Fx Forward Contract Template
Debt Instruments and Markets Professor Carpenter Forward Contracts and Forward Rates 2 Forward Contracts A forward contract is an agreement to buy an.
Fx Forward Contract Rates
Three Parts: A forward contract is a type of derivative financial instrument that occurs between two parties. The first party agrees to buy an asset from the second at a specified future date for a price specified immediately. These types of contracts, unlike futures contracts, are not traded over any exchanges; they take place over-the-counter between two private parties. The mechanics of a forward contract are fairly simple, which is why these types of derivatives are popular as a hedge against risk and as speculative opportunities. Knowing how to account for forward contracts requires a basic understanding of the underlying mechanics and a few simple journal entries. Recognize a forward contract.
This is a contract between a seller and a buyer. The seller agrees to sell a commodity in the future at a price upon which they agree today. The seller agrees to deliver this asset in the future, and the buyer agrees to purchase the asset in the future. No physical exchange takes place until the specified future date. This contract must be accounted for now, when it is signed, and again on the date when the physical exchange takes place. For example, suppose a seller agrees to sell grain to a buyer in 3 months for $12,000, but the current value of the grain is only $10,000. In one year, when the exchange takes place, the market value of the grain is $11,000, so in the end, the seller makes a profit of $1,000 on the sale.
The spot rate, or current value, of the grain is $10,000. The forward rate, or future value, of the grain is $12,000. Record a forward contract on the contract date on the balance sheet from the seller’s perspective. On the liability side of the equation, you would credit the Asset Obligation for the spot rate. Then, on the asset side of the equation, you would debit the Asset Receivable for the forward rate. Finally, debit or credit the Contra-Asset Account for the difference between the spot rate and the forward rate.
You would debit, or decrease the Contra- Asset Account for a discount and credit, or increase it for a premium. Using the example above, the seller would credit the Asset Obligation account for $10,000. He has made a commitment to sell his grain today, and today it is worth $10,000. But, he is going to receive $12,000 for the grain.
So he debits Assets Receivable for $12,000. This is what he’s going to be paid.
To account for the $2,000 premium, he credits the Contra-Asset Account for $2,000. Record a forward contract on the contract date on the balance sheet from the buyer’s perspective.
On the liability side of the equation, you would credit Contracts Payable in the amount of the forward rate. Then you would record the difference between the spot rate and the forward rate as a debit or credit to the Contra-Assets Account. On the asset side of the equation, you would debit Assets Receivable for the spot rate.
Using the example above, the buyer would credit Contracts Payable in the amount of $12,000. Then he would debit the Contra-Assets Account for $2,000 to account for the difference between the spot rate and the forward rate. Then he would debit Assets Receivable for $10,000. Record a forward contract on the balance sheet from the seller’s perspective on the date the commodity is exchanged.
First, you close out your asset and liability accounts. On the liability side, debit Asset Obligations by the spot value on the contract date. On the asset side, credit Contracts Receivable by the forward rate, and debit or credit the Contra-Assets account by the difference between the spot rate and the forward rate. Using the above example, on the liability side you would debit Asset Obligations by $10,000. On the asset side, you would credit Contracts Receivable by $12,000/. Then you would debit the Contra-Asset account by $2,000, the difference between the spot rate and the forward rate.
Recognize any gain or loss on the commodity sold from the seller’s perspective. Determine the current market value of the commodity. This is its value on the date of the physical exchange between the buyer and seller.
Next, debit, or increase, your cash account by the forward rate. Then credit, or decrease, your Asset account by the current market value of the commodity. Finally, recognize the gain or loss, which is the difference between the forward rate and the current market value, with a debit or credit on the Asset Account. In the example above the current market value of the grain on the date of the physical exchange is $11,000. First, the seller must increase cash based on the contracted amount, so he would debit cash by $12,000.
Next he must reduce the Asset account by the current market value by recording a credit of $11,000. Then, to recognize the gain of $1,000 (which is the current value, $11,000, less the spot rate, $10,000), he would record a credit on the Asset Account of $1,000.
Fx Options
Introduction FX forward contracts are transactions in which agree to exchange a specified amount of different currencies at some future date, with the exchange rate being set at the time the contract is entered into. The date to enter into the contract is called the 'trade date', and its settlement date will occur few business days later.
The time difference between the trade date and the settlement date is called the 'settlement convention'. A similar settlement convention exists at the maturity date of the contract, in which physical exchange of the currencies may be delayed as well. In the FX market, for the trades of any currency against USD, the standard time for the 'immediate' settlement convention is usually two business days after the trade date in the other currency.
One exception to this convention is CAD, which has one business day delay. Then the 'common' settlement convention is the first good business day after this immediate date that follows the holiday conventions of New York and the other currency. For the cross-currency trades in which USD is intermediate currency, the initial settlement convention of each currency is calculated separately with respect to its own conventions.
The latest of those two dates is picked as the 'immediate' settlement convention. Then the 'common' settlement convention moves this immediate date forward to the first good business day that follows the holiday conventions of New York and the two cross currencies. FX forward rates, FX spot rates, and interest rates are interrelated by the interest rate parity (IRP) principle. This principle is based on the notion that there should be no arbitrage opportunity between the FX spot market, FX forward market, and the term structure of interest rates in the two countries. Technical Details where = fair forward FX rate (quoted in units of domestic currency per unit of foreign) = spot FX rate (quoted in units of domestic currency per unit of foreign) = domestic interest rate (for term of forward) quoted on a simple interest basis = foreign interest rate (for term of forward) quoted on a simple interest basis = domestic accrual factor = foreign accrual factor Settlement convention refers to the potential time lag that occurs between the trade and settlement dates. Financial contracts generally have a delay between the execution of a trade and its settlement. This time period is also present between the expiry of an option and its settlement.
For example, for an FX forward against USD, the standard date calculation for spot settlement is two business days in the non-dollar currency, and then the first good business day that is common to the currency and New York. The only exception to this convention is USD-CAD which is one Toronto business day, and then the first common business day in Toronto and New York. For an FX option, cash settlement is made in the same manner, with the settlement calculation using the option expiry date as the start of the calculation. The settlement convention affects discounting cash flows and must be considered in the valuation. The FINCAD functions allow the specification of various FX rate market conventions that are able to cover most currency pairs available in the market. Regarding the possible input formats, the users can specify the conventions for the two currencies of the FX rate manually, in a combined or separate manner. For the former, two elements can be taken in as maturity descriptor and holiday convention that are shared for both currencies.
For the latter, five elements can be taken in as one set of maturity descriptor and holiday convention for the currency one, another set of similar inputs for the currency two and an additional input of holiday convention. This corresponds to the most generic specification of the settlement convention that can be used for cross rate trades, e.g. A CAD-EUR trade that has settlement dates calculated using New York as well as Toronto and Target holidays. Analysis Supported FINCAD FX forward functions can be used for the following:. Calculate an FX forward rate and a rate basis of FX forward and spot difference;.
Calculate fair value and risk report of an FX forward contract with settlement convention. To learn more about FINCAD FX forward functions. FINCAD is the leading provider of enterprise portfolio and risk analytics for multi-asset derivatives and fixed income. An industry standard since 1990, our advanced analytics, flexible architecture and patented technology enable financial institutions to make better investment and risk decisions. Our goal is to provide our clients with solutions that help them achieve their goals, with no compromises. Clients include leading global asset managers, hedge funds, insurance companies, pension funds, banks and auditors.