Abstract
In this paper, we review the role of market microstructure issues in the design and function of tax shelter schemes based on exotic currency option transactions. We review instruments commonly used in the currency derivative markets and discuss the critical role of market frictions in evaluating the sensibility of transactions from an economic perspective. We analyse a sample transaction with a potential 'sweet spot' payoff in order to identify the role of the potential sweet spot payoff in the valuation of the structure. We estimate the fundamental value of the structure using a theoretical value for the sweet spot. We then explain that realistic consideration of market microstructure, or trading frictions, suggest that the actual value claim for a potential sweet spot payoff is zero. Our analysis provides a simple framework for determination of the reasonableness of a claimed profit motive as motivation for entering into structured transactions that contain currency derivatives.
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