FIN.14:4.2 - Construct alternatives from what each arrangement makes happen
For each feasible form, recover the conditional cash and obligations it introduces. The following distinctions let the analyst construct a comparison without treating every instrument as interchangeable.
| Form | Financial construction | Condition that can change the choice |
|---|---|---|
| Change the activity or commercial terms | Recalculate receipts, costs and dates for the attainable operating alternative, including the party that takes the displaced risk. | Lost contribution, implementation cost, customer response or inability to change an existing commitment can outweigh the risk reduction. |
| Use an existing natural offset | Combine genuinely offsetting receipts and payments on compatible factors and dates; retain their separate performance and access conditions. | Equal currency totals can leave a gap if one payment arrives later or belongs to another entity. |
| Fix an exchange or rate through a forward or swap | Derive both parties’ payments from the actual reference, notional schedule, dates, fixed terms and settlement rule. | A delivery duty, changing exposure amount, basis difference, collateral or termination payment can make a price fix costly to maintain. |
| Create a money-market hedge | Borrow or invest in the relevant currencies now so that a known future receipt repays a debt or a future payment is covered by a maturing investment. | Borrowing and investing rates, credit capacity, taxes, access and the actual collection date determine the result; the construction introduces real financing and counterparty claims. |
| Use futures or another margined offset | Match the financial sensitivity and contract amount, then carry each margin movement and the eventual closing or delivery into the cash plan. | Standard quantities and dates can leave a residual; changes in the relation between the exposure price and contract price leave basis risk. |
| Buy an option | Obtain a defined right or contingent cash payoff, pay its premium when due and preserve the exercise, expiry and settlement conditions. | Protection can expire before the exposure resolves; premiums, imperfect matching or a physically delivered exercise can still require money or assets. |
| Insure or obtain a guarantee for a specified loss | Derive the covered event, eligible amount, deductible, limit and claim-payment conditions from the actual agreement. | Exclusions, waiting periods, disputes and provider default can leave a loss or a cash shortage even when the event is covered. |
For a known foreign receipt Q at time T, a simple money-market construction borrows Q / (1 + rF × a) foreign units now, converts that amount at an obtainable spot selling price and invests the home proceeds until T. Here rF is the actual foreign borrowing rate and a is the matching accrual fraction under the stipulated simple-interest terms. The receipt repays Q at T. For a known foreign payment, invest its discounted foreign amount now and fund that purchase from available home cash or actual home borrowing. Use the real compounding and payment rules when they differ. This explains the direction of borrowing and investment; a forward quotation is a different attainable alternative, not proof that either construction is accessible.
For an option, FIN.8 supplies valuation when the premium or conditional strategy must be assessed. An actual sufficient price and payoff can be used directly. Do not price protection by discounting a speculative expected payoff at an arbitrary corporate WACC. Similarly, a market forward rate is an executable term only if an actual provider offers it under usable conditions; it is not automatically a forecast of the future spot price.
Obtain the important terms before treating a form as feasible. A contract called a collar can contain a purchased option and a written option that creates a duty in another state. A zero initial premium can be financed by giving up favorable outcomes or accepting that duty. The combined terms, including barriers, limits or cancellation rights where present, determine protection. FDM.3 supplies the derivation of duties and state changes from those terms; FIN.14 compares their financial consequences.