Belvora Textiles will receive USD 5 million in three months. Spot is 83.20 and the three-month forward 83.85. What does selling the dollars forward lock in, and how does it compare with staying open if the rupee ends at 81.00 or 85.00?

The forward locks in Rs 41.925 crore whatever the rupee does. If the rupee strengthens to 81.00, staying open brings Rs 40.50 crore and the hedge is Rs 142.5 lakh ahead; if it weakens to 85.00, staying open brings Rs 42.50 crore and the hedge is Rs 57.5 lakh behind. An exporter with rupee costs and a thin margin hedges to make the margin certain, not to win the currency call.

A forward is a price agreed today for an exchange that happens later. Selling USD 5 million forward at 83.85 fixes Belvora's receipt at Rs 41.925 crore in three months, regardless of where the rupee trades on the day. The forward sits 65 paise above spot because rupee interest rates are higher than dollar rates. A bank that agrees to buy dollars from Belvora in three months can borrow rupees, buy dollars today and deposit them; the extra interest it earns on the rupee side over the dollar side, about 3.1% a year on these numbers, is passed back as the forward premiumThe amount by which the forward rate exceeds spot. For the rupee against the dollar it reflects the interest rate gap between the two currencies over the period.. So the exporter is paid for waiting, and the forward is not a forecast that the rupee will weaken by 65 paise. At today's spot the invoice would be worth Rs 41.60 crore; the forward adds Rs 32.5 lakh for the three months of carry.

Run both outcomes through the same two lines: forward, then open. At 81.00 the open position converts USD 5 million into Rs 40.50 crore, Rs 142.5 lakh less than the forward's Rs 41.925 crore; at 85.00 the open position brings Rs 42.50 crore, Rs 57.5 lakh more. The forward line is the same in both, which is the whole point of it. The open line moves by Rs 50 lakh for every rupee the dollar moves, because USD 5 million times one rupee is Rs 50 lakh. That sensitivity, Rs 50 lakh a rupee, is the number the managing director should hold in mind.

Think of a farmer who agrees a price for her crop at sowing. If prices rise by harvest she feels foolish; if they fall she keeps her farm. She did not sell forward because she knew prices would fall, but because she could not afford to find out. Belvora is the farmer: its costs are fixed in rupees, so a rupee that strengthens to 81.00 takes Rs 142.5 lakh straight out of the margin on this order, and the forward removes that risk for the price of giving up the upside at 85.00. If the order was costed at a budget rate below 83.85, the forward locks in a margin above budget, and that is usually the end of the discussion. A company that wants some upside can hedge part of the receivable, say two thirds, and accept the open remainder knowingly. What it should not do is leave the whole amount open because it has a view on the rupee; a textile exporter is not paid to take currency views.

State the limits. The forward is a firm contract: if the retailer pays a month late, Belvora still owes the bank dollars on the original date and will have to roll the contract, at a cost set by the interest gap at that time. If the order is cancelled, Belvora is left with a currency position it no longer needs, and unwinding it at 85.00 would cost real cash. The bank will also look at Belvora's credit line before writing the forward, because a forward that moves against the company is an exposure the bank carries until the dollars arrive. Regulatory rules on which exposures can be hedged and with what documentation also apply; confirm the current framework with the bank.