Investing It! : fluctuation

Hedging against Foreign Exchange Fluctuation!

Yogi — Wed, 13 Feb 2013 08:48:00 GMT

The Rupee – Dollar rates have been on a roller coaster ride for over 18 months now. As an NRI customer this movement affects the actual rate of return that you earn on your investments.

Any adverse movement in the rates can throw your investment planning in a tizzy; however there is a way you can hedge your exposure to currency movements and plan upfront on the returns to your investments.

This can be done through a simple product called Foreign Exchange forward contracts. These products are available with most banks offering NRI services.

What is a Foreign Exchange Forward Contract?

Foreign exchange forward contract is an agreement entered between the NRI Customer and the Bank to fix the rate of exchange of a currency pair which will take place at a future date, TODAY

E.g. Customer invests in a 1 year INR deposit on 1^st November 2012 and enters into a forward contract with the bank to convert his maturity proceeds into USD

This means on 31^st October 2013 when the NRE deposit matures, the maturity value will be converted into USD at the rate that was fixed on 1^st November 2012.

Eligible Currencies

A foreign exchange contract is permissible with Rupee as one leg and any of the FCNR currencies viz USD,GBP, CAD, AUD, EURO etc as the other leg. It is also permitted between the permissible FCNR cross currencies.

What this means is, you may be a US citizen and will be interested in a Dollar return, since that is the primary currency you hold. The interest rate regime in India is high, for a 1 year NRE deposit, you can earn returns higher than 9%. You invest in an NRE deposit for one year and take a forward contract to convert this into USD a year hence at a predetermined rate.

Basic Terminologies

Spot Rate : The rate at which his currency will be converted today!

e.g., the spot rate for USD to INR for today is 50

Forward Premia : Its the price that the customer has to pay to hedge his deposit.

e.g. 12 month forward premia for today is 2.97

Forward Rate : Spot rate + forward premia

i.e. the rate of exchange the customer has fixed TODAY, for conversion on maturity

i.e. 53.87+2.97 = 56.84

Swap cost : the forward premia as a percentage of the spot rate is called swap cost. It is the cost to swap from INR into USD at a later date

i.e. 2.97/53.87 = 5.52%

Why do you need it?

Lets take an example. Customer has USD 100,000 and wants to invest in an NRE deposit. The rate of exchange today for USD – INR is 50.

The principal amount: Rs. 50,00,000/- , Rate of Interest for a 1 year deposit : 9.25% p.a.

Deposit is booked on 1^st November 2012 and is maturing on 31^st October 2013.

The Maturity value of the deposit is INR 54, 78,792/-

Yield in INR : 9.57%

Exchange rate volatility can wipe out savings!

How does a Foreign Exchange Contract Work?

• Customer had USD 100,000, exchange rate for USD – INR is 50.

• The principal amount: Rs. 50,00,000/- , Rate of Interest : 9.25% p.a.

• Deposit is booked on 1^st November 2012 and is maturing on 31^st October 2013.

• The Maturity value of the deposit is INR 54,78,792/-

• The forward premia is 2.5, and the forward rate 52.5

• The customer enters into a forward contract, and will get USD 104,347

Yield in USD : 4.36% (FCNR deposit rate in USD : 2.78%)

Whatever be the exchange rate on maturity, the customer will still get the committed rate of 52.5

No worrying about exchange rate volatility

A foreign exchange contract is available for a minimum period of 3 days to a maximum period of 12 months. You can book a contract to hedge an existing deposit with the bank as well as a new deposit with tenure of 12 months.

Cancellation of a Forward Contract

It is important to note that a contract is a legal binding and an obligation on your behalf to accept delivery of the currency at the end of the tenure. In case you wish to pre-terminate the deposit, you will first need to cancel the contract. The contract will be cancelled at the prevailing market rate and as a practise followed by most banks, the gain or loss arising out of the cancellation will have to be borne by you.

It is also important to note, whatever be the market rate, the contracted rate is what you will get. As in the example above if the contracted rate to convert INR into USD is 52.5, and the market rate is 45, you will still get your funds at 52.5 only. There will be a notional loss or a gain depending on the market scenario vs the rate at which you have entered into a contract. But it is this very uncertainty that you are hedging for!

From a portfolio sense, It is always wiser to hedge your exposure on some part of your portfolio through foreign exchange contracts and keep some amount of exposure to encash favourable movements in currency to your advantage!

Daisy Fernandes is a personal finance enthusiast who is also pursuing her Certification in Financial Planning

How to benefit from Exchange Rate Fluctuation in stock market

Yogi — Fri, 02 Dec 2011 05:05:00 GMT

Nothing is unidirectional in this world. Similar is the case with exchange rates. Sometimes you hear that rupee has opened at 43 against dollar and after few trading sessions, it starts trading at 45 or even 50 at times. There are a lot of factors which are responsible for this dynamism of exchange rate including Government Policies, Interest Rate and demand and supply balance. Most of the factors are beyond the control of an individual investor and he has only a spectator’s role to play. One of the good points in this whole story is that if you are an informed investor, you can sense the direction of movement of exchange rate well in advance by understanding the basics of currency fluctuation theories. As you can sense the direction, why not to use this opportunity to extract some benefits from it? In this article, we will try to figure out the impact of currency movements on some exchange rate sensitive sectors in Indian stock market based on which an individual investor can take some smart decisions for short term.

Impact of Exchange Rate Fluctuation

Broadly speaking we can divide the companies into two groups which are majorly impacted by currency movements:

a. Net Exporters

These are the companies that sells products to outside world and receive money in foreign currency terms (be it dollar, pound, euro). Whenever rupee is strong as compared to these currencies, they are exposed to translation loss. This is because they are able to buy fewer rupees with same amount of foreign currency. This translation loss hurts them as they have to bear the raw material cost is in terms of rupees. If the rupee gets weaker as compared to foreign currency, the scenario reverses resulting in overall gain for the exporters.

b. Net Importers

These are the companies who buys product from outside world and pay in terms of foreign currency. Whenever rupee is strong, they can buy more foreign currency with it resulting in overall translation gain for them. In case of weaker rupees the situation reverses and there is an overall loss.

Choosing the sectors to invest

Now we know the broad impact of currency movement so let’s focus on the sectors where one should take exposure in case of anticipated currency movement (up or down)

Information technology (Infosys, TCS, Wipro)

This is one of the sectors which are most sensitive to exchange rates. It falls into category of net exporter hence benefits from rupee going weak. This is one of the recommended sectors to take exposure for short term as the stock price movements are in the tune of 4 to 5% in very short span of time.

Textiles (Arvind Mills)

This sector is a net exporter and receives most of the payment in dollar terms. It benefits once the rupee gets week.

Petrochemical (Reliance)

Earnings in most businesses are linked to dollar as the key input, crude oil is purchased in USD. Rupee appreciation benefits this sector in short and long term.

Pharma (Ranbaxy, Dr Reddy’s Labs)

This sector has exposure both in terms of export and import. They earn foreign currency through exports but they need it for imports too. This sector is a tricky one with respect to exchange rates.

Auto (Maruti, M&M)

This sector has considerable amount of income from export of vehicles. It benefits from rupee weakening but there is one more angle to it. Sometimes the parts they use for assembly are imported. The one who uses more indigenous parts benefits the most in case of rupee depreciation.

Summary of Buy/Sell decisions in Stock Market

Sector	Category	Rupee	Exposure
Information Technology	Exporter	Strong	Sell
Information Technology	Exporter	Weak	Buy
Textile	Exporter	Strong	Sell
Textile	Exporter	Weak	Buy
Petrochemical	Importer	Strong	Buy
Petrochemical	Importer	Weak	Sell
Pharma	Exporter/Importer	Strong	Tricky
Pharma	Exporter/Importer	Weak	Tricky
Auto	Exporter	Strong	Sell
Auto	Exporter	Weak	Buy

Conclusion

There are a lot of other sectors which might get affected based on their foreign currency exposure. This article has covered some important sectors so that you take an informed decision. If you want to analyze a particular sector of your choice you need to concentrate on few basic points like if the company is a net exporter or net importer and how much hedging company does to protect against exchange rate fluctuations.

Author

The author Bimlesh Singh is a CFA Level 2 candidate currently working as a business analyst in financial domain. He holds a Bachelor’s degree from IT-BHU. He can be reached at bimleshs@gmail.com.