A forward exchange contract is a mechanism by which one can ensure the value of one currency against another by fixing the rate of exchange in advance for a transaction expected to take place at a future date. It is a tool to protect the exporters and importers against exchange risks. The uncertainty about the rate which would prevail on a future date is known as exchange risk. From the point of an exporter the exchange risk is that the foreign currency in which the transaction takes place may depreciate in future and thus the expected realization will be less in terms of local currency. The importer also faces exchange risks when the transaction is designated in a foreign currency. In this case the foreign currency may appreciate and the importer may be compelled to pay an amount more than that was originally agreed upon in terms of domestic currency.
In the case of forward exchange contract two parties, one being a banker from one country entering to a contract to buy or sell a fixed amount of foreign currency on a specified future date or future period at a predetermined rate. The forward exchange contracts are entered into between a banker and customer or between two parties.
Features of Forward Exchange Contract:
The following are the features of a forward exchange contract. FEDAI has also laid down certain guidelines defining certain aspects of forward exchange contract.
a) Parties: There are two parties in a forward exchange contract. They can be,
- A bank and a customer.
- Two banks in the same country.
- Two banks in different countries.
b) Amount: forward exchange contracts are entered into for a definite sum expressed in foreign currency.
c) Rate: the rate at which the conversation of foreign exchange is to take place at a future date is agreed upon at the time of signing the forward contract which is known as the contracted rate and is to be mentioned in the contract.
d) Date of Delivery: Date of delivery in a forward contract means the future date
on which the delivery of foreign exchange is to take place and is computed from the spot date or date of contract. However in practice, date of delivery is computed from the spot date and hence if a forward contract is signed on 30th Oct with spot date as Nov, 2005 for 2months forward. The date of delivery is Jan 1, 2006.
In India Rule7, FEDAI has laid down certain guidelines regarding date of delivery under forward contract.
In the case of bills/documents negotiated, purchased or discounted-date of negotiation, purchase or discount and payment of rupees to customer. In the
case of bills/documents sent for collection, date of payment of rupees to the customer on realization of bills.
In case of retirement /crystallization of import bills/documents-the date of retirement /crystallization of liability whichever is earlier.
e) Option period: in India FEDAI under Rule 7 has laid down guidelines for option period. The option period of delivery in an option forward contract should be specified as a calendar week that is 1st to 7th, 8th to 15th, 16th to 23rd or 24th to last working day of the month or a calendar fortnight that is 15th or 16th to last working day the month. If the fixed date of delivery or the last date in an option forward contract happens to be a holiday, the delivery shall be effected/delivery option exercised on the preceding working day.
f) Option of delivery: In all option forward contracts the merchant whether a buyer or a seller will have the option of delivery.
g) Place of delivery: All contracts shall be understood to read to be delivered or paid for at the bank and at the named place. That is, the contractual obligations under a forward exchange contract like delivery of foreign exchange or payment are to be executed at the specified branch of the bank.
FEDAI guidelines for Forward Exchange Contracts: Rule No 7
- Exchange contracts shall be for definite amount.
- Unless date of delivery is fixed and indicated in the contract the option period of delivery should be specified as calendar week or calendar fortnight or calendar month.
- If the fixed date of delivery or last date of delivery option is a holiday, the delivery has to be effected on the preceding working day.
- Place of delivery is always at the Bank and at the named place.
- Option of delivery is always that of the merchant.
- The minimum commission is Rs 250 for booking a forward contract.
- Minimum charge is Rs 100 for every request of early delivery extension/cancellation.