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Geistesblitz 05/19

Written by LPA

May 31, 2019

Publications Geistesblitz

Initial situation

Due to the predominantly declining EUR-USD exchange rates since January last year, USD importers are increasingly hoping for a stronger EUR again. Coming from 1.2513 USD / EUR, the EUR-USD exchange rate currently remains close to its low 1.1153 USD / EUR.

In addition to the EUR-USD exchange rates, the EUR-USD volatilities are also clearly regressing. The current level was last reached almost 5 years ago. In comparison to the peak, they were approximately halved; for example, the 6-month ATM volatility drops from 11.7% to 5.7%.

The combination of these two developments makes it possible to put together at a attractive exchange rate. In this Geistesblitz, we present a strategy for USD importers. EUR-USD exchange rate at the current exchange rate level without any prior notice EUR-USD exchange rate.

Market overview (May 27 th 2019)

EUR-USD spot rate: 1,200 USD / EUR
6-month EUR-USD forward rate (including margin): 1.1360 USD / EUR

Shout Forward

Product description

The importer concludes a “shout forwad” from which he acquires 2,000,000 USD in 6 months at an exchange rate of 1.1200 USD / EUR against EUR. This is the current spot rate. In addition, the client has 50% in a EUR-USD exchange rate above 1.1200 USD / EUR. This unlimited participation reduces the EUR amount payable by the client by the “participation amount” [1] depending on the exchange rate development.

The opportunity at additional flexibility, because daily until maturity the client has the opportunity to directly pay the participation at an exchange rate. If the client does not exercise this option during the term and if the EUR-USD exchange rate is below the participation level at expiry, this option terminates. The client shall be settled at a minimum interest rate of 1.1200 USD / EUR.

[1] For this purpose, the USD participation amount is converted into its EUR equivalent. The USD participation amount is calculated as the product of the EUR-USD exchange rate difference and the EUR participation notional. If the EUR-USD exchange rate exceeds the participation rate at the time of exercise, the difference between the participation rate and the participation level is formed. Otherwise, the exchange rate difference and the USD participation amount are set at zero.

Indicative terms and conditions

notional: 2,000,000 USD
Maturity: 6 months
Guaranteed rate: 1,100 USD / EUR
Participation level: 1,100 USD / EUR
Participation intensity: 50% [2]

[2 ] Participation level and intensity define a EUR participation notional of 892,857 EUR (= 50% * 2,000,000 USD / 1.12 USD / EUR)

Influence of volatility on participation intensity

The following chart shows the effect of volatility on the participation of the intensity of the strategy and its attractiveness in the current environment.

For this purpose, the historical ATM volatilities of the EUR-USD exchange rate (on a monthly basis) already shown in Figure 1 were used as variable in the pricing of the strategy. All other influencing factors were kept constant. It could have been the current participation intensity of 50%. Since then, smaller participation intensities as low as 30% would have been possible.

Benefits and risks from the client’s perspective

Benefits:

Hedging a minimum EUR-USD rate at current level EUR-USD spot rate.
Unlimited participation in a rising EUR-USD exchange rate at 50% of the nominal.
The exercise date is freely selectable during the term.

Risks:

Hedged rate is 0.0160 USD / EUR below the alternative forward rate.
Participation in a rising EUR-USD exchange rate at 50% of the notional.

In a nutshell

The Geistesblitz “Shout Forward” shows clients paying for imports in USD a strategy how to hedge a minimum EUR-USD exchange rate at the level of the current spot. In addition, they participate at 50% in a potential EUR-USD rate without any restriction. Your client has the flexibility to pay the fee. The EUR-USD spot rate is perceived attractive.

LPA

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