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knock-out (knock into) forward

A Knock-out Forward is a derivative financial product through which the issuer offers the buyer a more attractive rate for a specific maturity date than a regular forward on condition that the exchange rate does not hit the Knock-out level during the contract. If the Knock-out level is attained, the contract is automatically cancelled and the transaction will not take place.

Due to their complex character, knock-out forwards are not the most suitable products for corporate treasurers wishing to protect their profits from FX risks. There are more efficient alternatives like Dynamic Hedging.

Knock-out forward contracts include the following elements:

Financial Asset:   EUR/USD
Position at Maturity:   EUR/USD short
Amount:   1,000,000
Spot Rate:   0.9350
Forward Rate:   0.9275
Knock-out Option Rate:   0.9150
Knock-out Level:   0.8800
Tenor:   6 months

 

Despite the name ‘forward’, a knock-out is actually a speculative options contract* and therefore not the most suitable option for a prudent CFO aiming to hedge against currency volatility. If the Knock-out rate is reached, the option will be cancelled and the buyer will remain exposed to currency volatility.