Forex Markets

Importers Dilemma – to hedge or not

 

  1. For Forex risk management, Indian importers can think of two basic choices –
    1. Hedge exposures – using forwards and/or options, full hedge or partial hedge
    2. No hedge – (Keep exposures open)
  2. Choice 1 – Hedge Exposures
    1. Hedge can be done on day one using forwards which would cost approximately 4%. However, by paying this much amount you have locked in the price for your future payments. Using forwards would have been one of the preferred options to go for in a year like 2018 wherein INR depreciated more than 15%
    2. Also, if the 4% cost of forwards is too high for a corporate to bear then by using options optimally this cost can be reduced. Few effective cost reduction structures like a seagull, call spreads can be used to optimize the cost and benefit of hedging.
    3. One of the important aspects of hedging exposures is, you are insuring the risk which could have been occurred with depreciation in INR
    4. Some corporate may look hedging from a gain/loss perspective. But for Indian importers, it is always better to treat the hedging from risk management perspective with a target to save the hedge cost reasonably and consistently.
    5. In a long-term horizon, 2% consistent saving can be achieved from the full hedge scenario conservatively.
  3. Option 2 – No hedge
    1. Sometimes, corporate might think it is better to keep exposures open without bearing any cost of hedging
    2. However, by not hedging you are exposed to unlimited risk on the exposures. The difference between a no-hedge and a full hedge can be thought of as a binary switch each day – hedge cost for the day versus spot movement during the day. This view helps in dynamic strategies alternating between no hedge and full hedge.
    3. Keeping exposures open would have cost a corporate very badly in a volatile year like 2018. There are periods where no hedge would be the best strategy while some years would result in severe losses
  4. It is always better to insure the risk exposed to exchange rates. It should be the first and foremost principle while managing foreign currency exposures. Now, how much cost to pay to hedge the exposures is a secondary step and which can be minimized by effective hedge strategies with permutation and combination of hedge instruments, time, hedge ratio and discipline.

 

By QuantArt 

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