Foreign currency RISK

There many types of risk in business,operational risk, financial risk and market risk. Today I will discuss about financial risk that a business faces and we as a individual business in our daily life. Lets talk about a situation that is common in business and in life,letsay you want to buy a mobile worth $ 1000 and exchange rate is 1$ = Rs.70 then it would cost you RS.70000.00, and you order your mobile after a week ,when exchange rate rises to 1$ = Rs 75,so now it would cost you Rs.75,000. Now lets analyse the situation the delay in ordering of mobile by one week costs you Rs.5000 to buyer of mobile. This can be profit also.The loss or gain due to fluctation is known as foreign currency fluctuations risk of business. This risk can be hedged or controlled by various ways :

• Entering into forward contract with bank. For example in above situations we can book forward contract with bank to buy $1000 after a week ,say contract is booked at RS.71,now buyer has no risk of fluctuation in market.
• Entering into futures contract in stock market. For example you buy at 71 and on the date you want to buy mobile sell your futures in stock market at prevailing rate in market. Lets say price in open market at Rs.75 then you would sell at Rs.75 and buy mobile at Rs. 75000 and you would save Rs.4000.

Now Let' s see the situation with different angle, if Rs. appreciates and the day we want to convert $ into RS the exchange rate is Rs.68, in that case we will suffer a loss of Rs.3000.

Now let me define hedging :

Hedging is a process of safeguarding ourselves from fluctuations in the market that might result in losses to an entity.

Hedging is not done with the objective of earning profit.Once we hedge a particular transaction risk then we should not be concerned about fluctuations in market.

Now question arises whether we should move towards hedging our foreign currency risks or not ?.

The answer to these questions would be discussed in details in coming posts.