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
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
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.