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Management of Transaction Exposure

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Forward Market Hedge

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In a forward market hedge:

  • A company that is long a foreign currency will sell the currency forward,

whereas,

  • A company that is short a foreign currency will buy the currency forward

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Forward Market Hedge�

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EXAMPLE

An Indian exporter will hedge his position by selling $10,000 to B, a US firm in future

Spot rate=1$=Rs 70

Forward rate=1$=Rs. 68

It means that the exporter will give$10,000 to B in future and will get Rs. 6,80,000. Any exchange gain or loss on the forward contract will be offset by a corresponding exchange loss or gain on receivables

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Forward Market Hedge�

Future Spot rate

Forward currency receivables

Value of original receivables

Gain/Loss on forward contract

Total cash flow

70

6,80,000

7,00,000

-20,0000

Rs. 6,80,000

68

6,80,000

6,80,000

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Rs. 6,80,000

66

6,80,000

6,60,000

+20,000

Rs. 6,80,000

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  • Future Contract
  • Option Contract
  • Risk shifting

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