FORWARD

CONTRACTS
Module:6
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FC is an agreement to buy or sell a specified asset at a certain time in the future
for a specified price agreed upon at the time of entering into a contract.
 Involves minimum two parties(buyer & seller) and customized where relevant
aspects of asset, quantity, price and delivery date are fixed.
 In the process, both buyer and seller avoid the price risk by prior negotiation &
locked the price in advance i.e. today.
 The seller is committed to make delivery on due date and the buyer is obliged to
pay the consideration.
 The buyer and seller of the contract assume risk, referred as counter party risk
on each other.
 Cancellation is possible with the mutual consent of both the parties prior to the
maturity of the contract.
 No exchange of money is done at the time of entering the forward contract.
However initial deposit (Margin Money) may be insisted and adjustable against
price and delivery to mitigate counter party risk. DO NOT SHARE WITH ANY BODY OUTSIDE THE CAMPUS
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The forward contract under which the delivery of foreign exchange, both buy and
sell should take place on a specified future date is known as “ Fixed Forward
Contract”.
Example:
An exporter, on 5th March, enters into a 3 month forward contract with his bank
to sell US$ 10,000, it means the exporter would be presenting a bill on 5th June to
the Bank. Exporter can not deliver foreign exchange i.e. US $10,000/ prior to or
later than 5th June.
Limitations:
1. Purpose will be defeated if the customer unable to deliver foreign exchange
exactly on due date. DO NOT SHARE WITH ANY BODY OUTSIDE THE CAMPUS

2. It is not possible for any customer to determine in advance the precise date on
which he will be tendering export documents.
3. It will be perfect for the exporter to have a period of days around
predetermined fixed date .
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An arrangement whereby the customer can sell or buy from the bank foreign
exchange on any day during a given period of time at a predetermined rate of
exchange is known as “Option Forward Contract”. The rate at which the deal
takes place is the option forward rate.
Example:
 On 30th Sept a customer enters into two months forward sale contract with the
bank with option over November.
 It means the customer can sell foreign exchange to bank on any day between 1st
Nov and 30th Nov.
 The period from 1st to 30th Nov is known as the “ Option Period”.
 Bank can not force the customer to deliver foreign exchange on any specific day.
 It is up to the customer to choose any working date within the option period.
 Option period, normally, should not be more than one month.
 Exchange control regulations are to be followed compulsorily both by the bank
and customer DO NOT SHARE WITH ANY BODY OUTSIDE THE CAMPUS
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 Exporters who expect to realize the sales in foreign currency face the risk of falling
price of foreign currency, need to protect asset loss i.e. receivables.
 If the foreign currency appreciates i.e. home currency depreciates , the value of the
assets would rise and exporter welcome it.
 In case of depreciation in foreign currency, is a cause of concern for exporter.
 This concern may be mitigated by selling the anticipated foreign currency by executing
a forward contract with the Bank.
 Exporter promised to deliver the foreign currency in exchange of receipt of the
domestic currency at a rate fixed now.
 Similarly, importers who have to make a definite payment in foreign currency at a
future date are apprehensive of its rising prices.
 The situation can be mitigated by freezing the exchange rate now by entering into a
forward contract to by the foreign currency.
 The importer would obtain the requisite foreign currency in exchange of delivery of
domestic currency with a rate fixed with the Bank now. DO NOT SHARE WITH ANY BODY OUTSIDE THE CAMPUS
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An exporter has sold merchandise worth GBP1,00,000 to a customer in England with a
payment term of 3m i.e. exporter expects to receive the money on three months from
now. The spot price of pound quoted by the Bank is Rs 86.2075.The exporter is expecting
depreciation of pound during the next three months and expects the price to be Rs86.00.
What exporter do to protect himself from depreciating pound/appreciation of rupee?
(Bank Quote 3 months forward rate for pound at Rs86.1075)
Solution:
 Exporter can sell a 3 m forward contract for GBP1,00,000 to the Bank and mitigate the
anticipated losses.
 Bank will pay Rs GBP1,00,000X86.1075=Rs86,10,750/ to exporter.
 If the rate reach to anticipated level of Rs86/ the exporter will realize Rs 86,00,000/.
 The exporter will be benefitted by Rs10,750/ due to entering forward contract.
 On the other hand if pound sterling(FC) say appreciate to Rs 86.2625, the realization
would be GBP1,00,000X86.2625=Rs86,26,250/ i.e. Rs15,500/ more than what is being
realized from the forward contract. DO NOT SHARE WITH ANY BODY OUTSIDE THE CAMPUS

Hedging ? Consists of taking an offsetting position in a related security.

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An importer has purchased a machine from a supplier in Germany for $ 10,000 for which
the payment is due in six months. The current(spot) price is Rs76.4075.The importer is
expecting USD to appreciate to a level of 76.6500 in six months time and is worried about
rising value of USD. What can be done to safeguard importer’s interest?
(Bank Quote 6 months forward rate for USD at Rs76.5500)
SOLUTION:
 The importer is expecting cash outflow of Rs 7,66,500/ if his anticipation about value of
USD proves correct.
 To save guard his position the importer may buy $ 10,000, 6 m forward from the bank.
 At the time of making the payment in USD after 6 months without booking forward:
Bank will provide the importer: $ 10,000
Importer will pay to the Bank: Rs 7,66,500/($ 10,000X76.6500)
 By booking of a forward buy contract, importer has ensured that it does not end up
paying more than Rs7,65,500 . The position will be clear on the spot rate at 6m.
 If spot rate is less than 76.5500, importer will loose. On the other hand , if spot rate is
greater than 76.5500, importer will gain.
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The forward contract under which the delivery of foreign exchange should take place on
a specified future date is known as “ Fixed Forward Contract”.
CALCULATION OF FIXED FORWARD BILL BUYING RATE
Rupee/Dollar market spot buying rate =Rs
Add: Forward premium (For forward period, transit period and Usance
period(Rounded off to lower month) OR
Less: Forward discount(For forward period , transit period and Usance period +
(Rounded off to higher month) - Rs
Less: Exchange Margin -Rs
Forward bill buying Rate for Dollar(Rounded off to multiple of 0.0025 =Rs

Say, Bank buys a 30 days sight Dollar bill for 2 months forward.
If the currency is at a premium: DO NOT SHARE WITH ANY BODY OUTSIDE THE CAMPUS

 For premium is (30 days+25 days+2 months), rounded off to previous month of DD
If the currency is at a discount
 For discount is(30 days+25 days+2 months), rounded off to due date month
TT buying rate, forward margin will include only 2 months forward period. 8
In the case of forward selling rates, the forward margin will include forward
period only. In other respects, the calculation is same as that of ready rates.
FORWARD SELLING RATES
Rupee/Dollar market spot selling rate =Rs
Add: Forward Premium(Forward Period)
OR +Rs
Less: Forward Discount(Forward Period) _Rs
Add Exchange margin for TT selling rate +Rs
Forward TT selling rate for dollar Rs
Add: Exchange Margin for bill selling rate +
Forward bill selling rate for Dollar Rs
Rounded off to nearest multiple of 0.0025 Rs
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From the following information you are required to calculate
A. Ready bill buying rate
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B. 2 months forward buying rate for demand bill
C. Ready rate for 60 days Usance bill
D. 2 months forward buying rate for 60 days Usance bill
Interbank US dollar rate
SPOT USD1 = 72.6000/6075
1 MONTH 3500/3600
2 MONTHS 5500/5600
3 MONTHS 8500/8600
4 MONTHS 1.1500/1.1600
5 MONTHS 1.3500/1.3600
6 MONTHS 1.5500/1.6600
Other Information:
 Transit period is 20 days.
 All forward rates are for fixed delivery.
 Exchange margin is 0.10% 10
 DO NOT SHARE WITH ANY BODY OUTSIDE THE CAMPUS

A. Ready buying rate

Dollar /Rupee interbank spot buying rate = Rs7
Less: Exchange Margin at 0.10% on Rs72.60000 =
Rs 7
As per FEDAI Rule =Rs72.5275
B. 2 months forward buying rate
Dollar/Rupee interbank spot buying rate =Rs72
Add: Forward premium for 2 months(Transit Period
20 days and forward period 2 month), considered
previous month of due date = 0
= Rs 73
Less: Exchange Margin 0.10% of Rs73.1500 = 0
Rs73 11
 DO NOT SHARE WITH ANY BODY OUTSIDE THE CAMPUS
C. Ready rate for 60 days Usance bill
Dollar/Rupee interbank spot buying rate =Rs72.6000
Add: Forward premium for 2 months(Transit Period
20 days and forward period 2 month), considered
previous month of due date = 0.5500
= Rs 73.15000
Less: Exchange Margin 0.10% of Rs73.1500 = 0.07315
Rs73.07685
As per FEDAI Rule: Rs73.0775
D. 2 months forward rate for 60 days bill
Dollar/Rupee interbank spot buying rate =Rs72.60000
Add: Forward premium for 4 months(Transit Period
20 days and forward period 2 month Usance 60 days),
considered previous month of due date = 1.15000
= Rs 73.75000
Less: Exchange Margin 0.10% of Rs73.7500 = 0.07375
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From the following information you are required to calculate
A. 1 month forward TT selling rate
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B. 3 months forward bill selling rate
Interbank US dollar rate
SPOT USD1 = 72.6000/6075
1 MONTH 3500/3600
2 MONTHS 5500/5600
3 MONTHS 8500/8600
4 MONTHS 1.1500/1.1600
5 MONTHS 1.3500/1.3600
6 MONTHS 1.5500/1.6600
Other Information:
 Exchange margin for TT selling rate is 0.15%
 Exchange margin for Bill selling rate is 0.20%

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A. 1 month forward TT selling rate DO NOT SHARE WITH ANY BODY OUTSIDE THE CAMPUS

Dollar /Rupee interbank spot selling rate = Rs72.60750

Add: One month forward = 0.10945
TT selling Rate Rs 73.07695
As per FEDAI Rule =Rs73.0770
B. 3 months forward bill selling rate premium = 0.36000
Rs72.96750
Add: Exchange Margin at 0.15% on Rs72.96750
Dollar/Rupee interbank spot buying rate =Rs72.60750
Add: Forward premium for 3 months 0.86000
TT selling Rate =Rs73.46750
Add: Exchange Margin for TT selling at 0.15% of Rs73.4675 = 0.11020
TT selling Rate Rs73.57770
As per FEDAI Rule: Rs73.5775
Add: Exchange Margin for bill selling at 0.20% of Rs73.57770 0.14715
Bill Selling Rate Rs73.72485
As per FEDAI Rule: Rs73.7250
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One export customer requests you on 15th July to book a foreign exchange
contract delivery September covering 30 days sight bill in New York under an
irrevocable letter of credit for USD 65000. DO NOT SHARE WITH ANY BODY OUTSIDE THE CAMPUS

Assuming US dollars are quoted in the local interbank market as under

SPOT (15/7) US$1= 72.5675/5750
SPOT/July 800/900
SPOT/Aug 1700/1800
SPOT/Sept 2250/2325
SPOT/Oct 3200/3300
SPOT/Nov 4100/4200
SPOT/Dec 5150/5250
Required:
1. Quote
2. Exchange Margin:0.10%
3. Transit Period: 20 days
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 The option to the customer is over September.
 The rule is to take the earliest delivery.
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 Taking earliest delivery, the date of delivery will be taken as 1st Sept.
 The Usance period of the bill 30 days and transit period of 20 days will work
out to 19th Oct as the probable date of the bank acquiring foreign exchange.
 As dollar is at a premium, quote to be rounded off to the previous month
 The rate to the customer will be based on Spot/Sept buying rate of prevailing
interbank market rate.
Dollar/Rupee interbank buying rate 72.56750
Add: Premium 0.22500
72.79250
Less : Exchange Margin o.10%on Rs72.79250 0.07279
Quote 72.71971
Rounded off to (FEDAI); Rs 72.7200 16
An importer wants to book forward contract on 2nd Aug’20 for sale by Bank to himm of
US$150000 full Nov. Prevailing interbank market rate & exchange rate:05%
SPOT rates on 2/8/20 US$1= 72.3700/3800
SPOT/Aug 0300/0400
SPOT/Sept 1100/1300
SPOT/Oct 1900/2200 DO NOT SHARE WITH ANY BODY OUTSIDE THE CAMPUS

SPOT/Nov 2700/3100
Solution: SPOT/Dec 3500/4000
The rate to the customer will be based on SPOT/Nov rate in the interbank market
Dollar/Rupee spot selling Rate Rs72.3800
Add: Premium 0.3100
Rs72.69000
Add: Exchange Margin(0.05% onRs 72.6900) 0.03634
Rs72.7266
Rounded off(FEDAI): Rs72.7275 17
 Exporter and importer have assured themselves of a fixed price mitigating
uncertainties against cost.
 The cost of forward hedge is measured in terms of premium or discount over
the spot price of the currency.
If forward price is higher than the spot price, the currency is said to be at
premium and reverse for discount. Therefore

Cost of Hedging=( FF - S 0 ) / S 0 [ If FF > S 0 -Premium, If FF < S 0 -Discount]

 The efficacy of the forward hedge can be measured only after the forward
contract period is over.
 The real measure of effectiveness of forward hedge comes from the spot price S F
at the end of the period of hedge, which reflects whether exporter/importer
actually benefited from the forward hedge or not.
The real cost of hedging = ( FF - S F ) / S 0
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1. Borrowed USD1 in the USA at the interest rate of RUSD for one year.
2. Convert USD1 into Indian Rupees at the exchange rate S 0 , which would give INR S 0.
3. Invest INR S 0 in India at an interest rate R INR for one year which would give
INR S 0 X (1+ R INR ) after one year.
4. Enter, simultaneously, into a forward contract to buy 1US dollar, after one year, at a
forward rate of F360.
5. After one year, enforce the forward contract at F360& sell investment and receive
S 0 X (1+ R INR ), This would give USD [ S 0 X (1+ R INR)/F360]
6. Pay back the loan which is (1+ RUSD ) from the amount received after converting the
Indian Rupees at the forward rate. Net Gain= [ S 0 X (1+ R INR)/ F360 ]- (1+ RUSD)
In an ideal situation, , there should be no gain i.e. Zero.
Therefore, [ S 0 X (1+ R INR)/ F360]= (1+ RUSD)
Forward rate F360 can be derived as, (1  R INR ) (1  R H )
F360  S 0 X  S0 X
(1  RUSD ) (1  R F )
Whenever, this theoretical relationship is violated, there will be an arbitrage opportunity.
It is called the covered interest rate arbitrage.
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Arjun is an NRI investor who has an opportunity to invest in India as well as in the USA.
The investment in USA can be made at 4% pa while the interest rate in India is 10% pa.
Since the interest rate in India is higher, the NRI investor, Arjun, decides to invest
USD100,000 in India for 90 days . Assume the current exchange rate is USD1=Rs65.
Calculate the 90 day and 180 day forward rates.
90 DAYS FCR 180 DAYS FCR
90 days interest rate in India = 180 days interest rate in India=
10%X(90/360)=2.5% 10%X(180/360)=5%
90 days interest rate in US= 180 days interest rate in US=
4%X(90/360)=1% 4%X(180/360)=2%
Then, Then,

1  0.025 1.025 1  0.05 1.05

F90  65 X  65 X  Rs 65.9653 F180  65 X  65 X  Rs 66.9117
1  0.01 1.01 1  0.02 1.02
=Rs65.9650 =Rs66.9125 DO NOT SHARE WITH ANY BODY OUTSIDE THE CAMPUS
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Forward Premium, can be expressed in terms of currency appreciation on a forward
basis. Forward premium is the forward rate expressed as the percentage increase from
the current spot rate and is written as under
FF  S 0 FF
Forward Pr emium   1
S0 S0
1  R INR FF 1  R INR
We know, FF  S 0 X , Therefore,  ,
1  RUSD S0 1  RUSD
FF 1  R INR R INR  RUSD
Now, 1  1 
S0 1  RUSD 1  RUSD

I. Thus Forward Premium is the difference between the home interest rate and the foreign
interest rate divided by (1+ foreign interest rate).
II. When the home country interest rate is higher than the foreign interest rate , the home
currency is expected to depreciate by a rate equal to the difference of the two interest rates.
III. If the annual interest rate in India is 10% and 4% in the USA, 6% is the interest rate
differential .Interest rate in India being higher, Indian rupee is expected to depreciate by
about 6% over a year or by about 1.5% every three months. DO NOT SHARE WITH ANY BODY OUTSIDE THE CAMPUS
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Hyundai Motors exports cars to Germany and every three months, it would receive
EUR500,000 from car shipment. On Jan 1st ,the exchange rate between the Indian Rupee
and the EURO was, € =Rs76.2750. The interest rate in Germany is 6% pa while the
interest rate in India is 9%pa. Hyundai wanted to hedge its Euro receipt through forward
contracts for the next six months.
1) What type of hedging activity would be suitable for Hyundai?
2) What would be the amount in Indian Rupees that Hyundai will receive after 90 days
and after 180 days if it enters into a 90- day and 180- day forward contracts
respectively? DO NOT SHARE WITH ANY BODY OUTSIDE THE CAMPUS
ANS: 1) Since Hyundai will be receiving Euros and converting them into Indian Rupees,
the appropriate hedging contract will be the forward selling of Euros for HYUNDAI.
2) The amount in Indian Rupees that Hyundai will receive can be ascertained as under
3) 90 -day interest rate in euro=6%X90/360=1.5% 180 -day interest rate in euro= 6%X180/360=3%
90 -day interest rate in Indian Rupees= 180 -day interest rate in Indian Rupees =
9%X90/360=2.25% 9%X180/360=4.50%
90 –day forward rate= 180 –day forward rate=
76.2750X(1+0.0225)/(1+0.015)=76.8375 76.2750X(1+0.045)/(1+0.03)=77.3850
Amount Received, Amount Received,
500,000X76.8375=Rs3,84,18,750 500,000X77.3850=Rs3,86,92,50022
GOOD
WISHES
TO ALL
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