InvestorQ : Can you explain how a rupee forward contract works and who is the other party?
Katherine Gonsalves made post

Can you explain how a rupee forward contract works and who is the other party?

Rutuja Nigam answered.
4 years ago

A forward dollar market is an OTC market. That means, it is not a recognized exchange but deals are conducted over the telephone. The participants are the large banks, mutual funds and financial institutions and hence the risk of default is almost non-existent. You can approach your banker and tell them to sell dollar forwards at the rate of Rs.66/$. Remember, forwards always quote at a premium and very rarely at a discount. By selling forwards, you have locked in your price at Rs.66/$ and therefore you are not worried even if the rupee appreciates to Rs.61/$. Of course, if the rupee weakens to Rs.68/$ then there is a notional loss. But the purpose of a hedge is to protect your downside risk not to making trading profits.

Rupee forwards are extremely popular among exporters and importers. Since exporters have dollar receivables, they need to protect themselves against an appreciation of the rupee. They would prefer a weak rupee as they get more rupees for each dollar earned. The importer, on the other hand, wants to protect against the depreciation of the rupee. Importers prefer a strong rupee as that will mean they have to pay fewer rupees to buy each dollar they need to pay out. Like importers, even foreign currency borrowers need to protect themselves against a weakening rupee. Historically, since importers and exporters need to anyways go through Authorized Dealer (AD) banks, forward cover was the logical choice for them. There are two types of forward contracts that banks offer. There are Fixed Date Delivery contracts which are settled on a specific future date. Secondly, there are Optional Delivery Contracts that banks offer with contracts that are deliverable any time within period of 12 months, almost equivalent to American options in equities.