B.1.2 Example II - Currency Options
On 1st June 2002, your bank buys a call option on 1000USD (in terms of INR) with a strike price of INR 50, and December 31st 2002 as the maturity date. The parameters of the deal are as follows:
Table B-25 Example II
Contract Type | Hedge |
---|---|
Contract Amount |
1000 |
Contract Currency |
USD |
Counter Currency |
INR |
Option premium |
2500 INR |
Booking Date |
01 |
Jun |
2002 |
Value Date |
01 |
Jun |
2002 |
Premium Pay Date |
01 |
Jun |
2002 |
Strike price |
50 INR/USD |
Current Spot Rate |
52 INR/USD |
Option Style |
Plain Vanilla |
Expiration Style |
American |
Earliest Exercise Date |
15 |
Oct |
2002 |
Barrier Type |
Double Knock Out |
Barrier |
53 INR/USD |
Lower Barrier |
48 INR/USD |
Rebate |
100 AUD |
Payment At |
Maturity |
Barrier Window Start Date |
01 |
Sep |
2002 |
Barrier Window End Date |
01 |
Nov |
2002 |
Revaluation Frequency |
Half Yearly |
Revaluation Start Month |
August |
Revaluation Start Day |
1 |
It is assumed the local currency in this case is neither USD nor INR or AUD
Intrinsic Value at Inception – Intrinsic value at inception is the pay off that can occur to the buyer if he were to exercise the option today.
Intrinsic Value = Contract Amount * (Spot rate – Strike Rate) in Counter CCY
In this case, the payoff is = 1000 * (52 –50) = 2000 INR
Time Value of the deal = Option premium paid – Intrinsic Value It is assumed the local currency in this case is neither USD nor INR or AUD Intrinsic Value at Inception – Intrinsic value at inception is the pay off that can occur to the buyer if he were to exercise the option today. Intrinsic Value = Contract Amount * (Spot rate – Strike Rate) in Counter CCY In this case the payoff is = 1000 * (52 –50) = 2000 INR Time Value of the deal = Option premium paid – Intrinsic Value = 2500 – 2000 = 500 INR
If the spot rate on the booking day was say 49 INR/USD (Lower than the strike rate), then the intrinsic value of the deal is 0 and the time value is the option premium paid.
BOOK
Table B-26 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
PUR_IV_DEF |
PUR_INCEP_IV |
2000 |
INR |
01-Jun-02 |
Cr |
OPT_PREM_PAY |
PUR_INCEP_IV |
2000 |
INR |
01-Jun-02 |
Dr |
PUR_TV_DEF |
PUR_INCEP_TV |
500 |
INR |
01-Jun-02 |
Cr |
OPT_PREM_PAY |
PUR_INCEP_TV |
500 |
INR |
01-Jun-02 |
PRPT
Since option premium is paid on the booking date itself, this event triggers along with the BOOK event.
Table B-27 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
OPT_PREM_PAY |
PUR_OPTION_PREM |
2500 |
INR |
01-Jun-02 |
Cr |
CUSTOMER |
PUR_OPTION_PREM |
1000 |
INR |
01-Jun-02 |
REVL
Amortization of Time Value occurs on 01-Aug-2002 as per the revaluation frequency.
Amt to Amort Till date = 500 * 60 / (7 * 30) = 142.86 INR
Table B-28 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
EXP_ON_HEDGE |
NET_AMORT_TV |
142.86 |
INR |
01-Jun-02 |
Cr |
PUR_TV_DEF |
NET_AMORT_TV |
142.86 |
INR |
01-Jun-02 |
Option Getting Knocked Out
An option is get knocked out if the spot rate touches or crosses a predefined barrier between the barrier window start date and end date.
Event KNOT (Knock Out)
Now suppose, on 10-Sep-2002, the spot rate touches or crosses 53 INR/USD. The option is Knocked Out and a pre-specified rebate of 100 AUD is paid at maturity. On Knock Out deferred intrinsic value and the remaining time value is recognized as Expense.
Table B-29 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
PUR_REBATE_REC |
PUR_REBATE_AMT |
300 |
AUD |
10-Sep-02 |
Cr |
PUR_OPT_INCOME |
PUR_REBATE_AMT |
300 |
AUD |
10-Sep-02 |
Dr |
PUR_HED_EXPENSE |
PUR_INCEP_IV |
2000 |
INR |
10-Sep-02 |
Cr |
PUR_IV_DEF |
PUR_INCEP_IV |
2000 |
INR |
10-Sep-02 |
Remaining amortization of time value is done at the time of the option getting knocked out and the total expense is moved to the main option expense GL.
REVL on Knock Out
TV amortized Till date = 142.86 INR
Total TV to be amortized = 500 INR
Current TV to be amortized = 500 – 142.86 = 357.14 INR
Table B-30 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
EXP_ON_HEDGE |
NET_AMORT_TV |
357.14 |
INR |
10-Sep-02 |
Cr |
PUR_TV_DEF |
NET_AMORT_TV |
357.14 |
INR |
10-Sep-02 |
Moving Inception TV to final Expense GL from Revaluation Expense GL
Table B-31 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
PUR_HED_EXPENSE |
PUR_INCEP_TV |
500 |
INR |
10-Sep-02 |
Cr |
EXP_ON_HEDGE |
PUR_INCEP_TV |
500 |
INR |
10-Sep-02 |
Event KNST (Knock Out Settlement)
In the above case the rebate is actually received on the maturity date of the contract. Accounting entries posted on the maturity i.e. 31-Dec-2002 are:
Table B-32 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
CUSTOMER |
PUR_REBATE_AMT |
300 |
AUD |
31-Dec-02 |
Cr |
PUR_REBATE_REC |
PUR_REBATE_AMT |
300 |
AUD |
31-Dec-02 |
Option not getting Knocked In
Let us assume that the barrier type is Double Knock In instead of Double Knock Out. If the option gets knocked in during the barrier window, it can be exercised any time according to the Expiration style. If it doesn’t get knocked in, a rebate is payable at expiry. Let us suppose that the option doesn’t get knocked in. The accounting entries and the events triggered at expiry in this case are given below.
REVL at expiry
TV amortized Till date = 142.86 INR
Total TV to amortize = 500 INR
Current TV to amortize = 500 – 142.86 = 357.14 INR
Table B-33 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
EXP_ON_HEDGE |
NET_AMORT_TV |
357.14 |
INR |
31-Dec-02 |
Cr |
PUR_TV_DEF |
NET_AMORT_TV |
357.14 |
INR |
31-Dec-02 |
KIST (Knock In settlement) at expiry
As mentioned above, a rebate amount is payable to the buyer of the option on expiry if the option does not get knocked in during the barrier window.
Table B-34 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
CUSTOMER |
PUR_REBATE_AMT |
300 |
AUD |
31-Dec-02 |
Cr |
PUR_OPT_INCOME |
PUR_REBATE_AMT |
300 |
AUD |
31-Dec-02 |
EXPR (Expiry)
On Expiry, the deferred intrinsic value is recognized as expense
Table B-35 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
PUR_HED_EXPENSE |
PUR_INCEP_IV |
2000 |
INR |
31-Dec-02 |
Cr |
PUR_IV_DEF |
PUR_INCEP_IV |
2000 |
INR |
31-Dec-02 |
Moving Inception TV to final Expense GL from Revaluation Expense GL
Table B-36 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
PUR_HED_EXPENSE |
PUR_INCEP_TV |
500 |
INR |
31-Dec-02 |
Cr |
EXP_ON_HEDGE |
PUR_INCEP_TV |
500 |
INR |
31-Dec-02 |
Contract Termination (TERM)
Now let us assume that the currency option contract was terminated on 01-Sep-2002
Termination Value (User I/P) = 2700 INR
Termination Gain = 2700 – 2000 (Inception IV) = 700 INR
Accounting entries passed at termination –
Table B-37 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
CUSTOMER |
PUR_INCEP_IV |
2000 |
INR |
01-Jul-02 |
Cr |
PUR_IV_DEF |
PUR_INCEP_IV |
2000 |
INR |
01-Jul-02 |
Dr |
CUSTOMER |
HED_TERM_GAIN |
700 |
INR |
01-Jul-02 |
CR |
PUR_GAIN_DEF |
HED_TERM_GAIN |
700 |
INR |
01-Jul-02 |
Event REVL at termination
Remaining time value of the option is recognized as expense on termination.
TV amortized Till date = 142.86 INR (As on 01-Aug-2002)
Total TV to be amortized = 500 INR
Current TV to be amortized = 500 – 142.86 = 357.14 INR
Table B-38 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
EXP_ON_HEDGE |
NET_AMORT_TV |
357.14 |
INR |
01-Sep-02 |
Cr |
PUR_TV_DEF |
NET_AMORT_TV |
357.14 |
INR |
01-Sep-02 |
Moving Inception TV to final Expense GL from Revaluation Expense GL after REVL on TERM.
Table B-39 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
PUR_HED_EXPENSE |
PUR_INCEP_TV |
500 |
INR |
01-Sep-02 |
Cr |
EXP_ON_HEDGE |
PUR_INCEP_TV |
500 |
INR |
01-Sep-02 |
AMDG after termination
Deferred termination gain in case of hedge deals is amortized over a period from Contract termination date (01-Sep-2002 in this case) to the contract maturity date. Suppose according to the frequency of amortization, deferred termination gain is amortized on the 01-Nov-2002.
Amount to be amortized Till date = 700 * (2 * 30) / (6 * 30) = 233.33 INR
Table B-40 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
PUR_GAIN_DEF |
NET_GAIN_DEF |
233.33 |
INR |
01-Nov-02 |
CR |
PUR_OPT_INCOME |
NET_GAIN_DEF |
233.33 |
INR |
01-Nov-02 |
If there is no other frequency of amortization between the contract termination date and contract maturity date where the deferred termination gain can be amortized, the remaining part is amortized on the contract maturity date. Since the contract has already been terminated, only the event AMDG is triggered. The accounting entries are
Amt to amortize till date = 700 INR
Amt already amortized = 233.33 INR
Current amount to amortize = 700 – 233.33 = 467.67 INR
Table B-41 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
PUR_GAIN_DEF |
NET_GAIN_DEF |
467.67 |
INR |
31-Dec-02 |
CR |
PUR_OPT_INCOME |
NET_GAIN_DEF |
467.67 |
INR |
31-Dec-02 |
Contract Exercise (EXER)
Contract Exercise happens depending on the Expiration style. In this case, since it’s a Plain Vanilla option with American Expiration style, it can be exercised anytime between the earliest exercise date (15-Oct-2002) and contract maturity (31-Dec-2002) if it doesn’t get knocked out during the barrier window.
Suppose the spot rate on 15-Dec-2002 is 55INR/USD. Since the strike is 50 INR/USD, the option is in the money on this date and the buyer can exercise the option.
Settlement Amount = 1000 (Contract Amount) * (55 – 50) = 500 INR
Table B-42 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
PUR_OPT_SET_REC |
PUR_INCEP_IV |
2000 |
INR |
15-Dec-02 |
CR |
PUR_IV_DEF |
PUR_INCEP_IV |
2000 |
INR |
15-Dec-02 |
Dr |
PUR_HED_EXPENSE |
HED_EXER_LOSS |
1500 |
INR |
15-Dec-02 |
Cr |
PUR_OPT_SET_REC |
HED_EXER_LOSS |
1500 |
INR |
15-Dec-02 |
It is important to note here that even though, the option is in the money, the amount tag populated here is HED_EXER_LOSS. This is so because even though the buyer of the option is getting a pay off equal to 500 INR, he is in an over all loss of 1500 INR (Inception IV – pay off).
AMRT on EXER
Remaining time value of the option is recognized as expense at the time of Exercise.
TV amortized Till date = 142.86 INR (As on 01-Aug-2002)
Total TV to be amortized = 500 INR
Current TV to be amortized = 500 – 142.86 = 357.14 INR
Table B-43 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
EXP_ON_HEDGE |
NET_AMORT_TV |
357.14 |
INR |
15-Dec-02 |
Cr |
PUR_TV_DEF |
NET_AMORT_TV |
357.14 |
INR |
15-Dec-02 |
Moving Inception TV to final Expense GL from Revaluation Expense GL on EXER after AMRT.
Table B-44 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
PUR_HED_EXPENSE |
PUR_INCEP_TV |
500 |
INR |
15-Dec-02 |
Cr |
EXP_ON_HEDGE |
PUR_INCEP_TV |
500 |
INR |
15-Dec-02 |
EXST (Exercise Settlement) after EXER
The following accounting entries pass on settlement after exercise of the currency option above. In this case the settlement event is triggered along with the exercise event.
Table B-45 Accounting Entries
Dr/Cr | Accounting Role | Amount Tag | FCY Amount | FCY/CCY | Date |
---|---|---|---|---|---|
Dr |
CUSTOMER |
PUR_SETL_AMT |
500 |
USD |
15-Dec-02 |
Cr |
PUR_OPT_SET_REC |
PUR_SETL_AMT |
500 |
USD |
15-Dec-02 |
Parent topic: Examples