Quantos are options or derivatives that allow investors to buy or sell an underlying asset at a predetermined price in a specified period, with payments converted into a preferred currency at a predetermined exchange rate. They protect against currency risk and allow exposure to foreign securities without exchange rate losses. Quantos come in various forms, including swaps, where investors swap interest rates with the payoff denominated in a currency other than the index.
In investing, an option or derivative is a contract between two parties for the option to sell or buy an underlying asset at a pre-determined price within a specified period. A quantity adjustment option, or how much, is an option where the asset is valued using a different currency than the currency in which it is paid for. While the value of the exercise prices and the intrinsic values of the quantos are denominated in a single form of currency, the payments, upon exercise of the options, are converted into a preferred form of currency at a predetermined exchange rate. Quantos attract international investors because they provide protection against currency risk. They allow investors to gain exposure to foreign securities while avoiding exchange rate losses.
For example, a US (US) investor can buy a futures contract as much as on the European stock market. This contract obliges the holder to buy or sell an asset at a fixed price on a future settlement date. Since quantums are settled in cash, the trader who has suffered a loss transfers money to the investor. If the US investor gets the gain, the counterparty converts cash into US Dollars (USD) from Euros (EUR) at the exchange rate stipulated in the contract. This provision protects the American investor from an adverse exchange rate.
Quantos come in a variety of forms, including the quanto swap or differential swap. Swaps consist of a series of cash swaps, where cash inflows are paid at a fixed interest rate and cash outflows are paid at a floating interest rate. In quantum swaps, investors swap interest rates, with the floating leg pegged to a foreign index and the payoff denominated in a currency other than the index. Each party to the swap is betting that the interest it will receive on its investment will exceed the interest it pays on money from its counterparty.
For example, a US trader enters into a quantum swap agreement with a counterparty in Europe, with each party investing the same amount of money. The denomination of the payoff, called notional, is the EUR. Periodically, the US investor pays fixed amounts to the EUR counterparty, while periodically receiving various amounts determined by a foreign index from its EUR counterparty, which are converted into USD at the USD London Interbank Offered Rate (USD LIBOR). The US investor hopes that the fixed US interest rate, at which he will pay interest to his counterparty, will be lower than the floating rate in Europe, allowing him to collect more interest on his investment than he pays. Quantos can also be structured with floating and indexed interest rates on both sides.
Smart Asset.
Protect your devices with Threat Protection by NordVPN
