Beware the TARF my son

What is a Target Redemption Forward (TARF)? The hidden risks of this exotic FX option.

If Lewis Carroll had been a risk manager he might have written:

“Beware the TARF my son

The vol that bites, the losses that snatch

Exotic options are no fun

When you learn there’s always a catch”

TARFs (or Target Redemption Forwards) are complex foreign currency derivatives (a form of exotic option). In essence they provide enhanced protection against adverse currency moves but terminate if a certain target is exceeded, leaving the purchaser exposed. The target can be set as the number of times a barrier level is hit or a maximum cumulative profit reached.

Numerous users of these products recently incurred losses as a result of market volatility. In some cases sellers of these products have compensated purchasers who feel they were not properly advised of the risk associated with TARFs. In our experience, any user of an exotic option is not a true hedger but either has some ‘view’ on the market or has been sold some-one's view on the market. TARFs are effectively trading instruments and any company using them is not truly hedging. Smaller companies especially would do better to keep their hedging simple and avoid these products which typically are complex to value and seldom can achieve hedge accounting. Perhaps Barrier Redemption Forward (or 'BARF') might be a better name.

To us the biggest loss these products cause is the general tarnishing of the derivatives market that occurs. Derivatives, and by extension hedging, can get a bad name and engender fear in some CFOs and boards. This can lead to companies avoiding transacting any hedging ironically exposing companies to significant risk.

Forge aHedge helps companies manage their commodity and fx hedging and truly understand their expected cashflows under varying potential price scenarios and hedging strategies.

Let's Forge aHedge!