Currency Option Strategies

• Currency Option Strategies provide you with an opportunity to execute, with zero initial cost, a series of currency transactions at better than standard exchange rates
• For sole traders and legal entities – both Czech and foreign - that wish to hedge their currency risks

Ratchet

• Resulting right or obligation of the client to exchange standard or increased transaction nominal as well as the final exchange rate depend on the reference spot exchange rate movement, specifically whether or not predefined barriers are reached

Payoff modifications:

• In case the spot rate does not reach Level 1 by the Expiration Date of the given reference period, a client may sell the nominal at the Forward Rate 1 that is not favourable (for such client)
• In case the spot rate reaches Level 1 but not Level 2 by the Expiration Date of the given reference period, a client may sell the nominal at the favourable Forward Rate 2
• In case the spot rate reaches Level 2 but not Level 3 by the Expiration Date of the given reference period, a client may sell the nominal at the highly unfavourable Forward Rate 3
• In case the spot rate reaches Level 4, a client must sell the increased nominal at the Forward Rate 1 on Expiration Dates of all remaining reference periods

Example:

• Client (EUR exporter) sells EUR/buys CZK
• Transaction nominal: EUR 1 million/EUR 1.5 million (increased)
• Expiration dates: monthly – from 20 April to 20 October
• Settlement dates: Expiration date + 2 business days
• Maturity date: 22 October
• Level 1 / Forward rate 1: 27.000
• Level 2 / Forward rate 2: 27.140
• Level 3 / Forward rate 3: 27.290
• Level 4: 27.510

Extendible Structured Knock-In Forward

• This product allows clients to execute a series of currency transactions with zero initial cost and at considerably better exchange rates compared to standard exchange rates
• However, clients do not know the final exchange rate, notional or whether or not the transaction would in fact be executed until the maturity date of individual currency forwards
• The following criteria affect the final exchange rate, notional amount, and transaction duration:

Final currency exchange rate

• In case the spot rate for the given maturity is fixed at a value greater than or equal to the Participation Rate or less than or equal to the Forward Rate, a client sells at the Forward Rate
• In case the spot rate for the given maturity is fixed at a value below the Participation Rate or over the Forward Rate, no transaction takes place under the concluded Extendible Structured Knock-In Forward

Leverage

• In case the spot rate for the given maturity is fixed at a value greater than or equal to the Participation Rate, a client sells the entire nominal
• In case the spot rate for the given maturity is fixed at a value less than or equal to the Forward Rate, a client sells the defined part of the nominal only

Right to extend the transaction by another period

• In case the extendibility condition is fulfilled on the first day of the given extendible term, the transaction is extended by another accumulation period (agreed transaction parameters remain in full force)

Example:

• Client (EUR exporter) sells EUR/buys CZK
• As of the settlement dates of individual accumulation periods, the client will exchange at either slightly better Forward Rate or significantly better Participation Rate
• 8 accumulation periods are agreed – with the last 3 being the so-called “extendible” periods
• Moreover, the transaction structure also involves “leverage” – in case the exchange rate movement is adverse from the perspective of the strategy buyer, the notional amount is higher than for positive movement:
  - Client sells EUR 1.5 million at the Participation Rate, if the spot rate is below or equal to the Participation Rate
  - Client sells EUR 1 million at the Forward Rate, if the spot rate is below or equal to the Forward rate

Target Accumulator

• Client gets a better than standard exchange rate; however, if the exchange rate movement is adverse from the perspective of the strategy buyer, the exchanged notional amount is higher than for positive movement
• Client does not know the exact notional amount to be exchanged by the maturity date of individual forwards
• In case the target amount is accumulated, the transaction is terminated – the remaining currency forwards are not settled at all
• Negative accumulation is usually not taken into account; accumulation is usually calculated as Max (forward rate – current value of the reference exchange rate; 0)
• Target amount is usually limited – in case the transaction is terminated due to the target amount being accumulated, the forward rate for the last exchange shall be adjusted to ensure the accumulated amount remains below the target amount

Product modifications:

• Leverage
  - The notional multiplier is possible (see the example below)
  - Client sells 100% of the nominal, if the EUR/CZK fixing is below or equal to the forward rate
  - Client sells 200% of the nominal, if the EUR/CZK fixing is above the forward rate
• Negative accumulation
  - Target amount also takes into account any negative accumulation
  - In case negative accumulation is agreed in the below mentioned example, the accumulated amount would be at CZK 920,000 after the third fixing
• Variable forward rate
  - Forward exchange rate goes up or down during the transaction – as in the example below
• Extendibility
  - Transaction may be extendible
  - In case extendibility conditions are met as of the agreed reference date, the transaction is extended by another identical structure

Forward rate once the target amount is reached:

• Constant – the last exchange would take place at the agreed forward rate - irrespectively of the amount, by which the target amount was exceeded
• Limited, with forward rate adjustment – forward rate of the last exchange after the target amount is reached, is adjusted to ensure the accumulated amount remains below the target amount
• Limited, with nominal amount adjustment – nominal amount of the last exchange is adjusted after the target amount is reached to ensure the accumulated amount remains below the target amount – i.e. modified nominal amount = nominal amount * (accumulated amount – target amount) / (current accumulated amount – previous accumulated amount)

Example:

• Client (EUR exporter) sells EUR/buys CZK
• Fixing dates: 29.10., 28.11., 19.12., 29.01., 27.02., and 27.03.
• Forward rate: 28.220; 27.820; 27.420; 27.020; 26.620; 26.220 (applicable to the given Fixing dates)
• Settlement dates: Fixing date + 2 business days
• Target amount: CZK 1 million
• Notional amount: EUR 1 million / EUR 2 million
  - If the EUR/CZK spot rate is below or equal to the Forward Rate for the relevant Fixing date, the client sells EUR 1 million
  - If the EUR/CZK spot rate is higher than the Forward Rate for the relevant Fixing date, the client sells EUR 2 million
• Possible resulting payment scenario:

First fixing:

• Fixing date: 29 October, settlement date: 31 October
• Current EUR/CZK spot rate as of the fixing date: 27.720
  - Client sells EUR 1 mil million/CZK at 28.220
  - Accumulated amount at CZK 500,000

Second fixing:

• Fixing date: 28 November, settlement date: 30 November
• Current EUR/CZK spot rate as of the fixing date: 28.000
  - Client sells EUR 2 mil million/CZK at 27.820
  - Accumulated amount remains at CZK 500,000

Third fixing:

• Fixing date: 19 December, settlement date: 21 December
• Current EUR/CZK spot rate as of the fixing date: 26.820
• Accumulated amount now exceeds CZK 1 million by CZK 100,000 – this results in the transaction termination and no other exchanges will take place
• Forward rate of the last exchange is adjusted to ensure the accumulated amount remains below the target amount of CZK 1 million – i.e. a client sells EUR 1 million/CZK at the adjusted rate of 27.320 (= 27.420 – 0.100)

• Potential profit or loss from transactions denominated in foreign currencies depends on foreign exchange rate fluctuations
• In theory, profit/loss is not limited in any way
• Depending on the selected option strategy, clients may not know the final exchange rate, exchanged nominal or whether or not the transaction would in fact be executed until the maturity date
• Although a client receives better than standard exchange rates, individual transactions may be rolled over automatically when the development of exchange rates is negative from the perspective of the strategy buyer (currency sold by the buyer appreciates). This results in longer maturity and higher notional (for leveraged strategies) than for positive development