Often businesses choose to hedge currency risk by buying a structured hedging product from a specialized broker or investment bank with a FX pair as an underlying asset class. Quite othen these structured derivatives are nothing else but a combination of multiple derivatives, each of them could be bought or sold in the markets directly. In such instances, the main service of a broker or a bank is convenience – the hedging product combines multiple derivatives into a single package with a zero cost to the buyer – often called premium-free product.
Financial derivatives trade at what is commonly known as bid and offer prices – prices at which broker/dealer offers to sell (client goes long) or buy (client sells short) a derivative. As with any market – the higher bid/offer price range (spread), the larger potential profit for the broker. Typically, brokers and banks design structured hedging products as a combination of multiple instruments and use short positions to make hedging products more affordable than normally. This also means that they are the sellers/buyers of these products at prices favourable to them. The end result is, that once the product is decomposed into its constituents, clients can end up paying rather high “convenience” price for packaging up these derivatives into a product.If you wouldn’t know how to decompose the structured product the broker has proposed, you wouldn’t know about the hidden fees you are actually paying. Also you should pay extra attention when analyzing the worst scenario outcomes as built in short options positions to make the products look cheaper can actually increase risk exposure in the most unfavourable scenarios for the company!
Thus, a structured hedging product might be ‘premium-free’ but certainly not. Furthermore, the ways that the product is designed to be ‘premium-free’ can often expose business to additional risks that it certainly is not looking for.