GBP/USD
The company is buying the base (GBP) and selling USD 1,250,000 in three months outright. As counterparty to the market maker, it is trading on the offer of the GBP/USD spot market at 1.6825. It needs to move the date from spot to the three month date which requires a swap points adjustment of -11.960. This creates a forward outright price of 1.6825 + (-11.960 × 0.0001) = 1.681304.
EUR/GBP
The company needs to sell the base currency EUR and buy GBP in three months outright. As it is selling the base currency to the market maker, it trades on the bid side of the EUR/GBP spot market at 0.8227. It needs to move the date from spot to the three month date which requires a swap points adjustment of +3.94. This creates a forward outright price of 0.8227 + (3.94 × 0.0001) = 0.823094.
After booking these trades it is then irrelevant what happens to the spot rates. The company has a defined GBP cash flow for its receivables.
Hedging a Series of Future Payments
A Mexican electric company imports gas to run its generators in the east of Mexico. It has signed a contract with a US-based gas extraction company to pay USD 500 million for gas supplied during the next year.
Payments are to be made in USD 100 million tranches, every three months, starting today. The company needs:
- Spot USD/MXN price for today
- Forward outright price for three months’ time
- Forward outright price for six months’ time
- Forward outright price for nine months’ time
- Forward outright price for twelve months’ time
The Mexican company could approach this in a number of ways. It could:
- Ask the bank to quote a spot price and four forward outright prices.
- Trade all five trades on an electronic trading platform. Sometimes this cannot be done if specific maturity dates are required outside of the standard period quotes.
- Ask for a spot rate and trade the full amount, then ask for swap points to adjust the maturities to the dates required.
Let’s look at the case where the Mexican company asks for a spot rate and trades the full amount.
On spot, the Mexican company will receive USD 500 million but it only needs USD 100 million now to meet its first payment. So, it will swap out USD 400 million (USD 500 million less the spot requirement of USD 100 million) in four FX swaps, of USD 100 million for three-, six-, nine- and twelve-months.
Spot is USD/MXN 12.9245/9295. The USD/MXN swap points are as follows: