A currency hedge that guarantees protection plus a share of any upside
The Forward Extra, introduced in a previous post, offers the holder the chance to gain from a favourable movement. That gain could be nothing, something, or 100%, depending on where the exchange rate moves.
A Participating Forward currency contract gives the holder some return no matter how favourably the exchange rate moves in future. Unlike the Forward Extra, the Participating Forward gives a limited return, the participation rate.
How does a Participating Forward contract work?
Say the participation rate is 60%, then in essence, the company gets the benefit of 60% of the favourable movement in the exchange rate.
As there is nothing free in finance, for the chance to gain additional income, or to reduce the future payout, the business purchasing the Participating Forward does so at a contracted forward rate that is slightly worse than the market rate for a straight forward contract.
If the exchange rate moves favourably, then (assuming a participation rate of 60%), the business will transact 60% of the contract at the favourable market rate and 40% at the contracted forward rate. The average rate will, in this example, therefore be more favourable than the market forward rate had the business decided to use a conventional forward contract to hedge its currency risk.
To discuss your currency risks or currency transfers, contact me now, without obligation or charge.