After a short, strong rally around
the turn of the month, the EUR-USD exchange rate has recently fallen sharply
again. As predominantly in the last two years, the USD is showing strength. The
EUR was even within striking distance of its 3-year low for a short time. In
view of the possible consequences of the shutdown in the context of the Corona
crisis, however, doubts are being raised about the sustainability of this
trend. The last few days have already shown a strong recovery. The galloping US
national debt and a narrowing interest rate differential with the EUR zone may
help further rebound the EUR.
In the current situation,
importers with USD payables are affected multiple times. Primarily from the
lower exchange rates and additionally from the shrunken forward premiums. If
they would like to be prepared for an even weaker EUR and at the same time
participate in a possibly stronger one, an optional hedge would be appropriate.
However, these have recently become dramatically more expensive. The EUR-USD
volatilities, which have been declining for a long time, have more than doubled
recently due to tension in the financial markets. For example, the 6-month ATM
volatility has risen from approx. 4.4% to approx. 12.5% and currently stands at
Figure 1: EUR-USD
6-month ATM volatility
With the current Geistesblitz we
would like to point out a possible solution to this dilemma for USD importers.
We present a strategy that allows your customers to fully hedge against a
falling EUR-USD exchange rate without having to forego an exchange rate
improvement in case of a EUR-USD countermove.
Market overview (March 27th
EUR-USD spot rate: 1.1045 USD/EUR
EUR-USD forward rate (incl. margin):
Figure 2: EUR-USD spot rate and
6-month ATM volatility
The importer concludes a
"Step-Up Forward" from which he acquires 2,000,000 USD in 6 months at
an exchange rate of 1.0800 USD/EUR against EUR. This corresponds to a reduction
compared to the spot rate as well as the forward rate in the
amount of 0.0245 USD/EUR and 0.0340 USD/EUR respectively. In turn, the customer
has the chance of an exchange rate improvement in case of a further rise in EUR-USD.
The exchange rate
improvement is stepwise and depends on the exchange rate at maturity. In the
best case, the highest bonus rate of 1.1800 USD/EUR can be achieved, an
exchange rate level last reached in September 2018. However, if the exchange
rate barrier of 1.2300 USD/EUR is reached or exceeded during the next 6 months,
the exchange rate improvements will not apply. Your customer will be settled at
the guaranteed rate 1.0800 USD/EUR. The exchange rate barrier helps to mitigate
the significantly higher costs of participating in rising rates. Despite
rapidly increasing exchange rate volatility, this offers a chance of very
attractive hedging rates as long as 1.2300 USD/EUR is not reached.
Indicative terms and conditions:
- Notional: 2,000,000 USD
- Guaranteed rate:
- Bonus rate 1:
1.1140 USD/EUR if the spot
rate at maturity is at least 1.1140 USD/EUR (but below 1.1470 USD/EUR)
- Bonus rate 2: 1.1470 USD/EUR if the spot
rate at maturity is at least 1.1470 USD/EUR (but below 1.1800 USD/EUR)
- Bonus rate 3:
1.1800 USD/EUR if the spot
rate at maturity is at least 1.1800 USD/EUR
- Exchange rate barrier: 1.2300 USD/EUR, if reached or
exceeded during the lifetime of the strategy (continuous fixing), the bonus
rates do not apply.
Figure 3: Graphical representation of the hedged rate
Benefits and Risks from a client perspective:
- Hedging USD payables
at a minimum EUR-USD rate, guaranteed rate 1.0800 USD/EUR.
- Purchase of the USD at
one of the three bonus rates with price improvement of up to 0.1000 USD/EUR (to
1.1800 USD/EUR) in the event of a rising EUR-USD exchange rate at maturity.
- Hedged rate is 0.0245 USD/EUR
below the current spot rate (1.1045 USD/EUR) and 0.0340 USD/EUR below the
alternative forward rate (1.1140 USD/EUR).
- The possibility to
improve on one of the three bonus rates does not apply, if the EUR-USD exchange
rate trades at or above the exchange rate barrier (1.2300 USD/EUR) at least
once until maturity.
In a nutshell
In the current
Geistesblitz "Step-Up Forward" customers with USD payables agree to a
EUR-USD minimum rate below the current spot rate of 1.1045 USD/EUR. In turn,
they have the opportunity to participate in case of a further rising EUR-USD
exchange rate by stepwise improving their exchange rate. In the best case, the
bonus rate of 1.1800 USD/EUR can be achieved. By using an exchange rate barrier,
the strategy takes advantage of the increased exchange rate volatility. It
offers the opportunity to reach hedging levels that would otherwise be
difficult to achieve with standard solutions in an environment with lower exchange
rates and increased volatility.