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- Region: Australia
- Australia
- New Zealand
- UK/US/Europe
A protection option for an Australian citizen selling their property in America
Mr Ramsey is due to receive US $1m in six months from the sale of his property in America. Although the sale has yet to be signed, the protection option provides him with a guaranteed worst case rate to convert the US dollars to Australian dollars in six months. If he has not sold the house by then, there is no obligation for him to actually sell the US dollars and buy the Australian dollars.
When he was entering into the protection option, the spot exchange rate was 0.70 and the six month forward contract rate was 0.6820, Mr Ramsey felt that the rate might fall further but didn't want it to go back over 0.70 as this would have reduced the number of Australian dollars he would receive for his US dollars.
He bought a protection option at 0.70 for a cost of 2.5% of the notional amount (ie $25,000). This meant that regardless of what happened to the exchange rate over the next six months, if the rate was higher than 0.70 on the pre-agreed date in six months' time, he could convert his US dollars into Australian dollars at 0.70.
Possible scenarios:
Scenario 1) If he had sold his American property and the prevailing rate in six months is 0.60
Mr Ramsey would let the option expire and sell the US $1 million in the spot market at 0.60 and receive AU$ 1,666,667
Scenario 2) If he had sold his American property and the prevailing rate in six months is 0.80
Mr Ramsey would exercise his protection option and sell the US $1m at 0.70 and receive AU$1,428,571 in return
Scenario 3) If he hadn't sold his American property and the prevailing rate in six months was 0.65
There would be no exchange of monies in this situation as the protection option he has purchased expires worthless and he does not need to sell US dollars and buy Australian dollars as he has not yet sold his house
Scenario 4) If he hadn't sold his American property and the prevailing rate in six months was 0.75
Mr. Ramsey would exercise the protection option at 0.70 and net settle the option by selling the AUD back in the spot market at 0.75
The downside of this strategy is that Mr Ramsey would have paid an unnecessary premium if the rate was not above 0.70 in six months
World First Pty Ltd holds an Australian Financial Services Licence - Licence No: 331945 -under the Corporations Act 2001 which authorises it to provide financial services in relation to foreign exchange contracts, derivatives and non cash payments facilities to persons within Australia.
