FORWARD CONTRACT

CONVENTIONAL PROCESS FOR

FORWARD CONTRACT
Forward Exchange Cover (FEC) facility is

available to Importers/Exporters to mitigate

exchange risks on under Document Credits
(DC) and Import/Export Contract (Cont)

Importer/Exporter can enter into Forward

Contract for sale/purchase of foreign

currencies with the Bank at any time from
the opening/registration of the DC/Cont
subject that the period of the FEC should not
exceed the validity of the DC/Cont
2

REGULATIONS
FE

cir 10/26.05.99):To prevent speculation by

importers and exporters, Banks are instructed that in
case of closing out of FEC with customers where
underlying DC/Cont has been cancelled or has expired
un-utilized, the spot rate for counter transaction would
be lower/higher of those prevailing on the date of
booking of the FEC and the date of close out.

FE cir 10/26.05.99):FEC for period less than one

month is prohibited,FEC for one month will be for

fixed maturity, in case payment is effected within one
month this will be done applying Spot selling rate
prevailing rate on the date of payment and the FEC
will be closed out at the maturity date.

Importer Forward Contract

for purchase of foreign
currency

1) Day 1 Importer comes to MBL. He has to pay US$

2)
3)
4)
5)
6)

1 million on Day 90. Wants to book forward rate.

Prevailing Rate on Day 1 is 60.
MBL buys US$ 1million spot @ 60
MBL enters into a spot sale: forward buy swap
with another bank XYZ
XYZ Bank charges a Rs 1 premium
MBL adds its fee of Rs 0.10 and quotes a forward
rate of 60+1+0.1 = 61.1. MBL enters into a
forward sale contract with the client.

Importer Forward Contract

for purchase of foreign
currency CONTD.

7)

On Day 90, Importer pays 61,100,000/- to MBL and

gets US$ 1 million.
8) On Day 40, Importer indicates his inability to take the
delivery and wishes to close out
9) MBL sells $ to client on Booking Rate i.e. @ 61.1 and
buys it back at the lower of:
10) Prevailing Rate on Day 1 i.e. 60
Prevailing Rate on Day 40 say 61
11) Client will be charged 61.1-60 = 1.1 per $ i.e.
1,100,000
12) In case the prevailing rate on Day 40 was 58,
13) The importer will be charged 61.1-58 = 3.1 per $ i.e.
3,100,000

Exporter Forward Contract for

sale of foreign currency
1) Day 1 Exporter comes to MBL. He will receive
US$ 1 million on Day 90. Wants to book forward
rate.
2)Prevailing Rate on Day 1 is 60.
3)MBL sells US$ 1million spot @ 60
4)MBL enters into a spot buy: forward sale swap
with another bank XYZ
5)XYZ Bank charges a Rs 1 premium
6) MBL adds its fee of Rs 0.10 and quotes a
forward rate of 60-1-0.1 = 58.9

Exporter Forward Contract for

sale of foreign currency CONTD.
7) On Day 90, Exporter receives 58,900,000/- and pays US$
1 million to MBL.
(7A)On Day 40, Exporter indicates his inability to give the
delivery and wishes to close out
8)MBL buys $ from the exporter on Booking Rate i.e. @
58.9 and sell it back at the higher of:
(i) Prevailing Rate on Day 1 i.e. 60
(ii)Prevailing Rate on Day 40 say 59
9) Client will be charged 60-58.9 = 1.1 per $ i.e. 1,100,000
In case the prevailing rate on Day 40 was 62,
the exporter will be charged 62.-58.9 = 3.1 per $ i.e.
3,100,000

SHARIAH ALTERNATIVE FOR FORWARD

CONTRACT

Importer Forward Contract for

purchase of foreign currency
Scenario 1: Complete Transaction maturing on Forward Delivery Date

Day 1 Importer comes to MBL. He has to pay US$ 1M on Day

90 to his overseas supplier. Wants to book forward rate.
1) Prevailing Rate on Day 1 is 60.
2) MBL enters into an agreement to purchase w/ another bank
XYZ US$ 1M on Day 90 say @ 61
3) MBL adds its fee of Rs 0.10 and quotes a forward rate of
60+1+0.1 = 61.1 Rs/US$. MBL enters into an agreement
with the client to sell $1 million on Day 90.
4) On Day 90, importer pays Rs 61.1M to MBL.
5) MBL keeps Rs 100,000 as its fee and pays Rs 61M to XYZ
bank to receive US$ 1M.
6) MBL pays $1M to (or on behalf of) the importer

Scenario 2: Incomplete
Transaction Closing Out
between the Booking and
Forward
Delivery
Date
Prior to or on the delivery date, importer indicates his

inability to take the delivery and wishes to close out the

contract (eg. Day 40).
On Day 40 MBL will do the following:
1) Enter

into a forward sale agreement (say @

Rs59/US$) with ABC bank to sell US$1M on Day 90
(to square its position with XYZ on Day 90).Client will
be charged upfront, the difference in this forward
rate and the Initial forward Rate for Day 90 (i.e. 61.159=Rs 2.1/US$)

Scenario 2: Incomplete Transaction

Closing Out between the Booking and
Forward Delivery Date

CONTD.
2)

Therefore in the above case if the spot rate on Day

40 is Rs 58/US$, according to this circular the
client should have been charged (i.e. 61.1-58=Rs
3.1/US$). To keep in line with SBPs requirement
which is to prevent speculation, MBL will charge
the same difference, however, the difference in
Spot Rate for Day 40 and Forward sale rate for
day 90 (i.e. Rs 59-Rs58 = Rs 1/US$ in this case)
will be given to charity and will not be included in
the gain/other income for bank

3)

In addition, client will also be charged commission

to execute this additional transaction.

4)

On Day 90 MBL will receive US$1M from XYZ and

will sell the same to ABC.

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Scenario 3: Transaction Premature

Delivery
In case the Importer wants the delivery of US$1M on Day 80 instead of Day
90
On Day 80 MBL will do the following:

2)
3)
4)
5)
6)

1) Buy US$1M from the market at spot rate (say @

Rs64/US$)
Settle the contract with the importer by selling US$1M for
Rs 61.1 M as per the initial contract.
Enter into forward sale agreement with ABC bank (say @
Rs63/US$)
Charge the Importer upfront the difference (i.e. Rs 1/US$)
In addition, client will also be charged commission to
execute this additional transaction.
On Day 90 MBL will receive US$1M from XYZ and will sell
the same to ABC.

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RELATED ISSUES
The need to identify scheduled banks to

advise them about our new format for the

forward contract (our contract is not a
sale/purchase
contract
rather
an
agreement to sell or purchase)
If the proposed Shariah alternative scheme
is followed, it appears that MBL may not
comply with SBPs circular (FE cir
10/26.05.99). Do we need to get SBP
approval?
12

Exporter Forward Contract

of purchase foreign currency
1.

2.
3.
4.

5.

Day 1 exporter comes to MBL. He will receive

US$ 1 million on Day 90. Wants to book forward
rate.
Prevailing Rate on Day 1 is 60.
MBL enters into an agreement to sell w/ another
bank XYZ US$ 1million on Day90 say @ 59
MBL subtract its fee of Rs 0.10 and quotes a
forward rate of 60-1-0.1 = 58.9. MBL enters
into an agreement to buy $1 million on Day 90.
On Day 90, client receives 58,900,000/- to MBL.

13

Exporter Forward Contract of

purchase foreign currency
CONTD.
MBL keeps 100,000 as its fee and
receives Rs 59,000,000 from XYZ bank in
consideration of US$ 1 million.
7. MBL pays Rs 58,900,000 to the exporter
and gets US$ 1 million on Day 90
6.

(7A) Prior to or on the delivery date, client

indicates his inability to take the delivery
and wishes to close out the contract.
8. MBL can only close out the contract on
Day 90.
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Exporter Forward Contract of

purchase foreign currency CONTD.
9. Prevailing Rate on Day 90 is 64.
10. MBL charges 100,000 from client as its fee.
MBL sells US$ 1 million to XYZ bank and receives
59,000,000. It buys $ on spot at 64 and loss
64,000,000-59,000,000 = 5,000,000 is charged to
the client. .
11. Prevailing Rate on Day 90 is 58.
12. MBL charges the client 100,000 as its fee. It
buys $ on spot at 58 and gains 59,000,00058,000,000 = 1,000,000. This gain is forwarded to
SBP.

15

SBP APPROVAL
The transformation commission of
State Bank of Pakistan (with some
other Shariah scholars) approved
the following foreign currency
forward cover transaction. We
could do the same procedure for
our Araboon/Hamish Jiddiyyah
transaction of shares.
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CONCLUSIONS
Forward

share transaction, should be through an

agreement/undertaking to sell or purchase at a future
date and it should not be a sale and purchase agreements.

An amount or part of the total price may be given by the

bank to the other party (seller) in advance by way of

earnest money (Araboon/HamishJiddiyyah)against the
shares to be purchased at a future date.

If at the agreed time the party does not perform,

the(seller) can recover the differential to compensate the

loss suffered by him due to depreciation of the price and
adjust the earnest money there against.

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Foreign Currency Forward

Cover
The Commission observed that forward foreign currency
covers will be permissible subject to the following conditions:
i) The amount of foreign currency is needed for

genuine trade or payment transactions. The need will

have to be supported by appropriate documents so as to
prevent forward cover for speculative purposes.

ii)The forward cover shall be through an agreement to

sell or purchase and it shall not be a sale and purchase
agreement. It means that sale/purchase shall take place
simultaneously at the agreed time in future at the rate
agreed upon initially at the time of agreement to sell or
purchase.

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Foreign Currency Forward Cover

CONTD.
iii. While it will be permissible to fix the price of foreign

currency in terms of Rupees according to the

agreement, no forward cover fee shall be recovered.
However, (i) an amount may be demanded by the
bank from its client in advance by way of earnest
money against foreign currency agreed to be sold at a
future date or (ii) the fee could be built into the
sale/purchase rate.

iv. If at the agreed time the party does not perform, the

bank can recover the differential and adjust the

earnest money there against.

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