The primary tool for hedging foreign-exchange risk is forwards. A foreign exchange forward is an agreement on a future conversion specifying all the details: the currency, the value date (expiration date), sell or buy, the amount and the exchange rate, in advance.

The forward rate is a composite:

forward rate = spot rate + swap points

The spot rate is the market rate for value date T+2, while the swap points represent the interest rate difference between the two currencies for the term of the forward.

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A currency swap allows you to convert an amount of foreign currency to forints or vice versa for a defined period of time at a defined exchange rate (of course you can do that with any currency pair quoted by the bank). In this way you can increase your liquidity in a given currency during a certain time period at the expense of concurrently reducing your liquidity in another currency.

I.e. this contract includes a spot or forward deal in a currency and an opposite forward deal in the same currency for a later settlement.

spot or forward deal + opposite forward deal = currency swap

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A plain vanilla option is similar to an insurance policy, which is meant to provide total coverage against unfavourable market shifts while allowing you to capitalize on favourable ones.

it has two basic types:

• call option (a right to buy on the buyer of the option’s side, an obligation to sell on the seller of the option’s side)
• put option (a right to sell on the buyer of the option’s side, an obligation to buy on the seller of the option’s side)

Options allow you to a much greater extent than cost-free arrangements to capitalize on favourable exchange rate shifts.

Since for many of our clients no cost is a top priority below we primarily present products that are combinations of various rights and obligations put together in such a way that the final product is cost-free.

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A barrier option is similar to a plain vanilla option with the difference that the option being activated or extinguished depends on something called the barrier level: if the market price reaches the barrier level at a specific point in time or anytime during the term of the contract then something will happen to the option, e.g. it is activated or is extinguished.

accordingly there are:

• knock-in options: if the spot price reaches the barrier level the option becomes a plain vanilla option
• knock-out options: if the spot price reaches the barrier level the option is extinguished

Another way to classify barrier options is according to when the reaching of the barrier is monitored:

• with a European style barrier the breaching of the barrier is only examined at a predefined time on expiry date
• with an American style barrier the breaching of the barrier is monitored from contract date to expiration date

Barrier options are popular because they are cheaper than plain vanilla options and therefore can be efficiently used in various option arrangements. A knock-in option and a knock-out option of the same contract term, nominal value, strike price and barrier have a combined value equal to the value of a plain vanilla option of the same contract term, nominal value and strike price.

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