InvestorQ : What is understood by a forward cover on the dollar?
Katherine Gonsalves made post

What is understood by a forward cover on the dollar?

Answer
user profile image
Rutuja Nigam answered.
2 years ago


If you are familiar with banking and international trade, you would be familiar with the concept of a forward cover. A forward cover is the most basic form of a forward contract. A forward cover is an over-the-counter (OTC) contract that is offered by a bank to its customers. Let us say that you are an exporter of handicrafts and you are scheduled to receive $500,000/- as an advance for the first leg of your order from the Middle East. This amount will be received in 3 months time. Currently, the exchange rate is at 65/$ and you are comfortable with that rate. Your calculation is that at the current exchange rate, this will translate into Rs.3.25 crore, which will be sufficient to pay off all your outstanding dues to suppliers. The catch is that you have just read in the papers that due to strong FDI flows into India, the INR could strengthen to Rs.61/$. That means, unless you take protection measures, you are likely to incur a notional loss of Rs.20 lakhs. You can get protection by asking your bank to sell forward dollars. You can buy forward dollars and you can also sell forward dollars based on whether you are an importer or an exporter. Basically, forward cover is a non-exchange traded method of hedging your currency risk.