Importance of the Hedging of the Forex Exposure

Hedging of the Forex Exposure, both actual and anticipated, is something that any company cannot neglect if they are into the business of Export and Import of anything. It is mandatory even for those companies which have only domestic operations in terms of the Sales and purchases but the prices of the commodity in which they deal gets derived from the International Prices. For example, a company manufacturing the Gold Jewelleries still has the Forex as well as the Commodity Price Risks even if the entire sales and purchases are done domestically. IT DOES NOT remain a matter of choice for them to come to the Forex/Commodity markets. If the RISK MANAGEMENT is not undertaken there may be a situation in which they can lose all that they have earned in their businesses otherwise. Even if a company has both Exports and Imports in its books it still needs to hedge the VOLUME and the MATURITY MISMATCHES.

Volume Mismatch is basically the difference between the overall volume of the Exports and the Imports separately (can look at the overall Forex assets and the Liabilities also to get the complete picture) and the company needs to take care of the difference between the two figures (Say, Exports of $ 100 mio and Imports of $ 50 Mio, resulting in the net exposure of $ 50 mio) whereas the Maturity Mismatch occurs if the company has the Export Payments coming on one day and the Import Payments are sent on some other day even if they are for the same quantum of Dollars. There could be very different rates on these two days which poses the risk of the losses, though the company may gain also if the rates turn out favourable. But can it be left to the mercy of the markets?

Hedging means?strategically using financial instruments (FORWARDS/FUTURES/ OPTIONS AND THE OTHER DERIVATIVE PRODUCTS) or some market strategies to offset the risk of any adverse price movements. What happens after Hedging is that the Companies make money either in their ACTUAL EXPOSURES or in the Financial Instruments that have been used to hedge them. Overall there is no loss (or Profit) except for the cost of acquiring the Financial Instruments, if any.

In my almost 19 years of Experience in the area I have met many Promoters and the MDs and the CEOs and am always surprised that most of them don’t really understand the Importance of Hedging and possess very poor knowledge in the area and either consider it a very tough task or feel that it is not important enough to know and feel that even without the knowledge they can survive as a ‘going concern’. I have even met some people who did not even know the ‘sides’ of their Exposures. I will quote one real life example of a person who was happy when INR was appreciating against the USD thinking that he was making money in the process. After a bit of enquiries and understanding his business structure I concluded that he was actually losing and when I explained it to him he was taken aback. I was also equally surprised as the company was not a very small size one.

I give below some very basics of the Risk Management strategies to be followed by all those who are ‘exposed’ as explained above, in the hope that some of them will understand the importance and take suitable action for safeguarding their profits:

1.??????Understand the importance of Hedging and also know ‘your side’.

2.??????Prepare a Risk Management Policy broken down to the actual Numbers. Avoid ambiguity to the max extent possible. Can take help from some experienced people as this Policy will be very crucial for the company and any defect can land the company in deep soup.

3.??????Identify a person for the job of hedging, preferably someone with some experience in the area. Get the person trained by the experts if needed.

4.??????Get the updated (and correct) data as frequently as possible.?

5.??????Hedge the Exposures with the suitable products adhering completely to the already prepared Risk Management Policy.

6.??????Review periodically and see if the Policy is working perfectly and change the Risk Management policy with the help of the new learnings if needed.

7.??????Decide if the company will remain a ‘cost centre’ or a ‘profit centre’ or a mix of both. Being a Cost centre means only the hedging activity will be allowed whereas the Profit Centre means the company will also try to make use of the two way movements of the market and try to make some ‘extra money’. For any such activity a suitable ‘risk capital’ will have to be allotted. This basically means that the Company will keep trading till they don’t lose more than a certain sum of money. The risk Capital will depend upon the various factors, like the ‘risk appetite’, overall profits of the Company, past experience and also on the knowledge level of the person who will actually do it. It’s worth noting that if the Company is not hedging its exposure optimally (i.e. doing either lesser or more than the required quantum) it is actually trading on that portion and this also makes it a ‘profit centre’ with all the risks/rewards attached with the same and consequently a ‘risk capital’ will again be needed to be assigned otherwise it could entail heavy losses.

8.??????Please understand that by not hedging also the companies lose money but it is not openly visible whereas after hedging completely there can only be the opportunity losses even if they look like actual losses.

Hope this small write up helps people in understanding the importance of Hedging. Suggestions are welcome from all for adding some more points or amending some of the above mentioned ones.

Abhijeet Bhushan

Group Head, Treasury, HKEPL

Email- [email protected]