L&T hedging Losses: Risk Management or betting Business

Is hedging always beneficial? Ask a Larsen and Toubro (L&T) executive and the answer will come as a big NO.
It has just experienced the disadvantages of international exposures in the commodities markets. Larsen & Toubro, the country’s largest engineering firm, said its Dubai arm could suffer losses of around Rs 200 crore, as its commodity bets have backfired.

The work of L&T is in the field of metal and construction. To hedge away the price fluctuations, L&T took futures positions in the London Metal Exchange (LME) to hedge some of the underlying commodity trades. The underlying and costly assumption made by L&T was that the prices of Zinc and some other base metals will either remain the same or go high, but may not decline. This is the assumption that proved to be costly to the tune of 200 Crore Rs.

Fortunately, L&T had made quite a lot of profit in the past few years by taking futures positions in the name of hedging. Unfortunately, this time their bet turned out to be incorrect.

Contrary to the assumption, the Zinc prices declined. Hence, the long positions that L&T took in futures market turned out to be a loss making venture.

Related: Example of Laker Airline collapse due to costly assumptions

That is the problem when Hedgers become arbitrageurs. As explained in this article about hedging, Hedging should be done for hedging (eliminate the risk or cutting the losses short), not for making profits. It’s easy to be lucky for the first few shots and assume that we can play around in these futures and options instruments and make profits.

However, it all works randomly. Warren Buffet has rightly defined the futures and options instruments as “Weapons of Financial Destruction”.

You don’t know how much you can loose in the F&O business. Ultimately, it’s the investors and shareholders who will suffer the losses due to the these hedging or betting activities of the financial managers of L&T

Table of Contents