Participating forward

Beneficial Movements

A participating forward structure provides a secured protected rate, while still allowing beneficial moves on a predetermined portion of the amount hedged.

If the spot rate at expiry is more favourable than the protected rate, then the holder of the participating forward is only obligated to transact a predetermined proportion of the hedged amount at the protected rate. They are then free to transact the remainder at the spot rate.

Participating forwards are generally structured as zero-cost premium products.

An example of how a participating forward works

A UK-based company imports materials from the US and needs to pay a supplier $500,000 in six months’ time.

1. Requirements

The company: would like to benefit from a favourable exchange rate and 100% rate protection is not willing to pay a premium for this

2. Current Forward Rate

The forward rate for a six-month period is 1.3400

3. Solution

The company is prepared to accept the worst-case rate of 1.3200. The company buys a participating forward with a protected rate of 1.3200 and a participation proportion of 50%.

There are two possible scenarios

Scenario 1:

Unfavourable market moves

GBP/USD weakens. At maturity, the exchange rate is 1.2900. The company is entitled to buy the full $500,000 at 1.3200.

Scenario 2:

Favourable market moves

GBP/USD strengthens. At maturity, the exchange rate is 1.4200. The company is obligated to buy $250,000 (50%) and the other half can be purchased in the spot market at 1.4200. Due to this strategy the company achieves an effective rate of 1.3700.