How Indian Businesses Use Derivatives for Hedging: A Simple Breakdown

Learning how Indian businesses protect themselves from market risks
Indian businesses work in a very unstable environment, where commodity prices change, currencies move in ways that are hard to predict, and interest rates go up and down. These changes can have a big effect on costs, revenues, and how well the business does financially.

Companies use derivatives to deal with these unknowns. Derivatives are financial instruments whose value comes from an underlying asset, like currency, commodities, interest rates, or indices.

This article explains in detail how Indian companies use derivatives to protect themselves, using easy-to-understand examples that are relevant to the real world.

1. What is hedging, and why do companies do it?
Hedging means protecting against risk.
Hedging is when you buy a derivative contract to protect yourself from price changes that could happen in the future.

Why Businesses Hedge
To keep cash flows steady
To keep profit margins safe
To make sure that costs are predictable
To lower the risk of global and domestic instability
Hedging isn't about making money; it's about not losing money.

2. The kinds of risks that Indian businesses hedge
Indian businesses usually protect themselves from these four big risks:

Risk of currency changes (fluctuations in foreign exchange)
Risk of commodity prices (metals, crude oil, and agricultural goods)
Risk of Interest Rates (changes in the cost of borrowing)
Equity/Market Risk (for companies with a lot of shares)
Let's look at each one in more depth.

3. Currency Hedging is the most common type.
Indian companies that buy or sell goods often protect themselves against changes in currency rates.
Events around the world, crude oil prices, FII flows, and central bank actions can all cause the rupee to change.

Who Needs to Hedge Their Currency?
IT companies like Infosys and TCS make money in USD.
Textile, pharmaceutical, and auto exporters
Importers are businesses that bring in goods from other countries, like oil refineries and electronics makers.
Tools for hedging common currencies
Contracts for the Future
A business agrees to trade money at a set rate in the future.
Easy
OTC-based Very popular in India
For example, an Indian exporter wants to be paid $1 million after three months.
If the USD/INR rate goes down, so does revenue.
So they use a forward contract to lock in the rate for today.
This makes sure that the money stays steady.

Currency Futures (USD/INR Futures on NSE/MCX-SX)
An alternative to forwards that can be traded on an exchange.
For example, a company that imports machinery worth $5 million buys USD/INR futures to protect itself from the value of the rupee going down.

Options for Currency
Companies buy or sell options to protect themselves from currency risk in a flexible way.
For example, an airline buys USD call options to protect itself from the rising dollar when it pays for leasing planes.

4. Commodity Hedging—Used by Producers and Manufacturers
Commodity derivatives are very important for Indian companies that have to deal with raw material costs.

Who protects commodity prices?
IOC, BPCL, and Reliance are oil refiners.
Companies that make metals (Hindalco, Tata Steel)
Companies that make jewelry (Titan, Kalyan)
Food and drink makers (like Nestle and ITC)
Common tools for hedging commodities
Futures for commodities (MCX, NCDEX)
Options for Commodities
OTC swaps with banks
How It Works: The Metal Industry
Tata Steel gets iron ore and coal from other countries. If the prices of goods around the world go up a lot, the cost of their inputs goes up too.
So they use iron ore index swaps and coal futures to lock in prices and keep their profits safe.

Example: Gold Hedging in the Jewelry Business
Jewelry companies buy gold futures to lock in prices for the future and avoid sudden price jumps.

5. Interest Rate Hedging: To Keep Borrowing Costs Low
Companies with big loans are affected by changing interest rates.

Who Uses It?
Companies that build infrastructure
Banks and non-bank financial companies
People who build homes
Businesses that sell bonds
Tools for Hedging Interest Rates
Interest Rate Swaps (IRS)
Forward Rate Agreements (FRAs)
Interest Rate Futures, but not very popular in India
For example, an interest rate swap
A business that has floating-rate debt (linked to MCLR) is worried that interest rates will go up.
In order to change its floating-rate loan into a fixed-rate loan, it enters into a swap.
Stability in paying back loans
Shield against rising interest rates

6. Equity Hedging—Used by Companies and Investors with Portfolios
Companies that own a lot of stocks, like mutual funds, banks, and insurance companies, protect themselves from market risk.

Tools for Hedging
Futures for Nifty or Sensex
Futures for stocks
Options: protective puts and covered calls
For example, hedging a portfolio
A fund manager has ₹200 crore worth of Indian stocks.
They buy Nifty put options when the markets seem unstable.
The gains from the put option make up for the losses in the portfolio if the market goes down.

7. How Indian companies decide whether or not to hedge
Some important things to think about are:

Size of Exposure
More exposure means you need more hedging.

Changes in the market
When the dollar, crude oil, or interest rates are unstable, hedging is very important.

Risk Appetite
Some businesses protect all of their risk, while others only protect some of it.

Cost vs. Benefit
Options are very safe, but they can be pricey.

Rules and guidelines from SEBI and RBI
These set limits and acceptable derivative instruments.

8. Real-life examples of Indian businesses using hedging
Infosys, TCS, and Wipro: Use forwards and options to protect USD receivables.
Airlines like IndiGo and SpiceJet hedge their aviation turbine fuel (ATF) and currencies.
Oil companies (IOC, BPCL): Protect themselves from changes in crude oil and the US dollar.
Jewelry companies: Use MCX futures to protect against changes in the price of gold.
Banks: Use interest rate swaps to protect bond portfolios.
9. Advantages of Hedging for Indian Businesses
Earnings that are easy to guess
Protection from changes in the market
Better planning and budgeting for money
Stable profit margins
Less likely to have money problems
An edge over the competition in pricing
Hedging lets businesses focus on what they do best instead of worrying about prices going up and down.

Last Thoughts
Derivatives may seem complicated, but they are very important for Indian businesses to manage risk and keep their finances stable.
Derivatives help businesses stay safe in a market that is not always clear. For example, a software exporter can hedge its USD revenue, and a jewelry store can hedge its gold prices.