A Zero-Cost Range Forward, also known as a Flexible Forward or a Zero Cost Option, is a hybrid option that combines a Put and a Call with identical currency amounts and expiry dates to lock in a range of exchange rates at which you can buy or sell foreign currency. This protects you against a negative movement in exchange rates, and still lets you gain if there is positive movement. You pay no up-front cost. While reading about Zero-Cost Range Forwards, keep in mind that an option is said to be "in the money" if the strike price is more favourable than the forward price, "out of the money" if the strike price is less favourable than the forward price, and "at the money" if the two prices are equal.

For Exporters:

If your company exports goods to the U.S., you need to buy Canadian dollars (sell U.S. dollars) to convert your U.S. receivables. You will lose money if the Canadian dollar rises in value because your U.S. dollar receivables will buy fewer of them. Combining options to create a Zero-Cost Range Forward can protect you against this by giving you a range of exchange rates within which you may buy Canadian dollars at expiry. By using the income from the sale of one option to purchase another, you can cover your exposure with no premium paid up front.

As an example, assume:

• You purchase an "out of the money" Canadian Dollar Call at 1.3240. This gives you the right to buy Canadian dollars at a lower rate than the current forward rate.

• You sell an "out of the money" Canadian Dollar Put at 1.3740. This obliges you to buy Canadian dollars at a higher rate than the current forward rate.

These combined contracts create a Zero-Cost Range Forward that defines a range of 1.3240--1.3740 within which your company will buy Canadian dollars at expiry:

• If, at expiry, the Canadian dollar has strengthened to a spot rate below 1.3240, you exercise your Call option and buy Canadian dollars at 1.3240. This is your maximum downside risk. The Put option will simply expire.

• If the Canadian dollar has weakened to a spot rate above 1.3740, TD Bank will exercise the Put option and your company must buy Canadian dollars at 1.3740. This is your maximum upside potential.

• If the Canadian dollar spot rate is between 1.3240 and 1.3740, you let both the Call and Put options expire and simply buy Canadian dollars at the prevailing spot rate.

For Importers:

If your company imports goods from the U.S., you will need to sell Canadian dollars (buy U.S. dollars) to pay these U.S. bills. You will lose money if the Canadian dollar falls in value because it will take more of your Canadian dollars to cover the same U.S. payables. Combining options to create a Zero-Cost Range Forward can protect you against this by giving you a range of exchange rates within which you may sell Canadian dollars at expiry. By using the income from the sale of one option to purchase another, you can cover your exposure at no cost. As an example, assume:

• You purchase an "out of the money" Canadian Dollar Put at 1.3800. This gives you the right to sell Canadian dollars (buy U.S. dollars) at a higher rate than the current forward rate.

• You sell an "out of the money" Canadian Dollar Call at 1.3300. This obliges you to sell Canadian dollars at a lower rate than the current forward rate.

These combined contracts create a Zero-Cost Range Forward that defines a range of 1.3300--1.3800 within which your company will sell Canadian dollars at expiry:

• If, at expiry, the Canadian dollar has weakened to a spot rate above 1.3800, you exercise your Put option and sell Canadian dollars at 1.3800. This is your maximum downside risk. The Call option will simply expire.

• If the Canadian dollar has strengthened to a spot rate below 1.3300, TD Bank will exercise the Call option and your company must sell Canadian dollars at 1.3300. This is your maximum upside potential.

• If the Canadian dollar spot rate is between 1.3300 and 1.3800, you let both the Put and Call options expire and simply sell Canadian dollars at the prevailing spot rate.

For more on how TD can work with you to manage your cash, foreign exchange and interest rate risk, review About TD Financial Management Services. Or, if you have a specific question, e-mail us and a TD Treasury representative will follow-up directly with you.