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Sunday, June 30, 2013

Hedging Currency and Crude Risks

Many a time, executives are focused on sales, operational efficiency etc but crude and currency also bring a lot of risks and can damage the bottom-line significantly. With billions of dollars being turned in and out daily on a global basis, it is extremely critical for treasury functions to hedge currency and crude risks.

It is typical to offer CAF and BAF riders but that ultimately is like passing on the costs to the customers and that can erode the dwindling customer base. The next major wave of business boom will help those corporations that can keep input costs locked in for customers regardless of market fluctuations. This is extremely critical because majority of the export volumes come from emerging markets, where currency fluctuations are far more volatile compared to USD / EUR / GBP

Coming to India specifically, the rupee is going through free fall and although things are expected to turnaround soon, a lot of importers, shipping and aviation companies are reeling under losses due to currency and bunker prices. The only ones who are relatively safe are the ones that hedged their risks appropriately.

In fact once the Rollar went beyond the 53-54 levels, treasury managers and business heads should have raised alarm bells; what really transpired is either passing on the costs to the customers and / or relying on taxation provisions that allows a firm to book losses on forex accounts.

The simple task was to ensure that there was a special purpose fund for hedging and the following positions should have been created

LONG USD-INR Futures + Long USD-INR 53 Put
This would have locked in a price of about 54.25 should any further weakening in the rupee and on the other hand, had the pullback taken place as expected, then there would be more reason to cheer.

I am attaching 2 charts;
This first chart has the daily USD-INR prices from 1st May 2013 and how a treasury position of Long Future / Long Put would have kept the input cost constant

Now I have put in fictitious data showing the rupee appreciating by 2 rupees that still ensures that benefits continue to accrue to the treasury position
Many a time, business professionals ignore this aspect, considering 'financial speculation'. We need to realize that this is an option available in the market specifically for locking in input costs and keep the P&L healthy. This is precisely the reason why the world's leading coffee chains keep a fund aside for coffee futures, corn flakes manufacturers keep a fund aside for corn futures and so on.

The other aspect has been some of the aviation companies taking a unidirectional position at peak crude prices only to find that they ended up with a double whammy; first being unhedged [and taking a hit when crude prices tripled] and then taking a unidirectional position [long only] assuming that prices will go up north perpetually.

Managing the hedging for large turnover companies is a combination of decision science and business skills. Moreover, in a country like India, accounting for such trades needs a separate 'arms-length' structure with robust auditing procedures. The hedging activities must strictly take place within parameters of 'Value At Risk' and ensure that the hedging activities do not cross the line for speculation as it is very tempting to cross this line when positive results start trickling in.

The fund manager needs to take into account a variety of factors like quantum of hedging, technical analysis and sound business economics. Most treasury managers at this point of time only look at the bigger picture and identify when and where funds need to be swept in; it is high time to do something unique that helps customers. This will be the next major winning factor for shipping and logistics companies in India and the ones who do this first will have 'First Mover's Advantage' to set new standards.

Your profit-centric analyst

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