Forex Investment and Currency Trading

A Knock-in Tunnel is a zero-cost structure that is similar to a standard Tunnel, except the potential benefit rate is unknown at inception. If spot trades at the knock-in level before expiry, the structure knocks into a regular tunnel that has a benefit level worse than a standard tunnel. If spot does not trade at the knock-in level before expiry USD dollars can be sold at prevailing market rates. The protection rate is generally the same for both the standard and Knock-in Tunnel.

Benefit

• Provides a hedge against a USD depreciation
• The buyer has the opportunity to benefit in a USD appreciation up to the trigger level. If the trigger trades, the buyer is locked-in at the benefit rate
• There is no fee or premium associated with this contract

Drawback

• The exchange rate of the future cash flow cannot be determined until maturity, although the worst and best case rates are known
• Opportunity to benefit in USD appreciation is limited
• An obligation exists, and hence market risk, if spot is above the protection strike and the underlying FX requirements change

Implied View

• Fairly confident of a USD/CAD appreciation, however require protection in the event view is wrong
• Sensitive to paying a premium. Desire to remain protected within a comfort zone