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Forex - currency trading

ars (CS) (445 Points)

03 November 2012

We haven availed a foreign currency loan in USD, maturing at the end of 6th month. How to protect the exchange rate difference, by hedging? What is to be done? wheter to buy or sell the futures? pl. explain by illustration. I am new to this.

What exactly happens in forward booking the transaction? i.e. at the time of availing and paying back the loan what is the importance of the spot and future price of USD v/s. INR pl. explain. What is cost / loss that may have to be incurred? can profit may be enjoyed?

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3 Replies

CA Mansi Kotadia (Chartered Accountant) (525 Points)
Replied 03 November 2012

Hedging is the activty that avoids the risk of loss due to Change in Exchange rate of Currency to a certain extent.

Say If we continue ur example you are suppose to make Repayment of a Foreign Loan so availed earlier on timely basis on the basis of futre financial trends and market anaylsis you set a foreign Exchange rate on basis of which you will repay your loan and it's instrest Despite of anyother forex rate prevailing in market. These is hedging of funds whereby your secure your position from loss or even risk of loss to the extent of your own set currency exchange rate.

Advantages Of Hedgeing The main advantage of the hedge is that it lowers the risk of an investment significantly when things doesn't work as in planned manner.

Disadvantage Of Hedgeing Alongwith the Cutting down of Risk The Potential reward of the Investor is also to be foegone as higly told " higher the risk higher is the reward "

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CA Mansi Kotadia (Chartered Accountant) (525 Points)
Replied 03 November 2012

Futures: (In Laymen Language) Futures are the Contract whoes price are based on some other underlying asset. they are the contract whereby both the buyer and seller are obligated to fulfil the contract at specified date on pre speicifed rate.

Eg: Say forth there is world cup in your city and you are trying hard to get the tickets for staduim but all are sold out except some of the resevered quota so u come to know a person who is influencial and got him signed a note that says to issue 2 staduim tickets to holder of the note. so the note so signed by influencial person is Underlying asset bcoz it gives a options holder a right to buy the Orignal stadium ticket

Now Future Mechanism : Buyer of futures can buy relatively more number of futures with same price compared to which he can afford a single share of a company. ( Yes futures are quoted at very low and affordable price compared to Individula share of the company.)

Future Trading : Trading Futre is just like trading anyother security. The profit and loss is with all same economic mechanism.

On expiration date if the closing index value is higher then the rate at which investor has initally bought futures ( it means you bought at low rate and at time of epirations the actualt rate is high) then investors earn profit.

It similar to Buying at low and selling at high trend of economy.

ars (CS) (445 Points)
Replied 05 November 2012

thanx mansi,

But, I was looking at a specific answer i.e. why one should sell futres for the present spot transaction of buying / availing loan in USD.

What exactly happens on the settlement date e. g. if I have sold future of say november contract of USD - INR @ 54.50 and it gets settled in on 29.11.12 @ 55.00 then practically, I have lost by .50p. per USD. how does it relates to my loan payment installment, on that date, to the bank.

I want to know the fundamentals behind the transaction of spot / future / their rates on loan availing date and the future loan settlement date.

Request to explain in details, preferably with an illustration.