X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2018 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
The Colour of Money - II - Outside View by Vikram Murarka
  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

The Colour of Money - II
May 15, 2012

Speaking to a number of exporters, importers, CFOs over the last several years, we have felt that most people find forex to be a tough beast to tame and view it with fear. Granted, managing forex risk is not easy, but it is not impossible either. To start with, there is a need to throw light on some fundamental concepts of forex risk management. In this series of articles, we will deal with questions such as:

  • What is your actual risk?
  • How much should you hedge?
  • What is Early Delivery?
  • Is the Forward Rate a forecast?
  • How to choose a Benchmark?
Never 0, never 100, and not in one go!

One of the most agonizing difficulties commonly faced by the risk manager is not knowing where the market is likely to go. This makes it nearly impossible for him to decide whether to hedge or not to hedge.

To put an end to his indecision, and not knowing what to do, he often leaves the exposure unhedged. His line of thought is, "Who knows whether taking a hedge will be right or wrong? It is better not to do anything. Who will take the blame if things go wrong?" Very often, the CFO/ CEO/ MD also agree with the risk manager, coming up with a number of justifications for the decision.

The strategy of inaction works well enough if the market is either stable or is moving in favour of the exposure. Unfortunately, the happy state of affairs does not last forever and the risk manager often ends up hedging in a state of panic when the market starts to go against him.

Underlying the above practice are two misconceptions:

  • The risk manager has a responsibility to hedge at the highest rates (for exports) and lowest rates for imports.
  • When he hedges, the risk manager should hedge 100% of the exposure.
However, the seasoned risk manager knows that it is not possible to get in at the tops and bottoms of the market on a consistent basis. So, he does not acceptable average rate for the hedge. The simple trick he employs is to hedge the exposure in parts instead of as a whole. He might break up the exposure into 3 parts, or 4 parts or even 10-12 parts, and then proceed to hedge each part at different rates and at different times in the market.

Since the hedges are undertaken at regular intervals, when the risk manager follows this strategy consistently over a sufficiently long period, he gets several benefits, as enumerated below:


  • Is able to achieve a decent average rate.
  • Does not have to worry about trying to achieve the highest or lowest rates. Or in other words, he does not have to try and "time" the market.
  • Even if a couple of forecasts, on which the hedges are based, go wrong, it is not a major worry because
    • the wrong forecast does not impact the entire hedge and
    • there are good chances that subsequent forecasts will go right.
  • Dramatically reduces the arbitrariness and ad-hocism in the hedging process and greatly enhances the systematic aspect of hedging.
  • All of the above, together, make the whole hedging process much more robust than if each exposure were to be hedged in one go.
Further, it has been our experience that in the hands of a skilled risk manager, this strategy can go so far as to help the company achieve an average realization rate that is better than the average market rate.

So, remember, do not leave your exposure totally unhedged, do not cover it fully at one go. Try and hedge in steps. This article has been authored by Vikram Murarka. He is the Founder of and Chief Currency Strategist at Kshitij Consultancy Services, India's first forex website, started back in 1998. Vikram has been forecasting and trading currencies since 1991.

The Colour of Money - Previous article | Next article

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Equitymaster requests your view! Post a comment on "The Colour of Money - II". Click here!

  

More Views on News

Sorry! There are no related views on news for this company/sector.

Most Popular

The Foundation for Sensex 100,000 is Laid(The 5 Minute Wrapup)

Feb 17, 2018

Top three reasons for Tanushree's presentation at Equitymaster Conference to be centered around a possible 30% correction.

India's Rs 1,66,276 Crore Problem(Vivek Kaul's Diary)

Feb 15, 2018

That's the loss, the government owned public sector enterprises are expected to make this year.

The Big Gamble(The Honest Truth)

Feb 15, 2018

Once you accept the fact that elections are round the corner and that this budget is geared to reach a 40% target, everything makes sense.

A New Quest for the Stock Market's MOST Profitable Ideas...(Smart Contrarian)

Feb 23, 2018

If you want to receive the best ideas in the Indian stick markets...you need to heed this important announcement.

NPAs Set to Rise Further with New RBI Rules(Chart Of The Day)

Feb 15, 2018

The RBI overhauls bad loan framework. Banks may come under additional pressure due to rising NPAs and increased provisioning.

More

Small Investments
BIG Returns

Zero To Millions Guide 2018
Get our special report, Zero To Millions
(2018 Edition) Now!
We will never sell or rent your email id.
Please read our Terms

MARKET STATS