Hopes of strong dollar boost forward premia

MUMBAI: The cost of hedging against foreign currency risks has seen a sudden rise. A spurt in short-term yields, coupled with tightening of liquidity conditions and importers purchasing the greenback to cover open positions have caused a sharp rise in forward premia.

Even as the rupee grew stronger to end the day at 45.42/43 vis-a-vis the dollar, the yield on the one-month forward premia has risen to 1.79%, while that on the one-year premia ended at 1.55%. The yield on the annualised six-month premia, which witnesses maximum activity from importers, rose to 1.67%, 17 basis points higher than Friday’s levels of 1.50%.

Buyers of foreign currency pay a premium or discount, depending on the view they take on the future course of the currency in order to hedge the risks associated with the price of the currency. A view that the rupee will weaken further implies that the buyer will pay a premium to avoid losses on paying higher amount for the currency. Despite the rupee strengthening over the past week, forward premia have risen due to liquidity conditions and rising yields.

The rupee on Monday ended marginally lower on account of dollar-buying by oil companies, but dealers were of the opinion that the dollar’s weakness globally limited the rupee’s losses. The rupee ended at 45.425/435 per dollar, marginally lower than the previous close of 45.41/42.

There was a sharp dip in the amount of funds absorbed by RBI through its reverse repo operations on Monday. As compared to Friday’s outstanding amount of Rs 18,275 crore, the central bank managed to mop up bids barely worth Rs 2,875 crore in its liquidity adjustment operations.

Call rates on Monday closed at 6.60-6.70%, after having risen to 6.80% during the day. According to a senior treasury official, drying up of liquidity conditions is customary before Diwali, wherein though consumer spending rises, shopkeepers seldom seem to deposit cash with banks.

Market participants are, hence, keeping away from taking fresh positions in government securities and actually seen squaring off positions, a treasury official informed. The rise in gilt yields also translates into higher premia paid on forward contracts.

Yields in the government securities market rose on fears of a rate hike later this month, considering the rise in levels of inflation. The yield on the benchmark 7.59% 2016 paper closed at 7.67%, up from Friday’s close of 7.63%.