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Hedging

 
Amid volatile exchange rates, corporates are now rushing to `hedge' their po sitions to avoid potential losses from such movements

1. What is hedging?

Hedging is a kind of transaction that protects a business or a trader from a particular posi tion in the markets ­ be it stocks, currency , com modities, or bonds. It is essentially a trade that is opposite of the basic position that is created in the normal course of business.

2. Why hedge currency position now?

Many corporates have borrowed in US dollars which they have to repay. When the rupee was appreciating, the amount of rupees they have to spend to buy USD was falling. Now that rupee is falling, the USD payments will rise vis-à-vis rupee. So they are hedging.

3. Why did companies not hedge in the past?

Normally , every borrowing corporate is supposed to hedge for its foreign currency exposure.But hedging comes with a cost which companies try to save by not doing it fully, especially when the rupee is fairly stable. This may turn counter-productive if the currency turns volatile on a sustained basis.

Now, it is turning volatile as it trades near its all-time low at 68.85 a dollar, hit during August, 2013. This has spooked companies, which think, the local unit will weaken further increasing their overseas repayment liabilities.

4. What are the tools for hedging?

Currency derivatives like the exchange traded futures, over the-counter forwards contract in both onshore and offshore markets.Moreover, `call' and `put' options are also some kind of derivative tool where you just need to pay only premium. Its cost is less than a futures transaction.All derivative tools give you the opportunity to book exchange rates that is expected next few months or a year.

5. Which tool is popular?

Forward contracts maturing in one to four months are favoured given that trade transactions of underlying goods are settled during that time period. There are contracts upto one year.

6. Why not futures?

Exchange traded futures mar ket is illiquid due to a set of rea sons, which the Reserve Bank of India (RBI) along with the capital market regulator are trying to address step by step.

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