Forward Contract from Importers and Exporters Perspective

In simple terms, a Forward Contract is an over-the-counter instrument that sets the price of an instrument today for delivery on a future date. This is done in exchange for another financial instrument or an asset as agreed at the time of Forward Contract execution.Forward Contract generally refers to currency (Foreign Exchange)market. Yet, this applies to other asset classes too such as Equity market, Commodities.In this session, we are detailing on currency Forward Contract and operational understanding about the same from both Exporters’ and Importers’ point of view.Currency Forward:It’s a special type of contract in which agreements are made between two parties  to exchange two different currencies at a future date, wherein the price of exchange is agreed today. Currency Forward as a hedging tool helps the buyer or seller in protecting the exchange fluctuations, thereby it helps them to forecast their cost well in advance.Currency Forwards are plain vanilla derivative instruments.Delivery Rate = (Current Spot + Premiums for period of contract ) ± Agreed bank exchange marginsDelivery Rate:Delivery rate is nothing but a rate agreed by both the parties at the time of entering into Forward Contract which will be delivered at any cost on maturity i.e., by end of Forward Contract date.Currency Spot:Currency Spot refers to rate either on Bid/Ask side of interbank rates applicable at that moment. SPOT generally gets delivered on T+2 days on the exchange of currency.Premiums:Premiums refer to interbank premium rates either on Bid/Ask side. Premiums are generally driven by interest rate differences between the currencies of exchange during the Forward Contract.Bank Exchange Margins:Except for Authorized dealers, none can deal in currency forwards. Generally, bank facilitates these trades where the client agrees to buy or sell foreign currency at future date with a bank. Bank executes these contracts by setting up LER(Loan Equivalent Risk) limits for the clients who need Currency Forwards.Typically, LER for major currency with INR as pair is Max of 20% for a 1-year tenor. Based on the relationship, bank charges margins for facilitation of this product ranging from 0.01% to 3%.Costs Involved:Typically Forwards are done on the basis of margin money, inform of FD or Limits and are assigned based on past performance of your import/export business during the last financial year. There is no specific cost as such, unlike Options where the premiums are paid upfront. However, there could be limit setup fee and exchange margins for facilitation of this product by authorized dealersFrom Importers perspective:Importers in India use this product to control the outflow of INR against the currency of purchase in the future date. This will enable to manage their profit margins respective to the transaction.Importers agree to buy Foreign Exchange i.e., currencies other than INR for delivery on future date depending on the trade. Foreign currency will be bought at a prescribed price by selling equivalent value of INR on maturity.In this case, it is assumed that the importer wants to get into Currency Forward contract basis, for a trade of 3 Months. His contract rate should be as followsInterbank Spot : 65.41Premiums for 3 Months:70.50 PBank Margins : As agreed mutually between bank and client, let’s take 5p for a dollar in this case.Client rate = 65.41 + 0.7050 + 0.05 i.e, 66.165 is delivery rate for this importer by end of 3 Months.Importers pay the premium, which increases the cost of the product. Hence, pricing of the product needs to be done accordingly.From Exporters Perspective:Again Exporters use this product to avoid any fluctuations in currency exchange. Since most of currency pairs are on premiums, Exporters are at the benefits in getting into Currency Forwards.Exporters get the premium paid for the period of Currency Forward contract over and above the SPOT interbank.Exporters in India agree to sell foreign currency and buy INR against an agreed rate, as per Currency Forward contract.Let's have a look at the same illustration above quoted from exporters perspective:-Interbank Spot  : 65.41Premiums for 3 Months: 68.50 PBank Margins : As agreed mutually between bank and client, let’s take 5p for a dollar in this case.Client rate = 65.41 + 0.6850 - 0.05 i.e, 66.135 is delivery rate for this Exporter by end of 3 Months.This is all about Currency Forwards till you enter into a contract with your authorized dealers. Banks set up your limits for such Currency Forwards based on your past performance(PP Limit) or on the basis of the current underlying exposure on foreign currency.Want to understand more on currency forwards? Please write to advisor@savedesk.in
Saravana Bhaskar
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Forward Contract from Importers and Exporters Perspective

Saravana Bhaskar
Blog
05th Oct, 2017
Forward Contract from Importers and Exporters Perspective

In simple terms, a Forward Contract is an over-the-counter instrument that sets the price of an instrument today for delivery on a future date. This is done in exchange for another financial instrument or an asset as agreed at the time of Forward Contract execution.

Forward Contract generally refers to currency (Foreign Exchange)market. Yet, this applies to other asset classes too such as Equity market, Commodities.

In this session, we are detailing on currency Forward Contract and operational understanding about the same from both Exporters’ and Importers’ point of view.

Currency Forward:

It’s a special type of contract in which agreements are made between two parties  to exchange two different currencies at a future date, wherein the price of exchange is agreed today. Currency Forward as a hedging tool helps the buyer or seller in protecting the exchange fluctuations, thereby it helps them to forecast their cost well in advance.

Currency Forwards are plain vanilla derivative instruments.

Delivery Rate = (Current Spot + Premiums for period of contract ) ± Agreed bank exchange margins

Delivery Rate:

Delivery rate is nothing but a rate agreed by both the parties at the time of entering into Forward Contract which will be delivered at any cost on maturity i.e., by end of Forward Contract date.

Currency Spot:

Currency Spot refers to rate either on Bid/Ask side of interbank rates applicable at that moment. SPOT generally gets delivered on T+2 days on the exchange of currency.

Premiums:

Premiums refer to interbank premium rates either on Bid/Ask side. Premiums are generally driven by interest rate differences between the currencies of exchange during the Forward Contract.

Bank Exchange Margins:

Except for Authorized dealers, none can deal in currency forwards. Generally, bank facilitates these trades where the client agrees to buy or sell foreign currency at future date with a bank. Bank executes these contracts by setting up LER(Loan Equivalent Risk) limits for the clients who need Currency Forwards.Typically, LER for major currency with INR as pair is Max of 20% for a 1-year tenor. Based on the relationship, bank charges margins for facilitation of this product ranging from 0.01% to 3%.

Costs Involved:

Typically Forwards are done on the basis of margin money, inform of FD or Limits and are assigned based on past performance of your import/export business during the last financial year. There is no specific cost as such, unlike Options where the premiums are paid upfront. However, there could be limit setup fee and exchange margins for facilitation of this product by authorized dealers

From Importers perspective:

Importers in India use this product to control the outflow of INR against the currency of purchase in the future date. This will enable to manage their profit margins respective to the transaction.

Importers agree to buy Foreign Exchange i.e., currencies other than INR for delivery on future date depending on the trade. Foreign currency will be bought at a prescribed price by selling equivalent value of INR on maturity.



In this case, it is assumed that the importer wants to get into Currency Forward contract basis, for a trade of 3 Months. His contract rate should be as follows

Interbank Spot : 65.41

Premiums for 3 Months:70.50 P

Bank Margins : As agreed mutually between bank and client, let’s take 5p for a dollar in this case.

Client rate = 65.41 + 0.7050 + 0.05 i.e, 66.165 is delivery rate for this importer by end of 3 Months.

Importers pay the premium, which increases the cost of the product. Hence, pricing of the product needs to be done accordingly.

From Exporters Perspective:

Again Exporters use this product to avoid any fluctuations in currency exchange. Since most of currency pairs are on premiums, Exporters are at the benefits in getting into Currency Forwards.

Exporters get the premium paid for the period of Currency Forward contract over and above the SPOT interbank.

Exporters in India agree to sell foreign currency and buy INR against an agreed rate, as per Currency Forward contract.

Let's have a look at the same illustration above quoted from exporters perspective:-

Interbank Spot  : 65.41

Premiums for 3 Months: 68.50 P

Bank Margins : As agreed mutually between bank and client, let’s take 5p for a dollar in this case.

Client rate = 65.41 + 0.6850 - 0.05 i.e, 66.135 is delivery rate for this Exporter by end of 3 Months.

This is all about Currency Forwards till you enter into a contract with your authorized dealers. Banks set up your limits for such Currency Forwards based on your past performance(PP Limit) or on the basis of the current underlying exposure on foreign currency.

Want to understand more on currency forwards? Please write to advisor@savedesk.in

Saravana
Blog Author

Saravana Bhaskar is the Brain Child behind incubation of White Matter. With over a decade of rich banking experience, he has handled many eminent positions in bank from Global Gateway Coordinator to Portfolio Head -South India. He is catalyst in steering White Matters’ association globally, with his proven abilities of leadership; his vision is to achieve transformational changes at White Matter. Bhaskar is true Car enthusiast, who has an insatiable interest in cars. He is an avid reader, and has ear for Music.

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