Exporter's USD Receivable: Forward vs Option Hedge
An exporter customer will receive USD 2.00 million in 90 days and asks the bank's treasury to protect the INR value. The spot rate is 83.20 INR/USD. The 90-day INR interest rate is 6.75% per annum and the 90-day USD interest rate is 5.25% per annum, on a 365-day basis. The bank quotes a 90-day outright forward at 83.50. It also offers a 90-day USD put/INR call option with a strike of 83.50; the premium is 0.60% of the USD notional, payable upfront in INR. The customer's board has approved hedging but requires that the hedged INR amount not fall below ₹16.50 crore. The customer is worried that the rupee may strengthen to 82.00 and wants to retain some upside. The treasury manager must check whether the forward is fairly priced, compare the forward with the option on a worst-case and break-even basis, and recommend a structure. Assume the customer can borrow INR at 7.00% to pay the option premium if needed.
1. Compute the fair 90-day forward using covered interest parity and assess the bank's quote of 83.50.
Read the worked answer
Fair forward = spot × (1 + INR rate × 90/365) / (1 + USD rate × 90/365). INR factor = 1 + 0.0675 × 0.246575 = 1.016644. USD factor = 1 + 0.0525 × 0.246575 = 1.012945. Fair forward = 83.20 × 1.016644/1.012945 = 83.20 × 1.003651 = 83.5038. The bank's quote of 83.50 is 0.0038 below fair, about 0.005%, which is within a normal bid-offer spread. It is not materially mispriced. The forward locks INR 2,000,000 × 83.50 = ₹16.70 crore.
2. Compute the option's worst-case net INR proceeds after funding the premium, and compare with the forward. Does it meet the board floor?
Read the worked answer
Premium = 0.60% × USD 2,000,000 × 83.20 = 0.006 × ₹16.64 crore = ₹9.984 lakh. Funded for 90 days at 7%: future value = 9.984 × (1 + 0.07 × 90/365) = 9.984 × 1.01726 = ₹10.156 lakh. Worst case for the exporter is rupee strengthening below 83.50; the put is exercised and USD are sold at 83.50. Gross INR = ₹16.70 crore; net = 16.70 − 0.10156 = ₹16.5984 crore, or about ₹16.60 crore. This is above the board floor of ₹16.50 crore by about ₹9.84 lakh. The forward gives ₹16.70 crore, about ₹10.16 lakh more, but no upside. At a spot of 82.00, the option still nets ₹16.5984 crore, so the floor holds.
3. At what maturity spot does the option beat the forward? Recommend a hedging choice given the customer's upside preference and the board floor.
Read the worked answer
For maturity spot S ≥ 83.50, the option expires and net INR = 2,000,000 × S − ₹10.156 lakh. Set this equal to the forward's ₹16.70 crore: 2,000,000S = 16.80156 crore, so S = 84.0078. The option beats the forward only if the rupee weakens beyond about 84.01. Between 83.50 and 84.01, the forward is better. Below 83.50, the option floor is ₹16.5984 crore versus the forward's ₹16.70 crore, so the option costs about ₹10.16 lakh for insurance. Given the customer's wish to retain upside and the board floor of ₹16.50 crore, the 83.50 put is suitable: it guarantees about ₹16.60 crore net and keeps upside above 84.01. If the customer wants to reduce the premium, a collar - buy the 83.50 put and sell a call at 84.50 - could be structured, but the cap must be disclosed and stress-tested against the board floor.