Forward contracts are agreements to buy or sell foreign currency at a fixed rate on a future date. They help businesses reduce exchange rate risk in international trade. However, sometimes the actual payment or receipt date may change due to business conditions. In such cases, forward contracts may be adjusted. The main adjustments include early delivery, extension, and cancellation of forward contracts. These facilities provide flexibility to exporters and importers in managing foreign exchange commitments.
1. Early Delivery of Forward Contracts
Early delivery means the settlement of a forward contract before its original maturity date. Sometimes exporters receive payment earlier than expected or importers need to make payment before the agreed date. In such situations, they may request the bank to deliver foreign currency before the contract date. The bank adjusts the forward contract at the prevailing spot rate on the date of early delivery.
The difference between the original forward rate and the current rate is calculated. Any gain or loss arising from this adjustment is settled between the bank and the customer. Early delivery provides flexibility to businesses when cash flows change unexpectedly. It helps avoid penalties or default in international payments. However, exchange rate difference may result in additional cost or benefit. Thus, early delivery allows smooth handling of unforeseen changes in trade transactions while managing currency risk effectively.
2. Extension of Forward Contracts
Extension of a forward contract means postponing the settlement date beyond the original maturity date. This situation arises when exporters do not receive payment on time or importers are unable to arrange funds as planned. In such cases, the customer can request the bank to extend the contract period.
The bank cancels the original forward contract at the current market rate and books a new forward contract for the extended period. The difference between the old rate and current rate is calculated and adjusted. This may result in a gain or loss for the customer. Extension helps businesses manage delays in international transactions without entering into new contracts separately. However, exchange rate fluctuations during the extension period may increase financial risk. Therefore, extension provides flexibility but may involve additional cost.
3. Cancellation of Forward Contracts
Cancellation of a forward contract means terminating the agreement before its maturity date. This may happen if the underlying trade transaction is cancelled or the business no longer requires foreign currency. The customer can request the bank to cancel the contract at the prevailing market rate.
The bank calculates the difference between the original forward rate and the current rate. If the market rate is favorable, the customer may gain. If not, the customer may incur a loss. The difference amount is settled immediately. Cancellation helps avoid unnecessary foreign exchange exposure when trade plans change. However, it may result in financial loss if exchange rates move unfavorably. Therefore, businesses must carefully assess their currency needs before entering into forward contracts.