After considering the concept of risk management , let move on to other concepts :-
- Forward exchange rate contracts :- it means buying or selling a currency at the price fixed today for future transaction. As the time span increases, bid-ask spread also get wider.
Example: - A person buys goods worth 100$ . Now the person is conscious about the rising prices of $. He would buy the dollar at Rs.48 as per forward contract. And he can settle his transaction at this rate no matter whatever the current rate going in the market. Even if $ is 53 or something, he still have to pay Rs.48 for the same. And if Rupee appreciates, and say $=45, then even he has to accomplish the contract @ 48.
- Honor, rollover or cancel :- forward contract :-
- Honor: - it simply means that the person has accepted the obligation or receipt as per the contract. There is no need to do anything about the same.
- Early honor: - Means you want to close the transaction today. So in case you are an exporter, you have already taken the contract to sell the foreign currency. So at today you’ll sell the currency on spot market (coz you wished to do so.) and you’ll take another buy contract for the forward rate contract date to cancel the above obligation.
Example: - you have to receive 50$ at 1$= Rs.50. Now suppose the rate today is 1$= 55.And say forward rate for $=50. You’ll surely choose the option of early honor and would earn the benefit of Rs.2 per $. And then you have to take another contract to cancel the earlier transaction.
- Roll over: - In this contract the person wants to receive or pay at a later date. The person can choose this option at the due date or before the due date.
At due date :- he’ll take 2 contracts. The first would be to cancel the already taken contract. And then second would be the forward contract.
Before due date :- the person would get into 2 forward contract. Suppose, a person need to pay on 30the august. Now, the person realizes on 10the august that his financial position is weak and wants to pay his debt on 1 Sept. So what should he do :-
- Buy ki jagah sell ka contract lega for 30th aug.
- Due date means 1sep ka forward buy ka contract lega. Simple !
- Money market hedge :- money market is a market for short term instruments. Its term may be overnight to a year. The money market is an approach to avoid foreign currency exchange. A person creates a simultaneous asset or liability as per his position. Let’s illustrate with an example :-
A person has to receive 52000$ from an American customer after 6 months. And interest rates are :-
USA :- 8% p.a.
India :- 10% p.a.
Spot Rate :- $ 1 = Rs.40
Receipt :- 52000 $ . It’s an asset so he will invest the same amount at present value in his home country. So first he has to take a loan, ( paisa kahan se aayega invest karne ke liye :O )
So loan will be taken from the same country the person is going to receive the money i.e. America.
Raising a loan =Amount receivable / (1+ periodic rate of interest)
= $ 52000/ (1+.08*6/12)
= $ 50,000
He will take the loan of $50000. And, he would invest the same amount in India at prevailing spot rate.
Means , 50000*40 = 20 lakh
Deposit the same money in india for 6 months @ 10% . And it’d be equal to 21 lakhs.
So, the total receipt under MMO is 21 lakhs. The loan amount would be cancelled by the actual receipt on the due date respectively.
Regards
Renu
CAclubindia
