Latest Derivative Hedging

The use of derivative instruments in corporate risk management has grown rapidly in recent years, caused partly by financial deregulation and partly by the success of the financial industry in designing a great variety of OTC and exchange-traded contracts. Derivatives enable their users to separate, value and transfer market risks. The use of derivatives, enhances the possibilities for active corporate risk management, which is likely to have an impact on profitability of the firm.

What is Hedging?

Hedging is a risk management strategy used in limiting or offsetting probability of loss from fluctuations in the prices of commodities, currencies, or securities. In effect, hedging is a transfer of risk without buying insurance policies.

Hedging

The volatility of interest rates has increased manifold in the last couple of years. Such volatility increases risk of raising capital at an increased rate in the future as well as higher interest pay outs on long term loans. Hence it is very important to have an ideal tool to manage interest rate risks.

Interest rates are linked to a variety of economic conditions. They can change rapidly, influencing investments and debt obligations. In a market environment where long term debt issuance by the corporates are increasing and the demand for it is growing, there is a strong need for a cost efficient hedging instrument against interest rate risk.

An Interest Rate Futures contract is "an agreement to buy or sell a debt instrument at a specified future date at a price that is fixed today." Exchange traded Interest Rate Futures are standardized contracts based on a GOI security.As there is an inverse relationship between interest rate movement and underlying bond prices, the futures price also moves in tandem with the underlying bond

Every business is subject to the risk of unforeseeable changes in business environment. Volatility in exchange rates affects business growth and can be significant. An exporter, importer or a corporate having foreign currency loans, is directly exposed to exchange rate fluctuation. A firm could also have significant risk imposed by indirect exposure, such as local purchases of imported goods via agencies, Forex loans on books of subsidiary etc. It is possible to mitigate these risks by using suitable hedging derivatives instruments.

Currency Derivatives are Future and Options contracts which can be bought or soldas a specific quantity of a particular currency pair at a future date. It is similar to the Stock Futures and Options but the underlying happens to be currency pair (i.e. USDINR, EURINR, JPYINR OR GBPINR) instead of