Ashish faces exchange rate risk arising from the fact that his earnings are in rupees and his expenses towards his children’s education will be in dollars. Any appreciation in the rupee will work in his favour, while depreciation will increase the cost of education. Ashish may not be able to forecast the direction of the exchange rate correctly, thanks to the global uncertainty. He should, therefore, not try to speculate the value of the rupee. Currency derivatives may turn out to be a risky choice not suitable for his longer term horizon of four to five years. Trying to time the markets might create problems if the rupee appreciates. He has a clear need, therefore hedging is a better alternative. He needs to consider ways to earn dollar income from rupee investments.
International investing might be a good choice. He may like to look at investing in dollar denominated bonds, ETFs and products. Foreign investments can provide a potent buffer against rupee depreciation. When the rupee slides against the currency of an international market where you have invested, you can get more rupees per unit of the currency invested and the net asset value (NAV) rises. Similarly, when the rupee ascends, the NAV decreases. For instance, an investment of $2,000 in a stock when 1 $= Rs.80 would mean his cost of investment in the native currency is Rs.1,60,000. In a scenario when the exchange rate increases to Rs.90, Ashish’s investment will be valued at Rs.1,80,000. Thus, he would have made a profit of Rs.20,000 from merely currency fluctuations.
Ashish may also like to look at international funds that invest in global markets. He should be careful not to choose risky international investments. Some invest in a few countries or themes and may carry equity and country risks. Some of these international funds are global only in name and may invest up to 65% in India to provide tax benefits to their investors. Some funds have high costs and a very small size too. Ashish should choose with a focus on his need to earn dollar income that will help manage his currency risk.
Content on this page is courtesy Centre for Investment Education and Learning (CIEL).
Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.