Question on early delivery of forex

This query is : Resolved

CA Sahil Singla.. (Querist)
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17 August 2011 Que.- On 15 July, 2007, SBI booked a forward purchase contact for Euro 50,000 due August 30 @ Rs. 56.35. On 10th Aug. the customer requests the bank to extend the forward contact for 30th Sept. Foreign Exchange rates on 10th August are:
Spot 56.1325 – 56.1675
Forward 30th Aug. 55.6625 – 55.7175
Forward 30th Sept. 55.4425 – 55.5375
At what rate the contract will be extended? What amount of loss / gain will be receivable from / payable to customer?
Answer: On 10th August, the bank will enter into two forward contacts with the customer.

(i) under first contract (maturity 30th August, 2007), bank will sell Euro 50,000 to the customer on 30th August @ 55.7175 (this contract is necessary for cancellation of 15th July contract )

(ii) under second contract, bank will purchase Euro 50,000 from the customer on 30thSept. @ 55.4425 (this contract is necessary as the customer wants Euro 50,000 on this date on forward basis )

On 30th August:

(i) The Bank will purchase Euro 50,000 from customer ( under 15th July contract) for 50,000 x 56.35 i.e. Rs.28,17,500

(ii) The Bank will sell Euro 50,000 to customer for 50,000 x i.e. 55.7175 i.e. Rs. 27,85,875 ( under the first contract entered on 10th August).

(iii) Profit to customer is Rs.31,625. This profit will be paid to customer on 10th August itself.

Doubt- In this case bank is suffering a loss- (56.35 - 55.7175)* 50000= Rs 31,625 mentioned as profit for customer in solution above. But we know that bank will not bear any loss on itself so it will recover this loss from the customer.( As it is a cancellation of contact before maturity.)

Plz correct me.

CA Sahil Singla..

CA Sahil Singla.. (Querist)
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17 August 2011 plz someone reply

Asha Kanta Sharma

Asha Kanta Sharma (Expert)
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19 July 2025 Explanation:
In the forward contract extension / cancellation, the bank does not bear any loss or profit on its own account; rather, any gain or loss arising from cancellation or extension of the forward contract is passed on to the customer.

What happens to this loss?
The bank does not absorb this loss.
This loss is recovered from the customer immediately on 10th August (at the time of contract modification).
In other words, customer pays Rs. 31,625 to the bank to compensate for the difference arising from cancelling the original contract early.

Why does the solution say “Profit to customer” of Rs. 31,625?
This wording can be confusing.
The “profit” in that context means the customer benefits by paying less or gaining because of favorable change in forward rates if the rates move in their favor.
But since the bank locks the rate and cancels the original contract, the difference is settled immediately with the customer.

So, to clarify:
The bank’s loss on cancellation is passed on to the customer as a payable amount.
The customer either receives or pays the difference depending on how the rates moved.
The bank never suffers a net loss or gain because it hedges or passes on all gains/losses.

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