Factors that affect the price of FX warrants

Similar to the Hang Seng Index and single stock warrants, the price of FX warrants is influenced not only by changes in the price of the underlying assets, but also by factors such as time decay, implied volatility, interest rate and outstanding volume, as shown in the table below:

Factors that affect the price of FX warrants
Factor Call Put
1. Base currency against the quote currency rises
2. Implied Volatility rises
3. Longer Maturity
4. Base currency against the quote currency yield spread increases

Impact of interest rates on the price of FX warrants

The influence of interest rates on FX warrants can be broadly divided into two parts. Firstly, it involves the fluctuation of the interest rate of both currencies and the impact of the market’s expectation of interest rates on the exchange rate trend itself. Secondly, it considers the impact of the expected change in the interest rate difference between the currency pairs on the valuation of FX warrants. Interest rates play a pivotal role in foreign exchange movements. In general, if the interest rate of a currency rises and the spread widens relative to another currency, investors may be inclined to buy a currency with a higher interest rate, thereby increasing the value of the currency.

However, is the rise in interest rates necessarily increase the exchange rate? Investors should note that this relationship is not inherently positive.

If interest rates continue to rise in one country, the borrowing cost for businesses and households will increase significantly due to the tightening of monetary policy. This increase could potentially slow down economic activity, affecting how the market sees the economic outlook and potentially causing a negative impact on exchange rates.

Think of it like when a company increases its the dividend, the stock price doesn’t always go up- but may sometimes fall. This depends on factors such as the market outlook towards the company's capital level, future earnings, the broader economic trends, and the flow of money in the market. So, when investors considering the future trend of the underlying assets, they should weigh in various fundamental and market factors before making directional investments.

Changes in the interest rate spread of currency pairs and the pricing of warrants

Anticipated changes in interest rate differentials between currency pairs will affect the trend of FX rates. For example, the FX warrants listed on the Hong Kong Stock Exchange are denominated in Hong Kong dollars, the interest rate differential between Hong Kong dollars and foreign currencies will impact FX warrants prices.

Example: GBP/HKD warrants

Assuming that the Bank of England raises interest rates, and the market anticipates an increase in the sterling interest rate to rise, while the Hong Kong dollar interest rate expectation remains unchanged, the price of GBP/HKD call warrants would fall, and put warrants would rise as the interest rate spread widens between the base currency and the quote currency.

It's important to understand that big shifts in interest rates over a short period of time are rare. As a result, these changes usually don't have a huge impact on the FX warrants price. The main factor that affects the prices of FX warrants is the trend of the currency pair itself.

*The interest rate expectations mentioned above cover different interest rate instruments in the interest rate market.

Foreign Exchange Warrants Risk Factor

Trading Time Difference

While the global foreign exchange market operates around the clock, foreign exchange warrants listed on the Hong Kong Stock Exchange are traded during the Hong Kong stock trading session. For example if a significant change occurs in the foreign exchange market after the Hong Kong Stock Exchange closes or during the New York trading session, investors won’t be able to promptly execute their buying and selling instructions.

Market liquidity

Currently, the Chinese Renminbi /HKD warrants issued by J.P. Morgan are linked to Offshore Chinese Renminbi /HKD currency pair. Investors need to be aware that the limited pool of RMB outside of Chinese Mainland, and any tightening of foreign exchange control could potentially impact the liquidity of Offshore Chinese Renminbi. This in turn may affect the price and potential returns of FX warrants. Investors should also note that the exchange rates quoted for onshore and offshore Chinese Renminbi are not the same, and the direction and magnitude of exchange rate movements may exhibit inconsistencies.

The above information provided by J.P. Morgan Securities (Asia Pacific) Limited ("J.P. Morgan") is for information and discussion purposes only and is not intended as an offer, invitation, inducement, advice, recommendation or solicitation for the purchase or sale of any above-mentioned listed structured products or financial instruments nor does it constitute a commitment by J.P. Morgan or its affiliates ("J.P. Morgan Group") to enter into any transaction. Past performance is not indicative of future results. There can be no assurance that future results or events will be consistent with any opinions, forecasts or estimates herein.
FX warrants (or currency warrants) are non-collateralised structured products. The price of the structured products may fall in value as rapidly as it may rise and investors may sustain a total loss of their principal invested. J.P. Morgan does not act as a fiduciary for or an advisor to any investor and is not responsible for determining the legality and suitability of an investment in any products or financial instruments by any prospective purchaser or existing holders. Investors must make their own risk assessment and where necessary, seek professional advises. Investor should not invest in these structured products unless they carefully read and understand the terms and conditions, risk factors and other information as set out in the relevant listing documents, and fully understand the features of the structured products and are willing to assume the risks associated with them.