Forward contracts simplified

Slides:

Advertisements

Similar presentations

11 Financial Derivatives Currency Future i.It is a Financial Contract to Buy or Sell the underlying Currency, the price of which (Currency Future)

Advertisements

FORWARD CONTRACT.

Chapter 3 Introduction to Forward Contracts

The purchasing power parity (PPP) theory measures the purchasing power of one currency against another after taking into account their exchange rate. ‘Taking.

Hedging Foreign Exchange Exposures. Hedging Strategies Recall that most firms (except for those involved in currency-trading) would prefer to hedge their.

13 Management of Transaction Exposure Chapter Objective:

Hedge by Financial Derivative Option, Forward, Futures and SWAP.

1 Foundations of Multinational Financial Management Alan Shapiro John Wiley & Sons Power Points by Joseph F. Greco, Ph.D. California State University,

1 Managing Accounting Exposure Chapter PART III. DESIGNING A HEDGING STRATEGY I. DESIGNING A HEDGING STRATEGY A.Strategies a function of management’s.

Lecture 6: The Forward Exchange Market

CHAPTER 9 MANAGING ACCOUNTING EXPOSURE. CHAPTER OVERVIEW I.MANAGING TRANSACTION EXPOSURE II.MANAGING TRANSLATION EXPOSURE III.DESIGNING A HEDGING STRATEGY.

MBA (Finance specialisation) & MBA – Banking and Finance (Trimester) Term VI Module : – International Financial Management Unit II: Foreign Exchange Markets.

Chapter 7 The Foreign Exchange Market. Outlines… Introduction, The Structure Of Foreign Exchange Market, Functions of foreign exchange markets Spot Market.

Lecture 6: The Forward Exchange Market Understanding Forward Exchange Quotes and the Use of the Forward Market.

Risk and Derivatives etc. Dr Bryan Mills. Traditional (internal) methods of risk management External: – banks, etc e.g. hedge, options, forward contracts.

BASICS OF DERIVATIVES BY- Masoodkhanrabbani Dated-july 28 th 2009.

A2 Business Studies – External Influences Economic opportunities and constraints.

Introduction to Futures & Options As Derivative Instruments Derivative instruments are financial instruments whose value is derived from the value of an.

Foreign Currency Risk Part 1 Mark Fielding-Pritchard mefielding.com1.

Foreign Exchange Risks Management -Vikram Tyagi. Risk Management Foreign Exchange Risks 1) Transaction Exposure Any deferred receipt or payment has exchange.

Chapter 4 Currency Derivatives.

15 International Operations © 2012 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale.

FOREIGN EXCHANGE MARKET. NEED FOR FOREX MARKET BANK INVOLVEMENT IN FOREX MARKET.

FORWARD CONTRACTS. Foreign Buyer Indian Exporter Order/LC For T-Shirts Shipment after 1 –year. Price $ 10 per T-shirt Exporters P/L calculations : T-Shirt.

Derivatives in ALM. Financial Derivatives Swaps Hedge Contracts Forward Rate Agreements Futures Options Caps, Floors and Collars.

A Pak company exports US$ 1 million goods to a customer in united states with a payment to be received after 3 months. A Pak company exports US$ 1 million.

Foreign Exchange Derivative Market  Foreign exchange derivative market is that market where such kind of financial instruments are traded which are used.

OPTIONS. Let's say that on May 1, the stock price of Abc Co. is Rs 67 and the premium (Cost) is Rs 3.15 for a July 70 call, which indicates that the expiration.

F9 Financial Management. 2 Designed to give you the knowledge and application of: Section H: Risk Management H1. The nature and type of risk and approaches.

Rates for PKR/US$ are quoted as follows: Rates for PKR/US$ are quoted as follows: Spot – Spot – month –

1 FORWARDS Definition: n An FX Transaction in which two parties agree TODAY to exchange currencies on a SPECIFIC FUTURE date & at a SPECIFIC RATE. n The.

IMPACT OF RUPEE DEPRECIATION.  What is a foreign exchange rate? A foreign exchange rate expresses the number of units of the home currency which have.

Chapter 13  Exchange Rates and the Foreign Exchange Market:An Asset Approach.

CHAPTER 7 Options Contracts and Currency Futures (Textbook Chapter 8)

1 Exchange Rates CHAPTER Exchange Rates What are they? What are they? How does one describe their movements? How does one describe their movements?

FORWARD CONTRACTS.

Transaction Exposure.

Module 3 - Foreign Exchange Market

International Fixed Income

Spending, Saving, and Investing

Chapter Twenty Two Futures Markets.

Foreign Exchange Markets

Chapter Eight Risk Management: Financial Futures,

The Currency Market: Lecture 2

Forward Contracts.

Chapter 30 – Interest Rate Derivatives

Understanding ‘Currency Derivatives’ – By Prof. Simply Simple TM

Many of you have written to me asking for the meaning of Purchasing-Power Parity (PPP). So what is it? The purchasing power parity (PPP) theory measures.

Futures Markets and Risk Management

Derivative Financial Instruments

Currency Forwards.

Derivative Markets.

Financial Markets and Financial Products

Michael Melvin and Stefan Norrbin

International Economics

Introduction to Futures & Options As Derivative Instruments

Derivatives (1) Currency Forward

Risk Management with Financial Derivatives

Chapter 9 International Financial Markets

Understanding ‘Carry Trade’ – By Prof. Simply Simple TM

Understanding ‘Carry Trade’ – By Prof. Simply Simple TM

Definition of Risk Variability of Possible Returns Or The Chance That The Outcome Will Not Be As Expected copyright anbirts.

CHAPTER 5 Currency Derivatives © 2000 South-Western College Publishing

Chapter Eleven Asset Markets.

Derivative Financial Instruments

Hedging with T-bond Futures

EC7095 Financial Statement Analysis

Hedging with Futures Takeo Aoki.

Lecture 2 – Derivative Market

Presentation transcript:

Forward contracts simplified By C.E.S Azariah, CEO, FIMMDA

Following slides illustrate Forward Contract pricing for USD/INR for Exporters by Banks

EXPORTER’S DILEMMA If after 1 year: Exchange Rate of 1 USD = Rs 29.00 Exporter gets USD 10.00 x 29.00 = Rs 290 per T.Shirt Cost of T-Shirt = Rs 380 Loss per T- shirt = Rs 90

If after 1 year : Exchange Rate of 1 USD = Rs 49 If after 1 year : Exchange Rate of 1 USD = Rs 49.00 Exporter gets USD 10.00 x 49.00 = Rs 490 per T- Shirt Cost of T-Shirt = Rs 380 Profit per T-Shirt = Rs 110

EXPORTER’S DECISION I am in the business of manufacturing T-Shirts, and I am satisfied with my profit margin of Rs 10/= per T-Shirt. I need a protection from business losses due to USD Exchange Rate fluctuations.

EXPORTER APPROACHES HIS BANK Request the Banker for a Quote (RFQ) for getting an Exchange Rate for USD valid as on 1 year hence (forward rate). Exporter undertakes to deliver X amount of USD , being the invoice amount of his T-Shirt exports, to the bank, one year hence, once his export of goods is completed, invoiced, and USD remittance received from foreign buyer.

BANKER’S DILEMMA The Exporter is asking Rupees (one year hence) in exchange for USD, which the Exporter will deliver after 1 year . The Banker can get Rupees to deliver to the Exporter, only if he sell the USD (acquired from the exporter) in the market. If the Exchange Rate of USD vs Rs remains fixed, for one year, it will be very easy for the Banker to quote a rate, but then, the Exporter’s Dilemma would not arise ! The Exchange Rate fluctuations , therefore, create a “Dilemma” for both the Exporter and the Banker !

BANKER IS FACED WITH SIMILAR DILEMMA AS THE EXPORTER If the Banker quotes today’s Exchange Rate plus his profit i.e.: 1 USD= Rs 39.00 less Rs 0.05 = Rs 38.95 (contracted rate) (principle of Take More, Give Less), I . After 1 year : If 1 USD = Rs 29.00 Bank delivers ………….. Rs 38.95 (contracted rate) Bank receives ……………. Rs 29.00 ( by selling the USD acquired from the Exporter after 1 year) Loss per USD = Rs 9.95.

II After 1 year : If 1 USD = Rs 49.00 Bank delivers ……………..Rs 38.95 to Exporter at Contracted Rate Rank received …………. Rs 49.00 (by selling the USD acquired from the exporter ) Profit per USD ………….RS 10.05

BANKER’S DECISION I am in the business of banking (borrowing and lending), and buying and selling financial products. I am satisfied with my profit margins of ___ %, and cannot afford unexpected losses. I will use my expertise in borrowing and lending, purchase and sale of foreign currencies vs Indian Rupees to deliver what the Exporter wants

ON DUE DATE I. If 1 USD = Rs 49.00 (a) Does the Banker make a profit of Rs 9.80 Contracted Rate with Exporter: 1 USD= Rs 39.20 Exchange Rate on Due Date 1 USD=Rs 49.00 Rs 9.80 Obviously NO – because the Banker repays the loan of USD 9.50 + Interest with the USD received from the Exporter .

On due date (contd) (b) Does the Exporter make a loss of 9.80 ? The Exporter’s Decision was to protect his business profit of Rs 10.00, which he has done by delivering the USD at the contracted rate of 1 USD= Rs 39.20. The Exporter suffers an “Opportunity Loss” by protecting himself against all Exchange Rate fluctuations.

On due date (contd) II . If 1 USD = Rs. 29.00 Does the Banker lose Rs. 10.20 by taking delivery of the USD at contracted rate of 1USD= Rs 39.20 ? Contracted Rate 1 USD = Rs. 39.20 Market Rate on due date 1 USD = Rs 29.00 Rs 10.20 Obviously NO – because there is no sale of USD on due date. The Banker sold the USD on the contract date at 1 USD = Rs 39.00. The dollar received from the exporter goes towards liquidating the USD borrowed.

On due date (contd) II (b) Does the Exporter gain Rs 10.20 by delivering the USD at contracted rate of 1USD = RS 39.20, when the market rate is Rs 29.00 on due date ? Obviously NO – because on the contract date itself the Exporter locked the rate at which he would sell the USD to the bankers on the due date. The Exporter has protected himself against the adverse movement of the USD

On Due Date (contd) I. What happens if the Exporter does not have the dollars to deliver on the Due Date, and asks the Banker to cancel the contract ? The results would be the same as the scenarios shown for cancellation of contracts after 3 months . If the USD rate is lower than contracted rate, the Exporter receives some money on cancellation . Why ? If USD rate on due date is higher than contracted rate, the Exporter has to pay the cost incurred by the banker on cancelling the contract. Why ?