Forex Hedging - Mark2Market P/L

This is always a confusing topic for me. We see lot of exporters (like Pharma, IT companies) reporting forex losses in their P/L. is forex loss bad for the company ? is forex gain good for the company ? are these real losses/gains or only notional ? why some companies report m2m every qtr whereas some (like astral) report at the year end. on what basis they decide to hedge or not to hedge and how much % of sales to hedge ? what would be the timeframe for hedging contract ? some companies have predictable monthly inflows (like accelya kale) , if they realize the sales revenue pretty quickly , like 1 or 2 months, why would they need to hedge ?

companies can have forex loans, do they hedge these loans ? again how do they decide the % to hedge.

for this example, lets assume no forex loans, its a net exporter, they get the sales realization in 3 months (assumption).

we are in oct’13, USD/INR is 62. we expect the inflows in 3 months. we think rupee will appreciate, we decide to hedge 40% of total sales of 1000 USD. sowe sell USD dec future at 62 (assume spot and future rates are same, negligible interest for 3 months). company ‘thinks’ rupee will appreciate, thats why they sell USD.

Case 1.

now in dec, USD is 64. they get their 1000 USD and close the contract(400 USD). they got 600 x 64 from unhedged dollars and400x62 from hedged dollars totalling 63200 rupees. they show 63200 in sales. because rupee depreciated by 2 rs (from 62 to 64), their m2m loss is 400 x 2 = 800. so they show 800 forex losses. seeing forex loss in P&L, we get negative reaction. this loss came due to rupee depreation, but that popped up the unhedged sales 600 USD by 1200 rupees. so they got a benefit of 1200 rupees in sales and loss of 800 in forex loss. so why worry ?

Case 2

in dec’13, the rupee is at 62. wedont seeforex loss (we are happy), but we got lesser rupees from unhedged dollars. so which is better ? m2m loss of 800 or gain of 1200 in sales ?

Case 3

in dec’13, rupee is at 59 (the original theme of hedging is to protect the dollars from appreciating rupee), we see forex gain of 400x3 = 1200 (we are happy again), but we lost 600x3=1800 rupees from unhedged dollars. so why should we be happy because there is forex gain ?

so is forex loss always bad for the company ? it becomes more tricky when we compare quarter to quarter comparision in stead of year to year (over long period the gains/losses newtralize to some extent).

now lets complicate it a bit more. we hedge for 6 months, we are in ocy’13, sell mar’14 contracts, we expect dollars to come in mar’14. so in oct-dec qtr, we show ‘notional’ m2m losses/gains as we are still holding the contract and also we didnt get the dollars, so no effect on sales. how do they show these ‘notiona’ m2m losses/profits ? versus the actual/real forex losses/gains ? in jan - mar qtr, we get real forex losses/gains as the contract closes, but that also effects the sales. so m2m losses in in oct-dec qtr may actually increase sales in jan-mar qtr.

can some one throw more light on this ? ok, in long run these forex losses/gains dont effect the company much as long as the business grows. but we have seen so many companies screw up this effecting their bottom line (polymed and several pharma, it companies). even if company says we hedge the sales, we dont indulge in specualtion. most companies fail to ‘read’ the situation and take wrong decisions (like selling dollars at 40 rupees 2 years back fearing it goes down to 30-35). they hedge when rupee keeps on depreciating (another mistake, in hindshight). again the percentage of hedging and the duration. these things dont effect the company in long run, but gives better entry points in short run

i am a novice in this, pl excuse me for any mistakes

Hi Bala,

Good initiative. This has always been a pain point for me too. Currently I have similar understanding as explained by you. Hope we get some more experienced ppl to share there view points and we build a solid funda on this topic for good.


Reviving the thread , I was searching how Forex hedging and M2M Profit loss works and came across this thread.Could someone Please help in understanding the above scenarios.