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Mumbai, July 23 (PTI) The Reserve Bank today proposed to withdraw its earlier suggestion to ban zero-cost derivative contracts, a product to hedge against volatility in foreign exchange rates. A company entering into a zero-cost derivative contract with a bank simultaneously buys an option as well as sells another option to the bank. The deal happens in a way where the premium earned from selling an option is used to pay for buying the other option, making it zero-cost for the company. In its revised draft guidelines on Over-the-Counter foreign exchange derivatives, the RBI said, "It is proposed, among others, to allow the use of cost reduction structures, subject to safeguards." Earlier, the RBI had proposed a ban on zero-cost structures in derivatives markets. It reconsidered its position after exporters and importers complained to the RBI that banning such derivative contracts would seriously hurt their forex risk management operations and global competitiveness. The zero-cost structure is a favourite tool for companies to cover their currency risks. It is an inexpensive, attractive, but often complex, derivative. However, many small firms lost huge amounts of money, particularly those with less sophisticated treasury operations. This happens particularly when the contracts depends on a huge amount of borrowing.
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