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Hedging Instruments against ForeignExchange Risk
A Project Report submitted toIndian Institute of Information Technology, Allahabad
In the partial fulfillment for theDegree of Master of Business Administration in Information Technology
Under the Supervision ofDr. ShvetaSingh
Mr. Ashish Srivastava
ByABHISHEK SINGHAJ AY PAL SINGH
MAHENDER SINGH.MSHAILENDER SINGHSHASHWAT PANDEY
May-2010
INDIAN INSTITUTE OF INFORMATION TECHNOLOGY,ALLAHABAD
Deoghat, J halwa, Allahabad, U.P., India 211012
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CERTIFICATE
I / we hereby certify that the Fourth Semester Master Project prepared by.. titled is an original piece ofwork done by me/us under the supervision of ..
I/we certify that the submitted work has not been undertaken elsewhere and is free fromplagiarism as per the www.plagiarismdetect.com website report.
[Candidates Signature]
Recommended in the partial fulfillment for the Degree ofMaster of Business Administration
in Information Technology examination.
[Internal Guide]
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Check List for Revised MBA/MSCLIS Project Reports of Two/Six Months Duration
1. Name of Student(s) with Roll No.
Mr. Abhishek Singh (IMB2008053)
Mr. Ajay Pal Singh (IMB2008029)
Mr. Mahender Singh (IMB2008022)Mr. Shailendra Singh (IMB2007058)
Mr. ShashwatPandey (IMB2008004)
2. Title of the Project:
Hedging Instruments against Foreign Exchange Risk
3. List of Computer resources used in addition to general network connected PC
hardware, please mention below if any Software including operating system(s),
compiler(s) any 4GL(s), 5/W tools, libraries were used duly mentioning their types
(open source / Free and open source / shareware / proprietary or any other) with
version number of the resource.
Windows 7 Basic
MS Office 2010
4. Category of the Project & your contribution claimed
Research Project Study of Hedging Instruments against Foreign Exchange Risk.
5. Claims of the work done in light of competitive already available in academicdomain/ products / providers of items or services of proprietary domain.
This is a purely fresh work which is done by us and there is no competitivework available in academic domain / providers of items or services ofproprietary domain.
We have taken certain information relevant to our study from various journals,
magazines and books which we have listed in the Reference section. We have used certain documents for our reference.
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Plagiarism Report -
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Acknowledgement
Behind every achievement lies an unfathomable sea of gratitude to those who have extendedtheir support and without whom it would ever have come into existence. To them I say mywords of gratitude.
Apart from our efforts, the successful completion of this project depends largely on theencouragement and guidelines of many others. We take this opportunity to express ourgratitude to the people who have been instrumental in the successful completion of thisproject.
We would like to show our greatest appreciation to our project guidesDr.Shveta Singh andMr.Ashish Srivastava. We cant say thank you enough for their tremendous support andhelp. Without their constant co-operation, encouragement and guidance this project wouldnot have materialized.
Also we would like to thank, Dr.Anurika Vaish (Divisional Head, MBA (IT) &MSCLIS)for providing the opportunity to take up this project and her valuable direction.
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Executive Summary
Risk can be broadly classified into two groups; business and financial. Business risk is
associated with the operating environment such as technological changes, marketing, etc.
Financial risk includes foreign exchange rates, interest rate, and commodity prices.
Foreign exchange risk arises as a result of uncertainty about the future spot exchange rate. It
is a result of uncertainty about the future spot exchange rate (due to the variability of
exchange rates), the domestic value of assets, liabilities, operating incomes, profit, rates of
return, and expected cash flows that are stated in foreign currency are uncertain. The report
explains the various hedging strategies employed by firms to manage their foreign exchange
risks. The uses of the following derivative instruments are explained:
Forwards
Futures
Options
Swaps
Foreign Debt
The report explains the hedging strategies that a firm should employ for managing foreign
exchange risk using Currency Options. The report explains the scenarios and their respective
hedging strategies. The scenarios are:
Bullish Conditions
Bearish Conditions
Volatile Conditions
Different periods are taken for analysis where historically the currency has shown the above
conditions and the analysis is done on the basis of the results.
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Table of Content-
1 Introduction.9
1.1Motivation..111.2Objective..11
1.3Problem Definition.11
1.4Kind of Foreign Exchange Exposure...11
1.5Factor affecting decision to hedge foreign currency risk....12
1.6Foreign exchange risk management framework...13
1.7Hedging strategy/Instruments...14
2 Literature Review/Related Work..16
3 Methodology...17
3.1Method......17
3.2Data Collection Sources...18
4 Selecting suitable strategy for managing Forex Risk...18
4.1Currency option strategies for Import transactions in Bullish Marketconditions.18
4.2Currency Option Strategies for Export Transactions in Bearish Market
Conditions....20
4.3Currency Option Strategy for Import Transaction in Volatile Market
Condition...21
5 Analysis and Result...24
5.1Bullish Market Condition255.2Bearish Market Conditions27
5.3Volatile Market Conditions29
5.4Comparisons of various hedging tools..30
6 Findings..34
7 Suggestions to SMEs..35
8 References...36
9 Appendixes..37
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List of Figures
1. Indian Rupee US $exchange rates in past 120days...10
2. Indian Rupee Euro exchange rates in past 120 days.10
3. Framework for Foreign Exchange Risk Management144. Long call option..25
5. Short put option..26
6. Combination of Long Call and Short Put Option...27
7. Long put..27
8. Short call option.27
9. Anticipation of spot rate movement.32
10.Spot comparison.33
11.Head to Head..3312.Hedging In Action..33
13.Future, Spot, Forwards.34
List of Tables
1. Futures Vs. Spot rates.30
2. Futures Vs. Forwards313. Comparing Futures, Forwards & Spot Rates31
Abbreviations & Symbols Used
1. USD$.US Dollar
2. INR.Rs..Indian National Rupees
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1. Introduction-
The Bretton Woods systems of administering the Foreign exchange rates were abolished in
favor of the market determination of the foreign exchange which was regarded as the regime
of the fluctuating exchange rates when it was introduced. Apart from that there was a lot ofvolatility is happening in the other markets around the world owing to increase inflation rates
and the oil price. The Corporate was struggling to cope with the uncertainty in profits, cash
flows and the future cost estimations. It was then that the financial derivatives such as foreign
currency, interest rates and commodity derivatives has emerges as the means of the managing
risk facing corporations.
In India, the exchange rates were de-regulated and were allowed to be determined by markets
in the year 1993. The economic liberalization measures of the early nineties facilitated the
introduction of derivatives based on the interest rates and foreign exchange. However
derivatives use is still a highly regulated area due to the main reason of high convertibility ofthe rupee. At present Forwards, SWAPS, and options are available in India and the use of the
foreign currency derivatives is permitted to a limited extent for the purpose of hedging only.
The project studies about the prospective on managing the risk that any firm faces due to
change in the fluctuation rates of the currency. The study investigates the prudence in
investing resources towards the main purpose of Hedging and then it introduces a concrete
tool for the purpose of risk management. These are applicable to the Indian scenario. The
motivation of this study came from the recent rise in the volatility in the money market of the
across the globe and specifically to the fluctuations in the price of US Dollar ,due to which
Indian exports were fast gaining a cost advantages. Hedging with the derivativesinstruments is a feasible solution to such a condition.
This project attempts to evaluate and observe the various alternatives and options which
would be available for the organizations for hedging the financial risks. By studying the use
of hedging instrument by major Indian firm across the various sectors, the paper concludes
that forward and options are preferred as short term hedging instruments whereas SWAPS
are preferred as long term hedging instruments. The frequent high usage of forward
contracts by Indian firms as in comparison to the other markets underscores the need for
rupee futures in India. Apart from that in addition to that the paper also looks at various ways
by which it is being accomplished. A review of the available literature results in thedevelopment of a frame work for the risk management process design and a compilation for
the determination of hedging decision of the firms. At the end this paper concludes by
pointing out that the onus is on the Reserve Bank of India (RBI), as the apex bank of the
India and its working group on rupee futures realizes the need for rupee futures in India and
the convertibility of the rupee.
1.1Motivation-
The key assumption in the concept of foreign exchange risk is that exchange rate changes are
not predictable and that this is determined by how efficient the markets for foreign exchangeare. Research in the area of efficiency of foreign exchange markets has thus far been able to
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establish only a weak form of the efficient market hypothesis conclusively which implies that
successive changes in exchange rates cannot be predicted by analyzing the historical
sequence of exchange rates. However, when the efficient markets theory is applied to the
foreign exchange market under floating exchange rates there is some evidence to suggest that
the present prices properly reflect all available information. This implies that exchange ratesreact to new information in an immediate and unbiased fashion, so that no one party can
make a profit by this information and in any case, information on direction of the rates arrives
randomly so exchange rates also fluctuate randomly. It implies that foreign exchange risk
management cannot be done away with by employing resources to predict exchange rate
changes.
The extremely volatile nature of the foreign exchange markets makes it imperative for the
firms dealing in Forex to take cautionary steps to avoid undesired consequences, which may
lead to shrinking profits. As the following graphs of US$ and Euro exchange rates against
Indian Rupee indicates how volatile the foreign exchange can be. Of late the volatility hasbeen constantly increasing due to global recession.
Indian Rupee US $exchange rates in past 120 days
Figure -1
Indian Rupee Euro exchange rates in past 120 days
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1.2Objective-
The objective of this project is to study the various hedging options available for exporters
and importers to hedge against volatile nature of foreign exchange in India and to find out the
effectiveness of hedging tools, Futures & Forwards, separately. Also try to do a comparison
of the prevailing practice of Forwards Contracts as hedging tool with the relatively new and
so far less tried Currency Futures.
1.3Problem Definition-
Over the past decades, statistics show that international trade has grown even more rapidly
than domestic economic activity in an endeavor to optimize the global allocation ofresources. The main problem deals with the exchange rates as the exchange rate between
currencies are volatile and these interests all bear currency risk. The consequence of
movements in foreign currency exchange rates can vary from receiving higher cash flows or
paying higher sums due to an appreciation of the currency of the transaction. Movements in
foreign exchange rates can also affect positively or negatively the value of a company. So the
consideration here is to find a suitable tool for foreign exchange hedging after comparing the
tools available for firms here in India.
1.4 Kinds of Foreign Exchange Exposure
Risk management techniques vary with the type of exposure (accounting or economic) and
term of exposure. Accounting exposure, also called translation exposure, results from the
need to restate foreign subsidiaries financial statements into the parents reporting currency
and is the sensitivity of net income to the variation in the exchange rate between a foreign
subsidiary and its parent. Economic exposure is the extent to which a firm's market value, in
any particular currency, is sensitive to unexpected changes in foreign currency. Currency
fluctuations affect the value of the firms operating cash flows, income statement, and
competitive position, hence market share and stock price. Currency fluctuations also affect a
firm's balance sheet by changing the value of the firm's assets and liabilities, accountspayable, accounts receivables, inventory, loans in foreign currency, investments (CDs) in
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foreign banks; this type of economic exposure is called balance sheet exposure. Transaction
Exposure is a form of short term economic exposure due to fixed price contracting in an
atmosphere of exchange-rate volatility. The most common definition of the measure of
exchange-rate exposure is the sensitivity of the value of the firm, proxied by the firms stock
return, to an unanticipated change in an exchange rate. This is calculated by using the partialderivative function where the dependent variable is the firms value and the independent
variable is the exchange rate (Adler and Dumas, 1984).
1.5Factors affecting the decision to hedge foreign currency risk-
Research in the area of determinants of hedging separates the decision of a firm to hedge
from that of how much to hedge. There is conclusive evidence to suggest that firms with
larger size, R&D Hedging Strategies against foreign exchange risk using Options expenditure
and exposure to exchange rates through foreign sales and foreign trade are more likely to use
derivatives. First, the following section describes the factors that affect the decision to hedgeand then the factors affecting the degree of hedging are considered.
Firm size:Firm size acts as a proxy for the cost of hedging or economies of scale. Riskmanagement involves fixed costs of setting up of computer systems and training/hiring of
personnel in foreign exchange management. Moreover, large firms might be considered as
more creditworthy counterparties for forward or swap transactions, thus further reducing their
cost of hedging. The book value of assets is used as a measure of firm size.
Leverage:According to the risk management literature, firms with high leverage have greater
incentive to engage in hedging because doing so reduces the probability, and thus theexpected cost of financial distress. Highly levered firms avoid foreign debt as a means to
hedge and use derivatives.
Liquidity and profitability: Firms with highly liquid assets or high profitability have less
incentive to engage in hedging because they are exposed to a lower probability of financial
distress. Liquidity is measured by the quick ratio, i.e. quick assets divided by current
liabilities). Profitability is measured as EBIT divided by book assets.
Sales growth: Sales growth is a factor determining decision to hedge as opportunities are
more likely to be affected by the underinvestment problem. For these firms, hedging willreduce the probability of having to rely on external financing, which is costly for information
asymmetry reasons, and thus enable them to enjoy uninterrupted high growth. The measure
of sales growth is obtained using the 3-year geometric average of yearly sales growth rates.
As regards the degree of hedging conclude that the sole determinants of the degree of
hedging are exposure factors (foreign sales and trade). In other words, given that a firm
decides to hedge, the decision of how much to hedge is affected solely by its exposure to
foreign currency movements. This discussion highlights how risk management systems have
to be altered according to characteristics of the firm, hedging costs, nature of operations, tax
considerations, regulatory requirements etc. The next section discusses these issues in theIndian context and regulatory environment.
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1.6 Foreign Exchange Risk Management Framework
Once a firm recognizes its exposure, it then has to deploy resources in managing it. A
heuristic for firms to manage this risk effectively is presented below which can be modified
to suit firm-specific needs i.e. some or all the following tools could be used.
Forecasts: After determining its exposure, the first step for a firm is to develop a forecast on
the market trends and what the main direction/trend is going to be on the foreign exchange
rates. The period for forecasts is typically6 months. It is important to base the forecasts on
valid assumptions. Along with identifying trends, a probability should be estimated for the
forecast coming true as well as how much the change would be.
Risk Estimation: Based on the forecast, a measure of theValue at Risk (the actual profit or
loss for a move in rates according to the forecast) and theprobability of this risk should be
ascertained. The risk that a transaction would fail due to market-specific problemsshould betaken into account. Finally, the Systems Risk that can arise due to inadequacies such as
reporting gaps and implementation gaps in the firms exposure management system should be
estimated.
Benchmarking: Given the exposures and the risk estimates, the firm has to set its limits for
handling foreign exchange exposure. The firm also has to decide whether to manage its
exposures on a cost centre or profit centre basis. A cost centre approach is a defensive one
and the main aim is ensure that cash flows of a firm are not adversely affected beyond a
point. A profit centre approach on the other hand is a more aggressive approach where the
firm decides to generate a net profit on its exposure over time.
Hedging: Based on the limits a firm set for itself to manage exposure, the firms then decides
an appropriate hedging strategy. There are various financial instruments available for the firm
to choose from: futures, forwards, options and swaps and issue of foreign debt. Hedging
strategies and instruments are explored in a section.
Stop Loss: The firms risk management decisions are based on forecasts which are but
estimates of reasonably unpredictable trends. It is imperative to have stop loss arrangements
in order to rescue the firm if the forecasts turn out wrong. For this, there should be certain
monitoring systems in place to detect critical levels in the foreign exchange rates forappropriate measure to be taken.
Reporting and Review: Risk management policies are typically subjected to review based
on periodic reporting. The reports mainly include profit/ loss status on open contracts after
marking to market, the actual exchange/ interest rate achieved on each exposure, and
profitability vis--vis the benchmark and the expected changes in overall exposure due to
forecasted exchange/ interest rate movements. The review analyses whether the benchmarks
set are valid.
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Figure 3-Foreign Exchange Risk Management Framework
1.7 Hedging Strategy/ Instruments-
A derivative is to treated as the financial contract whose value is derived from the value of
some other financial asset such as stock price, a commodity price, an exchange rate, an
interest rate, or even an index of prices. The main role of the derivatives is to reallocate risk
among financial market participants which helps to make financial markets more complete
and competent. This section highlights the hedging strategies for using derivatives with
foreign exchange as being considered the only risk assumed.
Forwards: Forwards are made-to-measure an agreement between the two parties to buy or to
sell a specified amount of a currency at a specified rate on a particular date in the future
purpose. The depreciation on received or receivable currencies hedged against by selling a
currency forward. If the risk of a currency appreciation (or the firm has to buy the currency in
future time say for import), it can hedge by buying the currency forward. E.g if (RIL)
Reliance India limited. wants to buy barrels of crude oil in US dollars for six months hence, it
can enter into a forward contract to pay INR and buy USD and lock in a fixed exchange rate
for INR-USD to be paid after 6 months regardless of the actual INR-Dollar rate at the time. In
this example the appreciation of Dollar which is protected by a fixed and forward contract.The main advantage of a forward contract is that, it can be tailored to the required needs of
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the firm and an exact hedging can be obtained. Besides these contracts are not marketable,
yet they cant be sold to another party when they are no longer required for binding.
Futures: Futures contracts and forward contracts are both similar but it is more liquid in
contracts because it is traded in an organized exchange that as the futures market. In
depreciating a currency can be hedged by selling the futures and appreciation can be hedged
by the buying futures. Advantages of future contracts in a central market are for futures
which eliminates the problem of double coincidence. Futures contracts require a less initial
outlay a proportion of the value of the future in which huge amounts of money can be gained
or lost with the accurate forward price fluctuations. It provides a sort of leverage in contracts.
The previous example for a forward contract for RIL applies here also just that RIL will have
to go to a USD futures exchange to purchase standardized dollar futures equal to the amount
to be hedged as the risk is that of appreciation of the dollar. As mentioned earlier that the
tailor ability of the futures contract is limited that as standard denominations of money can be
bought instead of the exact amounts that are bought in forward contracts.
Options: Currency Options are giving the right contract, not the obligation, to sell or buy a
specific quantity of one foreign currency in exchange for another at a fixed price called the
Exercise Price or Strike Price. The fixed nature of the price reduces the exchange rate
changes and limits the losses of open currency price positions. Options are well suited as a
hedging tool for contingent cash flows as is the case of bidding processes also. Call Options
are mostly used if the risk is an upstream trend in pricing of the currency, while Put Options
are used if the risk is a downstream trend. Once again taking the example of (RIL) which
needs to purchase crude oil in USD in 7 months, if (RIL) buys a Call option (as the risk is an
upward trend in dollar rate), i.e. the right time to purchase a specified amount of dollars at a
fixed rate on a specific date, there are two scenarios. If the exchange rate movement is
favorable i.e. the dollar depreciates, then RIL can buy them at the spot rate as they have
become cheaper. In some other case, if the dollar increases compared to todays spot rate,
RIL can exercise the option to buy it at the agreed strike price. In both case RIL would
benefits by paying the lower price to purchase the dollar.
Swaps: A swap is a foreign currency contract whereby the simultaneous purchase and sale of
identical amount of one currency for another with two different value dates is performed, at
the spot rate. The buyer and seller exchange both the fixed or floating rate interest paymentsin their respective currency swapping over the term of the contract. At the time of maturity
the principal amount is effectively re swapped at a predetermined exchange rate so, that the
parties end up with their original currencies. The benefits of swapping the firms with limited
appetite for exchange rate the risk may move to a partially or completely hedged position
through the mechanism of foreign currency swaps while leaving the underlying borrowing
intact. As a part of covering the exchange rate risks, swaps also allow firms to hedge the
floating rate of interest risk. Consider an export based company that has entered into a swap
for a national principal of USD $1 at an exchange rate of 42/dollar. The company pays US
6months LIBOR to the bank and receives 11.00% p.a. every 6 months on January 1st & July
1st, till five years. Such as a company would have profits in Dollars and can use the same to
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pay interest for this kind of borrowing (in dollars rather than in Rupee) thus hedging has
exposures.
Foreign Debt:The foreign debt can be used by taking advantage of the International Fischer
Effect relationship to hedge foreign exchange exposure. The example can be demonstrated as
an exporter who has to receive a fixed amount of US dollars in a few months from present.
The exporter stands to lose if the domestic currency appreciates against that currency in the
meanwhile so, to hedge this; he could take a loan in the foreign currency for the same time
period and convert the same into domestic currency at the current exchange rate. The theory
assures that the gain realized by investing the proceeds from the loan would match the
interest rate payment (in the foreign currency) for the loan.
2-Literature review/Related Work
There is a spectrum of opinions regarding foreign exchange hedging. Some firms feelhedging techniques are speculative or do not fall in their area of expertise and hence do not
venture into hedging practices. Other firms are unaware of being exposed to foreign exchange
risks. There are a set of firms who only hedge some of their risks, while others are aware of
the various risks they face, but are unaware of the methods to guard the firm against the risk.
There is yet another set of companies who believe shareholder value cannot be increased by
hedging the firms foreign exchange risks as shareholders can themselves individually hedge
themselves against the same using instruments like forward contracts available in the market
or diversify such risks out by manipulating their portfolio. (Giddy and Dufey, 1992).
The literature on the choice of hedging instruments is very scant. Among the availablestudies, Gczy et al. (1997) argues that currency swaps are more cost-effective for hedging
foreign debt risk, while forward contracts are more cost-effective for hedging foreign
operations risk. This is because foreign currency debt payments are long-term and
predictable, which fits the long-term nature of currency swap contracts. Foreign currency
revenues, on the other hand, are short-term and unpredictable, in line with the short-term
nature of forward contracts. A survey done by Marshall (2000) also points out that currency
swaps are better for hedging against translation risk, while forwards are better for hedging
against transaction risk. This study also provides anecdotal evidence that pricing policy is the
most popular means of hedging economic exposures. These results however can differ fordifferent currencies depending in the sensitivity of that currency to various market factors.
Regulation in the foreign exchange markets of various countries may also skew such results.
But when it comes to study in consideration of SMEs, not very much literature is available
yet.
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3. Methodology-
The objective of this paper is the comparative analysis of different hedging strategy available
for Indian SMEs. The research was analytical and descriptive in nature. Other attributes of
the research are as follows-
Sampling: Non Probability Sampling
Population: All the transactions Neetee Clothing was involved in after September 08
and settlement date being on or before May 09, involving foreign currency exchange.
Sample size:18 (the transactions in INR USD only; 13 export and 5 import; have
been taken as samples)
Period under study:9 months
Data- Secondary Data
3.1 Method-
The first step in the paper is to go through the various research papers available on the
different currency hedging strategies available for companies. The next step was identifying
the data which would be required for proceeding with the paper. The data that is needed for
the paper is primarily the currency rates between Rupee and Dollar. Next step down the line
was data collection. The paper involves the study of hedging strategies in the following three
scenarios regarding the Rupee v/s Dollar exchange rate:
Bullish Market Conditions
Volatile Market Conditions
Bearish Market Conditions
The daily exchange rates for INR/USD, INR/EURO were then collected from the RBI
website. Using the daily exchange rates the periods were identified where the exchange rate
experienced the above three conditions. For example, the Dollar was in bullish phase from
9th Jan, 2007 to 3rd March 2007 when the exchange rate rose by 7.9% from 48.18 to 51.97.The conditions were bearish in past 1 year where Dollar experienced decrease. Similarly, the
exchange rate experienced the greatest volatility between the period 1st March, 2007 to 23rd
December, 2008 where the Standard deviation was as high as 2.97. Based on the aforesaid
market conditions, the suitable hedging strategies were applied. The option premium was
calculated using the Black-Scholes Model. The data ordering involved various assumptions
because of unavailability of certain data. For example, the Strike Prices in certain cases were
taken to be the mean of the spot prices for the given period. For strategies that involved
hedging with more than one Option like Strangle or Butterfly Spread, the Strike prices were
assumed as mentioned in the data ordering part of the project. By applying the mentioned
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strategies in the above market conditions, the Net Cash flow for the importer and the exporter
were calculated. The results thus prove the suitability of the hedging strategies applied.
Next, Forward Rates practiced by Neetee during 1st of September 2008 and maturity date
being on or before May30th 2009, were taken and the foreign exchange risk covered by
Forwards were compared with a state if in same transaction Futures contract had been
practiced and analyzed how effective the hedging tool had been. The ultimate gain or loss of
each alternative, on spot rates, forward rates and futures rates, were compared and the best
one is find out for the Neetee in prevailing situations.
3.2 Data Collection Sources
1. Various internet sites and publications of authentic sources, like RBI, NSE and OTCEI.
2. Neetees internal data has been used to find out the Forwards rates it has used in the past 9
months while dealing in foreign currencies
Forward Contract Rates:
The Forward Rates of the transactions in USD that took place at Neetee Clothing after the
date when NSE introduced Currency Futures in the Derivatives market first time in India and
matured till May end 2009.During this period 6 such transactions took place.
USD INR Futures Rate:
The Futures Rate for the transactions took place was obtained from NSEs official website.
SPOT Rates:
Spot prices were collected from RBIs website.
4. Selecting Suitable Hedging Strategy for Managing Foreign Exchange Risk-
4.1 Currency option strategies for Import transactions in Bullish Market conditions
The foreign exchange market is said to be Bullish if the foreign currency concerned is
appreciating against the domestic currency. For example if the Dollar is appreciating against
the Rupee, then the market is said to be bullish.
In such bullish conditions, the importers who have imported goods on credit will have to pay
more than what they would have during the beginning of the period. To hedge against any
such risk arising due to the movement in the exchange rates, the following hedging strategies
using currency options are available for importers.
Period Chosen for Study:
The period chosen for the study in which the currency market was bullish or when Dollar
appreciated against the Rupee is from July 2008 to October 2008.
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4.1.1 Long Call
Call buying is a strategy used if the investor thinks that the underlying asset will advance in
price. It is important, given the risk that the hedgers have a clear idea about where the
exchange rate is going and when. For the most part, there are two types of Call buyers:
The bullish speculators wanting to take advantage of the leverage options can offer, and.
The investor buying a Call as a substitute for buying the stock.
Risk/Reward Characteristics
Break-even Point:
At expiration, the break-even point (B.E.) is equal to the strike price of the Call option plus
the Call option's premium. Before expiration, the break-even point is lower.
Profit:
Profits are unlimited as long as the underlying stock continues in advance.
Loss:
Losses are limited to the premium paid for the option.
At expiration, for every point XYZ is above the strike price, the Call option increases an
additional point in value.
Changes in implied Volatility: Changes in the option's implied volatility has an effect on the
"time value" portion of an option's premium. Thus, a change in the option's implied volatility
has the same effect as changing (+/-) the number of days remaining until the option's
expiration.
4.1.2 Short Put
The investor writing Put options should believe that the underlying asset is not going down.
The maximum profit is limited to the Put premium received and is achieved when the price of
the underlying is at or above the option's strike price at expiration. The maximum loss isunlimited.
Like uncovered Call writing uncovered Put writing has limited rewards (the premium
received) and potentially substantial risk.
Risk/Reward Characteristics
Break-even Point:
At expiration, the break-even point (B.E.) is equal to the strike price of the Put option minus
the Put option's premium. Before expiration, the break-even point is higher.
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Profit: Profits are limited no matter how large the advance in exchange rate.
Loss: Losses are unlimited.
Changes in implied Volatility:
Changes in the options implied volatility has an effect on the "time value" portion of an
option's premium. Thus, a change in the option's implied volatility has the same effect as
changing (+/-) the number of days remaining until the option's expiration.
4.2Currency Option Strategies for Export Transactions in Bearish Market Conditions
The foreign exchange market is said to be bearish when the foreign currency is expected to
depreciate with respect to the domestic currency. Thus, if the Rupee is expected to appreciate
and the Dollar is expected to depreciate, then Bearish conditions prevail. In such a case, the
importers are at a gain as they have to pay to the importer less than what they would havewhen the transaction took place. On the other hand, the exporters are at a loss as they have to
pay more to their creditor. Thus, in such a situation there arises a need for the exporter to
hedge their foreign exchange risks. The Option hedging strategies available to the exporter in
such bearish market are discussed below:
Period chosen for study-
The period chosen during which the currency market experienced bearish conditions is from
1st March, 2007 to 31st May, 2007. During this two month period, the Dollar depreciated by
7.7% from 44.287 to 40.87. The mean of the INR/USD spot rates during this period is 42.38
and standard deviation of the spot rates during the period is 1.39.
Purchase Put Option
Put buying is a strategy used if the investor thinks that underlying asset will decline. The
Speculative Put buyer looks for leverage, emphasizing the number of options he or she can
purchase. The "Hedger" Put buyer looks to protect a long position in the stock for a period of
time covered by the option.
Risk/Reward Characteristics
Break-even Point:
At expiration, the break-even point is equal to the strike price of the Put option minus the Put
option's premium. Before expiration, the break-even point is higher.
Profit: Profits are unlimited as long as the underlying stock continues to decline.
Loss: Losses are limited to the premium paid for the option.
Changes in implied Volatility:
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Changes in the option's implied volatility has an effect on the "time value" portion of an
option's premium. Thus, a change in the option's implied volatility has the same effect as
changing the number of days remaining until the option's expiration.
Sell Call Option
The investor writing Call options should firmly believe that the underlying asset is not going
up. This is because the strategy's break-even point at expiration is a certain distance above the
then current stock price. Thus, depending on the option's strike price, writing Call options can
be a viewed as a neutral to bearish strategy. Writing uncovered ("naked") Call options is a
strategy with very high risk for a small potential return.
Risk/Reward Characteristics
Break-even Point: At expiration, the break-even point (B.E.) is equal to the strike price of the
Call option plus the Call option's premium. Before expiration, the break-even point is lower.
Profit: Profits are limited no matter how large the decline in XY Z.
Loss: Losses are unlimited!!
Changes in implied Volatility: Changes in the option's implied volatility has an effect on the
"time value" portion of an option's premium.
4.3 Currency Option strategies for I mport transactions in Volatile Market conditions
It becomes extremely difficult for an importer/exporter when there is volatility in thecurrency movements. In such a scenario, hedging the foreign exchange risk becomes even
more significant as currency is expected to deviate more from its mean. Volatile exchange
rates make international trade and investment decisions more difficult because volatility
increases exchange rate risk. Exchange rate risk refers to the potential to lose money because
of a change in the exchange rate.
Period chosen for study:
The period chosen for study is from 1stJuly 2008 to 23rd December, 2008
The following are the hedging strategies available for importer in volatile market conditions:
Long Straddle
The long straddle is simply the simultaneous purchase of a long call and a long put on the
same underlying security with both options having the same expiration and same strike price.
Increasing volatility and large price swings in the underlying security. The hedgers
potentially profit from Hedging Strategies against foreign exchange risk using Options a big
move, either up or down, in the underlying price during the life of the options. Purchasing
only long calls or only long puts is primarily a directional strategy. The long straddle
however, consisting of both long calls and long puts is not a directional strategy, rather it isone where the hedger feels large price swings are forthcoming but is unsure of the direction.
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This strategy may prove beneficial when the investor feels large price movement, either up or
down, is imminent but is uncertain of the direction.
Benefit A long straddle benefits when the price of the underlying moves above or below the
break even points. If a large price movement occurs outside of this range, significant profits
can be realized. If an increase in the implied volatility of the options outpaces time value
erosion, likewise the position could realize a profit.
Risk vs. Reward
Maximum Profit:
Theoretically unlimited to the upside; limited profits on the down side as the stock can only
decline to zero.
Maximum Loss:Limited and predetermined, but potentially significant, equal to the sum of the two premiums
paid (call premium plus put premium). Maximum loss occurs should the underlying price
equal the strike price of the options at expiration.
Upside Profit at Expiration:
(Stock Price at expiration total premium paid) strike price.
Assuming Stock Price above BEP at expiration.
Downside Profit at Expiration:
Strike price - (Stock price at expiration +total premium paid).
Assuming stock price is below BEP at expiration.
The maximum profit on the upside is theoretically unlimited as there is no theoretical limit
on how high a stock price can rise. The maximum downside profit is limited by the stock's
potential decrease to no less than zero. Though the potential loss is predetermined and limited
in dollar amount, it can be as much as 100% of the premiums initially paid for the straddle.
Whatever your motivation for purchasing the straddle is, weigh the potential reward againstthe potential loss of the entire premium paid.
Break-Even-Point (BEP)
BEP: Two break-even prices:
Call Strike +Premium Paid
Put Strike Premium Paid
Volatility
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If Volatility Increases: Positive Effect
If Volatility Decreases: Negative Effect
Long Strangle
The long strangle is simply the simultaneous purchase of a long call and a long put on the
same underlying security with both options having the same expiration but where the put
strike price is lower than the call strike price. Because the position includes both a long call
and a long put, the investor using a long strangle should have a complete understanding of the
risks and rewards associated with both long calls and long puts. Since the strangle involves
two trades, a commission charge is likely for the purchase (and any subsequent sale) of each
position; one commission for the call and one commission for the put and commission
charges may significantly impact the breakeven and the potential profit/loss of the strategy.
The long strangle is similar to the long straddle. However, while the straddle uses the same
strike price for the call and the put, the strangle uses different strikes. In the case of the
strangle, the put strike is below the call strike. As a result, whereas the straddle expires
worthless only if the stock price equals the strike price, the long strangle expires worthless if
the underlying price is at or between the strike prices at expiration. The strangle will
generally provide more leverage when compared to a straddle as it is normally less expensive
to purchase a strangle than a straddle. Increasing volatility and extremely large price swings
in the underlying security. The hedgers potentially profit from a large move, either up or
down, in the underlying price during the life of the options. Purchasing only long calls or
only long puts is primarily a directional strategy. The long strangle however, consisting of
both long calls and long puts is a not a directional strategy, rather one where the investor feelsextremely large price swings are forthcoming but is unsure of the direction. This strategy may
prove beneficial when the investor feels large price movement, either up or down, is about to
happen but uncertain of the direction.
Break-Even-Point (BEP)
BEP: Two break-even prices:
Call Strike +Premium Paid
Put Strike Premium Paid
Volatility
If Volatility Increases: Positive Effect
If Volatility Decreases: Negative Effect
Short Butterfly Spread
Long two ATM put options, short one ITM put option and short one OTM put option.
Risk / Reward
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Maximum Loss: Limited to the net difference between the ATM strike less the ITM strike
less the premium received for the position.
Maximum Gain: Limited to the net premium received for the option spread.
Characteristics
When to use: When you are bullish or bearish on market direction and bullish on volatility,
Short put butterflies have the same characteristics as the Short Call Butterfly - the only
difference is that we use put options instead of call options. Short butterflies are an excellent
strategy if you expect the market to move, however, you are unsure about what direction the
market will move. For example, say there is an announcement due regarding earnings or a
Government figure to be released. You might be nervous about market activity and expecting
a large move in either direction. In these types of situations you might want to consider
implementing a short butterfly strategy - even though your profits are limited they are
inexpensive to establish therefore giving you a higher return on investment.
Short Condor Options
A Condor strategy is similar to a butterfly spread involving 4 options of the same type, with
the only difference that instead of three, four strike prices are involved. Just like a short
butterfly, Short Condors are used when an investor believes that the underlying market will
break out of a trading range but are not sure in what direction.
Risk/Reward Characteristics
Profit Potential of Short Condor Spread :Short Condor Spreads achieve their maximum profit
potential at expiration if the price of the underlying asset is within the 2 middle strike prices.
Maximum loss: Limited. The maximum loss of a short condor occurs at the center of the
option spread. I f youve broken the Condor down as 2 call (put) spreads, take the one that has
the maximum distance between the strike prices, add the net premium received for the spread
and that is the max loss.
Maximum gain: Limited. The maximum profit of a short condor occurs on the wings, when
the underlying asset is trading past the upper or lower strike prices. It is the maximum of the
difference between the lower strike call spread less the higher call spread plus the total
premium received for the condor.
Risk / Reward of Short Condor Spread
Upside Maximum Profit: Limited
Maximum Loss: Limited.
Break Even Points of Short Condor Spread:
A Short Condor Spread is profitable if the underlying asset expires outside of the price rangebounded by the upper and lower breakeven points.
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Lower Breakeven Point: Credit +Lower Strike Price
Upper Breakeven Point: Higher Strike Price Credit.
5. Analysis and Result-
5.1 Bullish Market Conditions
Long Call Option
The Strike Price for the call option is assumed to be 43.5 and the premium paid is Rs.0.2.
Thus, the graph shows that till the Spot Price is 43.5, the Net Cash Outflow for the hedger
would be Rs.0.2. The Payoff starts increasing at the strike price where the hedger starts
exercising his option. Hedger breaks even at the Strike Price plus Premium. The graph shows
that when the market is bullish, the hedger will make profits from the strategy which will
keep increasing with the bullishness of the market.
Short Put Option
The Strike price and the premium are again assumed to be 45.5 and Rs. 0.2 respectively. The
party which has bought the put option from the hedger will exercise the option till the Spot
Price is equal to the Strike Price. Once the Strike crosses the Spot, the party wont exercise its
put option. The Loss for the hedger will keep on increasing as the Spot keeps decreasing. But
as we expect the market to be bullish, the hedger will make a constant profit equal to
premium as the Spot crosses the Strike.
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Combination of Long Call and Short Put Option
Suppose an importer purchases USD call option from a bank at a strike rate of 45.50, & sells
USD Put option at a strike rate of 45.50. The premium paid on purchasing call option is 30
paisa and received on selling Put option is 20 paisa. Gain or losses at various levels of
exchange rate are shown through the graph. This strategy is aggressive strategy, suited for
situations when the Market is appreciating. The gains will be substantial and will keep rising
as the Dollar appreciates with respect to Rupee.
5.2 Bearish Market Conditions
Long Put
The Strike Price is assumed to be the mean of the spot prices in the period under
consideration. It is 50.5. The Option Premium is calculated using the Black-Scholes Model
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and it comes out to be Rs. .95 for the Put Option. Based on the above data, we generate the
shown graph for the Long Put.
Payoff which shows that as the market is bearish, the hedger makes increasing profits. Thus
the said strategy is appropriate when the market is expected be bearish. If the market is
bullish, the hedger will not exercise the Put Option and thus, make a constant loss equal to
the premium paid for the Put option i.e. Rs. 0.95.
Short Call Option
The Strike Price for the put option is assumed to be 40.5, which is the mean of the spot prices
for the specified period. The Call Option Premium is calculated using the Black-Scholes
model and is equal to Rs. 3.5. The hedger makes a constant profit equal to the premium of Rs.
3.5 till the Strike Price is equal to the Spot Price. The Losses are unlimited but are expected
only if the market is bullish. Thus, for bearish market, the hedger will make constant profits
as the buyer of put option wont exercise his option until the Spot Price is greater than or equal
to the Strike Price.
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Combination of Long Put and Short Call
A combination of Long Put and Short Call will give a linear return to the hedger, the profit of
which is inversely proportional to the Spot Price. As shown by the graph, as the Spot
increases the loss increases to infinity and as the Spot decreases the profit increases up to
Strike less Spot less Premium. Thus for a bearish market, this strategy is expected to yield
positive returns As the Spot becomes greater than the Strike, the yield will be negative, which
is least expected in a bearish market.
5.3 Volatile Market Conditions
Long Straddle
The Strike price is assumed to be the mean of the spot prices in the specified period that is
42.11. The Premium for Call option and Put Option are Assumed to be Rs. 0.5 and Re. 1
respectively. Since the hedger goes long on the Call as well as Put option, the initial
investment for the hedger is Rs. 1.5. The Payoff is a V-shaped graph indicating that as the
Spot approaches the mean, the return is the least for the investor. However, if the Spot varies
largely from the mean, the returns are large. Thus, this strategy is best when the volatility in
Exchange rates is high. If the hedger knows that the underlying is volatile, then he can benefit
from this strategy. Profit potential is unlimited in the bullish market conditions and it is
limited in the bearish market conditions.
Long Strangle
The call option strike price is assumed to be 45 and the premium on the call option is
assumed to be Re. 1. On the other hand, the Put Option Strike Price and premium are
assumed to be Rs. 42.11 and Rs. 0.5 respectively. Since the hedger goes long on the call and
the put options the initial investment for the hedger is Rs. 1.5. Within the range of the two
strike prices of the call and the put options, which is 42.11 to 45, the hedger is expected to
incur losses. However, outside this range, the losses start mitigating and ultimately turn to
profits. The profit potential is unlimited on the bullish side and is limited on the bearish side.
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Thus, the hedger can apply this strategy when the foreign currency is expected to be volatile,
thus making profit if it sways to either side.
Short Butterfly Spread
The two Short Call Options A and C are assumed to have extreme strike prices at 42 and 44with premium received on them assumed as Rs. 0.3 and Rs. 0.5 respectively. On the other
hand the Call Option B on which long position is held is assumed to have Strike Price of 43
and premium paid on them as 0.33. The ratio of Call Option A, B and C is 1:2:1.
We see that as the profit is constantly equal to the initial cash inflow from the net premium
received. But as the spot price becomes equal to the strike price of the Short Call Option A
that is 42, the profit starts declining till it reaches the Strike Price of Long Call Option B. At
this price, the hedger exercises his call option and starts mitigating the losses that he has
incurred. The profit potential is unlimited once the spot becomes greater than the Strike price
of the Call Option C. Thus, the strategy produces modest profits if there is volatility in the
movement of the underlying.
Short Condor Spread
This strategy is similar to Short Butterfly, involving four call option but with the difference
that instead of three, it has four strike prices. The strike price of the two extreme long Call
Options A and D are 40 and 45 and the premium received on them being Rs. 0.3 and Rs. 0.7
respectively. On the other hand, the Strike Price of Long Call options, B and C are Rs. 42 and
Rs. 43 with premium paid on them being Rs. 0.33 and Rs. 0.4 respectively. The Call Options
A, B, C and D are in the ratio 1:1:1:1. The Condor Spread yields limited losses and limited
profits. The Profit remains constant at the net premium received on the four options. It starts
declining when the spot price becomes greater than Strike Price of A. The maximum loss is
incurred when the Spot Price lies in the range between the Strike Prices of B and C after
which the loss starts to mitigate. The profit again becomes constant at
The initial net premium received as the Spot Price becomes greater than the Strike Price of D.
Thus we see that when the underlying that is Dollar is volatile, the Short Condor strategy
yields modest but positive returns.
5.4 Comparisons of various hedging tools-
The transactions in Neetee that took place within the period of start at NSE and maturity till
July have been taken for comparison with the forward agreements practiced by Neetee in this
period. The spot rate movements, Forwards ultimate yield have been compared with Futures
rates and tried to reach out to a conclusion if Futures promised to be better hedging tool as
compared with spot and forwards market.
(a)Futures Vs Spot rates
Here spot rate movement is compared with futures rates for corresponding periods.
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Date FOTWA
RDS
RATE
SPOT
at
the
contr
act
date
SPOT
RATE
at
settle
ment
date
Durat
ion
transact
ionn
Gain/l
oss
on
Forwa
rds
Gain/
Loss
on
SPOT
SPOT
Gain/
Loss
FUTU
RES
Gain/
Loss
FUTU
REs
Final
Impa
ct
26/09/
2008
48.132
5
46.61
97
51.886
7
6mnt
hs
export 1.512
8
5.267 5.267 -
3.537
5
1.729
5
11-02-
2008
49.873
8
50.71
56
49.73 3mnt
hs
export -
0.841
8
-
0.965
6
-
0.965
6
0.6 -
0.365
6
18/12/
2008
49.58 48.23
93
51.546
4
3mnt
hs
export 1.340
7
3.307
1
3.307
1
-
3.102
5
0.205
6
25/02/
2009
50.765 50.16
71
47.625 3mnt
hs
export 0.597
9
-
2.4921
-
2.4921
2.51 0.179
15/01/
2009
49.784
2
49.97
17
50.126
7
3mnt
hs
export -
0.342
5
0.155 0.155 -0.24 -
0.085
12-10-
2008
50.352
8
50.78
78
48.974 2mon
ths
export -0.435 -
1.813
8
-
1.813
8
1.665 -
0.148
8
19/03/
2009
51.525 52.49
97
50.61 1mon
th
import 0.974
7
1.889
7
1.889
7
-
0.722
5
1.167
2
22/01/
2009
51.547
5
49.93
15
52.195 2mon
ths
import -1.616 -
2.263
5
-
2.263
5
1.992
5
-
0.271
28/09/
2009
48.165 47.09
5
53.732
2
1mon
th
export 1.07 6.637
2
6.637
2
-3.88 2.757
2
Table-1
(b) Futures Vs Forwards
Dat
e
Tran
sacti
onn
du
rat
ion
SPOT at
the
contract
date
Futur
es 1
Futures
Settlem
ent Date
SPOT
RATE at
settlemen
t date
Future
s 2
SPOT
Gain/
Loss
FUTU
RES
Gain/
Loss
FUTUR
Es
Final
Impact
26/
09/
200
8
Expo
rt
6m
nt
hs
46.6197 47.00
25
26-Mar 51.8867 50.54 5.267 -
3.537
5
1.7295
11-
02-
200
8
Expo
rt
3m
nt
hs
50.7156 49.82 25-Feb 49.73 49.22 -
0.965
6
0.6 -
0.3656
18/
12/
200
Expo
rt
3m
nt
hs
48.2393 47.43
75
27-Mar 51.5464 50.54 3.307
1
-
3.102
5
0.2056
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8
25/
02/
200
9
Expo
rt
3m
nt
hs
50.1671 50.18 27-May 47.625 47.67 -
2.492
1
2.51 0.179
15/
01/
200
9
Expo
rt
3m
nt
hs
49.9717 49.74 28-Apr 50.1267 49.98 0.155 -0.24 -0.085
12-
10-
200
8
Expo
rt
2m
on
ths
50.7878 49.45
5
25-Feb 48.974 47.79 -
1.813
8
1.665 -
0.1488
19/
03/
200
9
Impo
rt
1m
on
th
52.4997 50.70
25
28-Apr 50.61 49.98 1.889
7
-
0.722
5
1.1672
22/
01/
200
9
Impo
rt
2m
on
ths
49.9315 48.54
75
27-Mar 52.195 50.54 -
2.263
5
1.992
5
-0.271
26/
09/
200
9
Expo
rt
1m
on
th
47.095 46.21 27-Oct 53.7322 50.09 6.637
2
-3.88 2.7572
Table-2
Comparing Futures, Forwards & Spot Rates-
Date FOTW
ARDS
RATE
SPOT at
the
contract
date
SPOT
RATE at
settleme
nt date
dur
atio
n
tra
nsa
ctio
n
Gain/l
oss on
Forwa
rds
Gain/Lo
ss on
SPOT
SPOT
Gain/
Loss
FUTURE
S
Gain/Lo
ss
FUTUR
Es Final
Impact
26/0
9/20
08
48.132
5
46.6197 51.8867 6m
nth
s
exp
ort
1.512
8
5.267 5.267 -3.5375 1.7295
11-
02-
2008
49.873
8
50.7156 49.73 3m
nth
s
exp
ort
-
0.841
8
-0.9656 -
0.965
6
0.6 -0.3656
18/1
2/20
08
49.58 48.2393 51.5464 3m
nth
s
exp
ort
1.340
7
3.3071 3.307
1
-3.1025 0.2056
25/0
2/20
09
50.765 50.1671 47.625 3m
nth
s
exp
ort
0.597
9
-2.4921 -
2.492
1
2.51 0.179
15/0
1/20
49.784
2
49.9717 50.1267 3m
nth
exp
ort
-
0.342
0.155 0.155 -0.24 -0.085
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09 s 5
12-
10-
2008
50.352
8
50.7878 48.974 2m
ont
hs
exp
ort
-0.435 -1.8138 -
1.813
8
1.665 -0.1488
19/0
3/20
09
51.525 52.4997 50.61 1m
ont
h
imp
ort
0.974
7
1.8897 1.889
7
-0.7225 1.1672
22/0
1/20
09
51.547
5
49.9315 52.195 2m
ont
hs
imp
ort
-1.616 -2.2635 -
2.263
5
1.9925 -0.271
28/0
9/20
09
48.165 47.095 53.7322 1m
ont
h
exp
ort
1.07 6.6372 6.637
2
-3.88 2.7572
(all rates in
INR/USD)
Table-3
Figure-9
Out of some 18 samples, 67% of the time the anticipation regarding prices movements
proved to be wrong, emphasizing the need to hedge against currency movement in opposite
direction.
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Figure 10- Spot comparison
Figure 11- Head to Head
Out of sample of 18, 78% times futures have yielded a better cover for Neetees transactions.
Figure 12- Hedging in Action
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Figure 13- Future, Spot, Forwards
Among all 3 futures being the best hedging instrument, faring better to others in minimizing
risk. Even in most unfavorable conditions too it has reduced the potential risk. Only once the
extremely volatile nature of INR- USD exchange rates resulted in Spot resulting in a potential
profit.
6- Findings
The company can hedge itself from foreign exchange risk by either of the
instruments; forwards, futures, options, swaps.
In Indian context, forwards and options are preferred as short term hedging
instruments while swaps are preferred as long term hedging instruments.
In a Bearish Market Conditions importers are at a gain as they have to pay to the
exporter less than what they would have when the transaction took place. On the other
hand, the exporters are at a loss as they have to pay more to their creditor. Hedging
strategies available to the exporter in such bearish market are Purchase Put Option or
Sell Call Option.
In a Bullish condition, the importers who have imported goods on credit will have to
pay more than what they would have during the beginning of the period. To hedge
against any such risk arising due to the movement in the exchange rates, the following
hedging strategies using currency options are available for importer - Long Call &
Short Put.
In volatile condition the currency movements hedging the foreign exchange risk
becomes even more significant as currency is expected to deviate more from its mean.
The options available in such volatile situation are-Long Straddle, Long Strangle,
Short Butterfly & Spread Short Condor Options.
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7-Suggestions to SMEs
To hedge in Forex market, especially when dealing in USD, SME should opt for
Futures contracts in organized market as futures provide a better cover for the
exchange risk.
Personnel well equipped with nuances of currency derivatives market should be hired
so that SME can obtain maximum gain from hedging, and covering maximum
possible loss.
As futures are available in certain denominations only the maximum possible amount
can be hedged by Futures and rest by Forwards.
SMEs can continue with Forwards while dealing in currencies other than USD, likeEURO, YEN etc.
As the amount payable/receivable at SMEs are of relatively smaller in size and also
the settlement period is less than a year ,swaps and options are not recommended in
their case. Though in future when suited options and swaps may be practiced.
Exchange traded currency derivatives provide a better transparency. And recently
currency trading in India has also started. So it is prudent to go for this.
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Hedging Instruments against Foreign Exchange Risk Page 36
8-References
[1]Corporate Hedging for Foreign Exchange Risk in India- Anuradha Sivakumar and
Runa Sarkar, Industrial and Management Engineering Department, Indian Institute of
Technology, Kanpur
[2]Hedging Foreign exchange risk: Selecting the optimal tool- Sarkis J. Khoury, K Hung
Chan
[3]http://www.francoazzopardi.com/research/exchange-rates-and-hedging-
instruments.pdf
[4]http://www.rbi.org.in
[5]http://texmin.nic.in/
[6] http://www.fedai.org.in/index.asp
[7]http://www.thehindu.com/biz/2007/05/14/stories/2007051400671500.ht
m
[8] Hedging instruments in emerging market economies, By:Sweta Saxena and
Agustn Villar :http://www.bis.org/publ/bppdf/bispap44d.pdf
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Hedging Instruments against Foreign Exchange Risk Page 37
9-Appendixes
9.1Letter of Approval from Amazines.com
From [email protected]
Date: Sat, May 8, 2010 at 2:18 AM
Subject :YOUR ARTICLE SUBMISSION - Amazines.com
Dear AJAY PAL SINGH,
Thank you for submitting your article titled 'Hedging Instruments against Foreign Exchange Risk' to
Amazines.com. Your article has been approved. You should be able to find your article on our
website within its assigned categories.
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9.2 Letter of Approval from Articlebase.com
from ArticlesBase.com
To : [email protected]
Date: Tue, May 4, 2010 at 5:45 AM
Subject Your article has been accepted at Articles Base
mailed-by home6.articlesbase.com
Hello AJAY PAL SINGH,
Your article Hedging Instruments against Foreign Exchange Risk has been
approved! (ArticlesBase SC #2286678)
To view it, please review the following link:
http://www.articlesbase.com/currency-trading-articles/hedging-instruments-against-foreign-
exchange-risk-2286678.html
Best regards,
The ArticlesBase Team
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