Forex Markets

Forex Hedging and Risk Management

2018 was a volatile year, events like trade war, elections, oil price and rising current account deficit, US Fed rate hikes, emerging market turmoil, and capital outflow kept INR volatile and 2019 is also expected to be similar, if not more unpredictable. In such a scenario disciplined hedging with a bit of dynamism helps in protecting risks and also save/benefit from hedge cost better than a full hedge or a no hedge.

Companies with both exports and imports have an important decision to make – whether to manage them separately or net them off. Each choice comes with its advantages and disadvantages.

Generally, full hedge (including the forward premium) works well for exporters except for the time when markets are highly volatile. The art of export hedging lies in identifying periods of those sharp depreciation and manage the hedge ratio accordingly. Companies can work on defining a high numerical objective for the realization rate for the year and work towards achieving it rather than being ad hoc about it.

For imports, the hedge cost is around 4%, but it can be brought down to approximately 2%  using dynamic strategies. Importing hedging is even more crucial in times like current year where the potential depreciation of INR can be significant.

Dynamism can be in FX management by using options as they automatically incorporate lower hedge ratio in adverse times. Exports can be hedged by using low-cost put options or put spreads. Import hedging can be done by using structures like seagull which are low-cost alternatives to plain calls.

Effective FX management requires a well-defined risk management policy framework. Foreign Exchange Risks should be effectively identified, assessed, monitored and managed consistent with the overall objectives of the company and in compliance with the legal requirements and regulations of the Reserve Bank of India. For this purpose to be achieved, numerical targets and appropriate MIS are required along with a disciplined hedge strategy.


By QuantArt 

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