Booking of Forward Exchange Contracts and Exchange Control Regulations

Forward exchange contract is a device which can afford adequate protection to an importer or an exporter against exchange risk. Under a forward exchange contract a banker and a customer or another banker enter into a contract to buy or sell a fixed amount of foreign currency on a specified future date as a predetermined rate of exchange. Our exporter, for instance, instead of groping in the dark or making a wild guess about what the future rate would be, enters into a contract with his banker immediately. He agrees to sell foreign exchange of specified amount and currency at a specified future date.… Read the rest

Definition of Currency Arbitrage

Arbitrage traditionally has been defined as the purchase of assets or commodities on one market for immediate resale on another in order to profit from a price discrepancy. In recent years however arbitrage has been used to describe a broader range of activities. The concept of arbitrage is of particular importance in International finance because so many of the relationships between domestic and international financial markets, exchange rates, interest rates and inflation rates depend on arbitrage for their existence. In fact it is the process of arbitrage that ensures market efficiency.

The purchase of currencies on one market for immediate resale on another in order to profit from the exchange rate differential is known as currency arbitrage.… Read the rest

Currency Swap Deals in Foreign Exchange Markets

Swap contracts can be arranged across currencies. Such contracts are known as currency swaps and can help manage both interest rate and exchange rate risk. Many financial institutions count the arranging of swaps, both domestic and foreign currency, as an important line of business. This method is virtually cheaper than covering by way of forward options. Technically, a currency swap is an exchange of debt service obligations denominated in one currency for the service in an agreed upon principal amount of debt denominated in another currency. By swapping their future cash flow obligations, the counterparties are able to replace cash flows denominated in one currency with cash flows in a more desired currency.… Read the rest

Execution of Forward Contracts in Foreign Exchange Markets

A customer under forward exchange contract knows in advance the time and amount of foreign exchange to be delivered and the customer is bound by this agreement. There should not be any variation and on the due date of the forward contract the customer will either deliver or take delivery of the fixed sum of foreign exchange agreed upon. But, in practice, quite often the delivery under a forward contract may take place before or after the due date, or delivery of foreign exchange may not take place at all. The bank generally agrees to these variations provided the customer agrees to bear the loss, if any, that the bank may have to sustain on account of the variation.… Read the rest

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.… Read the rest

Fixed and Option Forward Exchange Contracts

Under the fixed forward contract the delivery of foreign exchange should take place on a specified future date. Then it is known as ‘fixed forward contract’. Suppose a customer enters into a three months forward contract on 5th January with his bank to sell Euro 15,000, then the customer would be presenting a bill or any other instrument on 7th April to the bank for Euro 15,000. The delivery of foreign exchange cannot take place prior to or later than the determined date.

Though forward exchange is a mechanism wherein the customer tries to overcome the exchange risk, the purpose will be defeated if the delivery of foreign exchange does not take place exactly on the due date.… Read the rest