Suppose a mango pulp exporter receives
an export order worth, say, 10,000,000
from a Japanese food company with the delivery date being in 3 months
time. At the time when contract is placed, the Japanese Yen (JPY) is worth
say Rs.51.05 per 100 JPY in the spot market, while on MSEI a futures
contract for an expiry date that matches with order payment date is trading,
say, at Rs.51. This puts the value of the order, when placed, at Rs.5,105,000.
However, if the domestic exchange rate appreciates significantly (to Rs.50.20/100
JPY) when the order is paid for (which is one month after the delivery
date), the firm would receive only Rs.5,020,000 rather than Rs.5,105,000.
To insure against such losses, the firm can, at the time it receives the
order, can enter into 100 JPY futures contract of 100,000
each to sell at Rs.51 per 100 JPY, which involves contracting to sell
a foreign currency on expiry date at the agreed exchange rate. Suppose
on payment date the exchange rate is, say, Rs.50.20, the exporter would
receives only Rs.5,020,000 on selling the Japanese Yen in the spot market,
but gains Rs. 80,000 (i.e. 51 - 50.20 * 100 * 100,000/100 ) in the futures
market. Thus, overall the firm receives Rs.5,100,000 and protects itself
from the sharp appreciation of domestic currency against Japanese Yen.
In the short term, firms can make gains or losses from hedging. But the
basic purpose of hedging is to protect against excessive losses and to
benefit from knowing exactly how much it was going to get from its export
deal to avoid the uncertainty associated with future exchange rate movements. |
An automobile manufacturer in India
placed an import order worth, say, 10,000,000
with a Japanese auto parts manufacturer. The current spot rate of Japanese
Yen is, say, Rs.51.05 per 100 Japanese Yen and at this rate the value
of the order is Rs.5,105,000. The importer is worried about sharp depreciation
of Indian Rupee against Japanese Yen in coming months when the payment
is due and brought 100 Japanese Yen futures contract ( 100,000
each) on MSEI, say, at Rs.51.10/100 JPY. Suppose, at expiry date, Rupee
depreciated to Rs.51.50 the importer would have to pay Rs.5,150,000, but
he would gain Rs.40,000 (i.e. Rs.51.50 - 51.10 * 100 * 100,000/100) from
the futures market and the net outflow would be only Rs.5,110,000.
In the short term, firms can make gains or losses from hedging. But the
basic purpose of hedging is to protect against excessive losses and to
benefit from knowing exactly how much it was going to pay for the import
order to avoid the uncertainty associated with future exchange rate movements. |