Hedging Instruments Against Foreign Exchange Riskfinal Report1213

7/28/2019 Hedging Instruments Against Foreign Exchange Riskfinal Report1213

1/38

Hedging Instruments against Foreign Exchange Risk Page 1

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


2/38


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]


3/38


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.


4/38


Plagiarism Report -


5/38


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.


6/38


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.


7/38


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


8/38


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


9/38


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


10/38


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


11/38


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


12/38


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.


13/38


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.


14/38


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


15/38


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


16/38


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.


17/38


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


18/38


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.


19/38


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.


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.


20/38


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.


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:


21/38


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.


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.


22/38


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


23/38


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


24/38


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.


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.


25/38


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.


26/38


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


27/38


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.


28/38


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.


29/38


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.


30/38


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


31/38


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


32/38


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.


33/38


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


34/38


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.


35/38


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.


36/38


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


37/38


9-Appendixes

9.1Letter of Approval from Amazines.com

From [email protected]

To: [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.

https://www.amazines.com/view_article.cfm?CID=D%3C\K%276%3F[M_N_%3EJ-

L%3B%40S%3FO6%25%2F!PH%3FL%2B%3ACT5-

W5U%3E%27C%3A%203%2C]E%3E%2B%0A&articleid=1609053

We also encourage you to complete your author profile if you haven't already done so. Ourreaders enjoy knowing about the person behind the articles that they read. Plus it gives you

the chance to let them know what you are all about!

You can edit your articles by clicking on the "Add Article!" link on our homepage or logging

in through the right login form.

Did you know? You can get an abstract of every article posted to our site in your categories

by subscribing to email articles. This helps you see what other authors are posting and can

give you fresh ideas.

Just click here: Subscribe to Articles

Thank you again!

http://www.amazines.com


38/38

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

Join us on Facebook www.facebook.com/articlesbase

Follow us on Twitter www.twitter.com/articlesbase

Check out or Blog http://blog.articlesbase.com/

www.articlesbase.com

[email protected]

Make your voice heard by visiting our new feedback forum -

http://feedback.articlesbase.com/

Hedging Instruments Against Foreign Exchange Riskfinal Report1213

Documents

Transcript of Hedging Instruments Against Foreign Exchange Riskfinal Report1213