What are the Characteristic features of Foreign Currency Forward Contracts?


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Characteristic features of Foreign Currency Forward Contracts :

1. These contracts represent privately arranged agreements which are therefore

negotiated on ‘over the counter’ (OTC) basis. These contracts are highly flexible and

can be structured according to the requirements of the concerned parties.

2. Such contrasts are customized contracts, both in terms of amount and maturity, and

thus provide a means of achieving 100% hedge.

3. Banks normally do not demand any margin money and hence there is no interest

cost.

4. There is a commitment to exchange specified currency at an agreed price in future.

This means that delivery is mandatory and takes place at maturity on contracted

terms.

5. If the spot price on the maturity date exceeds the contract price, the forward buyer

stands to gain. The gain will be equal to spot market price minus contract price. If the

spot price on maturity date is below the contract price, he incurs a loss. The gain /

loss of the forward buyer is equal to the loss / gain of the forward seller which means

the risk – reward profiles are symmetrical. This is known as ‘Linearity’.

6. Delivery under such contracts is compulsory and it is not possible to set-off forward

purchases against forward sales. This mean it is not possible to trade in such

contracts. However contracts can be cancelled. Such cancellations are required to be

done with the same counter party.

7. Both parties to the contract are exposed to credit risk i.e.: the possibility of

counterparty failure in fulfilling contractual liabilities.

8. Profit or loss on forward contracts gets crystallised only on maturity. There is no

‘Mark to Market’ concept in forward contracts.

9. These are bilateral contracts with no brokers or intermediaries involved and therefore

there are no overhead expenses.

10. Under-utilisation, non-utilisation or late utilisation of the contract leads to cancellation

of contract on maturity at customers cost.

 


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MT UVA BMS

MT UVA- University, Vocational and Affiliated Education for BMS

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