Question

An importer’s financial market hedging alternatives don’t include which of the following:

A Use currency swaps to acquire financial liabilities in the foreign currency.

B Buy the foreign currency with long-dated forward contracts.

C Use a rolling hedge to repeatedly buy the foreign currency.

D Enter into a call option on the foreign currency.

Answer 1

First, let's understand the requirement of hedging for an importer:

Suppose an Indian importer imports goods worth $1,000 in India. The currency exchange rate is $1 = Rs 72.

Hence, his due amount is Rs 72,000 at the time of import.

Now, suppose at the time of payment, the exchange rate has changed to $1 = Rs 75. Now his obligation is to pay Rs 75,000 for the goods ($1,000).

Here, he faced the exchange rate risk in the transaction. To avoid this, he can hedge using:

1. Currency swap with maturity of the date of payment of the goods
2. Buy foreign currency with long dated forward contract with maturity of the date of payment of the goods
3. Enter into a call option on the foreign currency

What he will not do is:

• Use a rolling hedge to repeatedly buy the foreign currency

Because, he only needs to hold the contract till his billing date. He need not roll over the contract repeatedly.

Hence, the correct answer is Option C (Use a rolling hedge to repeatedly buy the foreign currency).