Below are the five factors of forward markets:
- Forward margin: Forward margin depends on the
perception of buyer and seller of the currency. It is nothing but a
premium on the currency where the forward is costlier than its spot
rate and a discount where the forward rate is cheaper then its spot
rate. Generally it is quoted for premium or discount based upon the
same currency as of the spot rate.
- Delivery option: It refers to the process of
choosing the value date within an agreed period. In interbank
market the date is limited to the extent of calendar month but it
can be extended to further date by mutual consent. One feature of
the Indian market is that the delivery of a claim for foreign
currency receivable is considered as delivery of the foreign
currency although the currency may be receivable after some
time.
- Card rates for customer transactions: The
customer transactions are undertaken at a large number of branches
to calculate card rates for the transactions in the FX treasury by
considering the ruling rates in the domestic and international
markets. These card rates are then communicated to the operating
branches by telephone or fax or e-mail etc. The card rates are used
for undertaking customer transactions for amounts not exceeding a
stipulated limit. Generally, these card rates are for relatively
small value transactions. For large value transactions which are
beyond the stipulated limits, the branches are expected to
telephone the FX treasury and get applicable rate. General, these
would be more competitive and based on the ruling interbank
rates.
- Interbank forward quotations: These quotations
are made paisa per dollar or any other foreign currency which is
applicable to end of the month deliveries. As the interbank market
will not be active beyond 12 months. The interbank forward
quotations are quotes used & applied for transactions between
two banks to ensure to remove the mismatch of maturities in their
forward transactions.
- Cash spots and call rates: The cash spot
margin in the interbank market is governed by the call market in
Indian currency. Because arbitrage is possible between borrowings
in the call market at a particular rate and sells cash or buy spot
dollar swap in the exchange market. Banks would use the cheaper
market. Therefore there is a strong correlation between the cash
spot margin and the call rate.
There are many reasons why a treasury department do hedging
against foreign exchange currency. But these can be mainly
elaborated in to three as follows.
- The first one is to protect profit margins from erosion due to
fluctuations in exchange rates. If your gross margins are less then
your requirement to protect gross margins are very high and if your
gross margins are high then your requirement will be less. Many
businesses will have a timeline for protecting profit margins that
match their sales cycle. Some foreign exchange hedging is booked to
match underlying contracts. Some are booked to cover a season or
project. Otherwise, hedging contracts might be booked on a rolling
basis.
- The second one is to create stability and predictability in
your cash flows against volatility, uncertainty, complexity and
ambiguity. Larger corporations, especially those listed or with
complex ownership structures, will often have a shareholder
directive to maintain stability in earnings. No CFO wants the share
price to plunge in line with currency fluctuations. Stability &
predictability can play an important role in meeting shareholder
expectations.
- The other reason is to remain competitive, If your competitors
are pricing their product as per average hedge rate then your
position will be different in the spot market. Hence it is
necessary to compete on the same playing field as your competitors
rather than on the foreign exchange market.