MANAGING FOREIGN

EXCHANGE RISK USING

DERIVATIVES

Garg Brothers & Co. Case

ABOUT THE COMPANY

Garg Brothers & Co., a 25 year old

company
Handicrafts exporter
Annual Profits - Rs. 25cr
Gross Margin 40%
Net Margin 25%
Payment to suppliers on delivery ;
Client pays on 90th day

 Expansion plans to export other asian

handicrafts like chinese and middle
eastern ones
For the same 12 cr to be spent on
advertising in europe ( 5cr surplus, 5cr
expected payments, 2cr loans)

SITUATION

Payments amounting to 5cr expected

Rs/$ falls to 62.75 from 65.5 at time of
delivery
ie a loss of almost 20 lacs
Rs/$ expected to be 59.5 on 90 th day from
delivery
Ankit to fall short in the advertising
budget

HEDGING

A hedge is an investment to reduce the

risk of adverse price movements in an
asset. Normally, a hedge consists of
taking an offsetting position in a related
security, such as afutures contract.
There is arisk-reward tradeoffinherent
in hedging; while it reduces potential
risk, it also chips away at potential gains.

DERIVATIVES DATA

Spot Rate Rs 62.75/$

90 day Fwd Rate Rs 60.50/$
90 day Call at Rs 60.50/$, premium
Rs 0.05
90 day Put at Rs. 60.50/$, Premium
Rs 0.10

Q1

Ankit should definitely go in to hedge his

positions to account for the depreciating
US$
While this will cost him and reduce his
margins, it also reduces the element of
risk, guaranteeing his margins.

CASE 1: NO HEDGE

Booking Rate RS/$

65.5

Amount US$

763358.8

Expected Amount INR

50000000

Profit/ Loss (at 25%

margin)

1250000
0

Profit/Loss at Rs 59.5/$

7919847

Profit/Loss at Rs 60/$

8301527

CASE 2: FUTURES HEDGE

Unhedged

Futures

Exchange Rate RS/$

65.5

60.5

Amount US$

763,358.78

763,358.8

Expected Amount INR

5,00,00,000 4,61,83,206

Profit/ Loss (at 25% margin)

1,25,00,000 86,83,206

Profit/Loss at Rs 59.5/$

79,19,847.3 86,83,206

Profit/Loss at Rs 60/$

83,01,526.7 86,83,206

CASE 3: PUT HEDGE

Unhedged

Put

Exchange Rate RS/$

65.5

60.5

Amount US$

763358.78

763358.8

Premium

76335.88

Expected Amount INR

50000000

46106870

Profit/ Loss (at 25% margin)

1,25,00,000 86,06,870

Profit/Loss at Rs 59.5/$

7919847.3 86,06,870

Profit/Loss at Rs 60/$

83,01,526.7 86,06,870

CASE 4: OPTIONS STRATEGY

1

Unhedged

Options

Exchange Rate RS/$

65.5

60.5

Amount US$

763358.78

763358.8

Premium

114503.8

Expected Amount INR

50000000

46068702

Profit/ Loss (at 25% margin)

12500000

8568702

Profit/Loss at Rs 59.5/$

7919847.3

8568702

Profit/Loss at Rs 60/$

8301526.7

8568702

CASE 5: OPTIONS STRATEGY

2
Unhedged

Options
Strategy

Exchage Rate RS/$

65.5

60.5

Amount US$

763,358.78

763,358.8

Premium

16,14,504

Expected Amount INR

5,00,00,000 4,45,68,702

Profit/ Loss (at 25% margin)

Profit/Loss at Rs 59.5/$

Profit/Loss at Rs 60/$

1,25,00,000 70,68,702
1,70,68,70
79,19,847.3
2
1,20,68,70
8301526.7
2