Thursday, June 05, 2008

Best hedging strategy : Go Naked

CFOs are taking it on the chin again. Earlier they got the stick from their boards for not foreseeing the fall of the dollar. Now they are held guilty of not anticipating a Rupee fall. Poor bean counters, they’ve nowhere to hide.

Before the mortgage crisis hit the developed world, the surge of dollars into India strengthened the Rupee. It gained about 12% from Rs.44 to Rs.39 and all hell broke loose with India’s exporters. Businesses had to protect their margins and they sold dollars forward hoping the currency to keep its downward drift. Now the reverse is happening. The Rupee has weakened by 7% and is touching 42.50 to the dollar. There is an opportunity loss (of Rs.2.50) here since the exporters have already sold their dollars forward (at Rs.40). For those exporters who have taken leveraged options (selling 2 calls and buying 1 put to maintain a zero cost hedge), they face a cash loss since two calls would be exercised by the option buyers against one put exercised by the exporter.

Heads I win, tails you loose, huh….? Take my word. When you earn exchange windfalls next time, book those profits into a separate Exchange Fluctuation Reserve and don’t take credit for it as business income in your revenue account. The surplus realization is anyway available to you in the form of working capital. You didn’t earn it because of your endeavors. It just happened. Not many CEOs will like it, I know! Use the same reserve to write off losses you suffer when exchange rates turn adverse, some day in future. That way your ass won’t get laid on that fired up grill. No risky hedges called for; just go naked.

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