Ilvani Software earns USD 50 million a year and spends USD 15 million in dollars. How much of its dollar exposure should it hedge, and how much does a one-rupee move change profit before and after hedging 60% of the net exposure?

Hedge the net exposure, USD 35 million, not the gross USD 50 million: the dollar costs are already a natural hedge. Unhedged, profit moves Rs 3.5 crore for every rupee. Selling USD 21 million forward, 60% of the net, leaves USD 14 million open and cuts that to Rs 1.4 crore. Stopping short of 100% leaves room for revenue that does not arrive, which a full hedge would turn into a speculative position.

Think of a family that earns in one currency and spends some of it in the same currency abroad: only the part they convert home is exposed to the exchange rate. Ilvani receives USD 50 million but spends USD 15 million in dollars, so only USD 35 million is converted into rupees and only that amount changes the rupee profit when the rate moves. The dollar costs are a natural hedgeCosts or liabilities in the same currency as revenue, which offset part of the currency exposure without any derivative.: when the rupee weakens, revenue rises in rupees, and so do the dollar bills, by a smaller amount. A hedge sized on the gross USD 50 million would over-hedge by USD 15 million and create a new exposure in the opposite direction.

One rupee on USD 1 million is Rs 10 lakh. On the net USD 35 million, a one-rupee move changes annual operating profit by Rs 3.5 crore, about 5% of the Rs 70.5 crore base; after forwards on 60% of the net, USD 21 million, the open USD 14 million moves profit by Rs 1.4 crore a rupee. A three-rupee strengthening, from 83 to 80, would cost Rs 10.5 crore unhedged and Rs 4.2 crore hedged; a three-rupee weakening would add the same amounts. The hedge gives up upside to buy a narrower range, which is its whole purpose.

Because the USD 35 million is a forecast, not a receivable. If a large client cuts its budget and revenue comes in at USD 40 million, the net exposure falls to USD 25 million, and a 100% hedge of USD 35 million would leave Ilvani short USD 10 million of forwards with no dollars to deliver, a currency bet the board never approved. At 60% the hedge stays inside the exposure even if revenue falls by more than a fifth. Most policies layer it: a higher ratio for the next quarter, where invoices are close to certain, and lower ratios further out, rolled forward each quarter. The remaining 40% is a deliberate choice, and the policy should say why: competitors bear the same rupee, client prices are often renegotiated when the rupee moves a long way, and hedging costs money in documentation and credit lines.

State the limits. The analysis treats the dollar costs as certain, when some, such as onsite salaries, scale with revenue and some do not. It ignores costs and revenue in other currencies, which a real exporter must net separately or translate through a cross rate. The hedge accounting treatment and the documentation needed for the forwards to qualify are rule-based and change from time to time; confirm the current standard with the auditors. And the 60% figure is a policy choice to be justified with the forecast error, not a market convention.