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)
