TREASURY CLASSROOM VOLUME 124

EXTERNAL COMMERCIAL BORROWING HEDGING

As in the world of globalization, many companies who are in the growing phase need to expand their base whether it could be domestic for a working capital requirement. Now Some companies go for External commercial borrowing.

ECB means some Indian company taking loans from the outside. Suppose ABC LTD had taken the loan from outside suppose the loan amount is around $100 million and the tenure is around 10 years & suppose the interest rate is around SOFR+125 basis points. The loan is taken from a foreign bank. ABC Ltd has functional currency in INR but the loan is in Dollars. So they are exposed to the revaluation risk now they need to hedge that ECB which is called fair value hedging. As fair value hedging means hedging of net exposure whether it is foreign currency assets and liabilities are subject to the revaluation risk. Now the money is given by the Foreign Bank as it is entering through the Indian Counterpart.

Now ABC LTD will do a Principal Only swap and coupon only swap. Now in the case of Principal Only Swaps, there is a POS rate suppose, the rate is around 70, then the ABC LTD will get a credit of around 700 CR. And after 10 years ABC LTD will give back the 700 Cr and get their dollars back. And loan will be settled now in this swap party is Foreign Bank. Now in this ABC LTD is hedged now after 10 years INR goes to anywhere ABC LTD has to pay around 700 CR. Now in this, they have to pay the POS cost which is (a 1-year fwd premium/ POS rate). Suppose 1-year fwd premium is around 300 paise then the POS cost is around 300/70= 4.2%. Now every year ABC LTD will pay around 700*4.2%= 29 cr every year around 29 Cr ABC LTD will pay this to Foreign Bank as a POS cost.

But ABC LTD is also paying SOFR+125 basis points. As 125 basis points are, the quality spread differential. As of now, SOFR is a floating element in that. Now it depends on the view of a corporate treasurer if suppose he is having a view that Central banks will hike the rate the in that case cost of hedging will go up. So ABC LTD is thinking of doing a coupon-only swap in which ABC LTD will continue to pay SOFR+125basis to the Foreign Bank and Bank will pay the SIFOR. In that bank is neutralizing the SIFOR. Bank will say that if I am neutralizing the SIFOR then you have to pay me a cost that is USD IRS swaps. Now suppose USD IRS swaps is around 2.2% then the net cost is around 2.2%+1.25%= 3.45%.

Total Cost of Hedging is= 4.2%+3.45%= 7.65%.