Variety

Never 0, never 100, and not at one go!

Vikram Murarka | Updated on March 10, 2018 Published on April 08, 2012

Mr Vikram Murarka

One of the most agonizing difficulties commonly faced by the risk manager is not knowing where the market is likely to go. This makes it nearly impossible for him to decide whether to hedge or not to hedge.

To put an end to this indecision, he often leaves the exposure unhedged. His line of thought is, “Who knows whether taking a hedge will be right or wrong? It is better not to do anything. Who will take the blame if things go wrong?” Very often, the CFO/ CEO/ MD also agree with the risk manager, coming up with a number of justifications for the decision.

The strategy of inaction works well enough if the market is either stable or is moving in favour of the exposure. Unfortunately, the happy state of affairs does not last forever and the risk manager often ends up hedging in a state of panic when the market starts to go against him.

Underlying the above practice are two misconceptions. First, that the risk manager has a responsibility to hedge at the highest rates (for exports) and lowest rates for imports. Second, that when he hedges, the risk manager should hedge 100 per cent of the exposure.

However, the seasoned risk manager knows that it is not possible to strike the tops and bottoms of the market on a consistent basis. So, he does not actively strive for that. He tries to achieve an acceptable average rate for the hedge. The simple trick he employs is to hedge the exposure in parts instead of as a whole. He might break up the exposure into 3, 4 or even 10-12 parts, and then proceed to hedge each part at different rates and at different times in the market.

Since the hedges are undertaken at regular intervals, when the risk manager follows this strategy consistently over a sufficiently long period, he gets several benefits, as enumerated below:

Is able to achieve a decent average rate.

Does not have to worry about trying to achieve the highest or lowest rates. Or in other words, he does not have to try and “time” the market.

Even if a couple of forecasts, on which the hedges are based, go wrong, it is not a major worry because (a) the wrong forecast does not impact the entire hedge and (b) there are good chances that subsequent forecasts will go right.

Dramatically reduces the arbitrariness and ad-hocism in the hedging process and greatly enhances the systematic aspect of hedging.

All of the above, together, make the whole hedging process much more robust than if each exposure were to be hedged in one go.

Further, it has been our experience that in the hands of a skilled risk-manager, this strategy can help the company achieve an average realisation rate that is better than the average market rate.

So, remember, do not leave your exposure totally unhedged, do not cover it fully at one go. Try and hedge in steps.

(The author is Chief Currency Strategist at kshitij.com. The views are personal. He can be reached at vikram@kshitij.com)

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Published on April 08, 2012
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