Abstract

The current day witnesses a huge competition in the international trade and the government is also keen on developing international trade. Under this all the countries have gathered on to single platform and opened gates for their trade. With the increased technology and the leverage to the traders to trade globally the trade is also happening with lower margins. Exchange is one area which is an asset to the country for the goods or services sold. With the increase in the International trade the exchange involved also is going huge changes, otherwise called as volatility. It may be mentioned that the volatility at times may completely erode the profit margins gained by the traders in a deal. The current study deals with such types of sensitivities inherently associated with the Exchange rates and thereby putting the entire trade under peril. This study envisages an address to such risks and a solution in the form of Forward Contracts to hedge the risk and allow a trade atleast with Break Even Point if not the profits. Forward contract is a 7method of hedging strategy that determines the scope for mitigation of risk arises out of Exchange fluctuations in day to day deals. It is an agreement between two parties to exchange one currency for another at a forward or future date. This protects the buyer against the risk of fluctuating rates when acquiring foreign exchange needed to meet future obligations. The report explains the procedures, precautions and conditions of booking, re-booking and cancellations of forward contract and how the forward rates are quoted at parity/premium/discount rates and since the exchange rate forecasting is difficult, there are several mechanisms which help in forecasting the rates. Forward contracts call for delivery on a date beyond the spot contract settlement, which ordinarily takes place within ten days of the transaction date. Unlike a futures contract, forward contracts do not take place on regulated exchanges and do not involve delivery of standard currency amounts. They are cancelable only with consent of the other party to a trade. This study also encompasses the regulations of RBI and FEDAI to be followed by both the customer as well as the Bank to keep them self safe.

Introduction
Derivatives which make the forward contracts an integral part within itself can be defined as Derivatives are financial instruments that have no intrinsic value, but derive their value from something else. They hedge the risk of owning things that are subject to unexpected price fluctuations, e.g. foreign currencies, bushels of wheat, stocks and government bonds. There are two main types: futures, or contracts for future delivery at a specified price, and options that give one party the opportunity to buy from or sell to the other side at a prearranged price. Derivative is a product whose value is derived from the value of one or more basic variables, called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying asset can be equity, foreign exchange, commodity or any other asset. Derivative instruments are management tools derived from underlying exposure such as currency, commodities, shares, bonds or any of the indices, used to reduce or neutralize the exposures on the underlying contracts. Derivatives could be Over the Counter (OTC) which means made to order (suited to ones requirements). OTC products are customized for the amount, period, etc., and are flexible to suit the needs of the customers. OTC derivatives are mainly offered by banks, and Financial Institutions, exchange traded products are traded on the floor of the exchanges and are standardized in terms of quantity, quality, start and ending dates. Due to standardization of products, exchange traded derivatives are less expensive in comparison to the OTC products. With the gates opened for the global trade and the agreements between the countries for selling their goods and services interalia. The scope of increase in the Inflow and out flow of the foreign currencies increased drastically. Also the natural Catastrophes and the step taken by wealthy countries to stop financing terrorism and wars on such countries have influenced the exchange rates huge and lead to a crisis due to the fluctuations. It can be said that the entire profit margin and the capitals can be eroded if the exchange rate volatility is not considered properly.

Indian foreign exchange market, in the recent times, experienced considerable volatility specifically in respect of USD - INR market segment. INR was traded at Rs. 48.92 per USD during April 2002; gradually, INR appreciated to Rs. 38.50 per USD by April 2008; from the highs of Rs. 38.50 per Dollar, the Rupee plummeted and touched a low of 42.67 per USD last week and is slowly moving towards the 43.00 mark. The partially convertible Rupee fell by more than 7% to a 13 month low this year reversing a 12% gain in 2007. The south-ward journey of Rupee is attributed to spiraling crude prices ($ 122 per barrel), inflation driven by high commodity prices and moderated inflows from FIIs due to slow down in international capital markets creating a demand supply mismatch. The sub prime crisis in US and the global meltdown have also become part of the recent past high volatile international currency markets. RBI, as a financial regulator, intervenes in the foreign exchange market to prevent excess volatility. Further, RBI does a balancing act by liberalizing limits on foreign exchange inflows and outflows from the point of convertibility angle. In a phased manner, RBI liberalized limits on the overseas investment by Indian companies. Now Indian companies can invest overseas up to 400% of their net worth and they are also allowed to invest in overseas energy and natural resources sector like oil, gas, coal and mineral ores in excess of the current limits with prior approval. Recently, RBI raised the limit on the overseas investment by mutual funds from USD 5 billion to USD 7 billion. RBI raised the limit on individual remittances up to USD 2, 00,000 p.a. In its recently announced monetary policy, RBI allowed Indian exporters to realize and repatriate the full value of export proceeds with in a period of 12 months from the existing 6 months from the date of export. Refining companies are allowed to hedge up to 50% of the volume of imports during the previous year or 50% of the average volume of imports during the 3 previous financial years, whichever is higher. According to BIS triennial Central Bank Survey 2007, the share of India's daily average foreign exchange turnover was at USD 34 billion (increased from 0.3% in 2004 to 0.9% in 2007). India's share in world's exports was at 0.52% in 1990 and increased to 1% in 2007. Thus the Indian foreign exchange market has widened and deepened with

the transition to a market determined exchange rate system and liberalization of restrictions on external transactions leading to full current account convertibility and partial capital account convertibility. As all the above mentioned situations do have an impact on exchange rate of Rupee as well as forward contract in respect of USD vis--vis INR, it is interesting to notice the forex developments and their implications especially on exporters / importers and other active forex market players including Banks. As the Banks are the most active forex market players with their presence in Foreign Currency deposits as well as loans, they can transmit their influence on interest rates and on forward contract. While arriving at the forward contract, banks / forex market players try to forecast the future price of the commodity (foreign currency) keeping in view the opportunity cost / carrying cost etc. Forward rate is an outcome of future expected exchange rate, which is a function of price level, interest rates and Balance of Payments. Forward Contract is typically OTC derivatives involving the fixation of rates in advance for deliveries in future. Under a forward contract, since the price of a commodity or foreign currency is fixed today for delivery on a future date, the risk of any adverse price movements is removed or covered. When a client buys this instrument from a bank eliminates the exchange rate risk for specified amount and period. The outset, which is the forward rate for a contract is available for most currencies depending on the exchange control and regulations. In turn, banks too profit from such transactions when the prices move in their favor. Like other financial instruments, this instrument is no exception when speaking about risks involved in the process of investment through bank. Investing through a bank mitigates the downside risk for client in an adverse situation. But in a favorable situation, the clients lose out. A potential open-ended risk is the consequence of a non-receipt of amount on the expected date due to the time taken for a transaction to be processed. Under such circumstances, the client would have to borrow from the spot market thus incurring loss. The reverse situation occurs when a client buys foreign currency and later realizes that it wasnt needed or the anticipated date of payment has changed. A settlement risk occurs when funds are paid before the receipt of currency. One of the parties to the contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price. The other

party assumes a short position and agrees to sell the asset on the same date for the same price. Other contract details like delivery date, price and quantity are negotiated bilaterally by the parties to the contract. The forward contracts are normally traded outside the exchanges. They are bilateral contacts and hence exposed to counter-party risk. Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset type and quality. As the Future contracted rates are defined based on the Interest rate variations in India and the respective currency country the same cannot be publicized in the public domain. On the expiration date, the contract has to be settled by delivery of the asset. If the party wishes to reverse the contract, it has to be compulsorily go to the same counter-party, which often results in high prices being charged. However forward contracts in certain markets have become very standardized, as in the case of foreign exchange, thereby reducing transaction costs and increasing transaction volume. This process of standardization reaches its limit in the organized futures market. Forward contracts are very useful in hedging and speculation. The classic hedging application would be that of an exporter who expects to receive payment in dollars three months later. The exporter is exposed to the risk of exchange rate fluctuations. By using the currency forward market to sell dollars forward, exporter can lock onto a rate today and reduce his uncertainty. Similarly an importer who is required to make a payment in dollars within two months hence can reduce the exposure to exchange rate fluctuations by buying dollars forward. If a customer has information or analysis, which forecast an upturn in a price, then the customer can go long on the forward market instead of the cash market. The customer would go long on the forward, wait for the price to raise, and then take a reversing transaction to book profits. Customer may well be required to deposit a margin upfront. However, this is generally a relatively small proportion of the value of the assets underlying the forward contract. The use of forward markets here supplies leverage to the customer.

Literature Review
Forward contract is a contract between the bank and its customers in which the exchange/conversion of currencies would take place at future date at a rate of exchange in advance under the contract. The essential idea of entering into a forward contract is to peg the price and thereby avoid the price risk defined by Union Bank of India Forward Rates = spot rate +/- premium/discount. Bombay Stock exchange has derived as forward contract are exchange traded contracts to sell or buy financial instruments or physical commodities for future delivery at an agreed price. There is an agreement to buy or sell a specified quantity of financial instruments/commodity in a designated future month at a price agreed upon by the buyer and seller. The contracts have certain standardized specifications. The standardized items in any future contracts are Quantity of the underlying assets. The date and month of delivery The units of price quotation and minimum change in price O.P. Agarwal explained forward contract as typical Over the Counter derivatives involving the fixation of rates (exchange rate, commodity price etc.) in advance for deliveries in future. National Stock Exchange of India says that forward contract is an agreement to buy or sell an asset on a specified date for a specified price. One of the parties to the contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price. Other contract details like delivery date, price and quantity are negotiated bilaterally by the parties to the contract. The forward contracts are normally traded outside the exchanges.

David A. Dubofsky opines hat forward contract gives the owner the right and obligation to but a specified asset on a specified date at a specified price. The seller of the contract has the right and obligation to sell the asset on the date for that specified price. At delivery, ownership of the good is transferred and payment is done.

Research Methodology
Need for the Study
Forward contracts in present times are widely used by the banking sector and also by the retail investors. It is important during exchange of currencies in the future at a specific rate for a specified date/optional date. There is a need to study the forward contracts mechanisms and legislation related in the changing times. As forward contracts helps to mobilize savings of economic development and protect interest of customers by ensuring the full disclosures and is required to avoid losses due to the volatility in the foreign exchange market, it is pertinent to study the operational procedures of forward contracts in India.

Scope of the Study

The study considers Forward contract and various related aspects like forward rate quotations, issues and different types of forward contracts and forward rates. The study explores the concept and procedure of booking and cancellation of forward contract in banks. The study also considers about the minimum requirements for a bank and who are eligible to book a contract with the customers.

Objectives of the Study

To study the concept of forward contracts and procedural aspects of executing of To study the operational procedure of executing forward contracts in IDBI bank To study the advantages of forward contract to the parties forward contracts

Sources of Data
The present study proposes to use data from secondary sources.

Secondary Sources

The data is collected from the sources like books and websites.

Limitations
The study has not considered external influences on forward prices, as the forward contracts involve the volatility resulting from various factors they too may have considerable impact on the prices The data collected for the duration (2009-2011) may not have any general character of finding as the markets for this period were reviving and continued to be unpredictable In the present study the illustrations are not the real life problems

Topic Analysis
Definition of Derivatives
The term Derivative indicates that it has no independent value, i.e., its value is entirely derived from the value of the underlying asset. The underlying asset can be securities, commodities, currency, livestock or anything else. In other words, derivative means forward, futures, option or any other contract of predetermined fixed duration, linked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securities. The Securities Contract (Regulation) Act 1956 defines derivative as under: Derivatives includes Security derived from a debt instrument, share, loan whether secured or

unsecured, risk instrument or contract for differences or any other form of security A contract which derives its value from the prices, or index of prices of

underlying securities.

Evolution of Derivatives
Derivatives, the dreaded word, are often viewed with a certain degree of awe. It is often felt that derivatives are shrouded deep in mystery. Derivative refers to a variable, which has been derived from another variable. Interest in derivative products may mostly arise out of interest in the underlying products, but it can also be without any interest in the underlying. Even if so, the values of derivatives and the underlying are interrelated and irrespective of the fact that one has interest in both or only the latter, the two will affect each other prices.

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The underlying can be any product, literally anything ranging from agricultural products, foreign exchange, interest rates, oil, gas, gold or silver, stocks and stock indices, financial instruments like treasury bills, bonds, etc. or anything in the world, which itself is traded. Thus, derivatives are derived from markets, products, risks or any underlying on which they are based. Derivatives have been in use for hundreds of years, in the form of futures or options, when high seas cargoes were brought and sold in future price or rice produce sold for future delivery by Japanese farmers. The future transactions were then done in various pockets, in anticipation of future deliveries. The explosion of the market could be linked to or coincided with the collapse of Breton Woods fixed exchange rate regime (35 USD= 1 Ounce of Gold) and suspension of US dollars direct, links to gold in the 1970s. The delinking of US dollars to a fixed parity of gold, effected volatility of exchange rates as also the interest rates. The increased volatility thus leads to the creation and explosion of a financial derivatives market which has since then grown manifolds. In early 1970s, the Chicago Mercantile Exchange introduced the worlds first traded currency future contract. Later in 1975, the first interest rate futures were introduced. Several exchanges then introduced exchange rate and interest rate futures contracts. By 1983, the derivative markets saw further growth with currency options trading in Philadelphia Stock Exchange. Trading in currency futures and options gave the world new range of risk management techniques for managing exchange risk, which helped in growth of global trade, investments and cross-border remittances. This was the time (early 1980s) when interest rate swaps were also introduced. Interest rate swaps helped borrowers and lender to switch their borrowings/lending from fixed to floating rate structures otherwise, as per their views on the interest rate movements. Mid 1980s saw a boost in the derivatives market, with a host of exchange rate, interest rate as also commodity price risk derivative tools/ products being traded in various exchanges, which was evident from the fact that Chicago exchange handled millions of derivative contracts manually. Initially, the derivative products were used mainly by the hedgers as actual users of the underlying contracts, who used these products for managing their risks. The 11

importers, exporters, financiers, borrowers, buyers, etc. were the major users of these products. Gradually, individuals and institutions tracked the prices of derivative products, much similar to the commodity prices or cross currency prices. This gave depth and volumes to the derivative market. Further, there were people who would be always on a look out for opportunities of mispricings and uneven pricing on the markets, and arbitrated between market differences, until the differences disappeared. Thus, hedgers arbitraged provided depth, volumes and initiative for newer derivative products, so that a large number of exchanges offered these products with spurt in volumes by the day. The derivative products in a short lifespan of 25 years, have seen tremendous growth, which can be observed from the fact in April 1988, the average daily turnover in derivatives was to the order of USD 1.3 trillion while, the national amounts outstanding for OTC 14 trillion respectively in June 1998. The main reasons for this growth in derivatives market increased volatility in the financial and commodity assets during 1970 and 1980s, the oil shocks in 1971 and thereafter, the need to insulate exchange risk for incomes in different currencies, arising out of increased global investments, technological advancements providing real-time information systems and 24-hour financial trading platforms, also development of pricing models and instruments based on computer-generated worksheets, the political developments and not the least but the important would be increasing professionalism amongst all market participants, be it banks, traders, actual users, companies, investors, etc.

Features of Derivatives
The basic features of a derivative may be stated as follows A derivative instrument relates to the future contract between two parties. It

means there must be a contract-binding on the underlying parties and the same to be fulfilled in future. The future period may be short or long depending upon the nature of contract

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Normally, the derivative instruments have the value which is derived from the

values of other underlying assets, such as agricultural commodities, metals, financial assets, intangible assets, etc. value of derivatives depends upon the value of underlying instrument and which changes as per the changes in the underlying assets, and sometimes, it may be nil or zero. Hence, they are closely related. In general, the counter parties have specified obligation under the derivative

contract. Obviously, the nature of the obligation would be different as per the type of the instrument of a derivative The derivative contracts can be undertaken directly between two parties or

through the particular exchange like financial futures contract. The exchange-traded derivatives are quite liquid and have low transaction costs in comparison to tailor-made contracts. In general, the financial derivatives are carried off-balance sheet. The size of the

derivative contract depends upon its notional amount. The notional amount is the amount used to calculate the pay off. For instance, in the option contract, the potential loss and potential payoff, both may be different from the value of underlying shares, because the payoff of derivative products differ from the payoff that their notional amount might suggest Usually, in derivatives trading, the taking or making of delivery of underlying

asset is not involved; rather underlying transactions are mostly settled by taking offsetting positions in the derivatives themselves. There is, therefore, no effective limit on the quantity of claims, which can be traded in respect of underlying assets Derivatives are mostly secondary market instruments and have little usefulness in

mobilizing fresh capital by the corporate world, however, warrants and convertibles are exception in this respect Derivatives are also known as deferred delivery or deferred payment instrument.

It means that it is easier to take short or long position in derivatives in comparison to

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other assets or securities. Further, it is possible to combine them to match specific i.e., they are most easily amenable to financial engineering Although in the market, the standardized, general and exchange-traded derivatives

are being increasingly evolved, still there are so many privately negotiated customized, over- the-counter (OTC) traded derivatives are in existence. They expose the trading parties to operational risk, counter- party risk and legal risk. Further, there may also be uncertainty about the regulatory status of such derivatives Finally, the derivative instruments, sometimes, because of their off- balance sheet

nature, can be used to clear up the balance sheet.

Types of Derivatives
Due to complexity in nature, it is very difficult to classify the financial derivatives, so in the present context, the financial derivatives which are very popular in the market have been described in brief. In simple form, the derivatives can be classified into different categories which are shown below

Derivatives

Basic Complex

Forwards

Futures

Options

Warrants & Convertible

Swaps

Exotics (Other derivatives)

Fig: 1.1 classifications of derivatives The way of classifying the financial derivatives is into basic and complex derivatives. In this, forward contracts, futures contract and option contract have been included in the basic derivatives whereas the swaps and other complex derivatives are 14

taken into complex category because they are built-up from either forwards/futures or options contracts, or both.

Forward Contract
A forward contract is a simple customized contract between two parties to buy or sell an asset at a certain rate in future for a certain price. Unlike future contracts, they are not traded on an exchange, rather traded in the over- the-counter market, usually between two financial institutions or between a financial institution and of its client.

Futures Contract
Like a forward contract, a futures contract is an agreement between two parties to buy or sell a specified quantity of an asset at a specified price and at a specified time and place. Futures contract are normally traded on an exchange which sets the certain standardized norms for trading in the futures contract. The features of futures contract are 1. Standardization One the most important features of futures contract is that the contract has certain standardized specification, i.e. quantity of the asset, quality of the asset, the date and month of the delivery, the units of price quotation, location of settlement, etc.

2. Clearing House In the futures contract, the exchange clearing house is an adjunct of the exchange and acts as an intermediary or middlemen in futures. It gives the guarantee for the performance of the parties to each transaction.

3. Settlement Price Since the futures contracts are performed through a particular exchange, so at the close day of trading, each contract is marked-to-market. For this exchange establishes a

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settlement price. This settlement price is used to compute the profit or loss on each contract on that day. Accordingly, the members accounts are credited or debited.

4. Daily Settlement and Margin

Another feature of a futures contract is that when a person enters into a contract, the person is required to deposit funds with the broker, which is called as margin. The exchange usually sets the minimum margin required for different assets, but the broker can set higher margin limits for the clients which depend upon the credit-worthiness of the clients. The basic objective of the margin account is to act as collateral security in order to minimize the risk of failure by either party in the futures account.

5. Tick Size
The futures prices are expressed in currency units, with a minimum price movement called a tick size. This means that the futures prices must be rounded to the nearest risk. The difference between a future price and the cash price of that asset is known as basis.

6. Cash Settlement
Most of the futures contracts are settled in cash by having the short or long to make the cash payment on the difference between the futures price at which the contract was entered and the cash price expiration date. This is done because it is inconvenient or impossible to deliver sometimes, the underlying asset. This type of settlement is very poor in stock indices futures contracts.

7. Delivery
The futures contracts are executed on the expiry date. The counter parties with a short position are obligated to make delivery to the exchange, whereas the exchange is obligated to make delivery to the longs. The period during which the delivery will be made is set by the exchange which varies from contract to contract.

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8. Regulation
The important difference between futures and forward markets is that the futures contracts are regulated through a exchange, but the forward contracts are self regulated by the counter- parties themselves. The various countries have established commissions in their country to regulate future markets both in stocks and commodities. Any such new futures contracts and changes to existing contracts must be approved by their respective commission.

Options Contracts
Options are the most important group of derivative securities. Option may be defined as a contract, between two parties whereby one party obtains the right, but not the obligation, to buy or sell a particular asset, at a specified price, on or before a specified date. The person who acquires the right is known as the option buyer or option holder, while the other person is known as option seller or option writer. The seller of the option for giving such option to the buyer charges an amount which is known as the option premium.

Warrants and Convertibles

Warrants and convertibles are other important categories of financial derivatives, which are frequently traded in the market. Warrant is just like an option contract where the holder has a right to buy shares of a specified company at a certain price during the given time period. In other words, the holder of a warrant instruments has the right to purchase a specific number of shares at a fixed price in a fixed period from an issuing company. Convertibles are hybrid securities which combine the basic attributes of fixed interest and variable return securities. Most popular among these are convertibles bonds, convertibles debentures and convertibles preference shares. These are also called equity derivative securities. They can be fully or partially converted into the equity shares of the issuing company at the predetermined specified terms with regards to the conversion period,

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conversion ratio and conversion price. These terms may be different from company to company, as per nature of the instrument and particular equity issue of the company.

Swaps
Swaps have become very popular derivative instruments in recent years all over the world. A swap is an agreement between two counter parties to exchange cash flows in the future. Under the swap agreement, various terms like the dates when the cash flows are to be paid and the mode of payment are determined and finalized by the parties. Usually the calculation of cash flows involves the future values of one or more market variables. There are two most popular forms of swap contracts i.e. interest rate swaps and currency swaps. In the interest swap one party agrees to pay the other party interest at a fixed rate on a notional principal amount, and in, return it receives interest at a floating rate on the same principal notional amount for a specified period. The currencies of the two sets of cash flows are the same. In case of currency swap, it involves in exchanging of interest flows, in one currency for interest flows in other currency. In other words, it requires the exchange of cash flows in two currencies.

Other Derivatives
These derivatives have been described as non-standardized derivatives. The basis of the structure of these derivatives was not unique. There are various examples of such non-standardized derivatives such as packages, forward start option, compound options, choose options, barrier options, standard oils bound issue, Index Currency Options Notes (ICON), range forward contracts or flexible forwards.

Main Difference between Futures and Forwards Contracts

Both forward contracts and futures contracts trade in future markets where the underlying assets are sold and purchased at a specified price, specified place. However, both the contracts differ on certain points. The following are the major differences between futures and forward contracts

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Futures contracts are standardized contracts which are traded on organized future markets. They are done through specified/ recognized stock exchanges. The forward contracts on the other hand, are private deal and are traded between two parties who can sign a forward contract delivery or indirectly through middlemen(authorized dealer)

The terms of the futures contract are standardized with the respect to the quantity of the asset, future period, future place which are generally common and determined by the exchange, whereas the terms of the forward contracts are decided by both the parties mutually. Hence, the forward contracts are individually tailor made and tend to be much larger than the standardized contracts.

The futures contracts are regulated through a respective exchange where they are registered. On the other hand, forward contracts are self regulatory and need not require any registration. Hence, forward contracts are riskier than the futures contracts.

Futures contracts are settled through a Clearing House which in affect, takes the guarantee to fulfill the contract. In other words, it reduces the default risk of trading. In case of forward contracts, these are private deals between the two parties and are subject to the risk of default on the terms of agreement

Futures contracts require margin payments and daily settlements. Daily settlements feature sets the value of the futures contracts at zero at the each trading day. On the other hand, the forward contracts are settled on the maturity date and not before that unless both the parties agree for this. However, bank in a forward contract can ask for margin. The procedure for maintaining the margin on a forward contract depends on the bank relationship with customer

Future contracts are available for delivery only on a few specified days in a year whereas forward contracts can be delivered on any date as agreed by the parties

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Most of the future contracts are settled without delivery. It means either they are off settled or settled by the payment of cash. On other hand, most of the forward contracts are settled by actual delivery of the assets

Future contracts entail brokerage fee for purchase for sale orders whereas the cost of the forward contracts based on bid-ask spread

Foreign Exchange
The foreign exchange market is a global, worldwide decentralized over-thecounter financial market for trading currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers. The primary purpose of the foreign exchange is to assist international trade and investment, by allowing businesses to convert one currency to another currency. Foreign exchange mainly deals with imports and exports.

Foreign Exchange
Remittances for other purpose other than trade

Goods which flows out

Goods which flows in

Money which comes in

Money which goes out

Export
Fig: 1.2 Foreign Exchange

Import

Import
Import is any good (e.g. a commodity) or service brought into one country from another country in a legitimate fashion, typically for use in trade. Import trade is regulated by the Directorate General of Foreign Trade (DGFT) under the Ministry of Commerce & Industry, Department of Commerce, and Government of India.

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Bank must ensure that the imports into India are in conformity with the Foreign Trade Policy in force and Foreign Exchange Management (Current Account Transactions) Rules, and the Directions issued by Reserve Bank under Foreign Exchange Management Act, 1999 from time to time.

. A general delimitation of imports in national accounts is given below:

An import of a good occurs when there is a change of ownership from a nonresident to a resident; this does not necessarily imply that the good in question physically crosses the frontier. However, in specific cases national accounts impute changes of ownership even though in legal terms no change of ownership takes place

Imports of services consist of all services rendered by non-residents to residents. In national accounts any direct purchases by residents outside the economic territory of a country are recorded as imports of services; therefore all expenditure by tourists in the economic territory of another country are considered as part of the imports of services. Also international flows of illegal services must be included.

Exports
Any good or commodity, transported from one country to another country in a legitimate fashion, typically for use in trade. Export goods or services are provided to foreign consumers by domestic producers. A general delimitation of exports in national accounts is given below

An export of a good occurs when there is a change of ownership from a resident to a non-resident; this does not necessarily imply that the good in question physically crosses the frontier. However, in specific cases national accounts impute changes of ownership even though in legal terms no change of ownership takes place

Export of services consists of all services rendered by residents to non-residents. In national accounts any direct purchases by non-residents in the economic territory 21

of a country are recorded as exports of services; therefore all expenditure by foreign tourists in the economic territory of a country is considered as part of the exports of services of that country. Also international flows of illegal services must be included

Types of Export Transactions

The transactions in inter bank may fall under the falling categories spot transactions forward transactions swap transactions non-deliverable forwards

Spot Transactions
The transaction where the exchange of currencies takes place tow days after the date of contract is known as the spot transaction. For instants, if the contact is made on Monday, the delivery should take place on Wednesday. If Wednesday is a holiday, the delivery will takes place on Thursday. The date on which in which currencies are to be exchanged is the value date. Both the currencies involved are paid on the same day so that there is no loss of interest to either of the parties for instance, if canara bank buys US capital dollars from SBI at Mumbai, the rupee payment will be made at Mumbai through the accounts maintained by both the banks with reserve bank. US Dollar payment will be made at New York, by correspondent banks of SBI paying to the correspondent bank of canara bank for its accounts. Both the rupee payment by canara bank and dollar payment by SBI will take place on the same value date. When no qualifications are added, a transaction in the inter-bank market is a spot transaction. But funds may be required urgently by a bank in which case it may require early settlement. In that case it may ask for a special quotation for delivery the same day or the next day.

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Where the agreement to buy or sell is agreed upon and executed on the same date, the transaction is known as cash or ready transaction. It is also known as value today or spot transaction. A transaction in which the currencies to be exchanged the next day of the transaction is known as value tomorrow or tom transaction.

Forward Transaction
The transaction in which the exchange of currencies takes place at a specified future date, subsequent to the spot date, is known as forward transaction or outward forward transaction. The forward transaction can be delivery one month or two months or three months. A forward contract for delivery of one month means the exchange of currencies will take place after one month from the date of contract. A forward contract for delivery of two months means the exchange of currencies will take place after two months and so on. The date of forward contract will be calculated from the spot rate.

SWAP Transaction
A SWAP transaction is a deal between the same counterparties in which the same currency for same value is purchased and sold for different maturities. For instance, Dena bank and IDBI bank agree under which Dena bank buys USD 5million spot and sells it forward for 2 months. The difference between the spot price and forward price is equivalent to the forward margin. Therefore, the forward margin is also known as swap points. These swap deal may also involve two forwards like purchase of 3 months forward and sale of 6 months forward.

Non- Deliverable Forwards

This instrument was developed in 1990s. Under non-deliverable forwards actual delivery of forward contract does not take place. On the due date, the spot rate for the

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currency concerned is compared with the forward rate agreed under the contract and the difference is settled. The market exists for emerging currencies for which ready markets may not exist. The markets concerned also exhibit disparities in interest rates and exchange rates offering arbitraging possibilities. The settlement is invariably done is US dollars.

Nostro Account
The Nostro Account is used by the bank which maintains the account to refer to its account with other bank. For a bank in India nostro account is an account maintained by it with a bank abroad. For example- Indian bank may maintain with Lloyds bank, London. Obviously, the account would be pound- sterling. Similarly, it have a dollar account with bank of America, New York. While corresponding with the foreign bank, Indian bank would refer its account with former as nostro account, meaning our account with you. So, for Indian banks nostro account means the bank account it makes abroad in foreign currency. All foreign exchange transactions are rooted through nostro account. Depending upon the time of realization of foreign exchange by the bank, two types of buying rates are quoted in India. They are TT Buying Rate Bill Buying Rate

TT Buying Rate
TT stands for Telegraphic Transfer. This is the rate applied when the transaction does not involve any delay in realization of the foreign exchange by the bank. In other words, the nostro account of the bank would already have been credited. The rate is calculated by deducting from the inter-bank buying rate the exchange margin as determined by the bank. Though the name implies telegraphic transfer, it is not necessary that the proceeds of the transaction are received by telegram. Any transaction where no delay is involved in the bank acquiring the foreign exchange will be done at the TT rate.

Bill Buying Rate

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This is the rate to be applied when a foreign bill is purchased. When a bill is purchased, the rupee equivalent of the bill value is paid to the exporter immediately. However, the proceeds will be realized by the bank after the bill is presented to the drawee at the overseas centre. In the case of a usance bill the proceeds will be realized on the due date of the bill which includes the transit period and the usance period of the bill.

Exchange Rates
The rate at which one currency may be converted into another and exchange rate is used when simply converting one currency to another (such as for the purposes of travel to another country), or for engaging in trading in the foreign exchange market. There are a wide variety of factors which influence the exchange rate, such as interest rates, inflation, and the state of politics and the economy in each country and also called rate of exchange or foreign exchange rate or currency exchange rate.

Types of Exchange Rates

The following are the types of exchange rates

Floating Rates
Floating rates are the main type of foreign exchange rates and the primary reason for currency fluctuations in foreign exchange markets. All major economies from developed countries allow the value of their currencies to float freely under market forces. Floating rates are preferable if a country's economy is strong enough to withstand the constant change in the value of its currency. For example, a country's currency may lose value in the foreign exchange market if trade deficit is causing weak demand for the currency and strong demand for foreign currencies. As a lower currency value is making

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imports more expensive and exports cheaper, both local and foreign buyers may switch their demand to the country's domestic goods and services. An economy that has the resources and means to meet the shifting demand can automatically adjust both foreign trade and domestic economic activities. Eventually the value of its currency can bounce back up.

Fixed Rates
The smaller economies of developing countries use fixed foreign exchange rates to promote trade and attract foreign investments. For example, by fixing its currency against the currencies of other countries, a country keeps export prices affordable to foreign buyers and accumulates trade surplus over time. Fixed currency rates also allow a country to assure foreign investors of the stable value of their investments in the country. However, under fixed rates, a country's monetary policies can become ineffective, especially when trying to stimulate domestic economic activities by consumers at home. Injecting more money into the economy would normally reduce a country's currency value against foreign currencies under floating rates. As imports become more expensive, consumers would gradually focus their demand on domestic products, potentially lifting up the economy. With fixed rates, however, the exchange value of domestic currency does not move and more money means more buying power for imports. Such an outcome does not achieve policy makers' intention to increase domestic demand.

Pegged Rates
Pegged foreign exchange rates are a compromise between floating rates and fixed rates. Under pegged rates, a country allows its currency to fluctuate within a fixed band around a periodically adjusted central value. Pegged rates are more appropriate for a transitioning, developing economy. They allow both stability and a certain degree of market adjustments. While no artificial exchange rates, fixed or pegged, can fix economic problems single-handed, they do provide an opportunity for growth. Countries hope that economic improvements can bring in the foreign currency reserves required to keep the stated rates. When an economy fails to produce the expected results, such a system

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cannot maintain the fixed value for long, according to Brigham Young University in "Fixed Exchange Rates vs. Floating Exchange Rates."

Features of Exchange Rate

The following are the features of the exchange rates

Exchange Rate always Fluctuates Due to Stronger or Weaker of Currency

It is the main feature of exchange rate that it always fluctuates. If our currency will strong at that time, our exchange rate will differ from previous exchange rate. Suppose, today, one dollar's exchange rate is 44.89. If tomorrow, our currency strong, we have to pay less for buying one dollar. It may be Rs. 43 or Rs. 42 for one dollar. This shows also the appreciation of our currency. Weaker of our own currency means depreciate our currency. At that time, we have to give more money for buying one dollar. It may be Rs. 46 or Rs. 47.

Exchange Rate always is affected from Balance of Payment and Trade, Interest Rate (inflation rate), Economic Growth and Fiscal and Monetary Policies and Political Issues
Exchange rate of any currency are affected from balance of payment and trade. More negative balance of trade will depreciate our currency. In future, if our balance of payment will be surplus, at that time, we can compare Rs. 1 with number of dollars in exchange rate. There are also lots of other factors which affect any currency exchange rate like interest rate or inflation rate, economic growth, fiscal and monetary policies and political issues

Exchange Rate is Two Types, One is Buying Exchange Rate and other is Selling Exchange Rate
If we talk about the feature of exchange rate mechanism, we should know that exchange rates are of two types. One is buying exchange rate and other is selling exchange rate. Both rates may or may not be equal.

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Bid Vs Offer
Prof. Tim Bennett has explained about bid and offer feature of exchange rate in his video lecture "Beginner's guide to investing: the currency market" that bid and offer always will be different. He explained this with an example, "Suppose we compare BP with USD and its bid may be 1.61863 USA dollar for every one British pound and its offer may be 1.61867 USA dollar for every one British pound. One more interesting thing, he explained in his video that bank's buy rate always will be your sell rate in bid and bank's sell rate will be your buy rate in offer.

Exchange Rate Quotations

An exchange rate quotation is the price of a currency stated in terms of another. It is similar to the expression of the price of a commodity. There is a peculiarity attached to exchange rate quotes. In case of a commodity, there is only way to express its price: as number of units of money needed to buy one unit of the commodity.

Illustration
It is always RS. 10 per kg of potatoes, never 100gm of potatoes per rupee. In case of an exchange rate quotation, both the items involved are a form of money, i.e., both the currencies. So, the price of any one of them can be quoted in terms of one unit of the other. Due to this, there exist a number of ways to express the exchange rate between a pair of currencies. The following are the various kinds of quotes are described in the following sections.

American v/s European Quote

A quote can be classified as European quote or American only if one of the currencies is the dollar. An American quote is the number of dollars expressed per unit of any other currency, while a European quote is the number of units of any other currency expressed per dollar.

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Direct quotation

Buy low Pay less units of home currency

Sell high Receive more units of home currency For a fixed unit of foreign currency

For a fixed unit of foreign currency

Fig.1.2 Direct Quotation

Indirect quotations

Buy high Acquire more units of foreign currency

Sell low

Part with lesser of foreign currency For a fixed unit of home currency

For a fixed unit of home currency

Fig 1.3 Indirect quotations

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Direct quote and Indirect Quote

A direct quote is the quote where the exchange rate is expressed in terms of number of units of the domestic currency per unit of foreign currency. An indirect quote is where the exchange rate is expressed in terms of number of units of the foreign currency for a fixed number of units of the domestic currency.

Inter-bank v/s Merchant Quote

Merchant quote is the quote given by the bank to retail its customers. On the other hand, a quote given by one bank to another is called an interbank quote. The convention is that the bank requesting the quote is the customer and the quote will be taken as that of the bank giving the quote i.e. the one which is acting as the market-maker.

Inverse Quote
For every quote (A/B) between two currencies, there exists an inverse quote (B/A), where currency A is being bought and sold, with its price expressed in terms of currency B.

Cross Rates
In the foreign exchange markets, it is a practice to quote most of the currencies against the dollar, and to calculate the exchange rate between other currencies with the dollar as the intermediate currency.

Forecasting of Exchange Rates

A factor affects the levels of and movements in exchange rates, often in a conflicting manner. A number of theories were propounded to explain these effects.

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Though a consistent prediction of the exact level of future exchange rates is impossible these theories help in forecasting the possible direction of the movement. Such forecasting is very important for players in the international markets, as the exchange rates have a great impact on their profits. Another set of players for who correct exchange rate forecasting is vital, are the customers. Their forecast about the movement in exchange rate propels them to undertake speculative activities, especially when their expectations are against those of the market. Though customers are generally ill-known for the destabilizing effects of their activities on financial markets, they are actually the liquidity providers of the markets. Also, as their views are generally opposite to the markets views, they stabilize the marketers by forming the other side of the demandsupply forces. The following are the models for forecasting the exchange rates: Forward rate as an unbiased predictor of future spot rates The demand-supply approach The monetary approach The asset approach The portfolio balance approach Technical analysis

Forward Rate as an Unbiased Predictor of Future Spot Rates

The forward rate is expected to be an unbiased predictor of the future exchange rate. There are two criteria for judging the effectiveness of a forecasting tool- its accuracy and its unbiasedness. A forecasting tool is said to be accurate if the forecast generated proves to be in accordance errors. An unbiased estimate is when the probability of an overestimate is the same as the probability of an underestimate. Various empirical studies have concluded that forward rates are indeed unbiased predictors of future spot rates, where the markets are competitive. For the market to be competitive, the concerned currencies should be freely floating and heavily traded. The presence of central bank intervention reduces the efficiency of the market. There is no evidence to support that the forward rates are accurate predictors of future rates. One possible reason for the inaccuracy of the forward rates is that at any point of time, the forward rate reflects

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expected developments in the variables affecting the exchange rates. On the other hand, the actual future spot rates are affected by all the expected and unexpected developments. As the unexpected developments cannot be factored in the forward rates, the estimates based on these are normally inaccurate. Due to this, the shorter the time gap, the more accurate the forecast based on forward rates is expected to be. Further, a customer who takes a forward position runs the risk of losing if the actual spot rate turns out to be adverse. Hence, the risk is undertaken tends to be compensated with a risk premium.

The Demand-Supply Approach

A currencys exchange rate is said to be determined by the overall supply of and demand for that currency. According to this view, changes in exchange rates can b forecasted by analyzing the factors are listed out in the balance of payments account, this approach is also referred to as the balance-of-payments approach. When the exchange rates are fixed, the effect of other factors is balanced by official demand or supply, which helps in preventing the movement of the exchange rate. In case of flexible exchange rate regime, however, any change in other factors results in a movement in the exchange rate. The demand curve of a currency is mainly derived from the countrys supply curve of exports. The supply of a currency is derived mainly from the countrys imports. Other factors affecting the value of a currency are trades in services, income flows, transfer the effect of appreciating the domestic currency, an exogenous increase in imports results in depreciating the local currency. A change in the level of trade in services has a similar effect. Income flows depend on past investments and the current rate of return that can be earned on these investments. Hence, an expected change in the rate of returns can be used to predict the direction of exchange rates. Any changes resulting in a reduction of an inflow would depreciate a currency, while a reduction of an outflow would appreciate the domestic currency. An increase in net transfers out of the country results in a depreciation of the currency and vice versa. An increase in the net flows on account of foreign investments has two effects. While the domestic currency appreciates at the time of the inflow, its supply increases in the future periods on account of the interest, dividends, profits, or rent earned by that investment and repatriated. The two factors affect the forecast of the exchange rates in the relevant periods accordingly. Another important 32

factor needed to be considered here is the expected change in earnings from foreign investments.

The Monetary Approach

The monetary approach assumes that Purchase Power Parity (ppp) holds good, i.e. an increase in the price level results in the depreciation of a countrys currency and vice versa. Using this assumption, this theory arrives at a few results that are diametrically opposite to that given by the demand-supply approach. With an increase in the real Gross Net Product (GNP) of a country. As the real product increases, so do the transactions and the demand for money need to be held for making purchase. Hence, an increase in the real GNP results in an increase in the real money demand. Due to this, lesser money is left for purchase of goods, services and bonds. With no change in the money supply, this brings down the price levels. With a reduction in the demand for bonds, the bond prices also go down, resulting in an increase in the nominal interest rates. Since this approach assumes PPP to hold well, a reduction in the price levels brings about an appreciation of the currency. Hence, an increase in the real GNP brings about an appreciation of the currency. This is in contrast with the predictions of the demand-supply theory. The theory also outlines the correction mechanism in the system. With a fall in the price level, the real money demand stands reduced. At the same time, an increase in the interest rates increases the opportunity cost of holding money, thus reducing the real demand for money. This leaves people with more money, thus reducing the real demand for money. This leaves people with more money to spend on goods and services, thus increasing the price levels. The predictions of the monetary theory can be summarized as follows: An increase in the real GNP of a country causes its currency appreciate An increase in real money demand makes the currency appreciate An increase in nominal interest rates causes the currency to depreciate An increase in the money supply causes the currency to depreciate

The Asset Approach

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This approach is also referred to as the efficient market hypothesis approach. It does not talk about the effect of changes in the basic economic variables on the exchange rates. According to this approach, whatever changes are expected to occur in the value of a currency in future gets reflected in the exchange rates immediately. That is, any expected change gets absorbed immediately. Hence, the current exchange rate is the reflection of the expectations of the market as a whole. This theory states the new information about the factors likely to affect exchange rates, comes to the market in a random manner. The efficient working of the market whose aim is to maximize their profits. Through their profit-maximizing activities, the participants ensure that all available information is quickly absorbed by the markets. There is one category of players in the currency markets, though, whose aim is not to maximize profits from currency movements. The presence of central banks comes in the way of existing exchange rates reflecting the expected values of currencies truly. This approach explains the implications of fiscal and monetary policy on exchange rate. Since, a fiscal deficit is expected to increase the money supply levels sometime in the future; an increasing fiscal deficit is likely to trigger off an immediate depreciation of the currency, even without an immediate increase in the money supply. Similarly, an expected increase in the money supply through the monetary policy would cause the currency to depreciate immediately.

The Portfolio Balance Approach

The portfolio balance approach states that the value of a currency is determine by two factors- the relative demand and supply of money and the relative demand and supply of bonds. According to this approach, people can hold assets across different countries, denominated in different currencies. Hence, any change in exchange rates changes the wealth of the holders of these assets, which becomes an instrument for maintaining equilibrium in money and bond markets.

Technical Analysis
Forecasting future exchange rates with the use of past exchange rate movements is called technical analysis, the forecasters are called technicians. A pure technician is the

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one who believes that clues in the past movements lead to future. Economic factors such as inflation rates, interest rates, balance of payments and political stability are ignored by pure technicians. A technician believes that exchange rate movements are predictable by using the data on historical movements, the contention being that irrespective of factors that contribute, the impact of all such factors is finally reflected in prices. Technicians develop their own forecasts about future currency values and each technician has individual method. There are many methods used by technicians such as sophisticated statistical models, charts of past exchange rate movements. Some technicians give simple recommendations about future foreign exchange movements. Most technicians use historical data for primary analysis and then make a forecast by keeping in view the economic and political factors.

Hedging
Hedging is one of the tools to manage foreign exchange risk. Hedging is the simultaneous buying and selling of foreign exchange positions to square off the exposed position, and to offset the risks of changing prices in the cash exchanges, or where the foreign exchange is actually bought or sold. With a view to eliminate or reduce substantially the risk of losses from change in exchange rates on position held, enterprises enter into a foreign currency transactions which serve as hedges. A forward exchange contract is the most popular method of hedging in the Indian context. This is a contract to deliver or receive certain quantity of foreign currency at a specified rate and on a stipulated date which means that pending submission of documents to the bank for purchase/ negotiation, you have made firm commitment with bank under which you agree to sell to the bank foreign exchange at a future date/period and the bank agrees to purchase at the firm rate the foreign exchange to be rendered by you on that date/during the agreed period. Thus you are in a position to know in advance the exchange rate you are going to get on submission of your export documents though you have to pay some charge for booking of a forward contract, you are certain about the rupee amount of the bill on conversion of foreign currency at a future date. For booking a forward contract, you should approach the bank. The bank will book a forward contract only against a firm export order showing description and quantity of the goods to be supplied, aggregate 35

price and approximate date of shipment. The bank can accept telex, cable order/fax in this regard, provided you give an undertaking to produce the original one. Where shipment has already been completed, forward contract will be booked on the basis of export bill tendered. It can also be booked against an irrevocable letter of credit provided L/C is complete in all respects and you need to give a declaration to the bank that you have not booked any forward contract against the underlying sale contract covering shipments under the L/C. you must ensure delivery of the related documents within the agreed period of the contract. In case you fail to deliver the documents within the specified period, the forward contract needs to be cancelled and fresh contract is to be booked for which your bank will levy cancellation charges. In case of documents are delivered before the stipulated period, it will involve early delivery, where the documents are not delivered at all, contract has to be cancelled either at your request or by the bank itself under certain circumstances, and this will entail cancellation charges. It therefore becomes extremely important that the period to avoid unnecessary charges on account of early delivery or cancellation of forward contracts. However, RBI permits facility for substitution of export order on specific request. The existence of forward premium or discount is due to a host of factors but primarily due to the interest rate differential between the two countries. Other factors include future expectations, political environment, etc. forward contracts in India could be taken for a maximum period of 180 days. The maturity profile has recently been lengthened and there are quotes available up to one year. The forward contract is one of the hedging tools to manage the risk

Foreign Exchange Contract

There are different types of Foreign Exchange Contracts. Ready or cash merchant contracts deliverable on the same day. Value next day or Tom contracts are deliverable on the day immediately succeeding the contract date. Spot contract is deliverable on second succeeding business day following the contract date.

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Forward contract is a contract deliverable at a future date, duration of the contract being computed from spot value date at the time of transaction.

Definition of Forward Contract

A forward contract is a contract between the customer and bank where the bank agrees to buy from the customer, (or) sell from the customer, foreign currency on a fixed future date, at a fixed rate of exchange.

For Example
Agarwal Jewellery, a leading gold ornament designer from India, requires 100 kilograms of gold to deliver gold jewellery to the Duty- Free Shopping Arcade of Dubai before next Christmas. Agarwal worries about high gold prices and wants to lock in the cost of buying its supply. Shah Gold Mines of Kollar is in the opposite position. It will extract gold before next Christmas, but does not know what the gold can be sold for. So the two firms strike a deal; Agarwal jewellery agrees in august to buy 100 kg gold from Shah Gold Mines at Rs. 9000 per 10 grams, to be paid on delivery in November. Shah Gold Mines agree to sell and deliver 100 kg gold to Agarwal Jewellery in November at Rs. 9000 per 10 grams. Agarwal and Shah are now the two counterparties in a forward contract. The forward price is Rs. 9000 per 10 grams. This is fixed today, but payment and delivery occur later. Agarwal jewellery which has agreed to sell in November has the long position in the market. Shah Gold Mines, which has agreed to sell in November, has the short position, both the companies have eliminated a business risk; Agarwal has locked in its costs, and Shah has locked in its revenues for 100 kg of output.

Definite amount and period

Forward contracts will have to be made for definite amounts and periods. Where a single contract is entered into for more than one rate for bills of different maturities, the contract must state the amount and date of delivery against each rate.

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Currency of Contract
Forward contracts can be booked by residents in any permitted currency even if it is different from the currency in which the underlying trade contract is denominated. It need not have rupee as one leg of the contract. For example an importer having a USD payable can Buy USD Sell INR or Buy USD Sell GBP or Buy GBP Sell INR etc. The customer can leave the other leg fully uncovered or obtain full / partial cover later depending on his views of the market. Care should always be taken to ensure that double exposure is not created in any currency (in the above case the importer can not enter into a contract where customer sells USD which will double his exposure in USD).

Delivery Options
The customer can enter into contracts which are deliverable on a fixed day (say 15th November 2003) or over a range of continuous days. However, such option period should not exceed one month (e.g. 1st November 2003 to 30th November 2003, 12th December 2003 to 11th January 2004, 7th January 2004 to 13th January 2004). Contacts permitting option of delivery must state the first and last dates of delivery.

Place of Delivery
All contracts are understood to be deliverable or paid for at the Bank and at the named place if specifically mentioned.

Date of delivery of the contract

While fixing date of delivery for sale contracts covering import bills the likely date of retirement or crystallization (whichever is earlier) should be reckoned. In case of other outward remittances, the date (or a range of dates 1 st November to 20th November 2003) of actual remittance should be reckoned. In case of inward remittances the date (or a 38

range of dates 1st November to 20th November 2003) of actual remittance should be reckoned. Before going into details of how a purchase contract involving exports should be treated here, it will be useful to know what factors are taken into account when rates are quoted by the Bank in these contracts. The main criteria that determines the premium or discount applicable to the contract over the spot rate is the date (or range of dates) when the foreign currency funds are expected to be received in our Nostro account. However, the delivery period as per FEDAI guidelines is the date (or range of dates) on which the customer is expected to deliver the shipping documents to the bank and take INR from the bank. Hence it is important that while obtaining rates from the treasury the date (or range of dates) when the foreign currency funds are expected to be received in our Nostro account is informed to them. Once this date(s) is taken into account by the treasury and rates are quoted, delivery of documents to the bank and payment of INR by the bank can take place at any time during the validity of the contract subject to: Based on its apparent tenor, the document / bill submitted will fall due for payment on any day during the agreed delivery period in the forward contract booked. To illustrate a forward purchase contract is booked on 1st November 2003 for $100,000 with delivery period from 1st April to 30th April 2004. The customer can now: Deliver documents for $100,000 on 1st January 2004 - shipment date 25th December 2003 and usance 120 days from date of shipment. The due date of this bill works out to 23rd April 2004 which falls between 1st April 2004 and 30th April 2004. (or) Deliver documents for $100,000 on 5th February 2004 shipment date 20th January 2004 and usance 90 days from date of shipment. The due date of this bill works out to 19th April 2004 which falls between 1st April 2004 and 30th April 2004. (Or) Deliver sight documents for $100,000 on 31st March 2004 where payment will be made on receipt documents by the buyer / foreign bank. (Or) Deliver documents on all three dates or any two dates on the same terms as above except for the amount which will have to be $100,000 in aggregate 39

Components
The following are the components of forward contract

Parties
A forward contract may be between a banker and his customer or between two bankers. A contract between a banker and his customer is usually entered into directly, while a contract between bankers may be made either directly or between themselves or through an exchange broker.

Date of Deliveries
A forward contract must state the fixed date or the first and the last dates of delivery and not such phrases as Delivery one week or Delivery one month forward or Delivery three months forward, etc. According to subject to Foreign Exchange Dealers Associations of India (FEDAI) rules Specimen of Forward Contract __________________________ (Name of the bank) To __________________ (Name and the address of the party with whom contract is entered into) We confirm having bought from/sold to you the following exchange Against (foreign Currency) Rate Usance Place Delivery Amount (local currency)

Subject to the rules and regulations of the FEDAI

Need for Forward Contract

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Though the International Monetary Fund (IMF) agreement stipulated fixed parties of the currencies of the member countries, it permits a margin of 2 % on either side of the parity. This means that the rate of exchange between the currencies of any two countries which are the members of the Indian Monetary Fund (IMF) may normally fluctuate within this brand, apart from the wider fluctuations, under extraordinary circumstances. Hence, an importer, who has payments to make to a foreign supplier, runs the risk of paying more, and an exporter, who has payments to receive from a foreign importer, faces the risk of receiving less, if the rate of exchange rises or falls. Forward deals in foreign exchange are to make to cover, i.e. avoid or eliminate such risks of exchange loss. A forward contract thus, enables the exporter who sells goods abroad in terms of a foreign currency to determine at once the amount realizable in terms of their own currency, and the importer who buys goods abroad in terms of a foreign currency to determine at once the cost of imports in terms of their own currency. It also renders debtors and creditors free from the risk due to fluctuations in the exchange rate. The customer, who desire to invest funds at financial centers offering high rates of interest, also find the forward exchange market useful to cover exchange risk in converting the investment on maturity into home or any other currency.

Features of Forward Contract

The following are the features of forward contract It is an agreement between the two counter parties in which one is the buyer and other is seller. All the terms are mutually agreed upon by the counterparties at the time of the formation of the forward contract Forward contract specifies a quantity and type of the asset to be sold and purchased It specifies the future date at which the delivery and payment are to be made It specifies a price at which the payment is to be made by the seller and buyer. The price is determined presently to be paid in future It obligates the seller to deliver the asset and also obligates the buyer to buy the asset

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No money changes hands until the delivery date reaches, except for a small service fee

Forward contract

Booking of forward contract

Re-booking or extension of forward contract

Fig 1.4 process of forward contract

Cancellation of forward contract

The Following are the Individuals who are Eligible for Booking a Forward Contract
Both a resident and a non resident can book forward contracts with an Authorized Dealer. However a non resident is permitted to cover only certain exposures.

Residents
A person resident in India may enter into a forward contract with an authorized dealer in India to hedge an exposure to exchange risk in respect of a transaction for which sale and/or purchase of foreign exchange is permitted under FEMA, or rules or regulations or directions or orders made or issued there under. Application cum Declaration for Booking of Forward Contracts up to USD 100,000 by Resident Individuals (To be completed by the applicant) I. Details of the Applicant

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a) Name b) Address c) Account No d) PAN No II. Details of the Foreign Exchange Forward Contracts required 1. Amount (specify currency pair).. 2. Tenor.. III. Notional Value of Forward Contracts outstanding as on the date IV. Details of Actual/ Anticipated Remittances 1. Amount: 2. Remittance Schedule: 3. Purpose:

Declaration I... (Name of the applicant), hereby declare that the total amount of foreign exchange forward contracts booked with the ______________________ (designated branch) of __________________________ (bank) in India is within the limit 100,000/- (US Dollar one lakh only) and certify that the forward contracts are meant for undertaking permitted current and/ or capital account transactions. I also certify that I have not booked foreign exchange forward contract with any other banks/ branch. I have understood the risks inherent in booking of foreign exchange forward contracts. Signature of the Applicant (Name) Place: Date:

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Non Residents
Foreign Institutional Investors (FIIs) can hedge the market value of their entire investment (equity and/or debt) as on a particular date. Where a hedge becomes naked in part or full owing to shrinking of portfolio for reasons other than sale of securities, the contract may be allowed to continue till its original maturity if desired by the customer. These contracts once cancelled can not be rebooked but may be rolled over on or before maturity. Non-resident Indians (NRIs) and Overseas Corporate Bodies (OCBs) can also book forward contracts to cover the dividend due to them on shares held in an Indian company. Investments made under portfolio scheme under Foreign Exchange Regulatory Act (FERA) 1973 and FEMA (Foreign Exchange Management Act) can also be covered subject to same terms and conditions applicable to FIIs. The balances held in National Rupee account of NRIs can also are covered by forward contracts with Indian Rupee (INR) as one leg in both cases. In case of balances in FCNR accounts, cross currency forwards can also be booked to convert the balances in one foreign currency to another foreign currency in which FCNR deposits are permitted to be maintained. FEDAI has recently clarified that forward contracts can not be booked for balances lying in demand accounts (in INR or FCY) even if the depositor agrees not to withdraw the funds during the contract period.

Foreign Direct Investments in India (FDI)

Forward contracts can also be booked to cover investments made in India since January 1, 1993 subject to verification of the exposure. Residents outside India can also enter into forward sales contracts to cover the currency risk arising out of the proposed FDI after ensuring that the overseas entities have completed all formalities and all necessary approvals have been taken for the investment. These contracts should not exceed six months and if cancelled can not be rebooked. Exchange gains if any on cancellation will not be passed on to the overseas customer.

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Persons having FDIs can enter into forward contracts with the Bank with rupee as one of the currencies to hedge the currency risk on dividend(s) receivable by them on their investments. However cover can be taken only after the rate of dividend is approved by the Board of Directors of the concerned company

The Following are the Governing Rules of RBI While Booking a Forward Contract
A person resident in India may enter into a forward contract with an authorized dealer in India to hedge an exposure to exchange risk in respect of a transaction for which sale and/or purchase of foreign exchange is permitted under the Act the authorized dealer through verification of documentary evidence is satisfied about the genuineness of the underlying exposure, irrespective of the transaction being a current or a capital account transaction can book forward contracts However, authorized dealers may allow importers and exporters to book forward contracts on the basis of a declaration of exposure subject to the conditions as mentioned below: The previous years actual import/export turnover, whichever is higher, subject to the following conditions The forward contracts booked in the aggregate during the year and outstanding at any point of time should not exceed the eligible limit i.e the average of the previous three financial years (April to March) actual import/export turnover or the previous years turnover, whichever is higher. Contracts booked in excess of 25% of the eligible limit will be on deliverable basis and cannot be cancelled. These limits shall be computed separately for import/export transactions. To provide greater flexibility to residents in managing their exposures, it has been decided that all forward contracts, booked by residents to hedge current account transactions, regardless of tenor, may be allowed to be cancelled and rebooked freely

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This relaxation will not be applicable to forward contracts booked on past performance basis without documents Any forward contract booked without producing documentary evidence will be marked off against this limit Importers and exporters should furnish a declaration to the authorized dealer regarding amounts booked with other banks /authorized dealers under this facility. An undertaking may be taken from the customer to produce supporting documentary evidence before the maturity of the forward contract Outstanding forward contracts higher than 50% of the eligible limit may be permitted by authorized dealers on being satisfied about the genuine requirements of their constituents after examination of the following documents

A certificate from the Chartered Accountant of the customer that all guidelines have been adhered to while utilizing this facility. A certificate of import/export turnover of the customer during the past three years duly certified by their Chartered Accountant/bank in the prescribed format In the case of an exporter, the amount of overdue bills should not be in excess of 10 per cent of the turnover, to avail the above facility

The Following are the Governing Rules of RBI for Cancellation and ReBooking of Forward Contract
A forward contract cancelled with one authorized dealer can be rebooked with another authorized dealer subject to the following conditions The switch is warranted by competitive rates on offer, termination of banking relationship with the authorized dealer with whom the contract was originally booked, etc. The cancellation and rebooking are done simultaneously on the maturity date of the contract. the responsibility of ensuring that the original contract has been cancelled rests with the authorized dealer who undertakes rebooking of the contract

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The Following are the Precautions while Booking a Forward Contract

Genuineness of the underlying exposure, irrespective of the transaction being a current or a capital account transaction The maturity of the hedge does not exceed the maturity of the underlying transaction The currency of hedge and tenor are left to the choice of the customer Where the exact amount of the underlying transaction is not ascertainable, the contract is booked on the basis of a reasonable estimate Foreign currency loans/bonds will be eligible for hedge only after final approval is accorded by the Reserve Bank where such approval is necessary or loan identification number is given by the Reserve Bank. Global Depository Receipts (GDRs) will be eligible for hedge after the issue price has been finalized Balances in the Exchange Earner's Foreign Currency (EEFC) accounts sold forward by the account holders shall remain earmarked for delivery and such contracts shall not be cancelled All forward contracts, booked by residents to hedge current account transactions, regardless of tenor, may be allowed to be cancelled and rebooked freely substitution of contracts for hedging trade transactions may be permitted

Booking of Forward Contracts

1. The transactions of booking of forward contract is initiated with the customer enquiring of his bank the rate at which the required forward currency is available. Before quoting a rate the bank should get details about (i) the currency, (ii) the period of forward cover, including the particulars of option, and (iii) the nature and tenor of the instrument. 2. The branch may not be fed with forward rates of all currencies by the dealing room. Even for major currencies forward rates for standard delivery periods may only to available at the branch.

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3. If the rate quoted by the bank is acceptable to the customer, he is required to submit an application to the bank along with documentary evidence to support the application, such as the sale contract. 4. After verification of the application and the documentary evidence submitted, the bank prepares a Forward Exchange Contract. 5. While preparing the contract, the following points are to be noted:

The branch may give a serial number to the contract, so that further reference to if becomes easy. Contracts must state the first and last dates of delivery. It is not permissible to state in contracts delivery one week or delivery one month or delivery three months forward, etc.

When more than one rate for bills with different delivers are mentioned, the contract must state the amount and delivery against each rate. No usance option may be stated in any contract for the purchase of bills. That is, the contract should not give option to the customer to tender sight bill or in the alternative 30 days bill, etc. It can be either sight bill or a usance bill of a specified usance as mentioned in the contract.

The first portion of the contract is relevant for booking of the contract. The second portion is used for recording deliveries under the contract. The contract should be complete in all respects.

6. The number of copies of the contract prepared will depend upon the requirements of the bank. The original of the contract duly signed by the bank, along with the duplicate, is sent to the customer. 7. The details of the contract are entered are entered in a Forward Contract Register. The resister also provides for recording of details of documentary evidence verified.

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8. The documents are verified and marked with the bank stamp and signature of the bank official, after entering the particulars of the forward contract booked. It is returned to the customer. 9. The due date of the contract should be arise in a regular and followed up on the due date. 10. Charges for booking the forward contract as prescribed by the bank concerned is recovered from the customer. 11. When the customer delivers foreign exchange on the due date, the transactions is done at the rate agreed.

Extension of Forward Contract

A customer who has entered into a forward contract may not be always be able to complete it on the due date for reasons beyond the control, such as strike, transport delay, non-receipt of supplies, non-availability of shipping space, etc. in such circumstances, the contract may, at the request of the customer, be extended at the option of the banker, on, before, or at the date of delivery of the exchange under the contract. Extension of forward contract consists of forward purchase and forward sale contract.

Extension of Forward Purchase Contracts

The following are the extension of forward purchase contracts

Time limit
A forward purchase contract may be extended by the authorized dealer, provided that the last date of delivery of the foreign exchange under the extended contract does not fall beyond 3 months in the case of exports to Pakistan or Afghanistan and 6 months in other cases from the date, or the expected date, of shipment, according as the goods have been already been, or are yet to be, shipped

Roll-over Forward Purchase Contract

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A roll-over forward purchase contract under a deferred payment agreement may, at the end of the initial period of six months and thereafter, at the end of each subsequent period of six months, be renewed by the authorized dealers, provided that the deferred payment terms originally approved by the reserve bank.

Extension for Relaxed Period

Where the Reserve bank has relaxed at the time limit for the realization of the proceeds of exports, an extension of a forward purchase contract against such exports, covering the extended period approved by the reserve bank, may be allowed without reference to the reserve bank

Extension of forward sale contracts

The following are the extension of forward sale contracts

Time Limit
A forward sale contract may be extended for a further period without reference to the reserve bank, provided that the last date of delivery under the extended contract does not fall beyond six months from the date, or expected date of shipment

Roll-Over Forward Sale Contract

The extension of forward sale contract on a roll-over basis under a deferred payment arrangement may, without reference to the reserve bank, be allowed after the initial or a subsequent period of six months, provided that the deferred payment arrangement was originally approved by reserve bank

Forward Sale Contract Against Surplus Freight

The extension beyond the original period of two months of forward sale contract with a foreign steamship/airline company operating in India against remittance to its head office of surplus collection of freight and passage earnings is permissible only with the prior approval of the reserve bank

Cancellation of Forward Contract

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A forward contract cannot be utilized against any other foreign exchange commitment or risk. The unutilized portion, if any, of a forward contract is, there of, required to be cancelled forthwith

Procedure
The following is the procedure for cancellation of forward contracts

No Reference to RBI Necessary

The unutilized portion of the forward contract, irrespective of the amount involved may be cancelled by the contracting bank without prior reference to the reserve bank.

Application
Where the unutilized portion exceeds U.S. $ 5,000 or its equivalent, the contract may be cancelled by the bank after obtaining from the contracting customer, an application in duplicate form. No forward contract should be kept open for an unreasonable length of time, merely on the ground that the application for cancellation has not been received from the customer. The cancellation should be effected if the authorized dealer is otherwise satisfied that the customer is not in a position to fulfill the contract

Endorsement on Import License

In cancelling a forward sale contract, the amount cancelled should be endorsed on the exchange control copy or the relative import license except the following conditions Where the contract has been entered into with an indenting agent under a valid letter of authority and the original holder of the import license decides subsequently to import either directly or through another indentor Where the original overseas supplier is not in a position to supply the relative goods and the importer desires to transfer the order to another supplier

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 Where the cancellation has arisen because of the freight and/or insurance having been settled locally and the amounts have already been endorsed on the license

Execution of Forward Contract

A customer under forward 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. Though the delivery or take delivery of a fixed sum of foreign exchange under a forward contract has to take place at the agreed time, quite often this does not happen and it may either take place before or after the due date agreed upon. However, the bank generally agrees to these variations provided the customer bears the loss if any on account of this variation. Based on the circumstances, the customer may end up in any of the following ways Delivery on the due date Early delivery Late delivery Cancellation on the due date Early cancellation Late cancellation Extension on the due date Early extension

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Late extension As per the Rule 8 of FEDAI, a request for delivery or cancellation or extension of

the forward contract should be made by the customer on or before its maturity date. Otherwise a forward contract which remains unutilized after the due date becomes an overdue contract. Rule 8 of FEDAI stipulates that banks shall levy a minimum charge of Rs. 100 for every request from a merchant for early delivery, extension or cancellation of a forward contract. This is in addition to recovery of actual loss incurred by the bank caused by these changes.

Delivery on Due Date

This is the situation envisaged when the forward contract was entered into. When the foreign exchange is delivered on the due date, the rate applied for the transaction would be the rate originally agreed, irrespective of the spot rate prevailing.

Early Delivery
When a customer requests early delivery of a forward contract, i.e., delivery before its due date, the bank may accede to the request provided the customer agrees to bear the loss, if any, that may accrue to the bank.

Cancellation/Extension of Forward Contract

The customer is having the right to cancel a forward contract at any time during the duration of the contract. The cancellation is governed by Rule 8 of the FEDAI. The difference between the contracted rate and the rate at which the cancellation is done shall be recovered or paid to the customer, if the cancellation is at the request of the customer. Exchange difference not exceeding Rs.50 shall be ignored. The spot rate is to be applied for cancellation of the forward contract on due date. The forward rate is to be applied for cancellation before due date. In the absence of any instruction from the customer, contracts which have matured shall on the 15th day from the date of maturity be automatically cancelled. If the 15th day falls on a holiday or Saturday the cancellation 53

will be done on the next succeeding working day. The customer is liable for recovery of cancellation charges and in no case the gain is passed on to the customer since the cancellation is done on account of customers default. The customer may approach the bank for cancellation when the underlying transaction becomes infractions, or for any other reason he wishes not to execute the forward contract. If the underlying transaction is likely to take place on a day subsequent to the maturity of the forward contract already booked, he may seek extension in the due date of the contract. Such requests for cancellations or extension can be made by the customer on or before the maturity of the forward contract.

Cancellation of Forward Contract on Due date

When a forward purchase contract is cancelled on the due date it is taken that the bank purchases at the rate originally agreed and sells the same back to the customer at the ready TT rate. The difference between these two rates is recovered from/paid to the customer. If the purchase rate under the original forward contract is higher than the ready T.T selling rate the difference is payable to the customer. If it is lower, the difference is recoverable from the customer. The amounts involved in purchase and sale of foreign currency are not passed through the customers account. Only the difference is recovered/paid by way of debit/credit to the customers account. In the same way when a forward sale contract is cancelled it is treated as if the bank sells at the rate originally agreed and buys back at the ready T.T buying rate. The difference between these two rates is recovered from/paid to the customer.

Early Cancellation of a Forward Contract

Sometimes the request for cancellation of a forward purchase contract may come from a customer before the due date. When such requests come from the customer, it would be cancelled at the forward selling rate prevailing on the date of cancellation, the due date of this sale contract to synchronize with the due date of the original forward purchase contract. On the other hand if a forward sale contract is cancelled earlier than

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the due date, cancellation would be done at the forward purchase rate prevailing on that day with due date of the original forward sale contract.

Extension on Due Date

An exporter finds that he is not able to export on the due date but expects to do so in about two months. An importer is unable to pay on the due date but is confident of making payment a month later. In both these cases they may approach their bank with whom they have entered into forward contracts to postpone the due date of the contract. Such postponement of the date of delivery under a forward contract is known as the extension of forward contract. The earlier practice was to extend the contract at the original rate quoted to the customer and recover from him charges for extension. The reserve bank has directed that, with effect from16.1.95 when a forward contract is sought to be extended, it shall be cancelled and rebooked for the new delivery period at the prevailing exchange rates. FEDAI has clarified that it would not be necessary to load exchange margins when both the cancellation and re-booking of forwards contracts are undertaken simultaneously. However it is observed that banks do include margin for cancellation and rebooking as in any other case. Further only a flat charge of Rs.100 (minimum) should be recovered and not Rs.250 as in the case of booking a new contract.

Overdue Forward Contracts

The customer has the right to utilize or cancel or extend the forward contract on or before its due date. No such right exists after the expiry of the contract. FEDAI Rule 8 provides that a forward contract which remains overdue with any instructions from the customer concerned on or before its due date shall on the 15th day from the date of maturity be automatically cancelled by the bank. The customer remains liable for the exchange difference arising there from but if it results in profit it need not be passed on to the customer. In case of delivery subsequent to automatic cancellation the appropriate current rate prevailing on such delivery shall be applied.

Roll over Forward Contracts

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When deferred payment transactions of imports/exports takes place, the repayment of the installment and interests on foreign currency loans by the customer requires long term forward cover where the period extends beyond six months. The bank may enter into forward contract for long terms provided there is suitable cover is available in the market. However the cover is made available on roll over basis in which cases the initial contract may be made for a period of six months and subsequently each deferred installments for the outstanding balance of forward contract by extending for further periods of six months each. For these transactions the rules and charges for cancellation / extension of long term forward contracts are similar to those of other forward contracts.

Inter-bank Deals
Foreign exchange transactions involve transaction by a customer with the bank while inter-bank deals refer to purchase and sale of foreign exchange between banks. In other words, it refers to the foreign exchange dealings of a bank in inter-bank market.

Cover Deals
The banks deal with foreign exchange on behalf of its customers. Purchase and sale of foreign currency in the market undertaken to acquire or dispose of foreign exchange required or acquired as a consequence of its dealings with its customers is known as the cover deal. In this way that is through cover deal the bank gets insured against any fluctuation in the exchange rates. While quoting a rate to the customer the bank is guided by inter-bank rate to which it adds or deducts its margin, and arrives at the rate it quotes to the customer. For example, if it is buying dollar from the customer special it takes inter-bank buying rate deducts its exchange margin and quotes the rate. This exercise is done on the assumption that immediately on purchase from customer the bank would sell the foreign exchange to inter-bank market at market buying rate. Foreign currency is considered as peculiar commodity with wide fluctuations price, the bank would like to sell immediately whatever it purchases and whenever it

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sells, it immediately tries to purchase so that it meets it is commitment. The main reason for this is that the bank wants to reduce exchange risk it faces to the minimum. Otherwise, any adverse change in the rate would affect its profits. In the case of spot deals the transaction is quite simple. If the bank purchased any foreign exchange, it would try to find another customer to whom it can sell this and thus books profit. In this process the profit would be the maximum because both buying and selling rates are determined by the bank and the margin between the rates is the maximum. If it cannot find another customer its sells in inter-bank market where the rate is determined by the market conditions and the margin is narrower here.

Trading
Trading refers to purchase and sale of foreign exchange in the market other than to cover banks transactions with the customers. The purpose may be to gain on the expected changes in exchange rates. In India the scope for trading, although still subject to controls, is getting wider the relaxations being made in the exchange control regulations.

Classification of Forward Contract

The forward contracts can be classified into different categories. Under the forward contracts (regulation) act, 1952, forward contract can be classified in the following categories:

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Forward contracts

Hedge contracts

Transferable specific delivery (TSD) contracts

Fig1.2 classification of forward contracts

Non-transferable specific delivery (NTSD) contracts

Hedge Contracts
The basic features of forward contract are they are freely transferable and do not specify any particular lot, consignment or variety of delivery of delivery of the underlying goods or assets. Delivery in such contracts is necessary except in a residual or optional sense. These contracts are governed under the provisions of the forward contract act, 1952.

Transferable Specific Delivery (TSD) Contracts

These forward contracts are freely transferable from one party to another. These are concerned with a specific and predetermined consignment or variety of the commodity. There must be delivery of the underlying asset at the expiration time. It is mandatory. Such contracts are subject to the regulatory provisions of the forward contracts act, 1952, but the central government has no power to exempt (in specified cases) such forward contracts.

Non Transferable Specific Delivery (NTSD) Contracts

These contracts are of such nature which cannot be transferred at all. These may concern with specific variety or consignment of goods or their terms may be highly specific. The delivery in these contracts is mandatory at the time of expiration. Normally, 58

these contracts have been exempted from the regulatory provisions of forward act, but the central government, whenever feels necessary, may bring them under the regulation of the act.

Concept of Forward Contract

In forward contract, two parties agree to do a trade at some future date at a stated price and quantity. No money change at the time of deal is signed. However unlike future contracts, they are not traded on an exchange. They are private contracts between two parties which may be between financial institutions, between a financial institution and one of its corporate client, etc. further; these contracts differ from cash or spot contracts where delivery is made immediate within a short period of time. Most of the forward contracts are traded on the over-the-counter (OTC) market or by telephones. Honoring the contract is made generally by taking and giving delivery and counter parties risk depends on the counter party only. At the time the forward contract is written, a specified price is fixed at which the asset is purchased or sold. This specified price is referred to as the delivery price. This delivery price is set such that the value of forward contract is zero at the time of formation. This means that it costs nothing to take either a long or a short position. This is done by convention so that no cash is exchanged between parties entering into the contracts. In this way, the delivery price yields a fair price for the future delivery of the underlying asset. One of the parties to a forward contract agrees to buy the underlying asset is said to have a long position. On the other hand, the party that agrees to sell the same underlying asset is said to have a short position.

Advantages of Forward Contract

The following are the advantages of forward contract Eliminate currency risk as foreign exchange costs are determined upfront Establish contracts to match the banks cash flows Set up delivery dates to match the cash flows Contracts are available in all the freely convertible currencies 59

Market liquidity typically available up to two years into the future

Limitations of Forward Contract

The following are the limitations of forward contract Lack of centralization of trading Illiquidity Counterparty In the first two of these limitations, the basic problem is that of too much flexibility and generality. The forward market is like a real state market in that any two design terms of the deal which are very convenient in that specific situation, but makes the contracts non-tradable. Counterparty risk arises from the possibility of default by any one party to the transaction. When one of the two sides to the transaction declares bankruptcy, the other suffers even when forward market trades standardized contracts and hence avoid the problem of liquidity.

Establishment and constitution of the Forward Markets Commission

The following are the procedure of the forward market commission The Central Government may, by notification in the official Gazette, establish a Commission to be called the Forward Markets Commission for the purpose of exercising such functions and discharging such duties as may be assigned to the Commission by or under this Act. The Commission shall consist of not less than two, but not exceeding four members appointed by the Central Government one of them being nominated by the Central Government to be the Chairman thereof; and the Chairman and the other member or members shall be either whole-time or part- time as the Central Government may direct provided that the members to be so appointed shall be persons of ability, integrity and standing who have shown capacity in dealing with problems relating to commerce or commodity markets, or in administration or who have special knowledge or practical experience in any matter which renders them suitable for appointment on the Commission.

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No person shall be qualified for appointment as, or for continuing to be, a member of the Commission if he has, directly or indirectly, any such financial or other interest as is likely to affect prejudicially his functions as a member of the Commission, and every member shall, whenever required by the Central Government so to do, furnish to it such information as it may require for the purpose of securing compliance with the provisions of this sub-section.

No member of the Commission shall hold office for a period of more than three years from the date of his appointment, and a member relinquishing his office on the expiry of his term shall be eligible for re-appointment.

The other terms and conditions of service of members of the Commission shall be such as may be prescribed.

Functions of the Commission

The functions of the Commission shall be To advise the Central Government in respect of the recognition of or the withdrawal of recognition from any association or in respect of any other matter arising out of the administration of this Act To keep forward markets under observation and to take such action in relation to them as it may consider necessary, in exercise of the powers assigned to it by or under this Act To collect and whenever the Commission thinks it necessary publish information regarding the trading conditions in respect of goods to which any of the provisions of this Act is made applicable, including information regarding supply, demand and prices, and to submit to the Central Government periodical reports on the operation of this Act and on the working of forward markets relating to such goods To make recommendations generally with a view to improving the organization and working of forward markets

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To undertake the inspection of the accounts and other documents of any recognized association or registered association or any member of such association whenever it considers it necessary

To perform such other duties and exercise such other powers as may be assigned to the Commission by or under this Act, or as may be prescribed

Powers of the Commission

The Commission shall, in the performance of its functions, have all the powers of a civil court under the Code of Civil Procedure, 1908 (5 of 1908), while trying a suit in respect of the following matters, namely Summoning and enforcing the attendance of any person and examining him on oath Requiring the discovery and production of any document Receiving evidence on affidavits Requisitioning any public record or copy thereof from any office Any other matters which may be prescribed The Commission shall have the power to require any person, subject to any privilege which may be claimed by that person under any law for the time being in force, to furnish information on such points or matters as in the opinion of the Commission may be useful for, or relevant to any matter under the consideration of the Commission and any person so required shall be deemed to be legally bound to furnish such information within the meaning of Sec. 176 of the Indian Penal code, 1860 (45 of 1860). The Commission shall be deemed to be a civil court and when any offence described in Sections. It is committed in the view or presence of the Commission, the Commission may, after recording the facts constituting the offence and the statement of the accused as provided for in the Code of Criminal Procedure, 1898 (5 of 1898) forward the case to a Magistrate having jurisdiction to try the same and the Magistrate to whom any such case is forwarded shall proceed to hear the complaint against the accused as if the case had been forwarded to him under Section 482 of the said Code.

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Definition of Forward Exchange Rate

A Forward Foreign Exchange rate is the exchange rate at which one currency can be exchanged for another currency for settlement on a predetermined future date. Clients can take advantage of forward exchange rates using Forward Exchange Contracts (FEC). An FEC allows clients to lock in an exchange rate today for a transfer that needs to occur in the future (between two days and twelve months from today), thereby protecting against exchange rate movements in the interim. The forward rate is calculated by adjusting the current market rate (the spot rate) for "forward points", which take into account the difference in interest rates between the two currencies and the time to maturity. The forward points are based on a formula which is standard industry practice; this is not an extra margin charged by foreign exchange.

Computation of Forward Exchange Rates

The following are the computation of forward exchange rates

Fixed Forward Contracts

The method of calculation of forward rates is similar to that of ready rates. The only difference is that in case of forward rates, the forward margin that is included in the rate will be for forward period as well. The forward discount or the forward premium included in the buying rate will be not only for the transit period and usance, but also for the forward period. For example if the banks buys a 30 days sight bill for 2 months forward, the total forward discount will be for 4 months (30 days usance + 25 days transit + 2 months forward, rounded off to higher month) For selling rates, forward margin is not considered while calculating ready rates. In the case of forward rates, the forward margin for the forward period will be included. In other aspects, the calculation is same as that of ready rates.

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The method of calculation of forward rate is shown below Forward Buying rate for Dollar Dollar/ Rupee spot buying rate 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 Forward buying rate for dollar * rounded off to nearest multiple of 0.0025 Forward Selling Rate Dollar/ Rupee market spot selling rate Add: forward premium ( for forward period) ( or) = Rs. -------- Rs.------------= Rs. * = Rs. --------------

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Less: forward discount (for forward premium)

+/ - RS. ---------____________ =Rs.------------

Add: exchange margin for TT selling rate Forward TT selling rate for dollar Add: exchange margin selling rate

+ Rs. ----------= Rs.------------* =Rs.-----------___________

Forward bills selling rate for dollar

= Rs. ----------- * _____________

* rounded off to nearest multiple of 0.0025 when quoted to customer

Option Forward Contracts

In the case of option forward contract the customer has the freedom to deliver the foreign exchange on any day during the option period. The bank should quote a single rate valid for the entire option period. The option rate quoted on behalf of the customer is based on the inter bank option forward rate, while between banks the option of delivery under a forward contract rests with the buying bank. To put it simply, the quotation under option delivery is as follows: for purchase transactions quote premium for the earliest delivery and for sale transactions quote premium for latest delivery.

Exchange Control Regulations

While booking forward contracts for customers, banks are required to observe that the exchange control regulations are complied with. Foreign Exchange Management (Foreign Exchange Derivative Contracts) Regulations, 2000 govern forward exchange 65

contract in India. The terms and conditions relate to booking, cancellation, rebooking etc. of forward exchange contracts are given below:

The authorized dealer, through verification of documentary evidence, should be satisfied about the genuineness of the underlying exposure The maturity of the hedge should not exceed the maturity of the underlying transaction The currency of hedge and tenor are left to the choice of the customer Where the exact amount of the underlying transaction is not ascertainable the contract can be booked on the basis of the reasonable estimate Foreign currency loans/bonds will be eligible for hedge only after final approval is accorded by the Reserve bank, where such approval is necessary In case of Global Depository Receipts (GDRs), the issue price should have been finalized Substitution of contracts for hedging trade transactions may be permitted by an authorized dealer on being satisfied with the circumstances under which such substitution has become necessary

Components 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.

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

Amount

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Forward exchange contracts are entered into for a definite sum expressed in foreign currency.

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.

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

Option Period

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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 affected/delivery option exercised on the preceding working day.

Option of Delivery
In all option forward contracts the merchant whether a buyer or a seller will have the option of delivery.

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

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Forward Rate
The rate of exchange fixed under a forward contract for buying or for selling a foreign currency for delivery at a specified future date is known as the forward rate. For contracts on other currencies, the rate is to be determined on the basis of market conditions.

Rules for Quoting Forward rate

The following are the rules for quoting forward rate Rules Premium Selling rates for sales to Quote maximum premium customer For option forward Deduct maximum premium from for longest period Buying rates for purchases from customers For option forward Deduct minimum premium for shortest period Add maximum discount for longest period Quote minimum premium Add minimum discount for shortest period Quote maximum discount Discount Quote minimum discount

Factors Influencing Forward Rates

The following are the factors influencing forward rates

Strength of the Economy

The strength of the economy affects the demand and supply of foreign currency.

If an economy is growing fast and is strong it will attract foreign currency thereby strengthening its own. On the other hand, weaknesses result in an outflow of foreign exchange. If a country is a net exporter (as were Japan and Germany), the inflow of foreign currency far outstrips the outflow of their own currency. The result is usually a strengthening in its value.

Political and Psychological Factors

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Political or psychological factors are believed to have an influence on exchange rates. Many currencies have a tradition of behaving in a particular way such as Swiss francs which are known as a refuge or safe haven currency while the dollar moves (either up or down) whenever there is a political crisis anywhere in the world. Exchange rates can also fluctuate if there is a change in government. Some time back, Indias foreign exchange rating was downgraded because of political instability and consequently, the external value of the rupee fell. Wars and other external factors also affect the exchange rate. For example, when Bill Clinton was impeached, the US dollar weakened. During the Indo-Pak war the rupee weakened. After the 1999 coup in Pakistan (October/November 1999), the Pakistani rupee weakened.

Economic Expectations
Exchange rates move on economic expectations. After the 1999 budget in India

there was an expectation that the rupee would fall by 7% to 9%. Since such expectations affect the external value of the rupee, all economic data the balance of payments, export growth, inflation rates and the likes are analyzed and its likely effect on exchange rates is examined. If the economic downturn is not as bad as anticipated the rate can even appreciate. The movement really depends on the market sentiment the mood of the market and how much the market has reacted or discounted the anticipated/expected information.

Inflation Rates
It is widely held that exchange rates move in the direction required to compensate

for relative inflation rates. For instance, if a currency is already overvalued, i.e. stronger than what is warranted by relative inflation rates, depreciation sufficient enough to correct that position can be expected and vice versa. It is necessary to note that an exchange rate is a relative price and hence the market weighs all the relative factors in relative terms (in relation to the counterpart countries). The underlying reasoning behind this conviction is that a relatively high rate of inflation reduces a countrys competitiveness and weakens its ability to sell in international markets. This situation, in turn, will weaken the domestic currency by reducing the demand or expected demand for it and increasing the demand or expected demand for the foreign currency (increase in the supply of domestic currency and decrease in the supply of foreign currency). 70

Capital Movements
Capital movements are one of the most important reasons for changes in exchange

rates. Capital movements of foreign currency are usually more than connected with international trade. This occurs due to a variety of reasons both positive and negative. When India began its economic liberalization and invited Foreign Institutional Investors (FIIs) to purchase equity shares in Indian companies, billions of US dollars came into the country strengthening the currency. In 1996 and 1997, FIIs took several billion US dollars out of the country weakening the currency. These were capital outflows. One of the reasons popularly believed for the rupee not depreciating in the manner other Southeast Asian currencies did in 1997-98 was because the rupee was not convertible on the capital account.

Balance of Payments
A net inflow of foreign currency tends to strengthen the home currency vis--vis other currencies. This is because the supply of the foreign currency will be in excess of demand. A good way of ascertaining this would be to check the balance of payments. If the balance of payments is positive and foreign exchange reserves are increasing, the home currency will become stronger.

Governments Monetary and Fiscal Policies

Governments, through their monetary and fiscal policies affect international trade, the trade balance and the supply and demand for a currency. Increasing the supply of money raises prices and makes imports attractive. Fiscal surpluses will slow economic growth and this will reduce demand for imports and encourage exports. The effectiveness of the policy depends on the price and income elasticitys of demand for the particular goods. High price elasticity of demand means the volume of a good is sensitive to a change in price. Monetary and fiscal policy supports the currency through a reduction in inflation. These also affect exchange rate through the capital account. Net capital inflows supply direct support for the exchange rate. Central governments control monetary supply and they are expected to ensure that the governments monetary policy is followed. To this extent they could increase or decrease money supply. For example, the Reserve Bank of India, to curb inflation, restricted and cut money supply. In Kenya, the central bank in

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order to attract foreign money into the country is offering very high rates on its treasury bills. In order to maintain exchange rates at a certain price the central bank will also intervene either by buying foreign currency (when there is an excess in the supply of foreign exchange) and selling foreign currency (when demand for foreign exchange exceeds supply). This is known as central bank intervention. It must be noted that the objective of monetary policy is to maintain stability and economic growth and central banks are expected to by increasing/decreasing money supply, raising/lowering interest rates or by open market operations maintain stability.

Exchange Rate Policy and Intervention

Exchange rates are also influenced, in no small measure, by expectation of change

in regulations relating to exchange markets and official intervention. Official intervention can smoothen an otherwise disorderly market, the intervention is the buying or selling of foreign currency to increase or decrease its supply. Central banks often intervene to maintain stability. It has also been experienced that if the authorities attempt to halfheartedly counter the market sentiments through intervention in the market, ultimately more steep and sudden exchange rate swings can occur

Interest Rates
An important factor for movement in exchange rates in recent years is interest

rates, i.e. interest differential between major currencies. In this respect the growing integration of financial markets of major countries, the revolution in telecommunication facilities, the growth of specialized asset managing agencies, the deregulation of financial markets by major countries, the emergence of foreign trading as profit centers per se and the tremendous scope for bandwagon and squaring effects on the rates, etc. have accelerated the potential for exchange rate volatility. Kenya intrinsically has a very weak economy but the rates offered within the country have always been very high. To illustrate this point the Treasury bill rate in September 1998 was as high as 23%. High interest rates attract speculative capital moves so the announcements made by the Federal Reserve on interest rates are usually eagerly awaited an increase in the same will cause an inflow of foreign currency and the strengthening of the US dollar

Tariffs and Quotas

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Tariffs and quotas exist to protect a countrys foreign exchange by reducing demand. Till before liberalization, India followed a policy of tariffs and restrictions on imports. Very few items were permitted to be freely imported. Additionally, high customs duties were imposed to discourage imports and to protect the domestic industry. Tariffs and quotas are not popular internationally as they tend to close markets. When India lifted its barriers, several industries such as the mini steel and the scrap metal industries collapsed (imported scrap became cheaper than the domestic one). Quotas are not restricted to developing countries. The United States imposes quotas on readymade garments and Japan has severe quotas on non-Japanese goods

Definition of Interest Rate

Interest rate is either an expense of consumption or revenue of investment on a money activity. For example, it is an expense of consumption when one borrows money from a financial institute and is being asked to return the money borrowed with interest, a percentage of the money borrowed in a future time. It is a revenue of investment when one loans out money and receives interest plus the principal sum in the future as compensation. Interest rate is affected by the economic conditions of a country. For instance, the Federal Reserve in the United States affects interest rates through the country's monetary policy.

How Forward Rate is Determined

Suppose if there is a exchange currency A into currency B today, you could gain interest of 6 percent annually by depositing the money into a CD for currency B. Under a certain contract with your business partner, you could not exchange the currency until one year from today. Because youre risk-free interest rate from the CD is 6 percent, your contract with your business partner is only worthwhile if your partner is willing to pay a forward rate of 6 percent. That is a total sum of currency B plus 6 percent of currency B.

Relationship between Interest Rate and Forward Rate

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The most common use of interest rate and forward rate is in hedging, a financial activity to minimize foreign exchange rate risks. Hedging is performed through a financial instrument, currency swap. When you exchange currency between countries, there are differences in monetary value that may lead to a loss of value of one currency when it is exchanged into another currency. This is known as exchange rate risk. In an effort to reduce the risk associated with differences in monetary value, you enter into a hedge where you offset the risk through exchanging a "spot" contract (that uses the interest rate of today) with a "forward" contract (that uses the forward rate of a certain future time) of equal amount.

The Relationship in the Simplest Term

The relationship between forward rate and interest rate in the simplest terms is "forward rate" is a predicted "interest rate" of the future.

How to Use a Forward Contract to Hedge the Interest Rate Risk

Interest rate risk to a borrower is the risk that rates will raise in the future. Many types of personal and corporate debt are floating, which means that the interest rate can be reset or move higher naturally if the rate is tied to an interest rate that goes up and down. Forward contracts can be used to hedge this type of risk.

Instructions
Determine what the mechanism is for the rate to move higher. Some rates can be reset only periodically based on movements in market rates such as the Prime rate, the Fed funds rate and LIBOR, which is the widely quoted London Inter-bank Offered Rate. Other interest rates can float all of the time, being tied directly to a rate that can move every day. Model the cash flows. Make a detailed spreadsheet of the debt, by month, using the actual dates involved in the schedule of interest

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and principal payments. If at all possible, build a forward curve of the interest rate that is used to calculate the interest expense. Then, run sensitivities on that forward curve to evaluate the magnitude of the forward exposure. Determine which type of forward contract best fits this stream of future interest cash flows. There are several commonly used instruments that can hedge forward interest rate exposure. The most direct is to lend the exact same amount of money that has been borrowed, at the exact same interest rate. This way, the interest expense earned will offset the interest expense paid. Forward contracts can be used to swap the floating interest expense with fixed future interest expense cash flows, thereby locking in a set rate in the present. Interest rate swaps are very common and represent a series of separate forward contracts that are timed to match the risk. Identify counterparty and negotiate the deal. Banks make money by doing deals in the forward interest rate markets and it will not be difficult to locate one that is willing to be counterparty to one of the types of trades. There will, however, be fees involved in dealing with a bank, so it is important to factor those fees into the cash flow model of the debt and its hedge. Manage the credit risk. The hedge will serve no purpose if the counterparty involved goes bankrupt and cannot pay its side of the deal. Look at the credit rating of the counterparty, and consider using a credit default swap to add protection against default. Such a swap would pay in the event of a default by the counterparty, but as in the case of all insurance, there will be a cost to entering the protective contract.

Forward Contract Mechanism

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Forward contracts are very popular in foreign exchange markets to hedge the foreign currency risks. Most of the large and international banks have a separate forward Desk within their foreign exchange trading room which is devoted to the trading of forward contracts. The following are the trading mechanism of forward contract:

Long Position
The party who agrees to buy in the future is said to hold long position

Short Position
The party who agrees to sell in the future holds a short position in the contract

The Underlying Asset

It means any asset in the form of commodity, security or currency that will be brought and sold when the contract expires

Spot-Price
This refers to the purchase of the underlying asset for immediate delivery. In other words, it is quoted price for buying and selling of an asset at the spot or immediate delivery

Future Spot Price

The spot price the underlying asset when the contract expires is called the future spot price, since it is market price that will prevail at some future date

Delivery Price
The specified price in a forward contract will be referred to as the delivery price. This is decided or chosen at the time of entering into forward contract so that the value of the contract to both parties is zero. It means that it costs nothing to take a long or a short position. In other words, at the day on writing of a forward contract, the price which is determined to be paid or received at the maturity or delivery period of the forward contract is called delivery price. On the first day of the forward contract, the forward price may be same as to delivery price. This is determined by considering each aspect of forward trading including demand and supply position of the underlying asset.

The Forward Price

It refers to the agreed upon price at which both the counter parties will transact

when the contract expires. In other words, the forward price for a particular forward

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contract at a particular time is the delivery price that would apply if the contract were entered into at that time.

The Determination of Forward Price

Forward contracts are generally to analyze than futures contracts because in forward contracts because in forward contracts there are no daily settlement and a single payment is made and only a single payment is made at maturity. It is essential to know about certain terms before going to determine the forward prices such as distinction between investment assets and consumption assets, compounding, short selling, and report rate so on because these will be frequently used in such computation. An investment asset is an asset that is held for investment purpose, such as stocks, shares, bonds, treasury, securities, etc. consumption assets are those assets which are held primarily for consumption, and not usually for investment purpose. There are commodities like copper, oil, food grains, and live hogs. Compounding is a quantitative tool which is used to know the lump-sum value of the proceeds received in a particular period.

Forward Contract at IDBI Bank

IDBI bank deals with forward contract and hedging options effectively which is also in time with the banks trade finance business. Banks exposure to free business at a higher and on peer comparison and hence bank is making effective tool amongst the related business processes. Bank has a policy of conducting frequent customer meetings enlighten the customer of the latest developments in the banking scenario and there by bringing awareness in the customers for making the availability of resources effectively. One such tool is the forward contract which has almost penetrated through mass customer base and used effectively in the banks daily business portfolio. RBI directions and FEDAI guidelines are scrupulously followed giving no room for any audit objective with respect to risk perception. Need for the forward contract limits are properly amended and then only eligibility is drawn to sanction the limits which show banks diligence in considering the moderate risk in forward contract business also. Though the risk contribution is less, same was also effectively priced. As leverage to the business the customer hence advantageous with the less margin and better rates, thereby the care for the transaction increases. 77

Process of Forward Contract at IDBI bank

The following are the process followed at IDBI bank The declaration limit for the forward contract is based on the past performance The bank should collect all the necessary documents required for the forward transactions After submission of the required documents by the customer or by the company, the bank should do final verification, endorsement and custody of all the underlying documents of the forward contract After the confirmation is received for booking of a forward contract from the treasury, the contract should be booked within 24 hours The bank is required to prepare and forward a forward contract note to the customer for the official signature of the authorized customer After the maturity date automatically the contract is cancelled on the 7th working day if there is no response from the customer The profit if any will not be passed on to the customer but the loss will be recovered Bank as per RBI policies is following with the respective location from the head office directly for the lapsed forward contracts which were still out standing in the books of forward contract

Processes / Procedures before booking forward contracts

The branch should set up sufficient limits for the forward contracts. The limits will be sanctioned by the Credit Committee at the appropriate level and will be known as Forward Contract Limit. It may be noted that Forward Contract Limit is a credit limit.

Booking of forward contracts based on past performance

Branches may allow importers and exporters to book forward contracts on the basis of declaration of an exposure and based on past performance subject to the following conditions 78

The forward contracts booked in the aggregate should not exceed the limits worked out on the basis of the average of the previous three financial years (April to March) actual import/export turnover. This is subject to the condition that at any point of time forward contracts so booked shall not exceed 25% of the limit within a cap of US $ 100 million. These eligible limits are to be computed separately for export and import transactions

The limit so arrived at would represent the total amount available to a customer for booking forward contracts without having to produce documentary evidence during the financial year. Any forward contract booked without producing documentary evidence will be marked off against this limit

The importers / exporters should furnish a declaration to the A.D regarding amounts booked with other banks under this facility An undertaking to be taken from the customer to produce documentary evidence before maturity / cancellation of the forward contract In view of this branches can obtain a chartered accountants certificate

from the company showing the average of previous three financial years actual import and export turnover. Maximum of 25% of such average can be set aside for the customer to book contracts without submitting documentary proof. This will be called Declaration Limit. This Declaration Limit is a regulatory limit and will be within the Forward Contract Limit which is a credit limit. For example a customer may be enjoying a Forward Contract Limit of Rs.4.5 crores. This means that contracts of aggregate value up to Rs.45 crores can be outstanding against the customer at any one time. The same customer may be given a Declaration Limit of say Rs.100 crores based on his past performance as explained above. In this case the Forward Contract Limit being a credit limit will be sanctioned by the credit committee while the Declaration Limit which is a regulatory limit will be set up at the branch level only. Aggregate INR value of forward contracts outstanding at any time should not exceed Rs.45 crores for this customer even though the Declaration Limit is Rs.100 crores. It may be noted that the limit is not a running limit. For example if a customer has a declaration limit of USD 100 million and books a contract of USD 10 million under this agreement, then his Declaration Limit will stand reduced to USD 90

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million. The branch should maintain separate manual record for tracking this. The format of the register is given in Annexure A. The limits will have to be set every April for the financial year. However, it is possible that many corporate may not have their export / import figures for the previous year ready in April. In those cases we may permit the corporate up to 50% of their previous years Declaration Limit. The same can be suitably corrected once the figures are received. In any case the required information should be submitted by the corporate before end of May every year. Delinquent cases should be referred to Corporate Office. In case of corporate whose main borrowing arrangements are with another bank, a letter from that bank indicating the limit set up by them for the year will be sufficient. Branches need not do this exercise separately. Importers/exporters desirous of availing limits higher than US $ 100 million may forward their applications to the Chief General Manager, Reserve Bank of India, Exchange Control Department, Forex Markets Division, Central Office, Mumbai400 001 justifying the need for higher limits. Forward contracts booked under the enhanced limits will be on a deliverable basis. Details of the import/export turnover of the past three years, delayed realizations/ payments during these years and existing limits, duly authenticated by the authorized dealer, may also be furnished in the enclosed format (Annexure VI)...

Cancellation and rebooking of forward contracts

Forward contracts booked in respect of foreign currency exposures of residents falling due within one year may be cancelled and rebooked. Branches may offer this facility without any restrictions in respect of export transactions (including cross currency contracts). For import and other non-trade transactions, this facility should be made available only to customers who submit details of exposure to us as per the format enclosed. For these purposes, import transactions falling due within one year will be a projected figure based on the past performance, nontrade payments and receipts would be on actual basis. The earlier limit of USD.100 million has been withdrawn by RBI and is no longer applicable. In other words forward contracts for imports and other non-trade transactions can be freely

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cancelled and rebooked provided the customer has submitted details of exposure as above. Forward contracts booked to cover exposures falling due beyond one year once cancelled, cannot be rebooked. All forward contracts may be rolled over at ongoing market rates. It should be noted that the above provisions are applicable only to residents and not non-residents such as FIIs and entities having FDIs in India.

Processes / Procedures while booking forward contracts

Branches should verify and satisfy themselves that the request for booking the forward contracts has been signed by signatory (ies) authorized for this purpose by the customer. Branch besides checking the underlyings and the request from the FEMA angle, will also ensure that sufficient forward contract limits are available. In case of FIIs, the amount eligible to be covered is to be determined on the basis of a declaration taken from the FII. In case of contracts booked on behalf of FIIs a monthly statement should be furnished to the Chief General Manager, Reserve Bank of India, Exchange Control Department (Forex Markets Division), Central Office, Mumbai 400001 before the 10th of the succeeding month indicating the name of the FII / Fund, the eligible amount of cover and the actual cover taken. The branch should be in receipt of a specific written request from the customer for booking the forward contract(s). It is possible that many customers may place the order on phone. In case of valued constituents the transactions may be processed pending receipt of written confirmation. Branch should follow up such cases to get written confirmation at the earliest. The details of underlying transaction for which the contract is being booked should also be verified to ensure that maturity of the contract does not fall beyond that of the underlying and the amount of the contract does not exceed the value of the contract. Our treasury marketing team also interacts directly with customers and book forward contracts. Procedures outlined above for branches should also be

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followed by front office. In such cases, the front office should immediately inform the details to the branch so that the branch can put through necessary entries. "Before booking the contracts, the branch / front office (whoever deals with the customer) should ensure that sufficient vacant Forward Contract Limits are available. Further, availability of Declaration Limit will also have to be ensured if applicable. Once the contract details are finalized, branch to put through necessary entries in Finacle and send reports to TBO in the required format.

Processes / Procedures after booking forward contracts

The customers request letter along with copies of documentary proof of the underlying will be filed in a separate file chronologically. The maturity of the contract should not exceed the maturity of the underlying transaction. It can however fall before the maturity of the underlying transaction. To illustrate, an exporter having a receivable on 31st March 2004 can book a contract for delivery on 31st March 2004 or any date (or range of dates) before 31st March 2004 say, 28th January 2004. He can not however book a contract maturing on 2nd April 2004 (i.e. beyond 31st March 2004). The original documentary proof will be returned to customer after making a suitable remark regarding the forward contract booked. In the copies of proof, there mark original examined and returned to customer should be made under the officers initials and banks round stamp. In case of foreign currency loans/bonds will be eligible for hedge only after final approval is accorded by the Reserve Bank where such approval is necessary or loan identification number is given by the Regional Office of the Reserve Bank. Global Depository Receipts (GDRs) will be eligible for hedge after the issue price has been finalized. In case of contract being booked under Declaration Limit proof regarding underlying transaction need not be obtained at the time of booking the

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contract. However, the same should be obtained before maturity / cancellation of the contract. A contract note will be prepared as per our standard format (Annexure B and C) and sent to the customer for his confirmation. Annexure B is for the customer and may be retained with him. Annexure C should be stamped and signed by the authorized signatory (ies) of the customer and returned to the bank for records. On receipt of the contract note (Annexure E) the branch will verify the same for authenticity of signature, sufficiency of stamps and other particulars and file it along with other papers. A copy of Annexure B will be sent on the day of booking to TBO also for their verification and records. Any discrepancies will be taken up by TBO with the branch immediately. Three diary notes should be made on the day of booking the forward contract at the branch. The first one being three days before last date of delivery, the second being the last date of delivery and the third being fifteen days after last date of delivery. Letter as per Annexure D should be sent to the customer on the first date reminding him of the contract maturing three days later. On due date the branch should again telephonically remind the customer to take up the contract. In the absence of any instructions from the customer, overdue contracts shall be automatically cancelled on the 15th days after maturity date after obtaining the rate from treasury. Profit, if any on account of such cancellation should not be passed on to the customer. However, loss if any should be recovered from the customer. In case the 15 th day falls on a Saturday or a holiday, the contract shall be cancelled on the succeeding working day. Where the customer wishes to take delivery, the relevant documents should be scrutinized by the branch to ensure that they meet the contract terms as well as FEMA, EXIM and other regulatory requirements. The transaction will then be processed in the usual manner and input in Finacle. Needless to say, the contracted rate will be applied to the transaction. A report will be sent to Treasury Bank Officer (TBO) in the prescribed format. Front office should be

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kept informed in case of forward sale contracts so that funding of Nostro account can be taken care of

Part Delivery
Part delivery under a contract is permitted. The transaction will be processed like a full delivery except that the amount of the transaction will be different. If the contract is still valid for further delivery, then the customer is permitted to take further part deliveries within the last date for delivery. For example, in a contract for say USD.100,000 booked on 15/12/2002 with a delivery option from 01/01/2003 to 31/01/2003 the customer can take delivery of USD.25,000 on 02/01/2003, USD.30,000 on 07/01/2003 and another USD.45,000 on 31/01/2003. For all transactions the contracted rate will be applied.

Early Delivery
Sometimes the customer may approach the bank for taking early delivery because the underlying commercial transaction may have been put through earlier than anticipated. For example, in the above case, the customer may choose to deliver USD.25, 000 on 25/12/2002 and the rest on any date(s) between 01/01/2003 to 31/01/2003. In case of early deliveries, branch should send details of early delivery to Treasury Market Officer (TMO)/Treasury for ascertaining swap loss / gain by mail and copy of this mail should be marked to TBO Forex mail ID - "forx_tbo@idbibank.com". TMO/Treasury should give the swap charges to be recovered (if no charge is to be recovered that should be mentioned as NIL) by way of reply to this mail. There after using same mail branch should confirm to TBO exact amount of charge recovered / paid to customer and accounted to debit or credit of Treasury. This is required to avoid reconciliation problems and to ensure that there is no income leakage. Part transactions under ready rates: It is also possible that customer may actually submit documents in excess of the contracted amount. Taking the same example cited above the customer may deliver documents for say USD.110, 000 on 25/01/2003. In this case, USD.100, 000 will be reported as delivery under the contract and USD.10, 000 will be reported as a ready transaction and rate obtained from treasury. 84

Multiple contracts under single bill

Customer is also permitted to utilize multiple contracts (either fully or partially) for the same bill. Except for the different rates to be applied for different amounts (aggregating to the amount of the bill submitted) other procedures will remain the same. Deliveries under all contracts will be reported to the treasury back office while deliveries under forward sale contracts should be reported to treasury front office for taking care of funding.

Cancellation before due date

The customer is permitted by RBI to freely cancel a forward exchange contract booked by him (except in case of contracts covering EEFC account balances and exposures falling beyond one year). Where the customer approaches the branch for cancellation before due date, the same will be reported to treasury. A purchase contract will be cancelled by applying appropriate forward TT selling rate and a sale contract will be cancelled by applying appropriate forward TT buying rate which should be obtained from the TMO/ Treasury. The difference on account of the cancellation will be passed on or recovered from the customer as applicable. The difference may be recovered / passed on only on the last date of delivery of the contract. As a policy our bank pays / recovers the difference immediately on cancellation. Interest at PLR / Fixed Deposit rate is set off against the proceeds and the net amount debited / credited to TBO. The detailed reporting and accounting procedures are given below.

Cancellation of forward contracts: Reporting and Accounting

Branch should first report to Treasury Front office about the cancellation of forward contract and obtain appropriate cancellation rate. Full details of forward contract to be cancelled are required to be informed to FX dealers for obtaining the rate. Thereafter, on same day branch should inform TBO in the prescribed format (Annexure E) the cancellation of forward contract. The Rupee amount will be recovered/paid by debit/credit to the customer's cash-credit or current account and the same should be

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worked out by deducting from the exchange differential, the interest amount for the period for which this early payment is accounted for. The final amount should accordingly be credited/debited to Treasury SOL096 Account: Branch Customer FX Charges Settlement (09631310010006), giving reference of related FX forward contract in narration field of the entry. Treasury Back Office will on same day respond this entry by correspondingly debiting/crediting respective branch account in their books for this amount. As a policy the bank pays / receives the differentials on date of cancellation. Interest on outflow of funds is to be calculated at PLR, while on inflow of funds at retail deposit rate of respective maturity for which the interest is payable. However, it is possible that some customers may prefer to pay / receive the differential on the due date. In cases where the recoveries have to be made from the customer at the maturity date, the same should be approved by the Corporate Banking department at the Corporate Office while sanctioning the FX limits to that customer.

Substitution of underlying contract

Branch may permit customers to substitute an export / import order under a forward contract provided it is satisfied after verification of suitable documentary evidence that genuine exposure to the extent of the amount of the original forward contract subsists under the substituted order. The amount and the tenor of the new order should enable the customer to affect deliveries under the contract.

Exception Handling
In case of contracts booked by Treasury Market Officer (TMO) directly, details received from the customer at the branch later vary from the details given by the TMO In that event, the TF will consider the details given by TMO as correct and report the transaction. Simultaneously, the difference will be reported to the TMO by email. The

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TMO will then take up appropriately and resolve the matter within 2 days and inform the TF by email. If not resolved within two days the matter to be informed to TF will keep following up with TMO till the matter is resolved. Where contracts have been booked by TMO and sufficient forward contract limits are not available In those cases, the TF will not report the transaction straightaway. Instead, a report will be sent to the TMO with a copy to the CB Head at the branch, Head, CB, Corporate Office, Head, Treasury Marketing, Corporate Office, Head, RMD, Corporate Office and Head, TF, Corporate Office. It will be the responsibility of the TMO to get the matter resolved the same day under intimation to the TF by email. However, if the matter is not resolved by 5.30 p.m. that day, then the TF will still go ahead and report the transaction using the particulars given by the TMO. It should be understood that as a result of these instructions, there should not be any transaction done by TMO but not reported by TF at the end of the day as the Bank has provided the risk cover to the customer.

Follow up for documentation from customer

Initial responsibility for follow up with customer for documentation will be with Trade Finance. Documentation includes request letter from customer, contract note (stamped sufficiently) signed by the customers authorized signatory, proof of underlyings where applicable and such other declarations etc., as necessary. TF should ensure that the contract note for the customers signature is prepared and sent / dispatched on the date of contract as far as possible and in any case the following working day. However where the customer fails to respond, the matter should be escalated by Trade Finance to the TMO as per the following time schedule: Request letter (Contract booked on 1st Nov and request letter not received till 3rd Nov should be escalated on 4th Nov). resolved 87 Signed contract note and Proof of underlying, other docs T+9 After escalating the matter to TMO, the TF will follow up with TMO till the matter is

Procedure Followed by IDBI for Cancellation of Forward Contracts

In the absence of the instructions from the customer after the maturity date of the contract, it is automatically cancelled after the 7th working day After the expiry or cancellation of the forward contract, if any profit is generated by the customer the same should not be passed on to the customer, but if loss arises it should be invariably recovered by the customer

MERCHANT RATES FOR M/S. ABC BANK LIMITED

T.T SELL T.T BUY 44.5 USD GBP 45.06 73.43 7 71.8 45.15 73.58 44.48 71.74 45.75 74.20 BILL/CARD SELL BILL/CARD FC BUY SELL FC BUY 43.9 0 71.2 TC Interbank Interbank BUY Buy Rate Sell Rate 44.1 5 71.5 44.8350 72.69 44.8450 72.74

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9 62.9 EUR JPY CHF DKK AUD SGD SEK HKD CAD NOK AED 64.29 56.26 53.64 8.70 48.39 36.94 7.07 5.87 46.27 8.17 12.33 3 54.5 0 51.4 5 8.35 46.4 0 35.4 2 6.78 5.63 45.2 7 8.00 12.0 7 64.42 56.37 53.75 8.72 48.49 37.01 7.09 5.88 46.36 8.19 12.36 62.80 54.39 51.35 8.34 46.31 35.35 6.76 5.62 45.17 7.98 12.05 64.95 57.65 54.70

0 62.3 5 53.1 5 50.4 0 45.4 49.35 37.70 6.00 47.65 5 34.7 0 5.50 43.9 0 11.7 12.70 0

5 62.6 5 53.4 0 50.7 0 45.7 0 34.9 0 5.55 44.1 5 11.7 5 12.21 12.26 47.42 36.20 6.93 5.75 45.79 8.09 47.47 36.25 6.98 5.80 45.84 8.14 63.64 55.40 52.57 8.53 63.69 55.45 52.62 8.58

*RATE OF JPY FOR 100 UNITS ABOVE RATES ARE VALID FOR THE DATE MENTIONED ON THE RATE SHEET CARD SELL AND CARD BUY RATES APPLICABLE FOR USD, GBP, EUR, AUD, SGD AND CAD ONLY

Telegraphic Transactions Bill Buying rate Forward Contracts Inter Bank

Data Analysis
M/S Satyam ltd. imported software tools worth of 1 million USD for the expansion of their company. For this, the company books a forward contract on 1st- june-2010 with AXIX bank at the spot rate of Rs. 46.18/- for a period of four months

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1-Jun10

T.T SELL

BILL/CAR D BUY

BILL/CAR D SELL

FC BUY

FC SELL

TC BUY

Inter bank BUY

Inter Bank Buy Rate 46.54 5 67.41 57.08 51.10 40.29 7.67 39.03 33.19 5.94 5.97 44.50 7.19 12.67

USD GBP EUR JPY CHF DKK AUD SGD SEK HKD CAD NOK AED

46.78 68.10 57.66 51.88 41.11 7.83 39.83 33.87 6.06 6.09 44.96 7.27 12.80

46.28 66.68 56.46 50.28 39.45 7.51 38.22 32.48 5.82 5.85 44.02 7.11 12.53

46.88 68.23 57.78 51.99 41.19 7.84 39.91 33.94 6.07 6.11 45.05 7.28 12.83

46.18 66.54 56.34 50.18 39.37 7.50 38.14 32.42 5.80 5.84 43.93 7.09 12.51

47.50 68.80 58.25 53.20 41.95 40.65 34.55 6.25 46.30 13.20

45.60 66.00 55.90 49.00 38.65 37.45 31.80 5.70 42.70 12.15

45.80 66.35 56.20 49.25 38.85 37.65 32.00 5.75 42.90 12.20

2-Jun10

T.T SELL

BILL/CAR D BUY

BILL/CAR D SELL

FC BUY

FC SELL

TC BUY

Inter bank BUY

Inter Bank Buy Rate 47.06 00 69.10 57.47 51.47 40.66 7.72 39.16 33.31 6.00 6.04 44.56 7.25 12.81

USD GBP EUR JPY CHF DKK AUD SGD SEK HKD CAD NOK AED

47.30 69.81 58.06 52.25 41.49 7.88 39.96 33.99 6.13 6.16 45.03 7.33 12.94

46.79 68.35 56.85 50.66 39.80 7.56 38.33 32.60 5.87 5.91 44.07 7.16 12.67

47.39 69.95 58.17 52.36 41.58 7.90 40.04 34.06 6.14 6.17 45.12 7.35 12.97

46.70 68.21 56.74 50.56 39.72 7.55 38.26 32.53 5.86 5.90 43.98 7.15 12.65

48.05 70.50 58.65 53.55 42.35 40.75 34.70 6.30 46.40 13.35

46.10 67.65 56.30 49.40 39.00 37.55 31.95 5.75 42.75 12.25

46.30 68.00 56.60 49.65 39.20 37.75 32.10 5.80 42.95 12.35

The advantage of booking a forward contract by M/S Satyam is that the USD is fixed at a spot rate of Rs. 46.18/-. If there is a fluctuation in the price it does not affect the company as they have already booked the contract at a particular rate. Suppose the next day price

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of USD goes up from Rs. 46.18/- to Rs. 46.70/- the company will be on safer side since they have booked a forward contract at a lower rate of USD. The price of USD on the due date of the forward contract is 47.08. The company has saved few a wide amount by booking a forward contract as there was increase in the USD in the month of October.
1-102010 T.T SELL BILL/CAR D BUY BILL/CAR D SELL FC BUY FC SELL TC BUY Inter bank BUY Inter Bank Buy Rate 46.23 5 73.03 60.79 53.90 43.87 8.16 42.19 34.19 6.46 5.96 44.90 7.68 12.59

USD GBP EUR JPY CHF DKK AUD SGD SEK HKD CAD NOK AED

46.47 73.78 61.41 54.73 44.77 8.33 43.05 34.89 6.59 6.08 45.36 7.77 12.72

45.97 72.23 60.13 53.03 42.94 7.98 41.31 33.46 6.32 5.83 44.41 7.58 12.45

46.56 73.93 61.54 54.84 44.86 8.34 43.14 34.96 6.61 6.09 45.45 7.78 12.74

47.08 72.08 60.01 52.93 42.85 7.97 41.22 33.40 6.30 5.82 44.32 7.57 12.43

47.90 74.55 62.05 56.10 45.70 43.90 35.60 6.20 46.75 13.10

45.30 71.50 59.55 51.70 42.05 40.45 32.80 5.70 43.05 12.05

45.50 71.90 59.85 51.95 42.30 40.65 32.95 5.70 43.30 12.10

The following is the graphical representation of fluctuation in the prices from June to October
1-Jun10 T.T SELL BILL /CARD BUY 46.28 BILL /CARD SELL 46.88 FC BUY 46.18 FC SELL 47.5 TC BUY 45.6 Inter bank BUY 45.8 Inter Bank Buy Rate 46.54

USD

46.78

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GBP EUR JPY CHF DKK AUD SGD SEK HKD CAD NOK AED
1-Jul10

68.1 57.66 51.88 41.11 7.83 39.83 33.87 6.06 6.09 44.96 7.27 12.8

66.68 56.46 50.28 39.45 7.51 38.22 32.48 5.82 5.85 44.02 7.11 12.53 BILL /CARD BUY

68.23 57.78 51.99 41.19 7.84 39.91 33.94 6.07 6.11 45.05 7.28 12.83 BILL /CARD SELL

66.54 56.34 50.18 39.37 7.5 38.14 32.42 5.8 5.84 43.93 7.09 12.51

68.8 58.25 53.2 41.95 40.65 34.55 6.25 46.3 13.2

66 55.9 49 38.65 37.45 31.8 5.7 42.7 12.15

66.35 56.2 49.25 38.85 37.65 32 5.75 42.9 12.2 Inter bank BUY

67.41 57.08 51.1 40.29 7.67 39.03 33.19 5.94 5.97 44.5 7.19 12.67 Inter bank Buy Rate 46.72 50 69.76 57.07 53.02 43.57 7.66 38.95 33.34 5.97 6.00 43.80 7.14 12.72

T.T SELL

FC BUY

FC SELL

TC BUY

USD GBP EUR JPY CHF DKK AUD SGD SEK HKD CAD NOK AED

46.96 70.48 57.65 53.83 44.47 7.82 39.74 34.03 6.10 6.12 44.25 7.22 12.85

46.46 69.00 56.45 52.17 42.65 7.50 38.14 32.64 5.85 5.87 43.31 7.06 12.58

47.06 70.62 57.77 53.94 44.56 7.83 39.82 34.09 6.11 6.13 44.34 7.23 12.88

46.36 68.86 56.33 52.07 42.56 7.49 38.06 32.58 5.84 5.86 43.23 7.05 12.56

47.70 71.20 58.25 55.20 45.35 40.55 34.70 6.25 45.60 13.25

45.75 68.30 55.90 50.85 41.80 37.35 31.95 5.75 42.00 12.20

46.00 68.65 56.15 51.10 42.00 37.55 32.15 5.75 42.20 12.25

1-Aug10

T.T SELL

BILL /CARD BUY

BILL /CARD SELL

FC BUY

FC SELL

TC BUY

Inter bank BUY

Inter bank Buy Rate 46.15 50

USD

46.39

45.89

46.48

50.72

47.10

45.20

45.45

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GBP EUR JPY CHF DKK AUD SGD SEK HKD CAD NOK AED
1-Sep10

73.28 61.00 54.13 45.27 8.27 42.84 34.79 6.55 6.06 45.43 7.69 12.69

71.76 59.72 52.47 43.44 7.93 41.12 33.36 6.29 5.82 44.48 7.53 12.43 BILL /CARD BUY

73.43 61.12 54.24 45.36 8.29 42.93 34.86 6.56 6.08 45.52 7.71 12.72 BILL /CARD SELL

71.62 59.60 52.36 43.35 7.92 41.04 33.30 6.27 5.81 44.39 7.51 12.41

74.05 61.60 55.50 46.20 43.70 35.50 6.20 46.80 13.10

71.05 59.15 51.15 42.55 40.30 32.70 5.70 43.15 12.05

71.40 59.45 51.40 42.80 40.50 32.85 5.70 43.35 12.10 Inter bank BUY

72.55 60.38 53.32 44.37 8.10 41.99 34.09 6.42 5.94 44.97 7.61 12.57 Inter bank Buy Rate 46.93 00 72.21 59.61 55.54 46.17 8.01 42.21 34.67 6.37 6.03 44.15 7.48 12.78

T.T SELL

FC BUY

FC SELL

TC BUY

USD GBP EUR JPY CHF DKK AUD SGD SEK HKD CAD NOK AED

47.17 72.95 60.21 56.39 47.11 8.17 43.07 35.39 6.50 6.16 44.62 7.56 12.91

46.69 71.47 59.00 54.69 45.23 7.85 41.35 33.96 6.24 5.91 43.69 7.41 12.65

47.26 73.10 60.33 56.50 47.20 8.19 43.15 35.46 6.52 6.17 44.71 7.58 12.93

46.60 71.33 58.89 54.58 45.14 7.83 41.27 33.89 6.23 5.90 43.61 7.39 12.62

47.90 73.70 60.85 57.80 48.05 43.95 36.10 6.30 45.95 13.30

45.95 70.75 58.40 53.25 44.30 40.50 33.25 5.75 42.35 12.25

46.20 71.10 58.70 53.55 44.50 40.70 33.40 5.80 42.55 12.30

1/10/201 0

T.T SELL

BILL /CARD BUY

BILL /CARD SELL

FC BUY

FC SELL

TC BUY

Inter bank BUY

Inter Bank Buy Rate 46.23 5

USD

46.47

45.97

46.56

47.08

47.9

45.3

45.5

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GBP EUR JPY CHF DKK AUD SGD SEK HKD CAD NOK AED

73.78 61.41 54.73 44.77 8.33 43.05 34.89 6.59 6.08 45.36 7.77 12.72

72.23 60.13 53.03 42.94 7.98 41.31 33.46 6.32 5.83 44.41 7.58 12.45

73.93 61.54 54.84 44.86 8.34 43.14 34.96 6.61 6.09 45.45 7.78 12.74

72.08 60.01 52.93 42.85 7.97 41.22 33.4 6.3 5.82 44.32 7.57 12.43

74.55 62.05 56.1 45.7 43.9 35.6 6.2 46.75 13.1

71.5 59.55 51.7 42.05 40.45 32.8 5.7 43.05 12.05

71.9 59.85 51.95 42.3 40.65 32.95 5.7 43.3 12.1

73.03 60.79 53.9 43.87 8.16 42.19 34.19 6.46 5.96 44.9 7.68 12.59

60 50 40 30 20 10 0 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10

From the above representation, there are fluctuations in the price of USD every month, since the company has booked the forward contract on a particular date; the company is benefited even if there are variations in the currency rates

Interpretations
The currency of USD is fixed as per the contract date Fluctuations in price does not affect the companys balance sheet Having booked the forward contract the company is now aware of their fixed commitments and then can move forward with their expansion plans with in their available resources. Had the company not booked the FWC, they cannot take any commitments further as their

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commitment is not evaluated and hence the expansion plan cannot be implemented, this will be certainly a detrimental factor for the companys growth Forward contract is not only a measure to hedge the rate fluctuation but also a measure of gauging the risk of a particular transaction and arresting the risk to a certain extent to the control of the company. As we are aware the rate may move in favor or against to the company and in both the cases the company will now be able to meet their obligations successfully with out any default as well as the company operations will be smooth In the current scenario of working under narrow margins and the trade being done globally the erstwhile huge margins could not be drawn and hence in majority of the industries the huge turnover only is deciding the profit margins. Under these circumstances FWC is a very useful tool to judge the market and arrive at a fixed future price to retain the profit margin for a consignment which is manufactured and processed for a sale

Findings
In the emerging Market scenario and in view of the increasing foreign Trade The banks have started using Nostro account for fund transfer The prices are different depending upon the type of transaction Currency fluctuations became inherent risk.

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Majority of the companies have been affected with the fluctuation risk which Global recession also is one of the reasons for such reasons and the variations in The recent past in the global environment has lead to many catastrophes viz.,

eroded their entire profits in a single transaction. the Demand and Supply of the foreign currency. Tsunami in Japan, Terrorist war in India by ISI, Wars on Iraq and Libya by American army and failure of bilateral discussion of India and Pakistan and Assassination of Bin Laden in Pakistan by America which lead to the threat of Terrorism in Asian region etc., To avoid all these risks, Forward contract is becoming popular hedging tool to These contracts are essentially focused on the foreign exchange market As the price of foreign currency is fixed today for future delivery in the forward Forward contracts leads to time lag between order and delivery Forward contract is an Over the Counter contract (OTC), which is customized and manage risk in recent years

contract, the risk of adverse price movement is covered/eliminated

tailor-made as per the specifications of the parties, in terms of quantity, maturity and price of a given asset. customer Forward contract essentially specifies a quantity and type of the asset to be sold The contract can be between a bank and a customer or between two banks There is no possibility of exchange of money until the date of delivery and purchased The company is protected against unfavorable exchange rates fluctuations Forward contracts leads to a better relationship between the bank and the

Suggestions

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Company who are into foreign exchange trade or any Individual anticipating a continuous flow of foreign exchange in the permitted regular route should understand the market and decide the necessity of Forward Contract.

Forward contract may not be useful always but this conclusion cannot be applied in all scenarios. Companies with their major chunk towards Export and Import should assess their risk portfolio with respect to the rate fluctuation as the rate fluctuation may completely erode their profits.

Any company should assess their position on the commitments to pay off the liabilities and this only will help them to step forward to expand their business portfolios.

All the liabilities may not be due for payment on immediate basis and some of them may be deferred for future and such fluctuation risks will generally happen in future contracts only. Hence it is advisable for a company to limit their risk to a calculated extent by booking forward contract.

As the time outlay for the company in a forward contract will be handsome, it will be helpful for the company to meet the payment obligations early and cancel forward contract before maturity to gain profits also.

Conclusion
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Globalization, deregulation, and liberalization, the world over, are creating opportunities and increased trade world over. The forces unleashed by globalization have intensified competition from within and outside the country. Thus with the increase in the competition the demand and supply has undergone a huge change leading to the increasing focus on the volatility in the currency. Business units are thus facing a multitude of risks, some familiar in the form of their relationships with the buyers and goods but also some quite unfamiliar ones in the form of the unexpected variations otherwise called as higher volatility in cash flows primarily for those who are more into export and import. Margins have become more thinner those who are into export trade in view of the competition and the quality to be on a higher side and the trade in the current day happened to be a double edged sword where these margins have become the deciding factors for the future of the business. In Indian foreign exchange market, in the recent times, experienced considerable volatility specifically in respect of USD - INR market segment. Indian foreign exchange market has deepened and widened over a period of time with the transition to a market determined exchange rate system and liberalization of restrictions on external transactions leading to full current account convertibility and partial capital account convertibility. Forward contract thus is an effective tool for foreign exchange dealers to sustain and retain their profits and help the country to move forward. A trade surplus country is only possible when the traders come forward to expand their export business. Securing these traders is the primary responsibility of the government and the same has been done on various incentives. Simultaneously the Government, the FEDAI and the RBI have took a serious view of the Forward contracts also as the ultimate deciding factor being the rate fluctuation which only will boost the spirits of the traders. I conclude such that the effective tool which was provided to the benefits of those people should understand and implement the same for their betterment as well as the country to develop in a expeditious manner.

Bibliography
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Books
1. O.P. Agarwal, "International Financial Management ", first edition, 2009, Himalaya Publishing House 2. O.P. Agarwal and B.K. chaudhuri Foreign Trade and Foreign Exchange", sixth revised edition, Himalaya Publishing House 3. Jeff Madura, "International Financial Management ", 7th edition, 2003 4. Anil Kumar Sharma and Anujit Mitra "What Drives Forward Premia in Indian Forex Market?", Occasional Paper published by RBI (Vol. 27, No. 1 & 2, Summer and Monsoon 2006)

Websites
http://www.answers.com/topic/forward-exchange-contract-in-accounting. http://corporateandinvestment.standardbank.co.za/pages/docs/its/forward_exchange_broc hure.pdf http://www.stgeorge.com.au/corporate-business/foreign-exchange/forward-transaction http://en.wikipedia.org/wiki/Forward_contract http://www.scribd.com/doc/52387374/forward-contract http://indianblogger.com/factors-affecting-foreign-exchange-rate/ http://www.ehow.com/about_6465200_relationship-forward-rate-interestrate.html#ixzz1P2RF2HcR

Annexure 1

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[A.P. (DIR Series) Circular No.63 dated December 21, 2002]

Information relating to exposures in foreign currency as on 1st April

Name of the corporate: Amount in USD Million equivalent i) ii) iii) Import transactions due within the Year Non-trade payments falling due Within one year Non-trade payments falling due beyond one year Of col.(1) amounts already hedged

Note
Authorized dealers may consolidate the above data for the bank as a whole for individual corporate and forward a report to Chief General Manager, Exchange Control Department, Reserve Bank of India, Central Office, Forex Markets Division, Mumbai- 400 001 (copy to Chief General Manager, Department of External Investments and Operations, Reserve Bank of India, Central Office, Data Cell, Mumbai -400 001) before 30th June every year. @ Calculated on the basis of last three years average, duly factoring in subsequent major changes, if any. Based on actual.

Annexure II
100

Declaration Limit Register __________ Branch Customer: Limit for the year:___________ (April March) limit Rs.________ lacs Date Reference Contract Amount (INR equivalent) Balance Intls Remarks (doc. Proof recd, reminder Sent,etc.) Intls Exports / Imports

Annexure III Forward contract confirmation

To From

101

The Branch Head IDBI Bank Limited

Telephone: We sold to you Rate We bought from you Date: Your request dated: Subject to rules / regulations of FEDAI

Fax: Delivery Date

Forward Contract Ref: Type of deal: New / rebooking For IDBI Bank Limited _________ Branch Authorized Signatories

In case of discrepancies immediately revert back to us

Please return the attached contract note duly stamped and signed by your authorized signatories

Annexure IV Forward contract confirmation

We brought from you 102 Rate We sold to you Delivery Date

Date: Our request dated: bank.

Forward Contract Ref: Type of deal: New / rebooking

We declare that we have not booked the underlying exposure with any other In case of imports and non-trade related transactions no forward contracts

were booked earlier and cancelled/ this is a rebooking which is as per extant RBI instructions. The documentary proof for the underlying exposure has been submitted We undertake to submit documentary proof for the underlying before utilization / cancellation of the forward contracts. Total such forward contracts (including this) booked without production of proof of underlying during the financial year does not exceed 25% of the average of the previous three financial years (April to March) subject to cap of USD 100 million or its equivalent. The contract is subject to extant FEDAI rules and regulations and prevailing For _________________ Authorized Signatories RBI regulations

Annexure V
Mail to: _________________ _________________ _________________

103

Date: Dear Sirs, OUR REF: FORWARD CONTRACT FOR ________________ BOOKED ON __________ DELIVERY: ___________________

We wish to draw your kind attention that deliveries under the captioned contract should be completed on or before the last date of delivery as above. You are therefore requested to arrange for the same. If for any reason you are not in a position to take up the contract in time, please note to send your instructions for roll-over / cancellation on or before the last date of delivery. Overdue contracts for which no instructions for roll-over / cancellation have been received by us will be dealt with as per extant FEDAI rules. Yours faithfully,

BRANCH HEAD

Annexure VI
REPORT OF CANCELLATION OF FX FORWARD CONTRACT(S) FROM Branch Name: Date:

104

TO: TREASURY BACK OFFICE ====================================== ===================== 1) CONTRACT TYPE (F/P or F/S) 2) CONTRACT REF. NO 3) CUSTOMER NAME 4) DATE OF BOOKING 6) CONTRACTED RATE 5) CURRENCY & AMOUNT BOOKED: : : FROM __________________ TO _____________ =============================================================== 7) DELIVERY OPTION VALUE DATE: FIXED : : : :

1) DATE OF CANCELLATION 3) RATE OF CANCELLATION AMOUNT PAYABLE/RECEIVABLE CURRENCY -------AMOUNT ____________

: : :

2) CURRENCY & AMOUNT CANCELLED:

=============================================================== RATE FOR CONVERSION OF EXCHANGE DIFFERENTIAL TO INR in Case of CROSS CURRENCY CONTRACTS: EXCHANGE DIFF. PAYABLE/RECEIVABLE @ : Rupee

## INTEREST @ % ON RUPEE OUTFLOW / INFLOW TO BE DEDUCTED FROM ABOVE ____________________________ NET AMOUNT IN RUPEE PAID to/RECEIVED from CUSTOMER and DEBITED/CREDITED TO H.O. A/C: Rupees __________________________ AUTHORISED 105 SIGNATORY : Rupees

(BRANCH)___________________________________________ ## Interest on outflow of funds to be calculated at PLR, while on inflow of funds at retails deposit rate of respective maturity for which the interest is payable. The rate of deposit applicable is the fixed deposit rate only and not any other deposit rate (SB). Therefore, for periods where the bank does not pay any interest (at present up to 14 days), no interest will be deducted from the receivable even though the recovery is made upfront. AUTHORISED SIGNATORY AUTHORISED SIGNATORY TREASURY (FXDEALING) BACK OFFICE --------------------------------------------------------------------TREASURY

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