Option Contract

There is an inherent “Exchange Rate Risk” in any international trade transaction denominated in a foreign currency, as an adverse movement in the exchange rate may reduce the realization of home currency for an exporter or increase the cost for an importer.

To reduce this exchange rate risk for a transaction to be concluded at future date, ‘Forward Contracts‘ maybe booked. It is a mechanism through which the rate is fixed in advance for purchase or sale of foreign currency needed at that future date.

Why a Forward Contract?

Flexible/customized contract
Guarantees a future price, limiting future losses
Requires no upfront payment
Assists in Budgeting/Forecasting/ Predicting Cash Flows

Who can book a Forward?

Importer/Exporter/ Resident/ NRI

Features

Tenor: 3 days to up to 5 years.
Over 1 year, it is termed as Long Term Forwards (LTFx). Exporters with vintage can enter into LTFx to receive higher premiums and better FX conversion rate.
Settlement can be on due date or any day before maturity of the contract.

An Option Contract gives a buyer the right (which is not an obligation) to buy/sell securities at a pre-determined price and date. The option is European style.

The buyer of the option contract is not required to buy/sell the security if they decide against it. They are however obligated in case of a forward contract.

This optionality comes with a price i.e. option premium which is generally paid upfront. Tenure, Volatility and Strike Price drive the Option Premium.

There are two types of Options:

BUY CALL: These give an importer the right to BUY foreign currency at pre-determined rate
BUY PUT: These give an exporter the right to SELL foreign currency at a pre-determined rate

Ideal scenarios for booking Options:

The client expects volatility in the market. And wants to hedge its positions and also leave the favourable market movement open, to maximise his gains
The client can book Options for not only current account transactions, but also capital account transactions

Features

MTM and collateral are not required to book options.

Loans are usually taken for capital expenditure and working capital requirements. Loans in INR tend to be costly as interest rates are high. The principal and interest has to be repaid in INR.

For clients receiving payments in foreign currency (FCY), an INR Term Loan carries an inherent risk of currency fluctuation while converting FCY receivables into INR for loan repayment.

A Foreign Currency Term Loan can combat this problem, where:

FCTL repayment in FCY acts as a natural hedge against any foreign currency receivables
A Term loan in Foreign currency usually tends to be cheaper than an INR Term Loan and can be availed on fixed or floating rate:
Fixed rate borrowings – protects the borrower against upward movements in the interest benchmark rates(SOFR/EURIBOR/SONIA)
Floating rate borrowings - enables the borrower to take advantage of downward movements in the interest rates

Why a Forward Contract?

Who can book a Forward?

Features

There are two types of Options:

Ideal scenarios for booking Options:

Features

A Foreign Currency Term Loan can combat this problem, where:

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