Convertible forward

A convertible forward is a form of hedging currency risk that carries no premium. 

Your worst case rate is slightly worse than the forward contract rate. However, you can benefit 100% if the exchange rate moves in your favour. You also have 100% protection if rates move against you. 

What makes a convertible forward different is this – the best case rate you agree is a ceiling. If the spot rate goes through this ceiling, you revert to a forward contract at your worst case rate. 

Advantages

• Guaranteed worst case rate

• You benefit 100% in any favourable moves up to your best case rate

• Zero premium to pay 

Disadvantages

• Your worst case rate is worse than a forward contract

• If the spot rate goes through your ceiling, you revert to your worst case rate

How it works for importers 

Let’s say that the Forward Contract rate is 1.23. Your worst case rate is set at 1.21 and your best case rate is set at 1.35.

Scenario 1 – On expiry, the spot rate is below 1.21

You buy your euros at 1.21

Scenario 2 – On expiry, the spot rate is above 1.21 and spot has not touched 1.35

You buy your euros at the spot rate

Scenario 3- On expiry, the spot rate is above 1.21 and has touched 1.35

You buy your euros at 1.21

How it works for an exporter

Let’s say that the Forward Contract rate is 1.23. Your worst case rate is set at 1.25 and your best case rate is set at 1.11.

Scenario 1 – On expiry, the spot rate is above 1.25

You sell your Euro’s at 1.25

Scenario 2 – On expiry the spot rate is below 1.25 and spot has not touched 1.11

You sell your euros at the spot rate.

Scenario 3- On expiry, the spot rate is below 1.25 and has touched 1.11

You sell your euros at 1.25

Important

For this kind of foreign currency hedge, you can set a time period in which the breach has to happen for the contract to revert to the worst case rate. For example if you set the time period for one month, the rate must breach your best case rate within that month for you to revert to your worst case rate. Outside of that month any breach does not count. You can set that time period to any time you like. 

Call us on 0800 030 5025 or +44  20 7801 9050 to see how we can help you. Alternatively arrange for us to call you back.