020 7898 0500Participating forward
A participating forward structure provides a secured protected rate, while still allowing beneficial moves on a predetermined portion of the amount hedged.
If the spot rate at expiry is more favourable than the protected rate, then the holder of the participating forward is only obligated to transact a predetermined proportion of the hedged amount at the protected rate. They are then free to transact the remainder at the spot rate.
Participating forwards are generally structured as zero-cost premium products.
An example of how a participating forward works
A UK-based company imports materials from the US and needs to pay a supplier $500,000 in six months’ time.
1. Requirements
The company:
- would like to benefit from a favourable exchange rate and 100% rate protection
- is not willing to pay a premium for this
2. Current Forward Rate
The forward rate for a six-month period is
1.3400
3. Solution
The company is prepared to accept the worst-case rate of 1.3200. The company buys a participating forward with a protected rate of 1.3200 and a participation proportion of 50%.
There are two possible scenarios
Scenario 1:
Unfavourable market moves
GBP/USD weakens. At maturity, the exchange rate is 1.2900. The company is entitled to buy the full $500,000 at 1.3200.
Scenario 2:
Favourable market moves
GBP/USD strengthens. At maturity, the exchange rate is 1.4200. The company is obligated to buy $250,000 (50%) and the other half can be purchased in the spot market at 1.4200. Due to this strategy the company achieves an effective rate of 1.3700.
Advantages of the participating forward
- Provides protection on 100% of the company’s exposure
- Allows the business to benefit from favourable currency moves on a pre-determined portion of the exposure hedged
- No premium payable
Disadvantages of the participating forward
- The protected rate will always be less favourable than the forward rate
Key facts
- Deposit and/or variation margin may be applicable in line with SCOL terms of business
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Disclaimer:
Option contracts are offered by Smart Currency Options Limited (SCOL) on an execution-only basis. This means that you must decide if you wish to obtain such a contract, and SCOL will not offer you advice about these contracts.
This material provides you with generic and illustrative information and in no way can it be deemed to be financial, investment, tax, legal or other professional advice, a personal recommendation or an offer to enter into an option contract and it should not be relied upon as such. Any changes in exchange rates and interest rates may have an adverse effect on the value, price or structure of these instruments.
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Foreign exchange options can carry a high degree of risk and are not suitable for everyone as they can have a negative impact on your capital. If you are in doubt as to the suitability of any foreign exchange product, SCOL strongly encourages you to seek independent advice from suitable financial advisers.
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SCOL is a wholly-owned subsidiary of Smart Currency Exchange Limited, and is authorised and regulated by the Financial Conduct Authority to carry out MiFID business with reference number 656427.
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