Hedging Forex Risk

Exchange risk arising on account of adverse movement of the exchange rates, can be avoided by the following methods:
  • By requesting the supplier to invoice the goods in Indian rupees (possible only when the seller agrees to it)
  • By entering into a forward exchange contract.
This involves booking of forward exchange contract with the bank of the importer.

For booking forward contract the importer should approach his bank with which an L/C has been opened. The bank will book a forward contract only against genuine trade transaction. The bank will verify suitable documents to ensure the authenticity and the amount of permitted currency of the underlying transaction. The amount, date and number of the forward contract will be marked on such documents under the stamp and signature of the bank to ensure that more than one forward contract is not booked in respect of the same underlying transaction. A transaction may be covered either in parts or in whole. The period and extent to which an exposure is to be covered is left to the choice of the customer. Ordinarily, the maturity of the forward contract matches with that of the underlying transaction. If the documents of import are not received within the agreed period of the contract, the contract needs to be cancelled(an fresh contract booked if desired) for which the bank will levycancellation charges as per FEDAI rules. In case the documents are received before the stipulated date and the importer wants early delivery, the bank will again levy charges for early delivery, as per FEDAI rules.

The importers should be careful in chosing the period of forward contract. Otherwise early delivery or cancellation of forward contract would lead to unnecessary charges. The RBI allows substitution of an import order on specific request, provided the bank is satisfied with the circumstance leading to the non-performance of the contract.

Where the documents are under a contract(Non-L/C case), the seller will submit the complete set of documents to his bankers with the request to either purchase/discount the documents to his banker with the request to either purchase/discount the documents or same on collection basis to the importer. In the former case the seller's bank finances the sellers whereas in the latter case, no financial facility is extended to the overseas seller. The seller's banker may advance some money against documents sent on collection basis while, treating the documents as collateral security.

When the documents are under L/C, the documents are prepared strictly in conformity with the letter of credit.
After preparing the documents the overseas seller will tender the documents to his banker for negotiation. The bank, after receiving the documents, will examine them to ensure that they are strictly drawn as per the terms of the credit. Following this the overseas banker will send the documents to the importer's banker in India. The impoter's bank will advise the importer to collect the shipping documents either against payment or acceptance as per the terms of the contract.

In case the documents are drawn under L/C, the issuing banker(of the overseas supplier) will examine the documents and if found in order it will hand over the same to the importer after debiting his account with amount involved or against acceptance as per the terms of the credit.

If the documents are not in line with the terms of the credit, the overseas banker can either refuse to negotiate further and ask the seller to send them on collection basis only; or it can contact the importer's bank(in the buyer's country) for authorisation; or it can also make payment under the reserve against seller's indemnity.