• Introduction to World First’s Hedging Service
• The Participating Forward
• The Protection Option
• The Risk Reversal

The Risk Reversal

A Risk Reversal for an Australian citizen selling their property in America

Mr Ramsey is due to receive $1m in six months from the sale of his property in America.

When he investigated using a protection option, the 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 0.75 as this would have reduced the number of Australian dollars he would receive for his US dollars. A protection option at 0.75 would have cost 1.5% of the notional amount (ie $15,000) but Mr. Ramsey felt that this was more than he wanted to pay.

To reduce the premium, Mr. Ramsey was happy to cap his upside potential at a best case strike rate of 0.6350 and keep his worst case strike rate of 0.7500. This reduced the premium paid to zero.

This meant that regardless of what happened to the exchange rate over the next six months, if the rate was higher than 0.75 on the pre-agreed date in six months' time, he could convert his dollars into pounds at 0.75

Possible scenarios:

Scenario 1) If the exchange rate rises and after 6 months is trading at 0.80

Scenario 2) If the exchange rate falls and after 6 months is trading at 0.60

Scenario 3) If the exchange rate falls between 0.6350 (best case strike rate) and 0.75 (best case strike rate) at expiry, for example 0.66

The downside of this strategy is that Mr Ramsey would have been better off being un-hedged if the rate at expiry is below 0.6350 and he would have been better off entering into a forward contract at 0.6820 if the rate is higher than 0.6820 at expiry.

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.