PAR FWD-AVERAGE RATE FWD-UNIFORM RATE FWD
BACKGROUND :When using FX forwards to protect the value of future cash flows in foreign
currencies, many corporates try to time the execution so that they lock in a more favorable
rate than the current forward. Some wait for the rate to improve - and subsequently end up
missing the boat. Others try to average into a better rate by entering lots of smaller
transactions at different times, resulting in a lot of administrative work without necessarily
achieving their aim.
The product envisages offering the client a uniform rate that can be applied for future trade
transactions thereby facilitating uniform calculations of liability/Margins for a fixed period of
time without worrying for market volatility.
DESCRIPTION OF THE PRODUCT
A Par Forward is an agreement to exchange a series of cash flows over time in one currency
for a series of cash flows in another currency with all exchanges occurring at the same
The Par Forward is therefore a series of foreign exchange forward contracts at one agreed
rate. It is not necessary for the cash flows to be of the same notional amount
An Indian company will receive USD 1,000,000 in dividends per year for 3 years.
Traditionally the company has sold the USD forward and bought USD. Given the interest
rate differential (INR rates higher than USD rates), the forward rates improve with tenor. For
example, while the current spot rate is 1USD = 49INR , the exchange rate for delivery in
one year is 51.00, 2yrs 54.00 and 3yrs 57. The company would normally enter into three
separate contracts as follows:
Time Company Sells Fwd RateCompany Buys
1 year USD 1,000,00051 INR 51,000,000
2 yearsUSD 1,000,00055 INR 54,000,000
3 yearsUSD 1,000,00057 INR 57,000,000
Alternatively, the company could utilise a 3 yr Par Forward at say 54.00 with the following
Time Company Sells Fwd Rate Company Buys
1 year USD 1,000,000 54.33 INR 54,000,000
2 years USD 1,000,000 54.33 INR 54,000,000
3 years USD 1,000,000 54.33 INR 54,000,000
The period could be adjusted to suit the customer. However, in terms of Indian
requirements, the same needs to be supported/backed by genuine import/export
transactions or by way of a definite income/liability to be effected/or based on past
The Par Forward has the effect of "advancing" some of the INR cash flow. The sum of the
cash flows is not the same as the straight forward transactions .The Par Forward allows the
company to receive the same amount of INR each year with the early cash flows at a rate
substantially more attractive than the market rate.
Like any forward, the Par Forward not only provides an exposure to the FX spot rate, but
also to the interest rate differential between the two currencies involved.
In effect, the company is receiving a fixed rate of interest in the currency bought forward,
and paying a fixed rate of interest in the currency sold forward. In this example, the
company would be receiving INR fixed rate and paying USD fixed rate. If this does not
coincide with the interest rate view of the company, they may wish to utilize a Floating Rate
There are a number of ways to consider the Par Forward. Simplistically, the Par Forward is a
series of forward contracts where the forward rates are adjusted so that some of the
forward exchanges "subsidizes" the others such that they are all equal amounts. As a "rule-
of-thumb", the Par Forward rate will approach that of the weighted average of the FX
Forward rates. This is not 100% accurate as it fails to take into account the concept of
The Par Forward rate is calculated as follows:
PV (CCY1 cashflows) * Par Forward Rate = PV (CCY2 cashflows)
where the Present Value (PV) for each series of cashflows is calculated using that currencies
zero coupon discount factors
Another way to think about the Par Forward is graphically:
The Par Forward rate is that rate such that the PV of Area A equals the PV of Area B. Where
the interest rate differential is favourable (i.e. higher interest rate in the currency being
bought), the Par Forward rate will be more attractive than short term forward rates and less
attractive than long term forward rates as in the example above.
In cash flow terms this results in improved cash flows in the short term. Where the interest
rate differential is not favorable, the Par Forward rate will be less attractive than short term
forward rates and more attractive than long term forward rates.
The Par Forward is an appropriate alternative for any user of FX Forwards. It is particularly
attractive where the company or investor desires a hedge for a stream of future cash flows.
The cash flows being hedged do not need to be at regular intervals or for the same notional
NOTES/IMPORTANT POINTS TO BE KEPT IN MIND
By its nature, the Par Forward changes the timing of cash flows from what would normally
be expected when using FX Forward contracts.
This therefore has taxation and accounting implications.
O As in the example above, the Par Forward may result in some forwards being
exchanged at better than market rates while others are at worse than market rates.
O Depending upon the accounting method utilized by the user, this may result in an
over or under statement of profits or losses.
Officially no Bank in India has launched this product. (Unofficially JPM is reported to be
offering the product)
We need to highlight the Benefits, Accounting, Taxation, as well as effect on
Permission of Reserve Bank of India is advisable in view of the above stated factors.
Also internal measures for effective maintenance of Par Measures, and booking back to
back hedging needs to be put in place.
O Simplicity. All forwards at one rate
O Par Forward rate can be better than short term forward rates (if interest differential
O Cash flows are not required to be equal or regular
O Potential accounting benefits
DISADVANTAGES :-Potential taxation and accounting implications
PRODUCT SUITABILITY :-Simple Defensive
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