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SCMP Reporter

INVESTORS wanting exposure to foreign exchange but fearful of the expense and risk can now consider unlisted currency warrants.

  Many investors in Hong Kong are already familiar with share warrants listed on the stock exchange. They provide a low-cost method of capitalising on share price movements.

  The same principles apply to currency warrants. They enable investors to speculate on exchange rate movements for a small percentage of the face value of their foreign exchange dealing.

    Compared to leveraged foreign currency dealing, warrants have a major advantage in that the potential losses are limited to the premium paid for the warrants. Potential gains are unlimited.

   'The most you can lose is what you pay up front' said Michael Sutherland, executive director of foreign exchange sales, capital markets and treasury at Swiss Bank Corp (SBC), which launched its first batch of currency warrants in Hong Kong in July.

   Unlike leveraged foreign exchange trading, warrants do not require investors to maintain a margin which must be topped up if it falls below a certain level.

   Warrants can also give investors time to see if their investment views prove correct or not.

  Investors in leveraged contracts can be closed out during adverse currency fluctuations, even though their view may be proved right in the long run.

   The new unlisted currency warrants are suitable for investors who have an understanding of currency markets and warrants.

   Investors should know enough about exchange rate movements to be able to take a view on what future rates are likely to be.

   Warrants give investors the right, but not the obligation, to buy or sell a currency on a pre-arranged date in the future, at a predetermined exchange rate, known as the strike price, which is chosen by the investor.

   In practice, warrants are rarely held until maturity, because investors try to get profits from trading the warrant rather than physical delivery of the foreign currency.

   The investor's profit or loss is determined by the value of the warrant when it is sold or redeemed.

   As Hong Kong's sole market-maker in currency warrants, SBC aims to establish a liquid market by undertaking to buy back warrants from investors.

   'You might not make any money, but you can always sell the warrant. Investors can take profits or limit losses at any time by selling their warrant to SBC,' said Mr Sutherland.

   Each SBC warrant has a face value of US$100, although the SBC requires a minimum investment of HK$10,000. All premiums and redemptions are paid in Hong Kong dollars.

   A warrant's premium depends on the spot (current) exchange rate, the two interest rates of the currencies being traded, the volatility of the exchange rate between the two currencies and the amount of time before the warrant expires.

    An example of how an investor can make a profit on a currency warrant is shown in the table.

   This illustrates how the investor correctly guessed that the US dollar would fall against the Canadian dollar. The option to sell (put) US dollars and buy (call) Canadian dollars at C$1.39 has become valuable since US$1 now buys only C$1.34.

   As a result, the warrant's value has increased by 87 per cent.

   This example is one of the 32 US dollar-based warrants launched by SBC in Hong Kong since July. There are six-month and nine-month call and put warrants in six currencies - German marks, Swiss francs, yen, Australian dollars, Canadian dollars and British pounds.

   But warrants are not only bought to make trading profits. They can also be used as a hedging tool.

   Mr Sutherland pointed out that with the recent increase in the value of sterling against the US dollar and therefore the Hong Kong dollar, many British expatriates may find buying assets in Britain more expensive than they had planned.

   Similarly, Hong Kong-based borrowers with loans in foreign currencies can use warrants to hedge against their loans increasing if the foreign currency they have borrowed in rises against the Hong Kong dollar.

   Currency warrants were first introduced in Hong Kong in 1987 and were listed on the stock exchange.

   According to Mr Sutherland, they were largely ignored because the issuers failed to follow them up with new warrants as exchange rates changed.

  'We will keep reissuing warrants as markets move to give investors a greater choice' he said.

  The fact that SBC warrants are not listed should not pose a threat for investors, he said.

  SBC is authorised to issue and deal in these warrants. The warrants are backed by the bank's AAA credit rating.

   The decision not to list the warrants on the stock exchange was taken so that SBC could issue new ones immediately in response to market conditions, without the delays of listing procedures.

   So far, about 12 banks and securities dealers are offering the SBC warrants to clients.

         Interested Investors should talk to their existing advisers.

     SBC currency warrant prices are constantly updated and quoted on Reuters and Telerate.

     HOW THEY WORK Warrant type: US$ put-C$ call Expiry: Dec 19. Purchase date: July 20. Face value: US$100 Spot price July 7: C$1.39 Strike price: C$1.39 Purchase price: HK$15 Spot price Oct 12: C$1.34 Redemption value: HK$28 Return: 87 per cent 



SBC's forex warrants reduce currency risk