Quanto

Quanto is a suffix for investment and leverage products that are hedged against currency fluctuations.

Quanto products are based on underlying assets that are not quoted in the currency of the investor. They are against the risk (or opportunity ) to hedge exchange rate fluctuations.

Exchange rate fluctuations may reduce a gain or loss, or even larger. However, some investors see in the exchange rate, an additional ( unpredictable ) risk they can turn by Quanto products, but at the price of additional (administrative) costs.

By financing to hedge any additional costs. These depend on the volatility, the interest rates of the respective currencies and the correlation between the underlying and foreign currency. Result, at Quanto products are generally slightly higher annual management fees (typically 1-4 %).

One way to hedge is a corresponding amount of foreign currency ( to date ) for sale, for example, via options. These then form the performance of the home to the foreign currency and vice versa neutralize the loss (or gain) due to the currency exchange.

Example

An investor buys a ( non- quanto ) Index Certificate on the S & P 500 at a level of $ 1,000.00. The euro - dollar exchange rate is at 1.00 EUR / USD, 1 Euro = 1 U.S. dollar.

He therefore invested exactly 1000 EUR.

The price in the home currency is then calculated as follows:

Here x stands for relative price change in the underlying and y for the exchange rate.

Scenario 1: Index rises, exchange rate rises

Owing to the increased exchange rate (home currency is more expensive) to reduce the gains of the index.

Index rises to 1050 USD ( 5 %), exchange rate rises to 1.05 EUR / USD ( 5 %). Result: 1000 EUR.

Scenario 2: Index falls, the exchange rate rises

The rising exchange rate (home currency is more expensive ) increases the losses of the index.

Index drops to 950 USD ( 5%), exchange rate rises to 1.05 EUR / USD ( 5 %). Result: 904.76 EUR ( loss: 9.5%).

Scenario 3: Index rises, exchange rate falls

The falling exchange rate (home currency is cheaper, foreign currency is more expensive) still increases the gain of the index.

Index rises to 1050 USD ( 5 %), exchange rate falls to 0.95 EUR / USD ( 5%). Result: 1,105.26 EUR (profit: 10.5%).

Scenario 4: Index falls, exchange rate falls

The falling exchange rate in turn neutralizes the losses of the index.

Index drops to 950 USD ( 5%), exchange rate falls to 0.95 EUR / USD ( 5%). Result: 1000 EUR.

Currency hedging of the certificate (Quanto )

The investor buys the certificate for 1000 EUR. He also borrows 1000 USD and converts these into (initially ) 1000 EUR.

Increases the exchange rate now at 1.05 EUR / USD loses the certificate at the same 5 % of its value (in U.S. dollars). By its Return Swap 1000 EUR investors but 5% more U.S. dollars, which compensate for its loss in the certificate now receives.

Decreases the exchange rate, however, at 0.95 EUR / USD rises, the value of the certificate in euro by about 5 %. In the same train, the back numbers of the U.S. dollar loan at 5 % more expensive.

Alternatively, the investor can buy a put option on the U.S. dollar, ie it acquires the right in the future Euros " sell" ( from the sale of the certificate ) to a certain dollar exchange rate to. "Fixed" by buying the option he practically its exchange rate to the cost of the option.

As a result, exchange rate fluctuations neutralize the opposite ( short ) position in U.S. dollars.

Basically, any investor can construct these currency hedging itself. However, this is complex ( borrowing or calculation of the option parameters ) and usually also more expensive ( transaction costs in proportion to the amount invested high) as a quanto product.

With a quanto product, the investor does not have to deal with this complex issue. His course in the home currency is always equal to the underlying price in foreign currency, regardless of changes in the exchange rate.