What is corporate hedging?
Corporate hedging is a mechanism to protect a firm’s exposure to foreign exchange risk. In this process they try to minimize losses from the volatility in the currency markets, by covering the exposure.
Why do corporates hedge?
In India, with the Reserve Bank of India moving towards a more market-determined exchange rate since the early 90s, the rupee has become more volatile against the dollar and other major currencies, forcing them to hedge their foreign currency exposure. Hedging objectives vary widely from firm to firm, even though it appears to be a fairly common issue faced by corporates. Another reason for hedging the exposure of the firm to its financial price risk is to maintain the competitiveness of the firm. Sometimes there is an opportunity loss in hedging, which is why some corporate, as a matter of risk management strategy, do not.
What are the risks to be hedged?
There are risks arising out of transaction with clients and other business associated which are called transactional risks. A foreign currency loan would yield a different value on conversion, depending on the way currency markets are moving. Similarly, an importer faces a currency risk as there could be a significant movement in currency value from the date on which it contracted the purchase and prevailing exchange rate on the delivery date. The same logic holds for exporters.
What are the challenges in hedging?
What we have seen recently is the phenomenon of two-way hedging, wherein both the importers as well as the exporters are hedging. This is due to the unpredictability in the direction of the currency movement. In the current year for instance, we have seen the rupee depreciating against the dollar since mid-April and steeply appreciating against the dollar since mid-August.
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