Apr, 10, 2012 By Vikram Murarka 0 comments
One of the most agonizing difficulties commonly faced by the risk manager is not knowing where the market is likely to go. This makes it nearly impossible for him to decide whether to hedge or not to hedge. To put an end to his indecision, and not knowing what to do, he often leaves the exposure unhedged. His line of thought is, "Who knows whether taking a hedge will be right or wrong? It is better not to do anything. Who will take the blame if things go wrong?" Very often, the CFO/ CEO/ MD also agree with the risk manager, coming up with a number of justifications for the decision.
The strategy of inaction works well enough if the market is either stable or is moving in favour of the exposure. Unfortunately, the happy state of affairs does not last forever and the risk manager often ends up hedging in a state of panic when the market starts to go against him.
Underlying the above practice are two misconceptions:
However, the seasoned risk manager knows that it is not possible to strike the tops and bottoms of the acceptable average rate for the hedge. The simple trick he employs is to hedge the exposure in parts instead of as a whole. He might break up the exposure into 3 parts, or 4 parts or even 10-12 parts, and then proceed to hedge each part at different rates and at different times in the market.
Since the hedges are undertaken at regular intervals, when the risk manager follows this strategy consistently over a sufficiently long period, he gets several benefits, as enumerated below:
Further, it has been our experience that in the hands of a skilled risk manager, this strategy can go so far as to help the company achieve an average realization rate that is better than the average market rate.
So, remember, do not leave your exposure totally unhedged, do not cover it fully at one go. Try and hedge in steps.
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