Cancellation and Extension of Forward Contracts: If the exporter is not able to deliver even within the option period, he may approach to the bank either for cancellation or for extension of forward contracts. Let us discuss them in detail.
1) Cancellation: The customer who has booked a forward contract may not be able to execute it and therefore, request the bank for cancellation. The bank would generally agree for the cancellation provided the customer is willing to bear the loss incurred by the bank by such cancellation.
When a forward purchase contact is cancelled on the due date, it is taken that the bank purchases at the rate originally agreed upon and sells back to the customer at the spot TT rate. The difference between these two rates is the loss on the transaction and is recovered from the customer. Of course, the amounts involved in purchasing and sale of foreign currency are not passed through the customer's account. Only the difference, being the loss on the transaction, is recovered by way of debit to the customer's account.
In the same way when a forward sale contract is cancelled it is treated as if the bank sells at the rate originally agreed and buys back at the spot buying rate. The difference between these two rates represents the loss to the bank and is recovered from the customer.
It is possible that the exchange difference is in favour of the customer. That is, the difference may result in a profit instead of loss. Such profit is passed on to the customer provided the contract is cancelled at the request of the customer.
2) Extension: An exporter may find that he is not able to export on the due date but expects to do so in about two months. So also, an importer may be unable to pay on the due date but is confident of making payment a month later. In both these cases they may approach their bank with whom they have entered into forward contracts to postpone the due date of the contract. Such postponement of the date of delivery under a forward contract is known as the extension of forward contract.
For extension of sale contracts the exchange control regulations provide that the contract, may be extended if the relative letter of credit or fm contract is extended for shipment and the import licence is valid for the extended period.
When the bank enters into a forward purchase contract with a customer it covers its own position by selling in the inter-bank market the same amount for the same delivery period.
On the due date when the contract is extended, irrespective of the fact that the customer has not delivered foreign exchange, the bank has to meet its commitment. For this purpose the bank buys spot from the market and delivers under the original contract.
Supposing the customer requires extension of two months, after two months the bank would be in receipt of foreign exchange under the extended contract. To cover its position the bank enters into a forward contract for two months.
The operations involved may be tabulated as under:
On the' date of the contract:
a) Purchase forward from customer
b) Sell forward to the market at market buying rate.
On due date when contract is extended:
c) Purchase spot from market
d) Sell forward to market at market at market to selling rate to fulfil
(b). buying rate to cover extended delivery of (a).
The bank will charge from the customer the loss suffered by it as also interest to the outlay of funds for the extended period. It will also make a flat charge.