Parvesh Aghi

FOREIGN EXCHANGE EXPOSURE

AND RISK MANAGEMENT

Prof. (Dr.) Asheesh Pandey

FOREIGN EXCHANGE EXPOSURE AND
RISK MANAGEMENT

The values of major

Foreign exchange (FX) currencies constantly
risk is an intrinsic part of fluctuate against each
doing international other, creating income
business. uncertainty for your
business.
 FOREIGN EXCHANGE EXPOSURE AND
RISK MANAGEMENT

Commodity Controlled Business Winner

Export-Import
Business Business Killer
Currency Uncontrolled (currency
fluctuations may
take away all profits)
 FOREIGN EXCHANGE EXPOSURE:
UNHEDGED
At $1=Rs.82 Payment,
Receivable 3 Month ($1
Export Coir Mattresses (May) lakh) Rs. 82 Lakhs

If in August, $1 = Rs. 85 Receivable= Rs. 85 Lakhs Profit =Rs. 3 lakhs

If in August, $1 = Rs. 79 Receivable =Rs.79 Lakhs Loss =Rs. 3 Lakhs

 Currency Price Effect

US $ Price Importer Exporter

82 Booking Booking

85 Loss Profit

79 Profit Loss
CAGR = 4%
FOREIGN EXCHANGE EXPOSURE AND
RISK MANAGEMENT

Many businesses like

But some businesses
to eliminate this
regard exchange rate
uncertainty by
movements as a
locking in future
profit opportunity.
exchange rates.
HEDGING CURRENCY
RISK
HEDGING CURRENCY RISK : is a way for a company to
minimize or eliminate foreign exchange risk.

External
Internal
Techniques-
Techniques-
involve dealing
within the
with a third
business itself party

10
Hedging Foreign Exchange Risk

External Techniques:
Internal Techniques: Forwards
Leading and lagging
Futures
Invoicing in domestic currency
Money Market Hedge
Netting
Options
Internal Techniques

Leading and Lagging-

Leading means advancing a Example: X Ltd imports
$1,00,000 goods from X :Ltd expects $ to
payment i. e. making a
abroad appreciate significantly in
payment before it is due. next 6 months . So X plans
Lagging involves postponing ( current rate 1$ =Rs 82)
a payment i. e. delaying to pay the amount upfront
Payable after 6 months
payment beyond its due date.
Internal Techniques

Leading and Lagging-Leading For example an Indian Firm

means advancing a payment i. which is due to receive
e. making a payment before it payments from it's customer when this happens we say
is due. Lagging involves in the UK, may press for that the Indian firm is leading
postponing a payment i. e. prompt payment from the it's receivables.
delaying payment beyond its customer if it expects the INR
due date. to appreciate in future

One pound = 102.5 Rs 100

Internal Techniques

Invoicing in Domestic
Currency- invoicing in X Ltd invoices Rs. 80,000 1$ = Rs 78 after 6 months
for their exports (at the
domestic currency, an time of export 1$ =Rs 80 )
X receives Rs 80,000
exporter can shift Importer has to pay $
Payment receivable after
transaction risk to his 1025.64 as against $1000
6 months
customer abroad

Rs 80,000/78= $1071.42
FOREIGN EXCHANGE EXPOSURE AND RISK
MANAGEMENT

So you may therefore find

You might lose customers to
that competitive pressures
competitors who offer more force you to explore a risk
currency flexibility and your
management strategy that
suppliers may be unwilling to
helps manage your foreign
accept payments in what is exchange risk more
to them a foreign currency
efficiently.
Internal Techniques

Example : X India Ltd owes

Netting-Exposure netting is a $1,00,000 to its group
method of hedging currency company X USA Ltd for the
risk by offsetting exposure in goods supplied and X USA
one currency with exposure in ltd also owes $ 80,000 for
the same or another currency. the services provided to X
India Ltd
Internal Techniques: Netting

Q. An American parent Company has subsidiary in UK and

France. Suppose UK subsidiary has to make dividend payment to
parent of GBP 250,000 in 3 months time, parent has 3 month
payable of EUR 500,000 to French subsidiary and French
Subsidiary has 3 month payable of GBP 300,000 to a British
supplier (who is not part of MNC).
Forecasted 3 months spot rates:
1 GBP = $1.5500
I EUR = $1.3000
How can netting be done?
Internal Techniques: Netting
Ans.
UK subsidiary is asked to pay GBP 250,000 to French subsidiary’s UK
supplier
Thus, French firm has to only hedge against residual payable of GBP
50000.
250,000 converted to EUR at forecasted rate of 1 GBP = EUR 1.1923
(1.5500/1.3000) and amount of EUR 298,075.
The parent may Hedge for residual amount of EUR201,925.
Note: Any discrepancy between forecast exchange rate and actual spot
rate on maturity can be settled by making necessary intra-company
transfers
Internal Techniques: Netting

Q. Now, suppose in previous example, actual spot rate turns out

to be:
1GBP = $1.6000
1 EUR = $1.2500
How would netting be settled in between parent and subsidiary?
Internal Techniques: Netting

Ans.
1 GBP = EUR 1.2800
At this rate GBP 250,000 = EUR 320,000
The parent must pay French subsidiary EUR 180,000
Parent has already taken cover of EUR 201,925
Hence, this technique not only reduces amount of exposure to be
covered company-wide but also minimize no. and amt of currency
conversion required to settle intra-company payments
This is mostly beneficial for MNCs having exposure in different
currencies but they need to have an updated information of receivables
and payables which may require centralize cash management system
External Techniques- Derivative Instruments

FORWARD FUTURES
CONTRACTS CONTRACTS

Money OPTION
Market CONTRACTS
Hedge
21
Currency Forward Contract
Forward Contract

A forward contract is a A forward contract can be

customized contract used for hedging or
between two parties to speculation, although its
buy or sell an asset at a non-standardized nature
specified price on a makes it particularly apt
future date. for hedging.
Forward Contract

A currency forward is a
The future date for which the
customized, written contract
between parties that sets a currency exchange rate is
fixed is usually the date on
fixed foreign currency
which the two parties plan to
exchange rate for a
transaction that will occur on conclude a buy/sell
transaction of goods.
a specified future date.
FORWARD CONTRACT

1. Private deals b/w two parties to

exchange cash in future
2. No cash flow at initiation of contract
3. Non-standardized contracts in self 6. There is normally no insistence on
regulated forward market margin as the bank and client know
Thus, Salient features of Forward each other
contract are: 4. Contract size and maturity period can
be customized so it provides perfect 7. High counter party risk which may
hedge lead to default
5. Mostly interbank transactions traded
over the counter
Understanding Currency Forward
Contracts

However, parties that enter

It protects the buyer or seller
Currency forward contracts are into a currency forward
against unfavorable currency contract forego the potential
primarily utilized to hedge exchange rate occurrences
against currency exchange benefit of exchange rate
that may arise between when a changes that may occur in
rate risk. sale is contracted and when their favor between contracting
the sale is actually made.
and closing a transaction.
Example of Forward Contract
A Ltd. of India has
imported some The amount is
payable in six months Spot Rate
chemical worth of
USD 3,64,897 from
time. The relevant BID $1 = 82.2150
spot and forward ASK $1= 82.2250
one of the U.S.
rates are:
suppliers.

Six Months forward Forecasted Spot rates

rate after six months Should he hedge his
forex exposure or leave
BID $1 = Rs 84.324 BID $1 = Rs 84.720
it unhedged ?
ASK$1= Rs 84.327 ASK$1= Rs 84.860
Solution

Six Months forward

Amount payable in rate $3,64,897 X 84.327
USD 3,64,897 after BID $1 = Rs84.324
six months =Rs 30,770,699
ASK$1= Rs 84.327
Solution

Amount payable if
Forecasted Spot not hedged
rates after six BID $1 = Rs84.720
ASK$1= Rs 84.860 $3,64,897X84.860
months
Rs 30,965,159
Solution

OPTION 1 : OPTION 2 : OPTION 1 is

HEDGED UNHEDGED better so take a
Rs 30,770,699 Rs 30,965,159 forward cover
Exercise
XYZ Ltd. of India has The amount is
imported some payable in six Spot Rate
equipment worth of months time. The BID £1 = 100.2150
£ 5,00,000 from one relevant spot and ASK £1= 100.2250
of the UK. suppliers. forward rates are:

Six Months forward Spot rates after six

rate months Should he hedge his
forex exposure or
BID £1 = Rs100.324 BID £1 = Rs100.720 leave it unhedged ?
ASK£1= Rs 100.327 ASK£1= Rs 100.860
Solution

Six Months forward

Amount payable in £ rate £ 5,00,000 X
5,00,000 after six 100.327 =
BID £1 = Rs100.324
months Rs 5,01,63,500
ASK £1= Rs 100.327
Solution

Spot rates after six BID $1 = Rs100.720

months ASK$1= Rs 100.860

Amount payable if not

hedged £5,00,000X
100.860
Rs 5,04,30,000
Outflow in rupee under both the
options

OPTION 1 : OPTION 2 : OPTION 1 is

HEDGED UHEDGED better so take a
Rs 5,01,63,500 Rs 5,04,30,000 forward cover
Exercise

An Indian importer has to

settle an import bill for $ (i) Pay immediately (ii) Pay after three The importer's bank
1,30,000. The exporter without any interest months with interest at 5 charges 15 percent per
has given the Indian charges percent per annum. annum on overdrafts.
importer two options:

The exchange rates in the Spot rate (Rs /$) : 3-Months forward rate The importer seeks your
market are as follows: 83.35 /83.36 (Rs /$) : 84.81 /84.83 advice. Give your advice.
Solution
If importer pays now, he
will have to buy US$ in Amount required to
purchase Add: Overdraft Interest
Spot Market by availing for 3 months @15% p.a.
overdraft facility. $1,30,000 X Rs 83.36 = =Rs 4,06,380
Accordingly, the outflow 10,836,800,
under this option will be

Total outflow = Rs
11,243,180

Spot rate (Rs /$) : 83.35 /83.36

Solution
If importer makes payment
after 3 months then, he will Accordingly, he will have to Amount of Bill = $1,30,000
have to pay interest for 3 buy $ in forward market. The Add: Interest for 3 months
months @ 5% p.a. for 3 outflow under this option @5% p.a.= $1625= Total $
month along with the sum of will be as follows: 1,31,625
import bill.

Amount to be paid in Indian

Rupee after 3 month under Outflow
the forward purchase Since outflow of cash is
contract option1 = Rs 11,243,180 least in (ii) option, it should
Option 2 =Rs 11,165,749 be opted for.
US$ 1,31,625 X Rs 84.83
=Rs.11,165,749
3-Months forward rate (Rs /$) : 84.81 /84.83
Exercise
XYZ Ltd. of India has The amount is
exported some receivable in six Spot Rate
equipment worth of months time. The BID $1 = 82.2150
$ 3,00,000 from one relevant spot and ASK $1= 83.2250
of the supplier. forward rates are:

Six Months forward Expected Spot rates

rate after six months Should he hedge his
BID $1 = Rs83.324 forex exposure or
BID $1 = Rs 82.124 leave it unhedged ?
ASK$1= Rs 83.327 ASK$1= Rs 82.128
Solution

Six Months forward

Amount receivable rate $ 3,00,000 X
$ 3,00,000 after 83.324 =
six months BID $1 = Rs83.324
Rs24,997,200
ASK $1= Rs 83.327
Solution

Expected Spot rates BID $1 = Rs 82.124

after six months ASK$1= Rs 82.128

Amount receivable
if not hedged
$3,00,000X 82.124
Rs 24,637,200
Inflow in rupee under both the
options

OPTION 1 : OPTION 2 : OPTION 1 is

HEDGED UHEDGED better so take
Rs 24,997,200 Rs 24,637,200 a forward cover
Currency Futures Contract
CURRENCY FUTURES

These are financial

contracts that obligate Of the two parties, one
agrees to buy (who takes
the contracts’ buyers to
long position) while other
purchase an asset at a
pre-agreed price on a agrees to sell taking
short position.
specified future date.
CURRENCY FUTURES

Future contracts are The exchange determines

the size of the contract,
(i) standardized contracts
price to be quoted,
(ii.) between two parties who do
not necessarily know each other delivery location and
(iii) guaranteed for performance limits on the amount by
by an intermediary known as Stock which the future price
Exchange can move in any one day.
CURRENCY FUTURES

Future contracts are Settled In the futures market,

on Mark to Market basis margin refers to the
(MTM) and are cash settled
initial deposit of "good
Buyers and seller are required faith" made into an
to deposit an initial margin
which is around 5% of the account in order to enter
value of the contract into a futures contract.
Currency Futures in India
In India the stock exchange provides foreign exchange risk management The contracts
available are:

Futures Contracts in
EUR-INR, GBP-INR
USD-INR,

To make the markets for

USDINR futures deeper
(maximum of 12 and more liquid, NSE has
and JPY-INR.
monthly contracts) now launched weekly
currency futures on the
USDINR.
Contract Size (Lot size )

1000USD 1000 EURO 1000Pounds

USDINR EURINR GBRINR

1,00,000
Yens
JPYINR
Example on Hedging Using
Currency Futures for Importer
XYZ is an Importer. On On 15th Nov
15th Nov, XYZ Limited
wish to book its outwards $ Futures is trading at No of Contracts
remittance for 31st Dec 83.60 (LTP) (100,000/$1000): 100
worth $100,000. Expiry on 31st Dec

What would be the cost

to importer if on
Buy Currency Futures 100 maturity RBI Reference
contracts at Margin 3% = INR rate is:
250,800 (83,60,000 *3%)
$1= 83.60 a. 85.90
b. 81.60

LTP : Last trading price

Month End 31st Dec : Case 1
Cash Loss =
Assume USD/INR (85.90-
85.90 (RBI Ref Margin will get
83.60)*1,00,000 released
Rate) = INR 2,30,000

Importer has to Net outflow = Rs

pay Rs 85,90,000 85,90,000 - He is hedged and
fixed his payment
on 31st Dec at spot 2,30,000 = Rs
rate 83,60,000 @83.60/$
Month End 31st Dec : Case 2
Assume USD/INR Profit: = (83.60-
Margin will get
81.60 (RBI Ref 81.60)*1,00,000
released
Rate) = INR 2,00,000

Importer will pay Net outflow = Rs

He is hedged and
Rs 81,60,000 81,60,000
fixed his payment
on 31st Dec at +2,00,000 = Rs
spot rate 83,60,000 @83.60/$
Example on Hedging Using
Currency Futures for Exporter
XYZ is an exporter. On 15th
Nov, XYZ Limited wish to $ Futures is currently trading
book its inward remittance at 83.60 No of Contracts
for 31st Dec. worth Expiry on 31st Dec (100,000/$1000): 100
$100,000.

What would be the hedged

price to exporter if on
Sell Currency Futures 100 maturity RBI Reference
contracts at Margin 3% = INR 2,50,800
(83,60,000 *3%) rate is:
$1= 83.60 a. 82.10
b. 85.60
Month End 31st Dec : Case 1
Cash Profit =
Assume USD/INR
(82.10- Margin will get
82.10 (RBI Ref
83.60)*1,00,000 released
Rate) = INR 1,50,000

Exporter will get Net Receipts = Rs

He is hedged and
Rs 82,10,000 82,10,000 +
fixed his receipts
on 31st Dec at 1,50,000 = Rs
spot rate 83,60,000 @83.60/$
Month End 31st Dec: Case 2
Assume USD/INR Loss: = (85.60-
Margin will get
85.60 (RBI Ref 83.60)*2,00,000
released
Rate) = INR 2,00,000

Exporter will get Net Receipts = Rs

He is hedged and
Rs 85,60,000 85,60,000-
fixed his receipts
on 31st Dec at 2,00,000 = Rs
spot rate 83,60,000 @83.60/$
Difference between
Forward and Futures
Contract
 Difference between Forward and Futures
S.No. Forward Future

1 Trading Location Over the Counter Exchange Traded

2. Regulation Self-Regulating RBI, SEBI
3. Frequency of delivery Mostly by actual delivery Cash Settled

4. Size of Contract Tailormade Standardized

5. Delivery Date Tailormade Standardized
6. Transaction Cost Bid-Ask Spread Negotiated brokerage Fees

7. Margins Not required normally Initial and Maintenance margins

required
8. Settlement On the Maturity Date by Daily on MTM basis, cash settled
actual deliver
Cash flows under forward and
Futures:
Value of forward contract
changes from the time the Forward contracts are settled
contract is entered to the time on maturity while futures Thus cash flows on forward
contract are settled daily on contract are different from
when it matures because the cash flows on futures contract
spot rate the time of contract MTM basis
and its maturity changes

For example a forward and a

futures contract on USD was
entered by importer on date 1 Cash flows to forward and
future transactions are shown
(D1) to buy USD at exchange as:
rate of USD/INR 74 for
settlement on date 4.
Cash flows under forward and
Futures:
Cash flows of Forward Contract
Date Forward Rate Settlement price Cash Flows from
(USD/INR) (USD/INR) Forward (INR)
D1 74.00 72.00 0
D2 74.00 73.00 0
D3 74.00 75.00 0
D4 74.00 76.00 76-74=2

Cash flows of Futures Contract

Date Forward Rate Settlement price Cash Flows from
(USD/INR) (USD/INR) Forward (INR)
D1 74.00 72.00 (2)
D2 72.00 73.00 1
D3 73.00 75.00 2
D4 75.00 76.00 1
Options Contract
Options Contract
Buyer has the right to buy while
seller has the obligation to sell
Value derived by the underlying
security
Option Price: Premium
Types of options

Call Option Put Option

Option to Option to
buy security sell security
(Long) (short)
Types of options
European Option
American
Settled on Expiry Option
of contract
Settled on before
(In India European or end of expiry of
options are contract
traded)
Call Option

Call options provide the holder the right (but not the obligation) to
purchase an underlying asset at a specified price (the strike price or
exercise price), for a certain period of time.
If the stock fails to meet the strike price before the expiration date, the
option expires and becomes worthless.
Investors buy calls when they think the share price of the underlying
security will rise or sell a call if they think it will fall.
Selling an option is also referred to as ''writing'' an option.
Call Option: Example
Reliance Industries is trading at 2361. (Feb. 15, 2022)

The call option is as follows: Strike price = 2300, Expiry Date = Feb. 24,
2022,Premium on the call = Rs. 81.50

In this case, the buyer of the Reliance call today has to pay the seller of
the Reliance call Rs. 81.50 for the right to purchase IBM at Rs.2300 on or
before Feb.14,2022. If the buyer decides to exercise the option on or
before expiry date, the seller will have to deliver Reliance shares at a price
of Rs.2300 to the buyer.
Put Option

Put options give the holder the right to sell an underlying asset at a
specified price (the strike price).
The seller (or writer) of the put option is obligated to buy the stock at the
strike price.
Investors buy puts if they think the share price of the underlying stock will
fall, or sell one if they think it will rise.
Concept of ITM, ATM and OTM
Condition Call Option Put Option
So>E In-the-Money Out-of-the
Money
So<E Out-of-the In-the-Money
Money
So = E At-the-Money At-the-Money
Example on Hedging Using
Currency Options for Importer
On 15th Nov, XYZ Option Strike price
Limited wish to book its 83.25 is available at
XYZ is an Importer. outwards remittance for premium of Rs 0.25
29th Dec worth
$100,000. Expiry on 29th Dec

What would be hedged

cost if settlement rate is:
1. INR 84.75
2. INR 82.25
Example on Hedging Using
Currency Options for Importer
On 15th Nov 2021, XYZ Option Strike price
Limited wish to book its 83.25 is available at
XYZ is an Importer. outwards remittance for premium of Rs 0.25
29th Dec 2021 worth
$100,000. Expiry on 29th Dec

No of Contracts Buy Call option 100 Option Premium = INR

(100,000/$1000): 100 contracts at $1= 83.25 25,000 (1,00,000 *0.25)
Month End 29th Dec : Case 1
Cash Profit = (84.75- Importer has to pay
Assume USD/INR 83.25)*1,00,000 = Rs 8,475,000 on
84.75 (RBI Ref Rate) INR 1,50,000- 29th Dec at spot
25000= 1,25,000 rate

Net outflow = Rs
He is hedged and
8,475,000 –
125,000 = Rs fixed his payment
@83.50-./$
8,350,000
Month End 29th Dec : Case 2
Assume
He will not
USD/INR 82.25 Loss = Rs 25,000
(RBI Ref Rate) exercise his right

Importer will pay Net outflow = Rs

He gets the gain
Rs 8,225,000 8,225,000
on 29th Dec at +25,000 = Rs on Rs
appreciation
spot rate 8,250,000
Example on Hedging Using
Currency Options for Exporter
On 15th Nov, XYZ Option Strike price
Limited wish to book its 82.25 is available at
XYZ is an exporter. inward remittance for premium of Rs 0 .25
29th Dec worth
$100,000. Expiry on 29th Dec

What would be hedged

cost if settlement rate is:
1. INR 83.50
2. INR 81
Month End 29th Dec : Case 1

Assume USD/INR Exporter will let the

Premium loss =25000
83.50 (RBI Ref Rate) option expire

Exporter will receive

Net inflow = Rs
Rs 8,350,000 on He is hedged at Rs
29th Dec at spot 8,350,000 -25000 =
Rs 8,325,000 83.25
rate
Month End 29th Dec : Case 2
Profit = (82.25 – 81 Exporter will receive
Assume USD/INR = 1.25) Rs 8,100,000
81.00 (RBI Ref on 29th Dec at spot
Rate) Net Profit =1.25-
25=100,000 rate

Net inflow = Rs
8,100,000 He gains on $
+100,000 = Rs appreciation
8,200,000
Review of Techniques for Hedging
Transaction Exposure
Some More Hedging
Techniques
Cross Hedging

When transaction exposure can For example a firm based in UK

not be hedged because of non- has 60-days payables in TZS
availability of hedging tool in a (Tanzania shilling), but no
particular currency, a firm may hedging tools are available for
hedge in a currency that may TZS. Firm identifies that USD as a
serve as a proxy for the currency currency that is highly correlated
in which firm has exposure with TZS

So firm purchases 60-days USD The effectiveness of this strategy

forward to hedge its exposure. is based on the degree to which
This called cross hedging two currencies are correlated.
Currency Risk Sharing

This hedge contract typically

It can be implemented by takes a form of a price
developing a customized
adjustment clause,
hedge contract embedded whereby price is adjusted to
in underlying trade
reflect certain exchange
transaction rate changes

Under currency risk sharing

both parties can share the
Suppose Ram Exports Pvt.
Ltd. gets garment order to risk beyond a neutral zone.
The neutral zone
receive $1,00,000 from
Alaska Ltd. In US. represents the currency
range in which risk is not
shared.
Currency Risk Sharing: Example

Ram Exports. Ltd. Suppose the neutral

Receives an order on zone is specified as a
$100,000 garment band of exchange
exports from Alaska rates: Rs.73-77/$ with
Ltd. a base rate of Rs.75.

It means that USDINR Within neutral zone

rate can fall at as low Alaska must pay
as Rs.77 or as high as $1,00,000 at the base
Rs.73 without rate of Rs. 75/$ or
reopening the contract. Rs.75 lakhs
Currency Risk Sharing: Example

However, if rupee depreciates

Thus, Alaska’s cost within beyond Rs.77/$ to Rs.78/$,
neutral zone can vary from Rs. this increased cost of Rs.1 is
73 lakhs to Rs. 77 lakhs. shared equally between the two
parties.

The new price would be

Rs.1lakh *75.50 =Rs.75.50
Thus, the exchange rate used lakhs
for settling the transaction
would be (75+ Hence, it would partially benefit
(1/2)=Rs.75.50/$ Ram Exports and partially hit
Alaska Ltd (as its cost would
increase but not fully)
Currency Risk Sharing: Example

Similarly if the rupee

appreciates to Rs. 72 the Here, Alaska would get partial
exchange rate used for settling
benefit and Ram Exports would
would be Rs. 74.50/$ (75- take partial hit
0.50) and transaction value
would be Rs.74.50 Lakhs

However, due to risk sharing

arrangement within the neutral Beyond neutral zone contract
zone the rupee value for Ram value rises or falls only half as
Exports would remain Rs.75 much under risk sharing
lakhs. It is akin to Alaska Ltd. arrangement as under no
Selling forward contract to Ram hedge alternative.
Exports at Rs.75
Currency Collars

For example in previous example,

if Ram Exports Ltd. Is willing to
It is a contract that provides accept variations in the value of
protection against currency its dollar receivables associated
moves outside an agreed upon with fluctuations in the Rupee in
range. the range of Rs.73-Rs.75.
Beyond that point it wants
protection.

With currency collar, also known If e1<Rs.73, then RF = Rs.73

as range forward, Ram Exports
can convert its $ receivables at If Rs.73≤ e1 ≤ Rs.75, then RF = Rs. e1
the following range forward rate If e1 > Rs.75, then RF = Rs. 75
which depends on the actual spot
rate (e1):
Currency Collars

For example in previous example,

if Ram Exports Ltd. Is willing to
It is a contract that provides accept variations in the value of
protection against currency its dollar receivables associated
moves outside an agreed upon with fluctuations in the Rupee in
range. the range of Rs.73-Rs.75.
Beyond that point it wants
protection.

Specifically, if future spot rate exceeds

In effect, Ram Exports is agreeing Rs.75, then it will convert proceeds at
to convert its $ proceeds at Rs. 75 giving bank a profit on the
future spot rate if that rate falls range forward.
within the range Rs.73-Rs.75 and Alternatively, if future spot rate falls
at boundary rates beyond that below Rs.73, it will convert proceeds at
range Rs.73 and bank suffers a loss
Currency Collar through Options
Currency Collar can also be
created by simultaneously In effect the purchase of put
buying an out of the money option is financed by the
put option and selling an sale of call option.
out of the money call option
of same size.

By selling off the upside potential

of call option Ram Exports an By adjusting strike prices such
reduce cost of hedging its that put premium just equals the
downward risk with the put call premium, you can always
option. create a cylinder with a zero net
The payoff profile of combined cost, in which case you have a
put purchase and call sale, is range forward.
also known as cylinder
Currency Collar through Options
If we assume that Ram
exports can buy put at strike
price of Rs.73 and sell call
option at strike price of Rs.75
with same premiums for both
it can create a zero cost
hedge
THANKS