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Companies buy cheaper derivatives to hedge rupee risk.

Date: 06-01-2020
Subject: Companies buy cheaper derivatives to hedge rupee risk
MUMBAI: Indian companies with sizable overseas liabilities are buying innovative and cheaper derivatives contracts to help lower the cost of currency cover, in some cases by up to 150 basis points, in the aftermath of the US action against Iran.

The rupee lost about 0.60 per cent against the dollarNSE -2.60 % in the first three trading sessions of 2020, beginning the New Year on a weak note.

“The recent geo-political tensions have brought the focus back on the risks from high oilNSE -1.60 % prices,” said B Prasanna, head of global markets and proprietary trading group at ICICI Bank. “Given the comfort on the external account due to the large balance of payments surplus and higher hedging cost, some importers were seen hedging their rupee risk through option strategies.”

The one-year forwards premium is now in the range of 4.1-4.2 percent, compared with 3.9 percent a month ago.

Companies now increasingly prefer complex strategies known as “call spread” or “call spread with put” (Seagull). Here, companies with long-term dollar loans are betting that the rupee would not fall beyond 88-89 against the dollar at the end of five years, when they must repay the debt.

“Such partially complex derivative deals are supposed to be less expensive by 100-150 basis points,” said K N Dey, founder of United Financials, a Mumbai-based forex advisory firm. “In a volatile market, it is advisable to go for a Call Spread/ Seagull rather than restricting possible gains in case of a rupee appreciation.”

So, a call spread of 71 and 89 would mean that as long as the rupee trades in this range, a company that has entered into such a deal would be able to buy dollars at the current rate of 71. The company benefits if the rupee gains unexpectedly to go above 71. The company could buy cheaper dollars to repay its forex loan.

“Although these hedging strategies help manage risks at lesser cost than forwards, they work only within a range,” said Prasanna.

Source: economictimes.indiatimes.com

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