Currency

Hedging I
Forwards

Need for Derivatives

Hedging Decision I (A):
Indian importer (M) imported 1000 units from
US @ 10$ per unit.
Today: 1$ = 44 / 45 INR
Total payment (in todays terms) = 45 *
10000 = 4,50,000 INR
But the actual payment would be made after
2 month from now.
What is the risk faced by the company M in this
scenario?
After 2 months, if 1$ = 45.5 / 47 INR
Actual payment for M = 47 * 10000 = 4,70,000
INR

Need for Derivatives

Hedging Decision I (B):
Indian exporter (X) exported 2000 units from
US @ 20$ per unit.
Today: 1$ = 44 / 45 INR
Total receivables (in todays terms) = 44 *
40000 = 17,60,000 INR
But the actual payment would be made after
2 month from now.
What is the risk faced by the company M in this
scenario?
After 2 months, if 1$ = 43 / 44 INR
Actual receivables for X = 43 * 40000 =
17,20,000 INR

Forwards
A non-standardized contract between
two parties to buy or sell an asset at a
specified future time at a price agreed
today
It is an obligation (not an option)
Cash
Tom
Spot

Need for Derivatives

Hedging Decision I (A):
Indian importer (M) imported 1000 units from
US @ 10$ per unit.
But the actual payment would be made after
2 month from now.
How to hedge?
M to buy 2 month USD / INR forward
Let today, if 2 month USD / INR forward = 44 /
44.8
M has locked the rate 1$ = 44.8 INR
So after 2 month, M will buy 10000$ @ 44.8 (per
$)

Need for Derivatives

Hedging Decision I (B):
Indian exporter (X) exported 2000 units from
US @ 20$ per unit.
But the actual payment would be made after
2 month from now.
How to hedge?
X to sell 2 month USD / INR forward
Let today, if 2 month USD / INR forward = 43.8 /
44.3
X has locked the rate 1$ = 43.8 INR
So after 2 month, X will sell 40000$ @ 43.8 (per
$)

Key Points
It is an obligation
No price no premium payment is required
Whether you are in profit / loss, you have to
fulfill your obligation
Which means your upside and downside both
are restricted, that too at same level.
What if I only want to restrict downside
(loss) and not upside (profit)
Will this also be available at no price??

Currency
Hedging II
Options

Need for Derivatives

Hedging Decision II (A):
Indian importer (M) imported 1000 units from
US @ 10$ per unit.
But the actual payment would be made after
2 month from now.
Can buy 2 month USD / INR forward @ 44 / 44.8
Wants to restrict only downside (loss) and
not upside (profit)
What to do?

Option
A non-standardized contract, under
which buyer of the contract gets the
right (option) but not an obligation to
buy or sell an asset at a specified future
time at a price agreed today.
For this right, buyer has to pay some price
called as premium
This price is received by seller of the
contract

Types of Options
There are two basic types of options:
1. A call option which gives the holder of the option the
right to buy an asset by a certain date for certain price.
2. A put option gives the holder of the right to sell an asset
by a certain date for a certain price.
Option Type
Call
Put

Buyer of Option
(Long Position)
Right to buy an asset
Right to sell an asset

Writer of Option
(Short Position)
Obligation to sell asset
Obligation to buy asset

Difference between
forward and options
Forwards
Both the parties have
committed
to
some
action.

It costs a trader nothing

(except for the margin
requirements) to enter
into forward or futures
contract.

Option
The holder of the option
has the right but not the
obligation to some action.
Purchase of an option
requires an upfront fees.