How Importers can Manage Currency Risk

Any individual or business that deals with foreign currency is exposed to forex risk. An importer or a foreign borrower has payables in foreign currency. An importer or a foreign currency borrower will have to hedge his business against a weakening of the rupee (Rate of Dollar Rupee going up)

An importer will have a dollar payable at a future date. Therefore, they need to ensure that the Dollar INR rate does not go up  too much as it will mean that they will require more rupees to get the equivalent amount of dollars.

Usually, Importer needs to make payment in 3-4 months. But during that month USD/INR can go up or down which is unpredictable so it can hedge their risk by buying the USD-INR. No one knows about the future so ,it is better to hedge (Like when you buy car you take car insurance before even thinking of future loss)

M/s Anuj Timbers imports wood from Africa and supplies to Indian Companies for Making Furniture. He has got an order to import teakwood. He enquires from his supplier and finds that the cost of wood is total $ 1,000,000. His Payment terms are payment on receiving shipment which is normally 1 month.

Current Spot rate is 84.40 and 1 Month Forward is at 84.50, He assumes a cost of Rs.84.70 per dollar as his cost and quotes a rate of same keeping a profit margin of 20 paise The Risk he carries is if Dollar rupee goes above 84.70 in 1 month then his profit will start incuring a loss in his deal. 

Using Forward Contract

He buys USD 1 Million Dollar in forward date at 83.50 and locks a profit of 20 paise

Using Currency Futures

Amount USD 1,000,000 1 lot = $ 1,000 No of lots = 1,000

He Buys 1,000 lots of one month Expiry at 83.50 thus locking a profit of 0.20 paise in this deal

As we can see that by hedging, the company is able to protect the 20 paise profit in the trade. We recommend importers having import exposures to use Bank Forwards / future contract for Managing Risk More efficiently.