InvestorQ : Why is it essential to hedge foreign exchange risk?
Abhisha Yadav made post

Why is it essential to hedge foreign exchange risk?

Bhavika Nehru answered.
3 years ago

Any individual or business that deals with foreign currency is exposed to forex risk. Irrespective of whether you are an exporter, importer, ECB borrower, FCNR borrower or a global tourist, currencies do tend to impact your economics. An importer or a foreign borrower has payables in foreign currency. Hence they will be keen to ensure that the INR remains strong so that they can get more dollars for the same amount of rupees when their foreign currency payable is due. An importer or a foreign currency borrower will have to hedge his business against a weakening of the rupee.

The exporter, on the other hand, has receivables in foreign currency at a future date. The exporter will have to ensure that the rupee stays weak as that will mean that he gets more INR for each dollar received. The exporter will be happy if the INR weakens but will need to protect himself against a strengthening of the rupee. For both the importer and the exporter, the same can be achieved through the USD-INR pair. The risk can be hedged either using futures or using options and we will see how both these methods can be applied. While the USD-INR pair is being taken as an example due to its liquidity and popularity, the same logic can be used for receivables in Pound, Euro and Yen also.