An exporter sold USD 2 million forward at 83.60 for this week, but the buyer will pay a month late. Spot is 84.40 and one-month forward points are plus 0.25. Cancel and rebook: what is the cash flow today, and what effective rate is achieved?

Cancelling costs Rs 16 lakh today, 0.80 a dollar on USD 2 million, and the new forward is booked at 84.40 plus 0.25, 84.65. In a month the company delivers the dollars for Rs 16.93 crore; less the Rs 16 lakh paid today, it nets Rs 16.77 crore, an effective 83.85. That is the original 83.60 plus the 0.25 of forward points for the extra month, so the hedge still protected the budget rate; the cost is cash out today and a month of funding on it.

If you promised to sell a friend your bicycle for Rs 8,360 next week and the market price is now Rs 8,440, getting out of the promise costs you the Rs 80 difference. The company's forward obliges it to sell USD 2 million at 83.60; with spot at 84.40, closing that obligation means buying the dollars at 84.40 and delivering them at 83.60, a loss of 0.80 a dollar, Rs 16 lakh, paid today. That loss is not new: it is the mirror of the gain the company has on its unhedged dollars, which are worth 0.80 more in rupees than when the forward was booked. The cancellationClosing out a forward before or at maturity by doing the opposite trade at the current rate. The difference between the two rates is settled in cash. just turns it into cash now, before the dollars arrive.

Put the two cash flows together. The new forward pays Rs 16.93 crore in a month; take off the Rs 16 lakh paid today and the company nets Rs 16.77 crore for its USD 2 million, an effective 83.85. That is exactly the original 83.60 plus the 0.25 of points, which makes sense: the company has extended a sale at 83.60 by a month, and a month of extension is worth the forward points. Strictly, the Rs 16 lakh leaves a month before the dollars arrive; at a 7% funding cost that month costs about Rs 9,333, which trims the effective rate to about 83.845. The hedge did its job: the rupee weakened, the company gave up that gain on the hedged dollars, and its budget rate held.

Three practical points separate a candidate who has done this from one who has read about it. The bank will cancel at its own buying rate for dollars, not the mid, and book the new forward at its selling rate, so both legs carry a spread and the effective rate will be a few paise worse than 83.85. Some banks offer an early or late delivery on the existing contract instead, an extension at a rate that rolls the old price forward; whether that is allowed, and how the cost is booked, depends on the central bank's rules for hedging contracts, which change and should be confirmed for the current year rather than assumed. And the Rs 16 lakh cash outflow today may matter more to a small exporter than the rate: a CFO short of working capital would want to know it before saying yes.

Say the limit of the working: if the rupee had strengthened instead, say spot at 83.00, the cancellation would have paid the company 0.60 a dollar today and the new forward would have been booked lower, and the effective rate would again come out at about 83.60 plus the points. The arithmetic does not depend on where spot moved, which is the whole point of the hedge.