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Spot | Forward
Outright Contracts | Swaps | Options | Zero
Cost Collars
Spot
Definition:
Spot refers to the price of one currency
in terms of another. For example, USD/CAD means that 1 USD equals
1.1250 CAD
Market Conventions:
A spot price is quoted as a spread between
the BID (level where the bank buys the underlying currency) and
the OFFER (level where the bank sells the underlying currency).
The underlying currency is the first one in the currency pair.
For example, if USD/CAD is 1.1250 - 1.1260, Scotiabank buys USDs
at 1.1250 against CAD and sells USDs at 1.1260 against CAD.
CAD Settlement:
Spot transactions settle one business
day after the transaction date for USD/CAD and in two business
days for all other currency pairs.
Transaction Level:
Spot Transactions levels are always (by
definition) current market levels
Advantages
· Exporters benefit from domestic
currency devaluation.
· Importers benefit from domestic currency appreciation.
· No transaction cost.
· Simple/Easy to monitor changes in the market.
Disadvantages
· Exporters are vulnerable to
domestic currency appreciation.
· Importers are vulnerable to domestic currency depreciation.
· Monitoring is required in order to transact at a favorable
rate
Forward Outright Contracts
Definition:
A forward outright is the price of one
currency in terms of another for settlement on a date other than
spot. In other words, the spot rate is adjusted by accounting
for the interest rate differential between two currencies.
Market Conventions:
Swap points are also quoted as BID and
OFFER, and are added to the spot component to obtain
the All In Forward.
For example:
Spot USD/CAD: |
1.1250 |
1.1260 |
3 month forwards: |
-.0032 |
-.0031 |
All In forward outright= |
1.1250
-.0032
1.1218 |
1.1260
-.0031
1.1229 |
Settlement:
Forward outrights settle at the predetermined
future date.
Transaction Level:
Forward Outright transactions levels
are always fixed
Advantages
· Complete protection from adverse
currency moves
· No transaction costs
· Simple to monitor
· Simple to unwind (very liquid).
Disadvantages
· Loss of opportunity gains resulting
from favorable currency moves.
· Liability from both parties to transact.
Swaps
Definition:
A contract to exchange two currencies
at one time (T1), in order to exchange back to each investor's
original position at some future date (T2), for a predetermined
price.
Market Conventions:
Swaps are quoted similar to outright
forwards as BID / OFFER spread on swap points. However, it is
the Far Date that is priced (T2)" Example: A holder of US Dollars
agrees to "sell and buy" US Dollars against CAD from Scotia.
This means a sale of USD at T1 and is accompanied by a purchase
of USD at T2 for a predetermined price.
Settlement:
Swaps settle at the near date and the
far date. However, if the near end matches the maturity of a
previous contract, it is only the resulting gain or loss that
is cash settled.
Transaction Level:
Two transaction levels, the rate on the near term (T1) and
the one on the far term (T2)
Advantages
· Allows a position to be "rolled" so
that settlement is postponed.
· Circumvents the money market
· Simple to unwind (very liquid).
Disadvantages
· Cash settlement must take place
against any transaction maturing on the near date.
Options
Definition:
An option gives the holder the right
but not the obligation, to buy or sell an underlying asset at
a predetermined price at or until a certain time. It differs
from a forward contract in that it is not an obligation to transact.
An option provides insurance from adverse currency movements.
Market Conventions & Language:
Strike price: The predetermined
price agreed to by both counterparties, i.e. the protection level.
Expiry date: The date on or up to which the option may be exercised,
i.e. decision deadline (by 10:00am New York Time).
Value date: The date on which settlement occurs.
American style: The option can be exercised at any time
up to the expiry date.
European style: The option can be exercised only on the
expiry date. The standard form for Over The Counter (OTC) options.
At the Money: An option is "At the Money" when the strike
price equals the underlying forward price.
In the Money: An option is "In the Money" when the strike
price is below the underlying forward price for a call and above
the underlying price for a put.
Out of the Money: An option is "Out of the Money" when
the strike price is above the underlying forward price for a
call and below the underlying price for a put.
Types of Options:
Call: The holder has the right,
but not the obligation to purchase the underlying asset at the
strike price.
Put: The holder has the right, but not the obligation
to sell the underlying asset at the strike price.
Example: Exporter with USD based sales wants to protect
receivables against a CAD rally, purchases a CAD Call (USD Put),
at a predetermined strike price, expiry and premium. Importer
with USD expenses wants to protect payables against a weakening
CAD, sells a CAD Call (USD Put), at a predetermined strike price,
expiry and premium.
Settlement:
The protection lasts until the expiry
date and settlement takes place one business day following exercise.
Advantages
· Complete protection against
adverse currency moves.
· Complete gains from beneficial moves.
Disadvantages
· A premium has to be paid.
Note: The above information on options
is provided strictly for information purposes, and is not available
through the ScotiaFX service. Indicative pricing and/or variations
on the above, can be obtained by contacting a Scotia Capital
representative.
Zero Cost Collars
Definition:
A zero cost collar consists of the simultaneous
purchase of one option and sale of another at different strikes,
both for the same amount, for the same time frame. In this way
complete protection against adverse currency moves beyond a certain
level is paid for by giving up gains beyond a second (more favorable)
rate.
Market Conventions & Language:
Zero Cost Collars are also called Risk
Reversals, Range Forwards, Tunnels, Caps and Floors.
Example:
Exporter with USD based sales wants to
protect receivables against a CAD rally, purchases a CAD Call
(USD Put) and sells a CAD Put (USD Call) for the same expiry
date and for the same amount, at "zero cost". Importer with USD
expenses wants to protect payables against a weakening CAD, sells
a CAD Call (USD Put) and buys a Cad Put (USD Call) for the same
expiry and for the same amount, at "zero cost".
Settlement:
The protection lasts until the expiry
date and settlement takes place one business day following exercise.
Advantages
· Complete protection against
adverse currency moves beyond the floor level.
· Zero transaction cost.
· Complete gains from beneficial moves up to a limit.
Disadvantages
· Benefit given up beyond a certain
point.
Note: The above information on zero
cost collars is provided strictly for information purposes, and
is not available through the ScotiaFX service. Indicative pricing
and/or variations on the above, can be obtained by contacting
a Scotia Capital representative.
Notice:
Nothing herein
should be construed as investment advice or a recommendation
to enter into a transaction. Each user must individually assess
the merits of a particular transaction, in consultation with
its own professional advisors. BNS is not acting as fiduciary
or advisor to any user of the ScotiaFX system.
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