Introduction
Knock-Out Forward Transaction of Foreign Exchange refers to that a buyer and a seller reach a forward contract that, on a pre-determined settlement day, one contractual party can buy or sell an agreed amount of currency on a price more favorable than the normal forward exchange rate. The prerequisite for the forward contract above is: both parties set one "knock-out" foreign exchange rate and. If this rate has not reached the market exchange rates before the delivery day, the contract above is performed; otherwise, the contract above should be automatically cancelled.
Features
This product helps customers in achieving conversions between different foreign currencies, and locking the forward exchange rate. Thus, the risks of foreign exchange rate fluctuations are reduced. This product can effectively constitute foreign exchange rate which is more optimized than that of the conventional ones, by combining two foreign exchange options (e.g. buying and selling two options concurrently). Meanwhile, the product can provide customers with "zero cost" due to its lower charges for transaction.
Target Customers
1. It is applicable to customers with the demand of foreign exchange transactions in the future for corporate import and export trade settlement, for credit margin payment, and so on.
2. Customers need to open foreign currency accounts in bank.
Process
1. Relevant transaction instructions are delivered by customers. The details of such transactions will be determined in the form of application letter. After the conclusion, the bank will conduct authentication on the transactions as well as achieve relevant collections and payments on the settlement day. The customers may request their banks to unwind such transactions, or conduct one extension on such transactions before the maturity day according to their demands.
2. Loss and earning from liquidation due market changes or from the process of these transaction restructuring must be undertaken by customers themselves.
3. Signature of an agreement: customers should sign the General Agreement on Value-maintenance Transactions of Foreign Exchange and the Application for Foreign Exchange Transactions with Bank of China in advance.
4. The corresponding credit line or margin is implemented via international settlement departments.
5. Inquiry: customers can determine the details of forward foreign exchange transactions via applications in writing, and make inquiries to Bank of China accordingly.
6. Transaction conclusion: Once a transaction is concluded, Bank of China will make corresponding authentication in writing.
7. Settlement: The actual delivery is carried out on the settlement day. The customers may require the bank to unwind the transaction, or give one extension to the transaction before the maturity day.
Kind Reminder
Applicants of such transactions must undertake the loss and gain from transactions due to market change as well as from the restructuring process.
Cases
One enterprise was required to pay the price of EURO 1.5 million in June 2007 with its collection currency of USD. Therefore, due to its mismatching payable currency and receivable currency, this enterprise should bear the risks of EURO appreciation. The operational personnel of Bank of China recommended forward products to this enterprise for fixing costs of foreign exchange rate. According to the market prices, the exchange rate of EURO against USD was 1.3290 while the 3-month forward was 1.3340. This enterprise wanted to wait for a better foreign exchange rate to buy EURO for the forward quotation is high. However, to wait is nothing but to totally expose its cash flow to the exchange rate risk.
Aiming at meeting customers' demands, Bank of China provided the enterprise with an exercisable "knock-out" product, namely the foreign exchange forward transaction, to lock the forward exchange rate at 1.3300 and the "knock-out" rate at 1.4100. If the market foreign exchange rate has never touched 1.4100 before the settlement day, the customer could purchase EURO at the rate of 1.3300, which was only 10 base points higher than the spot price but 40 base points lower than the forward price; otherwise, the contract would be automatically canceled. During the 3 months after the conclusion of transaction, the exchange rate of EURO against USD kept constant fluctuation within a narrow band, and never touched 1.4100, the "knock-out" rate. Eventually, this enterprise purchased EURO on the rate of 1.3300 on the settlement day with great satisfaction.
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