Cash-Spot is one of the lesser known technical concepts in the forex market. Nothing earth shattering, really, but it is always good to know the technical details of the market we operate in. The forex rates that we see in the normal course, quoted on the screens, in forecasts or in the papers, are all Spot rates (unless specifically mentioned otherwise) and do not pertain to today. Strange? To explain a little clearly, we introduce a few definitions, alongwith examples.

In simpler terms: Spot Date = Trade Date + 2 working days.   Cash Rate = Spot Rate minus Cash-Spot Difference.

Depends on Interest Rates

In the case of Dollar-Rupee, the Cash Rate is usually lower than the Spot Rate in the same way that the Spot Rate is usually lower than a Forward Rate. In other words, compared to the Spot Rate, the Cash rate is usually at a Discount, whereas the Forward rate is usually at a Premium. Note: any date after the Spot date is a Forward date.

The Cash-Spot market is largely a high-volume interbank market as it is based upon banks borrowing in one currency and lending in the other, usually to meet overnight reserve requirements. Thus, the Cash-Spot Difference depends on the difference between the Overnight or Call rates between the two currencies concerned.

If there is a holiday, or a couple of holidays (as over the weekend) between the Cash and Spot dates, then also the T+2 definition applies. In such case the Cash-Spot difference understandably increases.

Market Timings

The Cash-Spot market usually operates between 9.00 AM and 11.30 AM, with some stray deals being done till 12.00 Noon.

Is the Cash-Spot quoted?

Yes, the Cash-Spot and Cash-Tom rates are quoted on most forex rate services such as Reuters, Bloomberg, Newswire 18 and Tickerplant. We also report it daily in the Forward Rate Sheet that is sent out by e-mail to the subscribers of our daily Rupee Update service.

What does it mean for Exporters?

When an Exporter sells Dollars to a bank at the Spot Rate (say 55.95), he should get a credit into his Rupee account on the Spot date. If he insists on a credit on the transaction date (Cash date), the bank may well deduct the Cash-Spot difference (say 2 paise) and credit his account at the Cash rate, say 55.93. So, as a general rule, an Exporter should not insist on a same day credit.

What does it mean for Importers?

When an Importer buys Dollars from a bank at the Spot Rate, his Rupee account ought to be debited on the Spot date, and not on the transaction date. This is something that the Importer should be careful about and check on a regular basis. On the other hand, it may be good for the Importer to pay for the Dollars at the Cash rate as it would be cheaper than the Spot rate. In such case a debit on the transaction date would be justified.

Every activity has a budget

Hedging forex risk is a necessary part of business. This realization is slowly dawning on more and more companies now, thanks to the sharp increase in Rupee volatility. However, the understanding and belief is not fully entrenched yet. But, thankfully, it is slowly seeping in.

Still, no one has yet started setting aside an explicit budget for hedging. Budgets are duly allocated for even mundane activities like cleaning the staff toilets, for tea and biscuits for visitors, for stationery. And, of course, there are budgets for manufacturing and marketing and for salary payments. But, there are no budgets for forex hedging. It’s almost as if hedging is supposed to be costless.

Why is there no Hedging Cost Budget?

How much to budget? And, is it worth it?

Good questions. From our experience of hedging Dollar-Rupee risk through the KSHITIJ Hedging Method over the last 6 years, we’d say that a company should budget about 3-4% of its exposure as hedging cost. And, if that sounds like a very expensive proportion, let us assure you that it is worth it. If you hedge systematically, say as per the KSHITIJ Hedging Method, you stand to save or gain about 1% of your exposure, after accounting for the hedging cost.

In other words, hedging can give you a gross benefit of 4-5% and a net benefit of about 1% over and above the hedging cost.

Is it really necessary?

We would say, yes, it is necessary to explicitly sanction a Hedging Cost Budget. By doing so, you explicitly recognize hedging as a necessary and legitimate business activity; and you commit yourself to the act of hedging.

As soon as you’ve done that, you’ve taken the first step towards success in hedging!

To know more about hedging, its costs and how to go about it, you can write to us at info@kshitij.com

Forex risk management is a frustrating experience for most companies. There seem to be a thousand things that can go wrong at any time – the economy, the market, the forecasts, the regulations, the shipment and payment dates – and generally they do seem to go wrong all together, all the time, every time. If by any chance, or maybe by design, there is profit in any one year, it does not seem to last. Losses, when they inevitably come, tend to wipe out the profits of earlier years. Little wonder that most companies tend to give up on forex risk management in disgust, saying, “Forex is not our business!”

We disagree. Forex is very much the business of every importer and exporter. And, tackled with a common sense business approach, it can even add to the bottomline instead of constantly subtracting from it. But, that is material for another article. In this article, we shall look at how companies generally deal with forex risk management, and what problems they face.

Method 1 – Do nothing

The most common way to deal with forex risk, of course, is to wish it away, to do nothing. But sadly, as the School of Hard Knocks has taught all of us, avoiding a problem, turning a blind eye to it never works in the long run.

Method 2a – Hedge 100% on Day 1 with Forwards

The second most common way to deal with the issue is to hedge away the forex risk, by closing the original exposure or position straight away, usually with a forward contract, so that the risk is eliminated. This is a simplistic solution, commonly prescribed by textbooks and “purists” who espouse the belief that “forex is not your business.” The implicit suggestion is that the company is incapable of managing forex risk.

The problem with this method is that although risk is eliminated no doubt, one ends up sacrificing all potential profit as well. An associated problem with this method is that it is easy to adopt for the exporter who earns the forward premium, but is difficult for the importer who has to pay the same premium.

Method 2b – Selective hedging with Forwards

A variation to this method is to hedge sometimes and not to hedge at other times, based on the available market forecasts.

The problem with this method is that one doesn’t know whether the forecast is going to be right or wrong. One cannot have an idea of the chances of success. In case the forecast is prepared by the internal risk management team of the company, there is an additional risk of the forecast turning out to be biased. For instance, there’s a danger that an importer will be biased towards a weaker Dollar while an exporter would say that the Dollar is going to rise. In this, it helps to take a forecast from an external, professional forecaster, whose work is considered reliable. For instance, 72% of our forecasts are reliable.

Method 3 – Hedge exclusively through Options

The third, much less common way to hedge against forex risk is to use Options as the hedging tool, rather than the forward contract. This is a better way, no doubt, but it is still not the best way. The benefit of course, is that Options allow the company to partake of potential profit if the market moves in its favour, while eliminating the risk of an unfavourable move. It is, in a manner, the best of both worlds. The sad part is that options tend to be costly and are profitable only in trending markets. Further, most companies, especially exporters (who are used to receiving forward premium) do not have a hedging cost budget, which would enable them to pay the premium for buying options.

What is the way out?

Very well, we’ve pointed out the flaws in all the common risk management methods. Does this mean there’s no hope for beleaguered company managements? Thankfully, there is definitely a way out, and it works. In fact, it has worked for the last six years in various market conditions. We call it the KSHITIJ Hedging Method. It is built on common sense business principles and has been formulated after years of experience and trial and error.

Most importantly, it rejects the fatalistic belief that “forex is not my business.” Instead we believe that forex is very much the business of every importer and exporter. And, there is no business issue that cannot be dealt with efficiently if approached proactively. The KSHITIJ Hedging Method is built on the belief that something proper can definitely be done in forex risk management, that the effort is not destined for failure.