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Tasneem Chherawala
NIBM, 2016
Forward Contract
A bilateral contract between two parties in which one party agrees to buy and the other party
agrees to sell a pre-specified amount (Notional Amount) of an underlying asset at a prespecified future date at a pre-specified price.
Both parties to the contract have both the right and the obligation to settle the deal as per
the specified terms
The current date on which the Forward Contract is originated is the Deal Date (Trade Date)
The pre-specified future date is typically the Maturity / Expiry Date of the Forward Contract.
The pre-specified price is the Delivery Price / Forward Price.
Forward
contract
Long
Position
Payoff
gain
gain
Forward
contract Payoff to
seller
0
Delivery
Price
loss
Spot Price
At Maturity
Delivery
Price
loss
Spot Price
At Maturity
( ST F ) xN
Where K is the delivery price and ST is the spot price of
the asset at maturity of the contract and N is the Notional
Amount of the asset
Similarly, the payoff from a short position in a forward
contract, on one unit of an asset is given by
( F ST ) xN
FX Forward
A FX forward is a bilateral (OTC) agreement to exchange
a pre-specified amount of one currency for another at a
pre-specified Forward Rate (Delivery price) at a predetermined date in the future
In trading parlance, also known as FX Outright
FX
Forward/Outright
Rec: USD
Pay: INR
Deal date
Spot date
Value date
Settlement date
Payoff to
buyer in Rs.
Payoff to
seller (in
Rs.)
66.7225
USD/INR
Spot at
Maturity
66.7225
USD/INR
Spot at
Maturity
Hedging Instrument
Exporter sells EUR 1 mio
forward at forward EUR/INR
rate of 78. 5
If EUR/INR is unfavourable in
3 months (i.e., < 78.5),
Exporter still receives Rs. 78.5
per Euro, that is Rs. 78.5 mio
Effect of Hedging
Hedged Company has already
sold EUR forward
Hedged Company will
receive:
78.5 x 1,000,000 = Rs.
78,500,000
Forward
EUR/INR
Rate
Hedged Position
0
Spot EUR/INR at
Maturity
Spot
EUR/INR at
Trade Date
Short Position in
EUR/INR Forward
(Rs. Million)
Liabilities
(Rs. Million)
Rupee Denominated
265.00
Outside Liabilities
300.00
Owners Equity
160.00
Total Assets
Total Liabilities
460.00
460.00
298
Best Ask
67.36 67.365
138 67.7025
Volume Value
No. of
(Contrac
Spread LTP
(in
OI
Trades
ts)
crores)
5,782.0 1,647,1
1286 0.005 67.3625 859077
33043
7
57
67.71
12 68.0825 68.085
56 0.0025 68.085
2971
13880
94.14 142,459
833
0.015 68.435
2430
16.62 71,858
95
18 68.765 68.7875
66 0.0225 68.745
717
4.93 20,582
40
72 69.105
69.13
50
0.025
69.11
459
3.17 15,770
29
40 69.4025
69.45
11 0.0475
69.43
760
5.28 12,434
25
0.1 69.7175
11
122 68.425
68.44
40 69.675 69.775
10
0.08
2,214
$ Equivalent Amount
Net Settlement
66.00
=$ (1.015 1) million
= $ 0.015 million
FII pays NDF
counterparty
67.00
0 net settlement
68.00
=$(1-0.985) million
=$ 0.015 million
FII receives from NDF
counterparty
FX Swaps
Definition
An FX swap is a contract to buy an amount of currency at an
agreed rate, and simultaneously resell the same amount of
currency for a later value date to the same counterpart, also
at an agreed rate (or vice versa).
Technically an FX swap is a combination of a spot deal and a
reverse outright deal.
Terminology
buy-and-sell; sell-and-buy
In FX swaps the term sell/buy refers to the forward leg.
So if the dealer buys a FX Swap, he sells spot and buys
forward (sell and buy) and if the dealer sells a FX Swap, he
buys spot and sells forward (buy and sell).
FX Swaps
A dealer wants to buy a one-year EUR/USD FX swap for
EUR 10 m.
Which transactions does he conclude?
Sell-and-Buy EUR 10 m
The dealer will buy Euro one-year Forward and
simultaneously sell Euro spot
FX Swaps
Amount:
In a regular FX swap the base currencies amount
both for the spot and the forward transaction is the
same, in the example EUR 10 m.
However FX swaps can be structured with uneven
amounts as well.
Interpretation:
A pair of offsetting FX transactions for different value
dates, concluded at the same time and on the same
deal ticket with the same counterpart
The dealer is actually lending EUR for 12-month time
and simultaneously, borrowing USD over the same
period without FX risk
FX Swaps Applications
FX swaps are often employed if an existing asset
(liability) in one currency shall be transformed into an
asset (liability) in another currency for a specified period.
Corporate treasuries use it for switching from one
currency to another
They are also used to efficiently roll over existing FX
hedging contracts to later maturities
FX swaps are off balance products with which a banks
cash liquidity position can be managed very efficiently.
FX Swap Applications
An Indian firm currently has INR 6,00,000 cash available
It also has a 3-month USD 10,000 funding requirement
and wishes to utilise its INR funds to meet this funding
requirement without incurring FX risk
It sells a 3 month USD/INR FX Swap, in which it buys
USD spot against INR and sells USD 3 months forward
against INR.