Average Rate Option - ARO
Definition of 'Average Rate Option - ARO'An option used to hedge against fluctuations in exchange rates by averaging the spot rates over the life of the option and comparing that to the strike price of the option. Average rate options are typically purchased for daily, weekly or monthly time periods. Upon maturity, the average of the spot prices is compared to the strike price. If the average rate is less favorable than the strike price, the option issuer will pay the difference. If the average rate is more favorable then the option will expire worthless with no payment being made.Average rate options are often used by companies that receive payments over time that are denominated in a foreign currency. |
|
Investopedia explains 'Average Rate Option - ARO'For example, a U.S. manufacturer agrees to import materials from a Chinese company for 12 months, and pays the supplier in yuan. The monthly payment is 50,000 yuan. The manufacturer budgets for a particular exchange rate, and purchases an ARO that matures in 12 months to hedge against the exchange rate falling below the budgeted level. At the end of each month, the manufacturer purchases 50,000 yuan on the spot market to pay the supplier. Upon maturity of the ARO, the strike price of the ARO is compared to the average rate that the manufacturer has paid for the purchase of 50,000 yuan. If the average is lower than the strike, the option issuer will pay the manufacturer the difference between the strike price and average price. |
Related Definitions
Articles Of Interest
-
What Causes A Currency Crisis?
Find out what can cause a currency to collapse, and what central banks can do to help. -
Hedging Basics: What Is A Hedge?
This strategy is widely misunderstood, but it's not as complicated as you may think. -
How To Profit From Interventions In The Forex Market
The forex market can be extremely profitable. Learn how to spot an intervention and trade when it's occurring. -
Global Trade And The Currency Market
Learn how the Bretton Woods system got the ball rolling for world trade. -
How Companies Use Derivatives To Hedge Risk
Derivatives can reduce the risks associated with changes in foreign exchange rates, interest rates and commodity prices. -
6 Factors That Influence Exchange Rates
Find out how a currency's relative value reflects a country's economic health and impacts your investment returns. -
6 Asset Allocation Strategies That Work
Your portfolio's asset mix is a key factor in whether it's profitable. Find out how to get this delicate balance right. -
American Vs. European Options
These two options have many similar characteristics, but it's the differences that are important. -
Pay Attention To The Proxy Statement
Don't overlook this overview of a company's well-being. -
How Risk Free Is The Risk-Free Rate Of Return?
This rate is rarely questioned - unless the economy falls into disarray.
Free Annual Reports