Guide to net positions
A net position allows investment funds to enter into a series of forward contracts with a reduced propensity of being margin called.
All forward contracts are collated to create a cumulative risk position.
For a standard forward contract the classic credit conditions are based on a percentage and Tait takes into account the exposure per trade. Whereas, with net credit positions, we look at the overall exposure per client and calculate based on absolute values.
Net positions increase flexibility and, when used in conjunction with your custodian bank, ensure a more competitive environment for your credit conditions when engaging in currency risk strategies.
Mechanics of a net position
The following examples demonstrates how net positions work in practice.
Contract terms: Initial deposit: 0% Variation margin: GBP 500,000 Margin call: GBP 250,000
Open forward positions: Position 1: Buy ZAR 126,000,000 Sell USD 7,000,000 @ 18.00 Position 2: Buy INR 198,000,000 Sell GBP 2,000,000 @ 99.00
Suppose GBP depreciates by 5% against INR and suppose USD appreciates by 7.5% against ZAR. This affects the open positions in the following ways:
Position 1: A negative exposure of USD 525,000 (@ 1.3095 GBP/USD, this is 400,900 GBP) Position 2: A positive exposure of GBP 100,000 Combined: A negative exposure of GBP 300,900
In this case, the use of a net position means the combined exposure does not exceed the variation margin of GBP 500,000, so a margin call would not be executed.
If a net position were not in place, a margin call would need to be executed for position 1. As standard forward contracts use classic credit conditions based on a percentage, a 2.5% variation margin and a 2.5% margin call, given the 7.5% appreciation of USD against ZAR, would result in 3 margin calls being issued. This would total a cost of 525,000 USD or 400,900 GBP.
So the net position has saved you from being margin called.
Suppose GBP depreciates by 2.5% against INR and suppose USD appreciates by 12.5% against ZAR. This affects the open positions in the following ways:
Position 1: A negative exposure of USD 875,000 (@ 1.3095 GBP/USD, this is 670,000 GBP) Position 2: A positive exposure of GBP 50,000 Combined: A negative exposure of GBP 620,000
In this case, the combined exposure exceeds the variation margin of GBP 500,000, so a margin call would need to be executed. The margin call issued would request a payment of GBP 250,000, as set out in the initial terms of the contract. This payment decreases the combined exposure from GBP 620,000 to GBP 370,000, back below the variation margin. As net positions are in place, only a single margin call is required.
If the exposure increases above GBP 500,000 again, another margin call will be issued. If the exposure drops to zero, the margin call will be refunded.
If a net position were not in place, the positive exposure of position 2 would not offset any of your negative exposure on position 1. As standard forward contracts use classic credit conditions based on a percentage, a 2.5% variation margin and a 2.5% margin call, given the 12.5% appreciation of USD against ZAR, would result in 5 margin calls being issued. This would total a cost of 875,000 USD or 670,000 GBP.
So the net position has saved you from being margin called multiple times.
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