Module: | MODULE A: INTERNATIONAL BANKING
Q197: Consider the following statements regarding the lifecycle and cancellation of foreign exchange forward contracts under the Association rules:
1. Customers are permitted to request the early delivery of a forward contract before its maturity date, subject to the recovery of appropriate swap costs by the bank.
2. If a customer cancels a forward contract, the bank is entitled to recover any exchange loss arising from the cancellation directly from the customer.
3. An unutilized forward contract is automatically cancelled by the bank precisely on the final maturity date without any grace period being provided.
Which of the statements given above is or are INCORRECT?
2. If a customer cancels a forward contract, the bank is entitled to recover any exchange loss arising from the cancellation directly from the customer.
3. An unutilized forward contract is automatically cancelled by the bank precisely on the final maturity date without any grace period being provided.
Which of the statements given above is or are INCORRECT?
✅ Correct Answer: C
🎯 Quick Answer:
Option C is correct because only statement 3 is incorrect.Structural Breakdown: The Association rules allow flexibility.
If an exporter receives payment early, they can execute the contract early, though the bank will charge swap costs to adjust its own hedged positions, validating statement 1. If a contract is cancelled and the market rate has moved unfavorably, the customer must bear the loss, validating statement 2. Statement 3 is incorrect.
The Association rules mandate that an unutilized forward contract shall be automatically cancelled by the bank on the 3rd working day after the maturity date, providing a brief administrative grace period before forcefully unwinding the position.
Historical Context: The 3 working day auto-cancellation rule was implemented to clean up bank balance sheets, preventing long-expired, unfunded derivative contracts from lingering as unrecognized risks.
Causal Reasoning: The causal reasoning for charging swap costs on early delivery is that the bank itself has borrowed or lent funds in the interbank market matching the exact original maturity date.
Early execution forces the bank to break its own interbank funding arrangements, incurring a financial penalty that is passed on to the customer.