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Possible Scenario: Indian Rupee will depreciate against US Dollars due to country's rising import costs and slowing down of foreign equity inflows. However, INR may appreciate after some period when condition in domestic and global markets change in favour.
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Example 1:
Suppose an edible oil importer wants to imports edible oil worth USD 100,000 and places his imports order on July 15, 2008, with the delivery date being 4 months ahead. At the time when the contract is placed in the spot market, one USD was worth say INR 44.50. But, suppose the Indian Rupee depreciates to 44.75 per USD when the payment is due in Oct'08, the value of the payment for the importer goes up to INR 4,475,000 rather than INR 4,450,000. The hedging strategy for the importer, thus, would be:
| Current Spot Rate (15th July '08) |
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44.5000 |
| Buy 100USD-INR Oct ‘08 |
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(1000 * 44.55000) * 100 |
| Contracts on 15th July '08 |
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(Assuming the Oct '08 contract is trading at 44.55000 on July 15, 2008) |
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| Sell 100USD-INR Oct'08 |
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| Contracts in Oct' 08 |
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44.7500 |
| Profit/Loss (futures market) |
:
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1000 * (44.75- 44.55)
*100 = 20,000 |
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| Purchase in spot market @44.75 |
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44.75 * 100,000 |
| Total cost of hedged transaction |
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100,000 * 44.75 - 20,000 = INR 4,455,000 |
Thus, through hedging in futures market, the importer covers up to Rs.20, 000 against the loss due to depreciation of Indian Rupee over the contract period.
Contrarily, if an exporter takes a reverse view on the exchange rate movement, he can lock in the exchange rate by selling the USD-INR contract.
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Example 2:
A jeweller who is exporting gold jewellery worth USD 50,000, wants protection against possible Indian Rupee appreciation in Dec' 08, i.e. when he receives his payment. He wants to lock in the exchange rate for the above transaction His strategy would be:
| One USD-INR contract size |
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USD 1000 |
Sell 50 USD-INR Dec '08 contracts
(On 15th Jul '08) |
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44.6500 |
Buy 50 USD-INR Dec '08
Contracts in Dec '08 |
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44.3500 |
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Sell USD 50,000 in spot market @ 44.35
in Dec '08
(Assume that rupee depreciated initially, but later appreciated to 44.35 per
USD as foreseen by the exporter by end
of Dec '08)
Profit/Loss from futures
(Dec '08 contract) |
: |
50 * 1000 * (44.65 - 44.35) = 0.30 * 50 * 1000 =
INR 15,000 |
The net receipt in INR for the hedged transaction would be
50,000 * 44.35 + 15,000 = 2,217,500 + 15,000 = 2,232,500.
Had he not participated in futures market he would have got only INR 2,217,500. Thus, he kept his sales unexposed to foreign exchange
rate risk.
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