HEDGING FOREIGN EXCHANGE RISK

Hedging is a way for a company to minimize or eliminate foreign exchange risk. Two common
hedges are forward contracts and options. A forward contract will lock in an exchange rate
today at which the currency transaction will occur at the future date.
 No forward Cover
 Forward currency Cover
 Forward option contract

According to the international contract of sale:

Quantity = 34000 cotton shirts
Unit Price = USD 20 per shirt
Total price = USD 680,000
Assuming:
1 USD = Rs. 60.00
Spot rate on the date of order = Rs. 60 per USD
Notional profit or loss on the contract in situation of -
 No forward Cover:
1- Currency goes up 10%
When getting contract @USD = Rs.60
When shipment after 3 months @USD = Rs.66
Profit of Rs. 4080000
2- Currency down up 10%
When getting contract @USD = Rs.60
When shipment after 3 months @USD = Rs.54
Loss of Rs. 4080000
 Forward currency Cover @ USD 64:
3- Forward contract currency goes up 10%
Spot rate when getting contract @USD = Rs.60
Forward currency contract price @USD = Rs.64
3 month forward rate = Rs.70.40 for 1 USD
Profit of Rs.4352000
4- Forward contract currency down up 10%
Spot rate when getting contract @USD = Rs.60
Forward currency contract price @USD = Rs.64
3 month forward rate = Rs.57.60 for 1 USD
Loss of Rs.4352000

 Forward option contract @ USD 64:

5- Currency down up 10%
Spot rate @USD = Rs.60
3 months forward rate= Rs.64 for 1 USD
Option contract @USD = Rs.64
On delivery date actual currency rate = Rs.70.40
Decide to exercise option to get funds Rs.70.40 in open market
Profit of Rs.4352000
6- Currency down up 10%
Spot rate @USD = Rs.60
3 months forward rate= Rs.64 for 1 USD
Option contract @USD = Rs.64
On delivery date actual currency rate = Rs.57.60
Decide to exercise option to get funds Rs.64 in open market
No profit No loss