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Both importers and exporters run the risk of loss due to
fluctuations in the foreign exchange rates in international
business transactions.
transactions. An exporter who agrees to a certain
price in a foreign currency today may find himself at a loss
after a few months when the actually receives the payment
owing to a fall in the exchange rate of the contracted
currency.. Likewise, an importer¶s fortunes may also swing
currency
up or down with exchange rate movements.
movements.

For example, let us take an exporter in India who ships

5,000 shirts at US $ 4.00 each to an exporter in the US,
and expects to receive the payment after 60 days. days. In
today¶s date at $1.00 = Rs
Rs.. 46.
46.00,
00, he expects a payment of
Rs.. 9,20,
Rs 20,000.
000.00.
00. After the months, on actual receipt of
payment, the US $ is equal to Rs.Rs. 45.
45.30 and he, therefore,
receives Rs.
Rs. 9,06,
06,000.
000.00,
00, incurring a loss of Rs.
Rs. 14,
14,000.
000.00.
00.
This loss is actually due to weakening of the US $ against
the Indian rupee.
rupee.
|xporters in India can avail of forward exchange
covers provided by most commercial banks.
banks.
Foreign exchange rates are usually quoted as
Spot Rates or Forward Rates.
Rates.

O
  ΠFor immediate requirement of

foreign currency, the purchaser has no choice but
to buy foreign exchange on the spot (current)
market.. Spot rates are meant for immediate
market
delivery.. It is simply the current market rate
delivery
decided by demand and supply.
supply. Spot contracts
are the most basic and widely used foreign
exchange contracts.
contracts. This is an agreement to buy
or sell one currency in exchange for another.
another.
Spot transaction requires the receipt of the
bought currency in two days and the payment of
the sold currency in two days
days..
a
  ΠA forward contract
allows the exporter to buy or sell one
currency against another, for settlement
on some future date.
date. A forward contract
eliminates the risk of fluctuating exchange
rates by locking in a price today for a
transaction that will take place in the
future.. It does not eliminate losses
future
occurring in future but it makes the
outcome of the future transaction certain.
certain.
This is called hedging for expected foreign
currency transactions.
transactions.

A forward foreign exchange contract

protects the exporter from adverse
currency movements.
movements.
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The following hedging alternatives are available
to exporters in India to deal with foreign
exchange fluctuations risks :

r u 

  a

 ΠForward
transactions that offer one of the parties to the
transaction an option to set any value date within
a prescribed period.
period. Such options benefit the
party as he may know in advance the precise
date on which he would be able to deliver the
currency.. An option forward contract helps a
currency
company overcome market risk by deciding
today, a price for a foreign exchange transaction
at a future date.
date.
r a

  u 

 ΠA currency option
gives the buyer the right, not the obligation, to
exchange two currencies at a fixed rate at a
future point of time.
time. Under this type of option,
the buyer¶s downside risk is eliminated while
retaining the unlimited upside potential
potential.. It is akin
to an insurance policy.
policy. It is an effective µhedging
mechanism¶ that permits exchange rate (strike
price), without an obligation to do so.so. The option
may not be used, if the spot rate is more
favorable than the option¶s strike price.
price. With such
instruments the buyer is protected against an
adverse exchange rate movement while retaining
the ability to benefit from a favorable movement.
movement.
As the name indicates, the party has the option
to deal or not.
not.
r  O  ΠA currency swap is
defined as an exchange of principal and/or
interest payments on a loan or asset in
one currency for principal and/or interest
payments on equivalent loan or asset in
another currency at pre-
pre-fixed spot/forward
rate agreed on the trade date. date. For
example, a customer in India having a
loan in USD may enter into a currency
swap in order to hedge its USD interest
rate risk as well as the USD/INR exchange
risk.. Under this type of swap, the client
risk
may cover either only interest payment or
principal repayment or both.
both.
In India |
also offers a special
scheme called |




    to provide
protection from exchange rate
fluctuations to exporters of capital
equipments, civil engineering
contractors, and consultants who
have to receive payments over a
period of years for their exports,
construction works, or services.
services.