Deccan Auto Components: Netting, Money-Market Hedge and the Priced Put
Deccan Auto Components invoices a single German OEM in US dollars. On 1 April its book shows a firm USD 4.2 million receivable due 30 September, a USD 1.8 million payable to a Japanese licensor also due 30 September, and a USD 0.9 million payable due 30 June. The treasurer wants one net hedge, but the licensor's contract expressly bars set-off and is denominated in JPY with the USD settlement figure fixed. Market data: spot ₹83.20/83.45; six-month forward ₹83.90/84.10; three-month forward ₹83.45/83.65; USD six-month borrowing 5.50% and lending 5.25%; INR six-month borrowing 7.25% and lending 7.00% (simple annual rates; six months = half a year). A six-month USD put struck at ₹84.00 is available at ₹0.85 per USD, written on the full USD 2.4 million net figure. The CFO believes the rupee will trade between ₹82 and ₹85.
1. Identify the exposure that can actually be netted and hedged on 30 September, and explain how the 30 June payable and the licensor's no-set-off clause affect the hedge design.
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Available netting
- Same-currency, same-maturity flows: USD 4.2 million receivable less USD 1.8 million payable, both on 30 September → USD 2.4 million net receivable
- The USD 0.9 million payable on 30 June cannot be netted against a 30 September flow: the maturities differ, so there is no genuine offset. It requires its own three-month cover.
Effect of the no-set-off clause
The clause prevents Deccan from extinguishing its obligation to the licensor by contractual set-off; it does not forbid internal netting for hedge-sizing purposes. Economically, Deccan will receive USD from the OEM and pay USD to the licensor on the same day, so it bears FX risk only on the difference. But the hedge quantity is only USD 2.4 million if Deccan is genuinely able to apply the OEM receipt to the licensor invoice. Two conditions must be checked: (i) that incoming funds are not trapped in a different bank or jurisdiction, and (ii) that the OEM receipt cannot be delayed past the licensor's due date. If either fails, Deccan has a gross USD 4.2 million long position and a separate USD 1.8 million short position, and must hedge them separately.
JPY dimension
Because the licensor's USD amount is fixed at settlement, there is no residual JPY/USD translation exposure - the risk is purely USD/INR. Had the invoice been payable in JPY, the JPY would be a second exposure requiring its own forward or a JPY/INR cross-currency hedge.
Hedge design
- Six-month forward or option on USD 2.4 million, and
- Three-month forward on USD 0.9 million, or a 3×6 swap if the payable is likely to slip to September. Using a three-month instrument and rolling it would leave a gap risk that the treasurer should not accept on a known, fixed obligation.
2. Compare a forward hedge with a money-market hedge for the USD 2.4 million net receivable and quantify the difference in rupees.
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Forward hedge
The exporter sells dollars forward; the bank buys at its bid of ₹83.90.
- 2.4 million × 83.90 = ₹201.36 million = ₹20.136 crore
Money-market hedge
The exporter creates a USD liability today equal to the PV of the receivable, converts at spot, and invests in rupees for six months.
- Borrow USD: 2.4 ÷ (1 + 0.055 ÷ 2) = 2.4 ÷ 1.0275 = USD 2.33577 million
- Convert at the spot bid of ₹83.20 → 2.33577 × 83.20 = ₹194.336 million
- Invest for six months at 7.00% p.a.: × (1 + 0.035) = ₹201.138 million = ₹20.1138 crore
Comparison
| Hedge | Rupee inflow |
|---|---|
| Forward | ₹20.1360 crore |
| Money market | ₹20.1138 crore |
| Difference | ₹0.0222 crore (₹2.22 lakh) in favour of the forward |
Reasoning. The two are near-identical because covered interest parity holds in the quotes: the forward points (83.90 vs 83.20 bid, about 0.84%) approximately equal the six-month interest differential (7.00% vs 5.25% lending, about 0.875% less a small bid-ask wedge). The forward wins narrowly because it avoids the USD borrowing spread (5.50% versus 5.25%).
Practical choice. Take the forward: it is an off-balance-sheet, single-transaction hedge with no USD credit line consumed and no drawn-down borrowing capacity. The money-market hedge is worth using only when the company already has cheap USD borrowing capacity or when the forward market is quoted at a larger-than-arbitrage discount.
3. Evaluate the ₹84.00 put against the forward, giving the net rupee outcome at spot rates of ₹82.00, ₹84.00 and ₹86.00 on 30 September, and advise the CFO given his stated view of ₹82–₹85.
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Cost of the option
- Premium = 2.4 million × ₹0.85 = ₹2.04 million = ₹0.204 crore, payable upfront (ignoring its six-month funding cost)
- Net floor if exercised = 84.00 − 0.85 = ₹83.15, versus ₹83.90 on the outright forward
Outcomes on USD 2.4 million (₹ crore)
| Spot on 30 Sep | Unhedged | Forward @ 83.90 | Put @ 84.00, premium 0.85 |
|---|---|---|---|
| ₹82.00 | 19.680 | 20.136 | 2.4 × 84.00 − 0.204 = 19.956 |
| ₹84.00 | 20.160 | 20.136 | 2.4 × 84.00 − 0.204 = 19.956 |
| ₹86.00 | 20.640 | 20.136 | 2.4 × 86.00 − 0.204 = 20.436 |
Break-even against the forward
- 2.4S − 0.204 = 20.136 → 2.4S = 20.340 → S = ₹84.75
The put beats the forward only if the rupee depreciates past ₹84.75, i.e. about 2.0% weaker than the spot mid of ₹83.325 and 1.0% beyond the forward.
Advice
The forward already embeds roughly 0.9% of expected depreciation; the put must beat that plus its own premium. Under the CFO's own view of ₹82–85, the put's best case (₹85) yields 2.4 × 85 − 0.204 = ₹20.196 crore - only ₹6 lakh better than the forward, while its downside is ₹18 lakh worse. The put is not worth buying as a hedge here.
Buy the forward on the USD 2.4 million at ₹83.90 and cover the USD 0.9 million separately at the three-month forward of ₹83.45. Reserve the option for the genuinely uncertain exposure - for example, a bid that may or may not be won - where the company has contingent rather than firm cash flow. If the board insists on retaining some upside, use a participating forward or a collar (buy the ₹84.00 put, sell a call at ₹86.00) and disclose the capped upside rather than paying ₹20.4 lakh of premium.