FORWARD CONTRACTS

A Presentation by Shri R. A. Kamath, Chief Dealer 14-07-2012

FOREX TRANSACTIONS
All forex transactions has 2 aspects:
1.
2.

Rate of Exchange applicable for the deal Date of Delivery of Foreign Currency,

In all forex transactions, exchange rates quoted depends upon date of delivery of underlying foreign currency.

TYPE OF FOREX DEALS

Date of Transactions
09-07-2012

Type of Rate Quoted

Cash

Date of Delivery of Foreign Currency

Same Day Delivery 09-07-2012 Next Day Delivery 10-07-2012

09-07-2012

Tom

09-07-2012

Spot

2nd Day Delivery 11-07-2012

Beyond 2nd Day Delivery i.e. Behind 11-07-2012

09-07-2012

Forwards

WHAT ARE FORWARD CONTRACTS?

They are a type of derivatives used to hedge exchange risk. Basically, there are 3 type of derivatives 1. Futures 2. Options 3. Swaps.

FORWARD CONTRACTS
Futures & Forwards are both hedging instruments with basic difference being:
Futures They are standardised contracts dealt on exchanges They have standard Values Forwards They are Customised contracts dealt on OTC. They can be for any value as agreed between the parties. They are deliverable on any date or period as agreed between the parties.

They are deliverable on standard dates decided by the exchanges

FORWARD CONTRACTS
They are binding agreements between 2 parties wherein one party agrees to buy and other party agrees to sell a certain amount of foreign currency at a certain rate at a certain future date or future period. Since they are binding contracts any changes desired by either of the parties, the other party can seek payment for any loss, actual or notional, from the party desiring changes in the terms of contract.

TYPES OF FORWARD CONTRACTS

Basically, there are two types of forward contracts from Banks view point: 1. Forward Purchase Contracts (where Bank buys foreign currency generally from exporters) 2. Forward Sale Contracts (where Bank sells foreign currency generally to Importers). Further, forward contracts can be segregated based on delivery terms. If delivery is on specific date European Option & if delivery is during specific period American Option.

BASIS FOR BOOKING FORWARD CONTRACTS

1. Forward Contracts can be booked on the basis of i. Underlying confirmed contract in respect of trade / service transaction. ii. On past performance basis. iii. For Exporters to hedge EEFC balances. iv. For Resident Individuals up to USD 100K against self declaration on deliverable basis max. for 1 year period. v. For NRIs to hedge balances in FCNR a/c.

OPERATIONAL GUIDELINES
1. Branches are permitted to book FPC / FSC upto 200% of the Export / Import facility. 2. For customers without credit facilities, requests for booking of Forward contracts may be considered as per del. powers provided in credit policy subject to 10% cash margins 3. Branches should forward request of NRIs to hedge their FCNR / NRE term deposit balances to FED with recommendations who will thereafter seek approval at appropriate level and forward contract will be booked against marking of lien on NRE balances. 4. Appropriate application for FPC or FSC to be taken duly stamped and signed from the customer with Board Resolution in case of ltd. companies.

OPERATIONAL GUIDELINES
5. Documentary Evidence to be taken on record. In case of fax / email order, confirmed order to be obtained within 15 days. 6. Forward contract details to be marked on the documents & application under authentication. 7. Period of forward cover should not exceed the maturity of underlying contract. 8. In case of L/cs opened with documents on sight basis & documents are received, forward contracts cannot be booked.

OPERATIONAL GUIDELINES
9. Delivery under FPC will be considered when INR payment is effected. 10. Delivery under FSC will be construed when Importer makes payment or bills are delinked. 11. In case of contracts booked for hedging EEFC bal., contracts may be rolled over but should not be cancelled. 12. If the due date or the last date of delivery is declared as a holiday, contracts will mature on the previous day.

OPERATIONAL GUIDELINES
13. Substitution of Order is permitted provided the branch is satisfied with the reasons / unavoidable circumstances put forth by the customers. 14. Changes to the terms of contracts may be permitted subject to the customer agreeing to pay 1. Swap Cost and / or 2. Exchange Difference 3. Interest on Cash outlay 4. Charges as per service charges manual.

CULMINATION OF FORWARD CONTRACTS

For all forward contracts booked, liability vouchers are passed by Treasury Department. Hence branches should not pass separate liability vouchers. All forward contracts will result into any one of the following: a. Delivery on due date / option period. b. Cancellation on due date / early cancellation / Late cancellation / automatic cancellation. c. Early Delivery. d. Late Delivery. e. Extension on Due date /early extension / late extension.

FACTORS AFFECTING EXCHANGE RATES

There are several factors which affect exchange rates. To name a few: a. Demand & Supply b. Inflation c. Economic conditions of a country. d. Political situation e. Investment climate. f. Interest rate differentials. g. Technological development h, Tax rules i. Legal setup j. Central Banks policies, controls & interventions.

FISCHERS THEOREM
All forward rates are quoted as under: Spot Rate + /- Forward Margin. Forward Margin can be at a premium in which case it will be added to the spot rate and it can be at a discount in which case it will be deducted from the spot rate. According to Fischers Interest Rate Parity Theorem whether the currency will be at a premium or discount is decided by the interest rate differential between the currency it is compared with.

HOLGATES PRINCIPLE
In case of Fixed date contract what Premium or discount is to be quoted can be decided easily but in case of option period contracts it is difficult. Hence, we should apply Holgates Principle in such cases.
Type of Forward Contract FPC Premium Discount Presume early delivery & pay less premium Presume Late delivery & receive maximum discount

FSC

Presume Late delivery & receive maximum Premium

Presume early delivery & pay less discount

SWAP TRANSACTION
Simultaneously undertaking 2 transactions, a buy transaction and a sell transaction but for different delivery periods. 3 types of Swap transactions are: a. Currency / cross currency swaps. b. Interest rate Swaps. c. Position Swaps.

ANY QUESTIONS PLEASE ???

Thanks to all executives, Staff members from B category branches & Head Office Department & Special thanks to my team members. Ravi Kamath Chief Dealer Treasury Department