On average, the equivalent of about $1.5 trillion in different currencies is traded daily in the FX market around the world. Currency exchange transactions are typically done in amounts between $3 million and $10 million by banks, fund managers and currency exchange companies. With currencies being traded continuously in such large volumes, in different parts of the world, the currency rates change round the clock.
In such fluid environment, multi-currency transactions, wherein the company buys in one currency while it sells in another currency, become rather risky. Entire profit margin of a company might get wiped out if there is a considerable currency fluctuation during the course of an uncovered international transaction.
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It is possible to take steps to hedge foreign currency risk. This may be done through one or more of the following options:
i. Billing Foreign deals in Indian Rupee:
This insulates the Indian exporter from currency fluctuations. However, this may not be acceptable to the foreign buyer.
Most of International trade transactions take place in one of the major foreign currencies: USD, Euro, Pound Sterling, and Yen.
ii. Forward contracts:
You agree to sell a fixed amount of foreign exchange (to convert this into your currency) at a future date, allowing for the risk that the buyer’s payment is late.
iii. Options:
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You buy the right to sell the currency at an agreed rate within an agreed period. For example, if you expect to receive $35,000 in 3 months’ time, you could buy an option to convert $35,000 into your currency in 3-months. Options can be more expensive than a forward contract, but you don’t need to compulsorily use your option (e.g. if the currency movement is in your favor).
iv. Foreign currency bank accounts and foreign currency borrowing:
These may be appropriate where you have costs in the foreign currency or in a currency whose exchange rate is related to that currency.
In India pre-shipment and post-shipment credit can be availed in foreign currency at very competitive, Libor linked, rates. However, while taking a decision on availing credit in a particular currency, one has to be careful about the premium/discount factor of that currency and its expected movement in near future.
Post-shipment trade finance, a trader might just want to gain extra profit by benefiting from the premium factor on the currency in which he expects to receive his remittance in the future.