Forward Contract and Stock Futures

The Indian banking system is facing $26-billion outflows on account of foreign currency non resident-bank (FCNR-B) deposit redemption. Experts in the foreign exchange market said this outflow may put the rupee under pressure as there is some unhedged foreign exchange position in the banking system. RBI data suggested that forward long contracts for Oct-Nov are at $12.9 billion against $22.4 billion of maturing deposits, leaving a $9.5 billion gap. Let's take a closer look at how forward contracts help the financial market.

1. What is a forward contract?

A forward con tract is an agreement be tween two parties whereby the buyer of the contract carries an obligation to purchase an asset at a pre defined price at a future date. The seller, in this case, has an obligation to sell the as set at the set price.

2. Who uses this financial instrument?

Forward con tracts are mostly used by hedgers who want to be immune from the movement in asset price. For example, ex porters buy forward contracts from banks to lock in the value of the currency at which they will get their fu ture receivables from overseas buyers. In the process, they elim inate the exchange rate risk.

3. Is it different from futures contract?

Futures and forwards are financial contracts for hedging against price fluctuations. But futures contract is highly standardised whereas the terms of every forward contract are private agreements. Futures are traded on an exchange while forwards are traded over-the-counter.

Futures contract is used by speculators, who bet on the direction in which an asset price will move. Forward contracts are, on the other hand, used by hedgers who want to eliminate the volatility in asset price movement.

4. How have Indian banks hedged the FCNR-B deposits flow?

Banks mobilised $34 billion from overseas depositors be tween September and November 2013 through a special RBI scheme. Out of this, $26 billion came in through the FCNR-B window and banks then swapped those dollars with the central bank against a fee. RBI, in turn, bought forward contracts from other banks to get the set value for dollars when it takes delivery and regularly rolled over the positions. In this process, it has immune the rupee from depreciating sharply

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