Foreign Exchange Risk Management Forex Risk Management
Morning Briefing

Diversifying Dollar Rupee Risk

           14th August 2000

Treasury Risk Management

The Colour of Money - Series on Forex Hedging

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Risk Diversification
The majority of Indian corporates have at least 80% of their foreign exchange transactions in US Dollars. This is wholly unacceptable from the point of view of prudent Risk Management. "Don't put all your eggs in one basket" is the essence of Risk Diversification, one of the cornerstones of prudent Risk Management.

Disadvantages of $-Rupee Advantages of Major currencies
1. The very nature or structure of the $-Rupee market can be harmful because it is small, thin and illiquid. Thus, dealer spreads are quite wide and in times of volatility, the price can move in large gaps
1. By diversifying into a more liquid market, such as Euro-Dollar, the risk arising from the Structure of the Indian Rupee Market can be hedged
2. Impacted in full by the Trend of the market. For instance, if the Rupee is depreciating, its impact will be felt in full by an Importer
2. Trends in one currency can be hedged by offsetting trends in another currency. Refer to graphs and calculations below.
3. Dollar-Rupee, in particular, brings the following risks:
1) Lack of Flexibility...Payables once covered cannot be cancelled and rebooked
2) Unpredictability...Dollar-Rupee is not a freely traded currency and hence extremely difficult to predict. The normal tools of currency forecasting, such as Technical Analysis are best suited to freely traded markets
3) Lack of Information...Price information on Dollar-Rupee is not freely available to all market participants. Only subscribers to expensive "quote services" can get accurate information
3. These constraints do not apply in the case of the Major currencies:
1) Flexibility...Hedge contracts in Euro-Dollar or Dollar-Yen etc. can be entered into and squared off as many times as required
2) Predictability...the Majors are much more predictable and liquid than Dollar-Rupee and hence Entry-Exit-Stop Loss can be planned with ease, accuracy and effectiveness
3) Free Information...The Internet provides LIVE and FREE prices on these currencies.
$-Re Euro-Re
4.$-Rupee rose 2.35% from mid-June to 11th Aug.4.Euro-Rupee fell 4.63% over the same period
5. An Importer with 100% exposure to USD, saw its liabilities rise from a base of 100 to 102.355.An Importer with 25% exposure to the Euro saw its liability rise from a base of 100 to only 100.60

Even if a Corporate does not have a direct exposure to any currency other than the USD, it can use Forward Contracts or Options to create the desired exposure profile. Thankfully, this is permitted by the RBI. This is not Speculation. It is prudent, informed and proactive Risk Management

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