Initial deposit & additional deposits
When entering into financial transactions, it is essential for us to be prepared for unforeseen situations, including changing market conditions.
Overview
How it works
We require security for all flexible forward contracts in the form of a deposit on the total amount due. In rare cases where the initial deposit is no longer sufficient, we may require an additional deposit.
Initial deposit
5% of the transaction value as a safety buffer when locking in the exchange rate.
Margin call
If the exchange rate moves significantly and the initial deposit is no longer sufficient, we request an additional deposit.
Settlement
All deposits are settled against the final instalment amount at settlement.
Initial deposit
When a client enters into a flexible forward contract with ValutaPartners, an initial deposit is required immediately after locking in the exchange rate. The initial deposit amounts to 5% of the transaction value.
This deposit, also known as the initial deposit, serves as a safety buffer in case the client is unable to meet the obligations of the forward contract.
This can occur in scenarios such as a company insolvency or when unforeseen circumstances prevent the client's underlying transaction from proceeding.
If such a scenario occurs, we are compelled to close the forward contract at the current market exchange rate. This always involves an opposite transaction. This may result in a loss, as the exchange rates of both transactions will most likely differ. Any such loss can then be covered by part of the initial deposit already paid. The remaining amount is then refunded. If closing the forward contract does not result in a loss, the client receives the full initial deposit back.
Calculation example of an initial deposit
Imagine that a client needs to make a payment of USD 100,000 in three months. With a flexible forward contract, this client can lock in the euro-to-dollar exchange rate now. Let's say this rate is locked in at 1.0950.
We at ValutaPartners buy the required dollars at a slightly more favourable rate, let's say 1.1000 euros per dollar. This means we pay a total of EUR 90,909.09 for the USD 100,000.
After locking in the rate, we ask the client to make an initial deposit of 5% of the total transaction amount in euros. The client must therefore transfer 5% of EUR 91,324.20 (= USD 100,000 / 1.0950), which amounts to EUR 4,566.21, to their account at ValutaPartners.
Now, imagine that the exchange rate rises to 1.1200 in the following weeks. This means that an opposite transaction where we would have to sell USD 100,000 at that point would yield EUR 89,285.71. This is less than what we initially paid, namely EUR 90,909.09. This would represent a potential loss of EUR 1,623.38 for ValutaPartners.
In this case, the initial deposit of EUR 4,566.21 would more than cover this loss if we had to close the transaction early. However, if the exchange rate continues to rise, the potential loss may exceed the amount of the initial deposit.
Additional deposit
In situations where the exchange rate moves so unfavourably that the initial deposit is no longer sufficient to cover the potential loss, we need additional security.
Let's assume that the exchange rate continues to rise, to 1.1600. This significantly reduces the value of our transaction: if we had to close the forward contract now, selling USD 100,000 would only yield EUR 86,206.90.
However, we must not forget that we originally paid EUR 90,909.09 for those USD 100,000. This means we would now have a loss of EUR 4,702.19. This loss exceeds the initial deposit the client made.
We then request an additional deposit, also known as a margin call, equal to 5% of the original transaction amount.
Drawdowns
With a flexible forward contract, a client can choose to make partial payments before the final settlement date, also known as 'drawdowns'.
This partial payment is made at the originally agreed exchange rate and reduces the outstanding balance of the forward contract. This decreases the amount still covered by the initial deposit, and thereby also the likelihood of a margin call — after all, the exchange rate must now fluctuate even more before the initial deposit becomes insufficient.
To illustrate, let's return to our client from the earlier example, who has now made a partial payment (or "drawdown") of USD 30,000. As a result, the outstanding balance of the flexible forward contract is now only USD 70,000. If the exchange rate now rises further, to 1.1600, we would only receive EUR 60,344.82 for those USD 70,000 upon sale.
However, for these USD 70,000 we owe an amount of EUR 63,636.36 at the exchange rate of 1.1000. If we had to close this forward contract now, we would suffer a loss of EUR 3,291.54. Fortunately, the initial deposit of EUR 4,566.21 still covers this loss. In this situation, no additional deposit would be required.
Forward contract settlement
The initial deposit and any margin call deposits are ultimately settled against the final instalment amount.
To illustrate, let's return to our client from the earlier example, who has an outstanding balance on the flexible forward contract of USD 70,000. On the settlement date, this client needs USD 70,000 / 1.0950 = EUR 63,926.94. This client had already made an initial deposit of EUR 4,566.21 (and had no margin calls).
Therefore, they only need to transfer EUR 59,360.73 to their account at ValutaPartners. After receiving these euros, the USD 70,000 can be transferred to this client's beneficiary.
Do you have any questions?
We understand that the information above may raise questions. Please do not hesitate to contact us. One of our currency experts at ValutaPartners is always ready to help you.