To hedge or not to hedge

Currency futures can help safeguard foreign exchange exposure, provided the amount involved is huge and you understand the product

While going abroad, most people plan in advance for flight tickets, accommodation and travel. But, they don’t take enough precaution against possible shocks from depreciation in currency value. Instruments such as currency derivatives can help those who travel abroad, either for business, pleasure or higher studies, to lock in the rate of the dollar. But so far, there have been few takers for it, say experts.

In India, banks and currency brokerages offer currency futures and options, though the margin money requirement varies. Currency futures are derivative contracts, traded on stock exchanges like MCX-SX, NSE and USE. The contract allows the investor to buy or sell one currency against another on a specified future date, at a price specified on the date of contract.

In currency futures, it is possible to pair the rupee with four foreign currencies — dollar, euro, pound and yen. The futures are traded in lots and the minimum lot size is $1,000 (Rs 55,000 at a conversion rate of Rs 55 to $1).
 

HOW TO TRADE IN CURRENCY FUTURES?

• Step 1: Open a trading account with any currency brokerage for an initial margin of 2-5 per cent per contract. Say, you want to take an exposure of Rs 55,000, the margin would be Rs 2,700
• Step 2: Documents required for KYC are proof of identity , residence and bank account.
• Step 3: You have to take positions to trade. Say you need $30,000 (Rs 16.50 lakh) after a year. You can book a contract of a year by rolling over one-month contracts for a year for the amount
• Step 4: On maturity, if the actual contract value increases to $32,000 (rupee appreciates), then the brokerage pays you the difference. And, if the value falls to $28,000 (rupee depreciates), you pay the difference of Rs 1.10 lakh
• Step 5: Banks also allow trading in currency futures, but not necessarily for retail investors. While banks are known to charge very low margins for corporate customers, retail investors can be charged 10 per cent or more, as the ticket size is low 
• Step 6: Banks will insist on knowing the reason behind the trade, to meet KYC needs. 
• Step 7: Documentation with banks is more stringent than with brokerages

Predicting currency value
Rajesh Saluja, managing director and chief executive officer (CEO) at ASK Wealth Advisors, says, “It doesn’t make sense for a retail individual who is either planning a holiday abroad or wants to send his child to study abroad to use currency futures, because such people would typically start planning a year or more in advance. And, to have a view about the rupee for such a time horizon is a little difficult. Say, the course is of two years, you start preparing a year in advance, which means, having a view three years in advance.”

Another problem is currency futures trading is not available in Australian or New Zealand dollars, favoured destinations for students these days, says Manojit Gogoi, regional director, Alpari Forex, a currency brokerage. But they can use futures if they know their payment schedule ahead, he says.

“Once a student decides on the country and university he will join, and gets an idea of the fee structure, he/she can start booking contracts. It will also depend if the entire fee has to be paid upfront or each semester. Then, students working part-time need not hedge because they are getting paid in that currency,” he says.

However, Saluja points out, it is very difficult to predict the rupee movement for such long tenures. “Those who feel the rupee will depreciate drastically should take this route. But, most individuals will not have any view on the rupee, for they don’t understand the money market,” he says.

Hedge partially
It is advisable to lock in only a portion of the foreign currency units you might require to spend on travel through futures and this would help hedge if there is adverse movement in the future, says Anil Rego, chief executive officer, of Right Horizons.

“It is always prudent not to hedge the entire exposure, as this would mean any positive movement of the home currency may be missed,” he says.

Tough to understand
Viral Shah, head, institutional business at Geojit Comtrade, also advises against trading in currency derivatives for retail individuals. “One, because their ticket size is low and so does not make much of a difference. Second, annually, you will have to pay between Rs 3 and Rs 4 extra,” he says.

For instance, on Monday the forward contracts are priced at Rs 57, while the spot rupee rates are Rs 55.

Third, the risk involved in taking a higher loan amount is far lesser than that involved in currency derivatives, which individuals don’t understand. It makes sense for companies to use this route, as they deal in huge amounts. Individuals had better stay away. We haven’t seen any individual take exposure to this route, he adds.