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FOREIGN CURRENCY FORWARD RATE CONTRACTS
#1
FOREIGN CURRENCY FORWARD RATE CONTRACTS
All Forward contracts should be for a definite period and amount. In case delivery date has not been specified, an
option period of maximum one month may be given. In case the last date for delivery happens to be non-working
day for Forex dealing, preceding working day will be considered for effecting delivery.
All contracts, which have matured and have not been picked up, shall be automatically cancelled on the rh day
after the maturity Date.
EXCHANGE RATES MECHANISM
Consequent to Liberalization, RBI has removed all restrictions on exchange rate quotations. Therefore, Indian
currency is on a boating rate system. Banks are now free to quote their own rates based on market rates. Market
rates are determined by forces I Demand and Supply. By convention, exchange rates can be quoted in two ways
viz.
DIRECT METHOD: A given number of units-of focal currency per (47 otioreign currency e.g. US$ 1= Rs. 45.00

INDIRECT METHOD: A given number of units of foreign currency per given units of local currency e.g. Rs. 100 =
US$ 2.222 India, it was the practice to use the Indirect method of quotation. The unit in India was Rs. 100.
However, with effect from 2ndus 1993 direct quotations are being used.
TWO- WAY QUOTATION: The foreign exchange quotation by the Bankbas two rates — one at which the quoting
Bank is willing buy and the other at-which it is willing to sell. For example: U S $ I = Rs 45.00 - 45,20 ere the
Bank will enter into purchase transaction at Rs 45.00 and Self transaction at Rs 45.20. Hence the principle; Buy
low & all, high.
RATES: This rate is applied when the transaction does not involve-any -delay in realization of the foreign
exchange by the ink. In other words, the Nostro account of the bank would already have been credited. TT Buying
rate is arrived at each bankdeducting its required margin from the inter-bank buying rate that is being quoted in
the market. • w example, if SBI (market) is quoting US$1 = INR 44.20/25 in...the-market, JOB which needs to
arrive at its TT Buying rate pending on the market rate will quote as follows;
20 minus its desired margin of say 0 .15% as follows:
20 - 0.15% of 44.20 = 44.1337 (may be rounded to 44:1335)
ire it is presumed that 10B will quote 44.1337 to the CUStoitier, buy dollars from him and sell it in the market SBI
in this ample) at 4.4 20.The difference goes in to the margin (profit) account of 10B.

BILL BUYING RATES: These rates apply when foreign bills, are purchased. Banks build in higher margins in Bill
buying to factor the higher risk and transaction costs. For Usance bills, banks quote rates taking the forward
premium or discount on the rrency for matching future periods also in to consideration.

FORAWARD RATES: When the delivery has to take place at a date farther than the spot date, then it is a
forward transaction 'aced out on Forward. rate. A currency could be quoted at a higher ('Premium') or a lower
('Discount') rate tar future liveries. Given the connection, between exchange rates and funds.cost in a totally free
market, the premium / discount on wards would tend to equal the difference in interest rates inthe IWO
currencies.
ARIVING AT FORWARD RATES: Forward rates are arrived as follows under normal circumstances
If the currency is quoted at a premium : Forward rate = Spot rate + Premium
If the currency is being quoted at a discount : Forward rate = Spot rate - Discount
Spot price.
Interestrate differentials in the currencies involved. -Term or tenor of the quote (One month, two month etc ).
Clean inward _remittances (PO, MT, TT, DD) for which cover has already been credited to ADs account abroad.
Conversion of proceeds of instruments sent for collection.
Cancellation of outward TT, MT, PO etc. Cancellation of a forward sale contract.'Bill Buying Rate Purchase /
Discounting of Bills and other Instruments.Where bank has to claim cover after payment. Where drawing bank at
one centre remits cover for credit to a different center. Foreign - TCs / Currency Notes:
Applied for purchase of Foreign TCs & Currency
EXCHANGE ARITHMETIC : During the course of their business, banks acquire FX from their Exporter/NRI and
other customers and sell FX to their Importer /other customers. They purchase and sell FX like any other
commodity. They have to cover their transaction costs after adding some profit too. Earlier the Foreign Exchange
Dealers' Association of India (FEDAI) used to issue guidelines for computing rates and bank charges for FX
transactions. However, FEDAI has given freedom to the banks for calculating rates / fixing charges for merchant
transactions. Therefore, in India, now FX rates are determined by market forces of Demand and Supply.
BANKS QUOTE BASED ON MARKET RATES: In practice, Exchange rates are quoted based on SPOT rates
available in the markets. Banks can choose from various sources and decide the market participant for their deal.
Let us say, the Market participant is quoting rates as follows for USD as: USD 1 = 46.25/35.
This means they will buy dollars at 46.25 and sell at 46.35.
SCENARIO-1: BANK HAS TO PURCHASE AN EXPORT BILL:
An Exporter has approached the bank with a bill denominated in US Dollars. He wants to know at whit rate the
Bank will buy the bill from him. The dealer knows once he buys the dollar bill from his customer, he has to sell it
in the market at Rs 46.25. If he has to make a profit in this transaction, he has to quote a figure lesser than Rs
46.25 to the customer. The difference which is called margin depends upon the Bank's policy. Assuming that the
bank wants to make a 0.1% margin, the dealer will do the following calculations. Rate at which the Market buys
from him : 46.25000
Less 0.1% of 46.25 (46.25 X 0.10/100) : 0.04625
Rate to be quoted to Customer : 46.20375 rounded to 46.20
(Hint: Rounding off depends on the rule given in the problem)
Thus, the bank will reduce its required margin from Market Buying rate and quote a suitable rate to the
customer.
SCENARIO-2: BANK HAS TO QUOTE A SELLING RATE TO AN IMPORTER
Let us say an Importer wants to retire a bill in US $. Bank has to now quote a selling rate to him. Once again the
Dealer will turn to the Market rates. This time, he needs to buy the Dollars from the market and sell them to the
Importer after making sure that his profits are assured Assuming that the Bank wants the same 0.1% margin
here also, the Dealer would do the following calculations: Rate at which the Market would sell him dollars : 46.35
Add Required Margin (46.35 X 0.1/100) : 0.04635
Rate at which Bank will sell to the customer : 46.39635 rounded to 46.40
SUMMARY : Margins are reduced from Market buying rates to arrive at Bank's buying rates.
Margins are added to Market selling rates to arrive at -Bank's selling rates:—
'Banks add different margins to different transactions depending on—their policy, risks. Transaction costs, stature
of the customer, current positions in the currency to be quoted under the same formula. In a Direct rate scenario,
the maxim is always "Buy low and Sell high"
EXAMPLES: If the market is quoting GBP 1=78.60/80, at what rate can your Bank buy GBP from the market?
Answer: GBP1=78.80
1. If you have to quote a TT buying rate for GBP with a 0.20% margin, what will be the quote if the market is
quotingGBP 1=78.50/70 round off to two decimals?
Answer:Market buying rate = 78.500, Less Margin @0.2% =0.157 , Rate to be quoted = 78.343 Rounded to
78.34
3.Inflow of USD 100,000.00 by TT for credit to your exporter’s account, being advance payment for exports
(credit received in Nostro statement received from New York correspondent). What rate will be applied if the
market is quoting 45.40/50 for USD. As the customer is very valuable, you are not collecting any margin in
this transaction:
Answer: When we apply rate to the TT received, we are purchasing USD from customer, we have to sell it in the
market. Market buys USD at Rs. 45.40. We shall have to quote rate based on 45.40, less our margin. Since we
don’t intend making any margin here as stated in the sum, the rate quoted will be USD1=45.40.
4.Your foreign correspondent maintaining a Nostro. Rupee account_ with your' bank, wants to fund his account
by purchase of Rs. 30.00 million, against US dollars. Assuming that the USD / INR interbank market is at
45.2550 .1 2650, what rate would be quoted to the correspondent, ignoring exchange margin. Calculate
amount of USD you would receive in your USD Nostra account, if the deal is struck.

Answer: The Correspondent wants to credit INR 30 million i.e. INR 300,00,000 (Rs 3 crones). He will be placing
corresponding amount of dollars in our Nostro account with a request to convert and credit to his Rupee account
with us. In other words, we will be purchasing dollars from him and therefore have to quote a USD buying rate to
him.
Market rates (also called Inter-bank rates) are USD 45.2550/2650
Market buys from us at : 45.2550,Less margin (nil here) :,Rate to be quoted : 45.2550
Amount of dollars required for INR 30,00,00,00 is 30,00,00,00 = USD 662910.175 or USD 662,910.18 If the deal
is struck, the foreign bank would pay USD 662,910.18 to our USD Nostra account.
CROSS RATES : At times, direct quotes are not available for certain pairs of currencies in the market. For
example, we may have a quote for INR/USD and another for USD/GBP. However INR/GBP may not be readily
quoted. In such situations dealers arrive at INR/GBP rates using the Cross rate mechanism and the Chain rule.
CHAIN RULE :
Rule for arriving at a comparison or ratiu between two quantities which are linked together through another
quantity and consists of a series of equations, commencing with a statement of the problem in the form of a
query and continuing the equation in the form of a chain so that each equation must start in terms of the same
quantity as that which concluded the previous equation. 1)You have to quote Cross rate for retirement of Import
bill for GBP 100,000by TT. Your margin is 0.15%. Market rate quotations are GBP / USD 1.8300 / 10, USD / INR
45.40/50.
Answer: This is an Import bill settlement, we have to sell the required FX i.e. GBP 100,000 to the customer. We
have to
thereforePuy this required sum of GBP 100,000 from the market. i--10.ru $ 1(ZThe
market is selling GBP as-I-GB11)1-.8300/83TrisFte-r3fore, first we need USD.
To buy USD, the rates quoted are 1USD = 45.40/50.
Since we are buying, the market rate will be USD 1=45.50.
We need to pay USD 1.8310 to get 1GBP.
Therefore we need (1.8310 X 45.50) INR. i.e. INR 83.3105 to buy 1 GBP. We have to add our margin which is
0.15% Final rate will be (INR 83.3105) plus ( 0.15% of 83.3105=0.1250) = 83.4355(TT selling rate)
2) M/s PQRS wants to remit JPY 10.00 million by TT value spot, as pa payment of an Import invoice.
Given that USD / INR is at 45.2500/45.2600 and USD / JPY is 108.15 / 108.25, and a margin of 0.15% is to be
loaded to the exchange rate, calculate rate to be quoted and the Rupee amount to be debited to the account of
M/s PQRS .
Answer: Since JPY is to be sold against Rupee, and the rate is not directly given, we would use cross rate
mechanism to calculate the same. We need to buy USD against INR and use the USD to buy JPY for the deal.
Thus, USD / INR rate would be 45.2600 (market USD selling rate — high) and USD / JPY at 108.15 (market JPY&
selling rate low). The JPY / INR rate would be 45.2600 / 108.15 = 0.418492 per JPY
100 JPY = 41.8492.
Add: Margin of 0.15 = 0.0628
41.9120
Rounded off to = 41.9100/100 JPY
Total rupee amount to be debited to the account of M/s PQRS would thus be 10,00,0000 X 41.9100= Rs.
41,91,000(Note: JPY is quoted as per 100 Yen, as per FEDAI guidelines)
FORWARD RATES : As we are aware, banks have to quote forward rates in certain cases such as:
While entering in to a Forward Sale or Forward.Purchase Contract, While discounting a Usance Bill.
By definition, Forward rates are rates quoted beyond Spot deliveries i.e. beyond T + two working days. While
quoting Forward rates, Banks take cognizance of Forward rates quoted by the markets.
The currency may be trading at a higher price (premium) or a lower price (discount) compared to the Spot prices.
The Forward rates are arrived at as follows: If !he Currency is at a Premium Forward rate = Spot rate + Premium
If the Currency is at Discount.Forward rate =Spot rate — Discount
After arriving at rates as above, Banks will build in their margins (add or reduce as the case may be) and quote
the final Forward rate to the customer.
1) On 5 January, Exporters tenders for discounting, e)pottbill_for US 500,000.00, drawn 90 days sight (transit
period 25 days) due date 30 April. Compute applicable rate and amount to be credited, presuming:
Exchange margin of 0.15%,
Spot Rupee 45.40/50 and premium Spot — April 40 paise,
Rate to be quoted to nearest 0.25 paise, and rupee amount to be rounded off, and
Interest to be charged at 7.50% for first 90 days and 10.50% thereafter. Answer:
Calculation of Bill buying rate
Spot Rate Rs. 45.4000
Less: 0.15% margin 0.06'$1 f
45.3319,Say 45.3325
Add: April Premium_ .4000
Rate of the transaction (Bill Buying Rate) 45.7325 ,Calculation of amount payable to the customer: USD
500,000.0J at 45.7325 = 2,28,66,250.00, Interest 90 days @ 7.50% = 4,22,869.00, 25 days @ 10.50 =
1,64,449.00
Amount payable to exporter = 2,22,78,932.00 (Commission and out of pocket expenses ignored)
2) On 15 September, a customer request for booking of a Forward contact for export bill of USD 150,000.00, to
be realized in the month of December.

 Answer:
For calculating rate for forward purchase contract, we need to take forward premium for November, the one that
the market would pay, i. e. 30 paise. Convention: For a sale contract premium for the full period, up to end date
of the contract shall be charged where as for Spot rate as 45.40, Premium : 0.30, Forward : Rate 45 .70
Forward Inter-bank rate arrived is 45.70 and deduct 0.05 paise as margin to arrive at 45.65 as customer forward
rate for delivery of export proceeds during December, full month at the option of the customer (Forward TT
Buying Rate).
3)On 1 January 2004, a customer requests to book Forward contract, for retirement of import bill for USD
100,000.00, due for payment on 15 March 2004. Given rates Spot / INA-4-6.00/95orward premium as under:
Spot January: 10/12, Spot February : 21/23, Spot March :32/34, Feb-15 to March: 5/6
Charge Margin of 0.20%, Answer: Being a merchant sale forward booking transaction, rate would be calculated as
under:
USD / INR spot to be taken as 46.05, Premium payable : Spot February 23 paise
Feb — 15th March 6 paise ,Add: Total premium 29 paise 0.29
Thus IB forward rate would be: 46.34
Add: Margin 0.20% 0.09,,patefor customer 46.43
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#2
Thank you very much for the excellent explanation.
Im working in forex dept. at Canara Bank and this post really helped me.
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