for Anticipated

Hedge Cost Low....................................High


Low....................................High

Yes.......................................No

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