Forward contract

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vinod (Querist)
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11 April 2014 Hi every one...
Here i have a query on Forward Contract.

I am an importer where i imported some materials for 10000 USD through LC and entered a Forward Contract with bank.
Now i have the exchange rate like this, date of inception 1.4.2014 (spot rate) 1 USD = INR 60, I am assuming that the INR value may depreciate to 62 and entering into a forward contract (1.10.2014 @ 62/USD)

I need to solve this through the formula. please help me in a detailed manner.

Nikhil Kaushik

Nikhil Kaushik (Expert)
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11 April 2014 what do you want to solve in this?

vinod

vinod (Querist)
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11 April 2014 Value at Risk (VaR) using formula

Asha Kanta Sharma

Asha Kanta Sharma (Expert)
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25 July 2024 Calculating the Value at Risk (VaR) for a forward contract involves understanding the potential loss that could arise due to adverse movements in exchange rates. In your case, you're looking to hedge against the risk of INR depreciation relative to USD.

Here's how you can calculate the potential loss using the forward contract and the spot rate:

### Given Data:
- Spot Rate (at inception): 1 USD = INR 60
- Forward Rate: 1 USD = INR 62
- Contract Amount: 10K USD

### Steps to Calculate Potential Loss (VaR):

1. **Determine the Forward Settlement Value:**
- Forward Settlement Value = Contract Amount × Forward Rate
- Forward Settlement Value = 10K USD × 62 INR/USD
- Forward Settlement Value = 6.20K INR

This is the amount you will receive in INR if you honor the forward contract at maturity.

2. **Calculate the Potential Loss:**
- To calculate potential loss, compare the forward settlement value with the value you would get at the spot rate (assuming spot rate changes unfavorably).

Let's assume the spot rate worsens to 1 USD = INR 63 by the contract maturity date (1st October 2014).

- Value at Spot Rate = Contract Amount × Spot Rate
- Value at Spot Rate = 10K USD × 63 INR/USD
- Value at Spot Rate = 6.30L INR

Therefore, the potential loss would be:

- Potential Loss = Forward Settlement Value - Value at Spot Rate
- Potential Loss = 6.2L INR - 6.30L INR
- Potential Loss = -10,000 INR (Negative indicates loss)

### Interpretation:
- The negative potential loss of 10K INR indicates that if the spot rate depreciates to 1 USD = INR 63 by the contract maturity date, you would incur a loss of 10K INR.
- This loss is the difference between what you would receive from the forward contract (at the agreed rate of 62 INR/USD) and what you could have received at the spot rate (63 INR/USD).

### Formula for VaR:
VaR (Value at Risk) in this context is essentially the potential loss due to adverse movements in exchange rates, calculated as shown above.

- **VaR = Forward Settlement Value - Value at Spot Rate**

This calculation helps you assess the risk exposure from the forward contract and plan accordingly to mitigate risks associated with currency fluctuations.

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