Execution of Forward Contract - Forex Management

The foreign exchange may be delivered on the due date as per the forward contract. Or, the delivery may take place earlier of later than the due date. Alternatively, the customer may request cancellation of the contract. This request for cancellation may be made on the due date, before the due date or later than the due date. Yet another alternative is that the customer may request postponement of the date of delivery under the forward contract, This request for postponement may be made on the due date, earlier than the due date or after the due date.

The various possibilities are summarized in the form of a chart below:
FORWARD CONTRACT

forward-contract

From chart it is clear that a forward contract may end up in any of the following ways:

  1. Delivery on the due date.
  2. Early delivery.
  3. Late delivery.
  4. Cancellation on the due date.
  5. Early cancellation.
  6. Late cancellation.
  7. Extension on the due date.
  8. Early extension.
  9. Late extension.

Rule 8 of FEDAI governing this subject stipulates that the request for delivery, cancellation or extension of the forward contract should be made by the customer on or before its maturity date. A forward contract which remains unutilized after the due date becomes an overdue contract. This section deals with delivery on or before the due date.

Delivery on Due Date
This is the situation envisaged when the forward contract was entered into. When the foreign exchange is delivered on the due date, the rate applied for the transaction would be the rate originally agreed, irrespective of the spot rate prevailing. The following example and solution may explain the practice of delivery on due date contract.
Example: The bank has entered into a contract of forward purchase of Swiss Francs 10,000 with a customer at the rate of Rs.32,5000. On the due date, the spot rate of Rs.32,7600/8200. State the amount that will be credited to the account of the customer on purchase of the bill.
Solution: The bank would apply the rate of Rs.32,5000 as originally agreed for purchase of the bill. The amount credited to the account would be Rs.3,25,000.
Example: On 1st March, the bank enters into a forward contract for 2 months for selling USD at Rs.46,6600. On 1st May, the contract is put through in retirement of a bill for USD 1,000 drawn on the customer. On this date, the sopt rates are Rs.49,3100/5600. Calculate the amount that would be debited to the account of the customer.
Solution: The bank would apply the rate originally agreed upon, i.e. Rs.46,6600 and debit the account of the customer with Rs.48,660.

Early delivery of Forward Contract Example

Early Delivery
When a customer requests early delivery of a forward contract, i.e. delivery before its due date, the bank may accede to the request provided the customer agrees to bear the loss, if any, that may accrue to the bank.
When the bank entered into a forward sale contract with a customer, it would have covered its position by entering into a forward purchase contract with the market for the same amount and for a matching period. For example, suppose the bank has agreed on 1st April to sell USD 10,000 to the customer delivery June at the rate of Rs.49,1400. Theoretically, on the same day, i.e., on 1st April, a forward purchase would be made by the bank with the market for USD 10,000 due June. The idea is that during June when the contract matures, the bank can realize the purchase contract and sell it to the customer. Suppose further that the customer requests that the contract be executed on 1St May itself, the Bank would execute the contract at the original rate agreed upon. Viz., Rs.49,1400 and recover separately any loss that it may suffer. Let us study how the loss is computed.
On 1st May the bank can sell US dollars to the customer by buying it from the market at the spot rate prevailing. But the bank has already entered into a forward purchase contract with the market due June and it has to meet its commitment. Therefore, on 1st May, the bank would enter into another forward sale contract with the market due June and thus be able to dispose of the US dollars when received under the forward purchase contract.

The various operations involved may be summarized thus:

with-customer

On 1st May, the bank makes a spot purchase and forward sale of the same currency for the same value. The difference between the rate at which the currency is purchased and sold in a swap deal is the swap difference.
The swap difference may be a ‘swap loss’ or ‘swap gain’ depending upon the rates prevailing in the market. If the bank buys high and sells low, the differences is swap loss recoverable from the customer. If the bank buys low and sells high, the difference is the swap gain payable to the customer.
On 1st May, the bank receives rupees from the customer on sale of foreign exchange to him. It pays rupees to the market for the spot purchase made. If he amount paid exceeds the amount received, the difference represents outlay of funds. Interest on outlay of funds is recoverable from the customer from the date of early delivery to the original due date at a rate not lower than the prime lending rate of the bank concerned.
If the amount received exceeds the amount paid, the difference represents inflow of funds. At its discretion, the bank may pay interest to the customer on inflow of funds at the appropriate rate applicable for term deposits for the period for which the funds remained with it.

Charges for early delivery will comprise of:

  • Swap difference:
  • Interest on outlay of funds: and

In addition, at its discretion, the bank may levy some processing charges.


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