A study on Foreign Exchange Rate Volatility in India and Use of Technical Analysis in Hedging the Exposure

Abstract

International trade is riskier than the domestic trade, due to many reasons. The most important risk is the exchange rate risk and the resultant exposure. Any risk management tool like hedging is costlier often, if all the transaction exposures are hedged. The importers have to hedge only when the local currency depreciates, and the exporters when it appreciates otherwise hedging cost is an added burden and will be substantial, and will erode the profit. In India, the volatilities of the Foreign Exchange rates of major currencies are very high, for example, the Euro depreciated 9.59% during 2000 but appreciated by 14.69% during 2003, and GB Pound depreciated 3.42% during 2005, appreciated by 4.28% during 2006 and again depreciated by 0.16% by August 2007. These volatilities are due to many factors like fluctuations in FII, FDI, interest rate differentials between the countries, inflation rates etc. The need of the hour is the forecasting accuracy of the exchange rates to decide what to hedge and what not; when to hedge and when not. This paper deals with the Foreign Exchange rate movements in India for the major currencies like US dollar, GB Pound Sterling, Euro and Japanese Yen from 1999 to August 2007 and attempts to give solutions to this exchange rate challenge using Technical Analysis.