Hedging

As we all know international trade happens on a continuous basis and hence traders are always exposed to currency risk for exports and imports. To overcome this currency risk, traders subscribe to a service knows as “hedging” offered by banks.  Banks via hedging service provide currency fluctuation protection to traders by charging a fee. This fee is floating and is determined by considering factors such as rate of currency fluctuation occurring in world economy.To exemplify, let’s take an example of a trader in India selling goods to United States (US). Let’s say he sells goods worth Rs. 61 million to a buyer in US on credit period of 6 months. Now this buyer is to get $1 million taking 1USD/INR= 61.00. Now assume INR becomes strong in this six months time and the exchange rate becomes 1USD/INR=58.00. When the buyer pays, this translates to only Rs.58 million which causes a loss of Rs. 3 million to the Indian exporter. Similar case can be for an importer when INR weakens. Now if this trader subscribes to hedging service offered by a bank, the bank would pay the loss of additional Rs.3 million to the trader nullifying his loss. This is a kind of risk absorption service offered by bank. Not only goods and services but borrowings are also hedged for risk minimization.

What traders do is when they expect the currency to be stable, they do not hedge which they consider as an unnecessary expense and expose their trade/borrowings to currency risks. But this can cause huge losses even resulting into collapsing of businesses as happened during economic recession in 2008.

Hedging is pivotal to international trade and it is important that businesses adopt a balance between hedged and un-hedged and strike a balance for optimizing their profits with minimized currency risks.

Thanks for reading!!

-Varun Chauhan

Foreign Trade & Foreign Exchange

Imports and exports are a very crucial part of country’s economy. In present geographical scenario each country does not have complete resources to sustain entire needs of its economy. A country has to import goods and services which it is deficient in and export goods and services which it feels are surplus in production. This is what is called a ‘foreign trade’ and happens across the world in present global scenario. It may happen that a country may impose restrictions on some of the products being exported in view of controlling prices of the products within the country or impose restrictions on imports of some products and services in view of protecting the industry producing the same goods and services from external competitors. These are known as trade restrictions.

Now comes the most crucial part, the instrument on which this trade happens – the currency. There are about 150 different currencies in the world. The US Dollar being the most traded currency forms the base currency of most trade happening in economic world. This gives rise to a logical question – Why only US dollar? Why not any other currency? The explanation lies in the fact that it’s currently the most stable currency in the world economy. The stability comes from the economy of the United States. US dollar is reliable as it has never been devaluated. This currency is so reliable that countries like Panama, El Salvador and Ecuador use it as the only official currency with no local country currency.

As we all have observed that a currency values change just as share values change. There a many factors which determine the value of a currency with respect to the base currency. To exemplify let’s take India Rupee (INR) versus US Dollar (USD). Now the value of INR will depend on factors like Inflation, Interest Rates, Current Account Deficits, Public Dept, Terms of Trade, Political stability and Economic performance of India. These factors together determine value of currencies across the world.
Thank You for reading !!

-Varun Chauhan