Module: | MODULE A: INTERNATIONAL BANKING
Q14: Read the following statements concerning the Reserve Bank of India regulatory guidelines for corporate entities seeking to hedge foreign exchange risk using derivative products. Identify the correct combination.
Statement 1. Indian corporate entities are strictly prohibited from entering into over-the-counter currency derivative contracts purely for speculative purposes, and every transaction must be backed by an underlying exposure.
Statement 2. A corporate importer can book a forward contract based on past performance limits, meaning they can hedge an anticipated future import even if the specific customs documents for that exact transaction are not yet in hand.
Statement 3. If an underlying import transaction is cancelled, the corporate entity is forbidden from cancelling the associated forward contract, and must take physical delivery of the foreign currency regardless.
Statement 2. A corporate importer can book a forward contract based on past performance limits, meaning they can hedge an anticipated future import even if the specific customs documents for that exact transaction are not yet in hand.
Statement 3. If an underlying import transaction is cancelled, the corporate entity is forbidden from cancelling the associated forward contract, and must take physical delivery of the foreign currency regardless.
✅ Correct Answer: A
🎯 Quick Answer:
Option A isolates the correct statements. Statement III is operationally false.The central bank tightly regulates this to prevent destabilizing the national currency.
Structural Breakdown: Statement I is correct.
The golden rule of the Reserve Bank of India regarding over-the-counter derivatives is the underlying exposure rule.
A company can only buy a derivative like a forward contract to protect an actual business transaction like a pending import payment or export receipt.
Speculation without an underlying asset is illegal for corporates.
Statement II is correct.
Recognizing that businesses have continuous operations, the central bank allows corporates to book forward contracts based on their average past performance, for example the average turnover of the last three years, to hedge anticipated exposures before formal invoices are generated.
Statement III is incorrect.
If the underlying business transaction, which is the import, is cancelled, the associated forward contract can and must be cancelled.
The corporate does not take physical delivery of the currency.
Instead, the bank settles the difference between the contracted rate and the current market rate in Indian Rupees, either recovering a penalty or passing on a gain.