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Both importers and exporters run the risk of loss due to
fluctuations in the foreign exchange rates in international
business transactions.
transactions. An exporter who agrees to a certain
price in a foreign currency today may find himself at a loss
after a few months when the actually receives the payment
owing to a fall in the exchange rate of the contracted
currency.. Likewise, an importer¶s fortunes may also swing
currency
up or down with exchange rate movements.
movements.
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Forward
transactions that offer one of the parties to the
transaction an option to set any value date within
a prescribed period.
period. Such options benefit the
party as he may know in advance the precise
date on which he would be able to deliver the
currency.. An option forward contract helps a
currency
company overcome market risk by deciding
today, a price for a foreign exchange transaction
at a future date.
date.
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A currency option
gives the buyer the right, not the obligation, to
exchange two currencies at a fixed rate at a
future point of time.
time. Under this type of option,
the buyer¶s downside risk is eliminated while
retaining the unlimited upside potential
potential.. It is akin
to an insurance policy.
policy. It is an effective µhedging
mechanism¶ that permits exchange rate (strike
price), without an obligation to do so.so. The option
may not be used, if the spot rate is more
favorable than the option¶s strike price.
price. With such
instruments the buyer is protected against an
adverse exchange rate movement while retaining
the ability to benefit from a favorable movement.
movement.
As the name indicates, the party has the option
to deal or not.
not.
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O A currency swap is
defined as an exchange of principal and/or
interest payments on a loan or asset in
one currency for principal and/or interest
payments on equivalent loan or asset in
another currency at pre-
pre-fixed spot/forward
rate agreed on the trade date. date. For
example, a customer in India having a
loan in USD may enter into a currency
swap in order to hedge its USD interest
rate risk as well as the USD/INR exchange
risk.. Under this type of swap, the client
risk
may cover either only interest payment or
principal repayment or both.
both.
In India | also offers a special
scheme called |
to provide
protection from exchange rate
fluctuations to exporters of capital
equipments, civil engineering
contractors, and consultants who
have to receive payments over a
period of years for their exports,
construction works, or services.
services.