Asymmetric Forward is a product which is structured in order to hedge the foreign currency (FX) risk. Asymmetric Forward structure allows the hedger
to make the FX transaction with a better rate than the forward rate. The notional amount of the transaction depends on the value of the spot rate at the expiry date. If the spot at the expiry date is at a disadvantageous level according to forward level, hedger must do the transaction with a leveraged amount. For example if the leverage ratio is 2 and the notional amount is 1,000,000 then hedger will make the FX transaction with an amount of 1,000,000 when spot rate at maturity is at an advantageous level according to forward rate. On the other hand the hedger must buy/sell 2,000,000 when the spot rate at expiry is at a disadvantageous level. Thus hedger increases the probability of the hedge to be in the money at the expiry date. On the other hand this transaction also increases the potential loss amount of the hedge because of the leverage ratio. There are two parameters in order to price the Asymmetric Forward structure. One is leverage ratio and the other is asymmetric forward level. Hedger gives the desired value of one of these parameters to the market maker and market maker quotes the other parameter by making the structure zero cost for the hedger.
On the pricing screen user enters both of these parameters to Derivative Engines pricing tool and value of the structure is displayed as the result. A Hedger can price Asymmetric Forward structure easily with Derivative Engines seeking for the zero cost by changing the value of the parameters.
Leverage Ratio: Hedger buys an in the money option and sells an out of the money option. Hedger does not pay any premium for the structure. The leverage ratio is the ratio of the notional amount of the option that customer sells to the notional amount of the option that customer buys.
Applications:
When Asymmetric Forward is done for Hedging purposes the leverage amount should be equal to the foreign currency risk of the hedger. For example; when a hedger who has a short position at EUR/USD parity, makes the Asymmetric forward product with a leverage ratio of two, the maximum amount that will be bought should be EUR 1,000,000. This means that when spot rate at maturity is in favor of hedger, the FX transaction amount will be EUR 500,000 otherwise it will be EUR 1,000,000. If hedger makes the transaction as EUR 1,000,000 to EUR 2,000,000 then this will cause a speculative position for the hedger. Since the risk amount to be hedged is EUR 1,000,000 the hedger has the risk to make a EUR 2,000,000 transaction.
Advantages:
-
Hedger makes the transaction from a better rate than
the forward price.
-
Product is formed costless
Disadvantages:
-
If at maturity spot rate is not in
favor of hedger the loss coming from the transaction is leveraged with the
leverage ratio.
