Foreign Exchange Risk Management

Foreign Exchange Risk Management

1. EXECUTIVE SUMMARY

In this report I have tried to study the attitude of Indian corporate towards currency risk management and the problems faced by the companies dealing with their currency exposure which occur as a result of exports or imports or both. The study has also included the problems faced by the banks, the authorised dealers of foreign exchange in India, in managing their forex (foreign exchange) market operation as it has large implication on the corporate currency exposure.

Indian corporate have an attitude of staying away from the currency market. Companies consider hedging as unwanted cost centers. Periods of exchange rate stability bred complacency. Importers are confident that the Central banks shall intervene to halt any rupee decline where a exporters are of the view that rupee has always been over rated and that there is no way that it shall appreciate from the present value. These reason keep them away from hedging their exposures.

Companies which are involved in hedging, go the conservative and orthodox way to hedge their exposure. Many companies surveyed, take forward contracts as tool for hedging their exposure. This is mainly because of lack of awareness and experience. Many of the companies feel that the importance of currency risk management will increase, in coming years but very few of them are making themselves ready to face the situation.

Banks that act as facilitators are also suffering from acute problems. Public sector banks, which control 75% of Indian forex market, have always been under staffed and governed by bureaucratic rules.

The market for derivatives other than forward contracts is very shallow. Many of the banks reason it out to be as a result of corporate reluctance and lack of information and technology. Most of the banks in public sector do not merge the forex and money operation and they do not treat their forex operation as a separate profit centre. This bred inefficiency in their working which has affected the corporate sector.

The corporates have been recommended to look strategically into their exposure and take prudent decision in hedging. This decision should be backed by professional treasurers, an efficient back office and good forecasting techniques. They have been asked to go in for various other derivatives that are flexible and cost effective. The banking sector has been recommended to recruit specialised personnel for the job with latest technology to deal in the market. They should start providing variety of other derivatives to the industry. They should also merge their money market and forex operation and treat is as a separate profit centre.

These all measures will definitely make the forex market deep and vibrant, which will make the work easier for corporates in dealing with the currency exposure.

2. INTRODUCTION

“We have to sleep with one eye open”

Managing director of an Indian company having huge diversified investment across the countries.

The sub-prime crisis emerged in the United States in mid-2007 and spilled over to Europe and other economies. From mid-2007 to mid-2008, the spillovers were relatively modest. The situation began to change in mid-2008. Then, following the bankruptcy of Lehman Brothers in mid-September 2008, developments took a dramatic turn leading to a global financial crisis.

The currencies of many countries, like those of many emerging and developing economies, suffered large depreciations with the onset of the global financial crisis. Collapsing trade and financial flows led to substantial balance of payments gaps, triggering fast depreciations and higher exchange rate volatility. The exchange rate losses varied largely commensurate with the extent and nature of each country's exposure to trade and global financial markets. Countries with floating currencies have faced increasing exchange rate and price volatility, which could also deter long-term investment.

Companies have to set their house in order and give a micro as well as macro look at the currency exposure which they are facing. With increase in volume of business in external sector, companies should make themselves tuned to the dynamics of foreign exchange (currency) market.

2.1 Foreign exchange RISK MANAGEMENT

An asset or a liability or an expected future cash flow stream (whether certain or not) is said to be afflicted with currency risk when currency movement changes (for better or for worse) the home currency value.

There is always a possibility of the exchange rate changing between the home and foreign currencies, interest rate differentials widening and inflationary effects amounting, to an adverse reaction for the expected cash flows. The concept of currency risk also emanates when an investor is planning to diversity his portfolio internationally to improve the risk- return trade off by taking advantage of the relative correlation among risks on assets of different countries. This involves investing in a variety of currencies whose relative values may fluctuate, it involves taking currency risks.

The foreign exchange market is psychological in nature. A large number of transactions are speculative in nature which depends upon expectations of a large number of participants.

People tend to hitch their expectations to one fundamental.

For example, they might look at the money supply in the USA. The logic is that an increase in money supply will result in:

Þ An increase in inflation

Þ FEDERAL BANK squeezing money

Þ Interest rate rising

Þ Dollar becoming more attractive for holding.

But this event of money supply could also lead to a different series of outcomes an shown by the following logic.

According to fisherman equation,

Nominal rate = Real rate + Inflation rate. An increase in inflation would mean the interest rates would be higher. Higher interest rates on bond and equity prices would make them less lucrative and thus lead to a bearish effect. There would be a selling pressure on the dollar and hence the exchange rates would tend to move against the dollar.

Dealings in foreign exchange market is said to be around $ 1000 billion each day. Out of this sizeable chunk of more than 75% is on speculative basis. And this speculation has been pointed out as major cause of the south Asian turmoil.

Since the mid 1970's a potent mix of fast-interlocking market and a revolution in information technology has increased the speed, frequency and magnitude of price changes in the financial markets, which, in turn have multiplied both opportunity and risk for the CFO.

Not, surprisingly, in the developed markets, much innovative energy has been devoted to devising instruments and mechanisms that enable CFO to survive this turbulence. While creative financial engineering has opened the floodgates for a deluge of products, two broad classes of risk management have evolved.

The first deploys a natural hedge to manage exposure to risk. Typically, this means explicitly factoring in risk perceptions when choosing the components of the financing mix. Or, to neutralize exposures in a particular market, a natural hedge could involve taking a counter position in another market. The second class of tools however creates a synthetic hedge by utilizing specific financial instruments. Notably, derivatives.

2.2 Problems in Indian foreign exchange market

Our foreign exchange market suffers from several constraints.

i) There are a lot of ceilings on open positions and gaps and hence there is a virtual absence of market making and position trading.

ii) There is prohibition of initiating transactions in the cross currency in the overseas market.

iii) Besides the forward contracts, there is no free access to the other products like futures, swaps, etc. The market lacks the required liquidity and depth for the derivatives to be economically viable.

3. LITERATURE REVIEW

Foreign Exchange risk management have always been an area look up by people from varied fields, weather literary or profession related matter. For the purpose of this paper I gone through few literary works to understand the whole concept and formulate my paper, a distinct one.

Collier and Davis (1985) in their study about the organization and practice of currency risk management by U.K. multi-national companies. The findings revealed that there is a degree of centralised control of group currency risk management and that formal exposure management policies existed. There was active management of currency transactions risk. The preference was for risk-averse policies, in that automatic policies of closeout were applied.

Batten, Metlor and Wan (1992) focused on foreign exchange risk management practice and product usage of large Australia-based firms. The results indicated that, of the 72 firms covered by the Study, 70% of the firms traded their foreign exchange exposures, acting as foreign exchange risk bearers, in an attempt to optimize company returns. Transaction exposure emerged as the most relevant exposure.

Jesswein et al, (1993) in their study on use of derivatives by U.S. corporations, categorizes foreign exchange risk management products under three generations: Forward contracts belonging to the First Generation; Futures, Options, Futures- Options, Warranties and Swaps belonging to the Second Generation; and Range, Compound Options, Synthetic Products and Foreign Exchange Agreements belong to the Third Generation. The findings of the Study showed that the use of the third generation products was generally less than that of the second-generation products, which was, in turn, less than the use of the first generation products. The use of these risk management products was generally not significantly related to the size of the company, but was significantly related to the company's degree of international involvement.

Phillips (1995) in his study focused on derivative securities and derivative contracts found that organisations of all sizes faced financial risk exposures, indicating a valuable opportunity for using risk management tools. The treasury professionals exhibited selectivity in their use of derivatives for risk management.

Howton and Perfect (1998) in their study examines the pattern of use of derivatives by a large number of U.S. firms and indicated that 60% of firms used some type of derivatives contract and only 36% of the randomly selected firms used derivatives. In both samples, over 90% of the interest rate contracts were swaps, while futures and forward contracts comprised over 80% of currency contracts. Hentschel and Kothari (2000) identify firms that use derivatives. They compare the risk exposure of derivative users to that of nonusers. They find economically small differences in equity return volatility between derivative users and nonusers. They also find that currency hedging has little effect on the currency exposure of firms' equity, even though derivatives use ranges from 0.6% to 64.2% of the firm's assets. Our findings are very important since no previous work has examined the FERM practice in Indian context. This study will be a pioneering attempt in Indian scenario and first of its kind to survey the Indian companies and their risk management practices.

4. RESEARCH METHODOLOGY

OBJECTIVE OF THE RESEARCH

The objective of the research has been to study.

1. The attitude of Indian corporates towards risk arising out of foreign exchange (currency) exposure.

2. The ways and means adopted by banks in helping the corporates deal with their foreign exchange exposure. It would also include the problems and limitations faced by the banks, which ultimately has an affect on corporate exposures.

3. To understand the level of awareness of derivatives and their uses, among the firms.

It has been undertaken to draw inferences which could prove the hypothesis of my study.

It has been much of a preliminary research with the main objective to study the problems faced by the Indian corporates in the currency market. As corporates deal through the banks, the problems faced by the banks also affect the corporates.

DATA ACQUISITION METHOD

The research has been based on data acquired from the various companies and banks in Delhi and NCR.

Data Type consists of facts, motives and opinions have been extracted through open-ended questions and other information though close ended questions.

SOURCES OF DATA

The data has been collected both through primary as well as secondary sources.

(i) Primary Source: - The objective of the primary source data collection has been to extract information on corporate view of their currency risk management and their dealing strategy. Primary data has been collected through self-administered questionnaire, the response of which has been had by interviewing financial executive of various firms and officials from various banks.

(ii) Secondary Sources: - Data through secondary sources have been collected from journals published by Reserve Bank of India and other commercial banks like State Bank of India UTI Bank etc. Internet also provided some important information. The objective of the secondary data collection has been to get consolidated information on the foreign exchange dealings and transactions in India. The usage of secondary data has been minimal in the research.

DATA COLLECTION

Formalized questionnaires were used to collect the data. It contained both open-ended and close-ended questions. Bankers were asked few open-ended questions where as corporates were asked closed ended questions with checklist and multiple choice answers.

SAMPLING METHOD

The universe undertaken for the study are all the Indian companies which have a foreign exchange turnover above Rs. 50 crores per annum and commercial banks which deal in foreign exchange and have been nominated by Reserve Bank of India as Authorised Dealers in foreign exchange. The frame for the population has been companies with forex turnover of above Rs. 50 crores per annum and having their offices in Delhi.

Sample Size: As it was impossible to interview all the elements in the universe, I selected few corporates and banks as my sample size. There were many hindrances in getting appointments with financial executives, which further brought down my sample size. Finally I selected 20 corporates and 6 banks as my sample size.

HYPOTHESIS

The research undertaken has been based on the main assumption that.

“Currency Risk management has very few takers in Indian corporate.”

My contention is that currency risk management is at a nascent stage and has very few corporate dealing with it.

The main hypothesis is backed by the following hypothesis.

Hypothesis - I

* Indian importers do not go in for hedging even when the US dollar is at a premium.

Hypothesis - II

* Indian exporters do no hedge their exposures because of confidence in rupee not appreciating.

Hypothesis - III

* Indian companies going in for hedging are very conservative in their approach to currency risk management.

Hypothesis - IV

* Indian companies are not ready to face the situation, which may arise as a result of opening up of the Indian foreign exchange market.

Hypothesis - V

* Indian banking sector is inefficient in providing flexible hedging solutions to corporate forex exposure.

Hypothesis - VI

* Indian banks do not take currency risk management as a specialised job.

TYPE OF RESEARCH

Descriptive- The research includes a questionnaire survey and it is a fact finding enquiry. And the focus is on finding the views of various respondents (Bank Managers and financial executives of the companies and other qualified people) about trends and details of Currency risk management.

SAMPLE DESIGN

* SAMPLE UNIT: Delhi and NCR region

* SAMPLE SIZE: 20 Companies and 6 Banks

SAMPLE SELECTION: Random, convenient

5. CURRENCY RISK & MANAGEMENT TECHNIQUES

5.1 THE NATURE OF EXPOSURE AND RISK

The value of a firm's assets, liabilities and operating income vary continually in response to changes in economic and financial variables such as exchange rates, interest rates, inflation rates, relative prices and so forth. The impact of every financial decision on the value of the firm is uncertain and various options can be evaluated in terms of their risk return characteristics.

The nature of uncertainty can be illustrated by a number of commonly encountered situations. An appreciation of the value of a foreign currency (or equivalently, a depreciation of the domestic currency)., increases the domestic currency value of a firm's assets and liabilities denominated in the foreign currency receivable and payables, bank deposits and loans etc. It will also change domestic currency cash flows from exports and imports. An increase in interest rates reduces the market value of a portfolio of fixed rate bonds and may increase the cash outflow on account of interest payments. Acceleration in the rate of inflation may increase the value of unsold stocks, the revenue from future sales as well as the future costs of production. Thus the firm is “exposed” to uncertain changes in a number of variables in its environment.

Let us begin with the definition of foreign exchange exposure.

Foreign exchange (Currency) exposure is the sensitivity of the real value of a firm's assets, liabilities or operating income, expressed in its functional currency, to unanticipated changes in exchange rates.

Note the following important points about this definition.

Values of assets, liabilities or operating income are to be denominated in the functional currency of the firm. This is the primary currency of the firm and in which its financial statements are published. For most firms it is the domestic currency of their country.

Exposure is defined with respect to the real values i.e. values adjusted for inflation. While theoretically this is the correct way of assessing exposure, in practice due to the difficulty of dealing with an uncertain inflation rate this adjustment is often ignored i.e. exposure is estimated with reference to changes in nominal values.

The definition stresses that only unanticipated changes in exchange rates are to be considered. The reason is that markets will have already made an allowance for anticipated changes in exchange rates. For instance, an exporter invoicing a foreign buyer in the buyer currency into the price. A lender will adjust the rate of interest charged on the loan to incorporate an allowance for the expected depreciation. From an operational point of view, the question is how do we separate a given change in exchange rate into its anticipated and unanticipated components since only the actual change is observable? One possible answer is to use the forward exchange rate as the exchange rate expected by the “market” to rule at the time the forward contract matures. Thus suppose that the price of a pound sterling in terms of rupees for immediate delivery (the called spot rate) is Rs. 60.000 while the one months forward rate is Rs. 60.20. We can say that the anticipated depreciation of the rupee is 20 paise per pound in one month. If a month later, the spot rate turns out to be Rs. 60.30 there has been an unanticipated depreciation of 10 paise per pound.

In contrast to exposure which is a measure of the response of value to exchange rate changes, foreign exchange risk is defined as:

“The variance of the real domestic currency value of assets, liabilities or operating income attributes to unanticipated changes in exchange rates.”

In other words, risk is a measure of the extent of variability in the values of assets etc. due to unanticipated changes in exchanges rates.

5.2 Classification of Foreign Exchange Exposure and Risk

Three types of foreign exchange exposure and risk can be distinguished depending upon the nature of the exposed item and the purpose of exposure estimation. These are as follows.

Transaction Exposure:

This is a measure of the sensitivity of the home currency value of assets and liabilities which are denominated in foreign currency, to unanticipated changes in exchange rates, when the assets or liabilities are liquidated.

Transaction exposure can arise in different ways:

* A currency has to be converted in order to make or received payment for good s and services.

* A currency has to be converted to repay a loan or make an interest payment (or, conversely, receive a repayment or an interest payments) or.

* A currency has to be converted to make a dividend payment.

* Being one of the parties to an unperformed foreign exchange forward contract.

Process of a “Transaction Exposure”

The process of Transaction exposure includes various types of sub exposures. It starts when a seller quotes price to the buyers for the products or services enquired upon by the buyer. After receiving the quotes buyer place an order with the seller for the desired quantity, it includes the Quotation exposure as the cost of production may vary during the period between which orders has been enquired upon and placed. After that there is possibility of Backlog exposure from the time order has been placed till the time goods has been ready for shipment due to uncontrollable exchange rates fluctuations. The possibility of exchange rate fluctuations cannot be ruled out till the time full and final payment has been received, it leads to presence of billing exposure into the transaction.

Quotation + Backlog + Billing = Transaction

Exposure Exposure Exposure Exposure

Suppose a firm receives an export order. It fixes a price, manufactures the product, makes the shipment and gives 90 days credit to the buyer who will pay in his currency. A company has acquired a foreign currency receivable, which will be liquidated before the next balance sheet date. The exposure affects cash flows during the current accounting period. If the foreign currency has appreciated between the day the receivable was booked on the day the payment

was received, the company makes exchange gain which may have tax implications. In a similar fashion, interest payments and principal repayments due during the accounting period create transaction exposure. Transaction risk can be defined as a measure of uncertainty y in the value of assets and liabilities when they are liquidated.

Translation Exposure:

Also called accounting Exposure is the exposure on assets and liabilities appearing in the balance sheet but yet to be liquidated. Translation risk is the related measure of variability.

The key difference between transaction and translation exposure is that the former involves actual movement of cash while the latter has no direct effect on cash flows. (This is true only if there are no tax effects arising out of translation gains and losses).

Translation exposure arises when a parent multinational company is required to consolidate a foreign subsidiary's statements from its functional currency into the parent's home currency. Thus suppose an Indian company has a U.K subsidiary. At the beginning of the parents financial year the subsidiary has real estate, inventories and cash valued at pound 1,000,000, pound 200,000 & pound 150,000 respectively. The spot rate is Rs. 60 per pound sterling. By the close of the financial year, these have changed to pound 1,200,000, pound 205000 and pound 160,000 respectively. However during the year, there has been a drastic depreciation of the pound to Rs. 56. If the parent is required to translate the subsidiary's balance sheet from pound sterling into rupees at the current exchange rate, it has “suffered” a translation loss. Note that no cash movement is involved since the subsidiary is not to be liquidated. Also note that there must have been a translation gain on the subsidiary's liabilities.

There is broad agreement among theorists that translation losses and gains are only notional accounting losses and gains. The actual numbers will differ according to the accounting practices followed and depending upon the tax laws, there may or may not be tax implications and therefore real gains or losses. Accountants and corporate treasurers however do not fully accept this view. They argue that even though no cash losses or gains are involved, translation does affect the published financial statements and hence may affect market valuation of the parent company's stock. Whether investors indeed suffer from “translation illusion” is an empirical question. Some evidence from studies of the valuation of American multinationals seems to indicate that investors are quite aware of the notional character of these losses and gains and discount them in valuing the stock. for Indian multinational, translation exposure is a relatively less important consideration since the law does not require translation and consolidation of foreign subsidiaries financial statement s with those of the parent companies.

FASB 52 specifies that US firms with foreign operations should provide information disclosing effects of foreign exchange rate changes on the enterprise consolidated financial statements and equity. The following procedure has been followed:

* The current rate is used to translate Assets and liabilities that is the rate prevailing at the time of preparation of consolidated statements. .

* The actual exchange rates prevailing on the date of transactions are used to translate all revenues and expenses. For items occurring numerous times weighted averages for exchange rates can be used.

* Translation adjustments (gains or losses) are not to be charged to the net income of the reporting company. Instead these adjustments are accumulated and reported in a separate account shown in the shareholders equity section of the balance sheet, where they remain until the equity is disposed off.

“Measurement of Translation exposure”

Translation exposure = (Exposed assets less Exposed liabilities) (Change in the exchange rate)

There are Four methods for currency translation:

1. Current rate method

2. Monetary/non-monetary method

3. Temporal method

4. Current/non-current method

Current Rate Method

It is the simplest and the most popular method allover the world. Under this method, all balance sheet and income items are translated at the current rate of exchange, except for stockholders' equity. Income statement items, including depreciation and cost of goods sold, are translated at either the actual exchange rate on the dates the various revenues and expenses were incurred or at the weighted average exchange rate for the period.

Dividends paid are translated at the exchange rate prevailing on the date the payment was made. The common stock account and paid-in-capital accounts are translated at historical rates. Further, gains or losses caused by translation adjustment are not included in the net income but are reported separately and accumulated in a separate equity account known as Cumulative Translation Adjustment (CTA). Thus CTA account helps in balancing the balance sheet balance, since translation gains or loses are not adjusted through the income statement.

The two main advantages of the current rate method are, first, the relative proportions of the individual balance sheet accounts remain the same and hence do not distort the various balance sheet ratios like the debt-equity ratio, current ratio, etc. Second, the variability in reported earnings due to foreign exchange gains or losses is eliminated as the translation gain/ loss is shown in a separate account - the CTA account. The main drawback of the current rate method is that various items in the balance sheet which are recorded at historical costs are translated back into dollars at a different rate.

The Monetary/Non-monetary Method

This method differentiates between monetary and non- monetary items. Monetary items are those that represent a claim to receive or an obligation to pay a fixed amount of foreign currency unit, e.g., cash, accounts receivable, current liabilities, accounts payable and long-term debt.

Non-monetary items are those items that do not represent a claim to receive or an obligation to pay a fixed amount of foreign currency items, e.g., inventory, fixed assets, long-term investments. According to this method, current rate is used to translate all moneary items while historical rates Re used to translate non-monetary items the average exchange rate for the period is used to translate Income statement items, except for items such as depreciation and cost of goods sold that are directly associated with non-monetary assets or liabilities. These accounts are translated at their historical rates.

Temporal Method

This method is a modified version of the monetary/non-monetary method. The only difference is that under the temporal method inventory is usually translated at the historical rate but it can be translated at the current rate if the inventory is shown in the balance sheet at market values. In the monetary/ non-monetary method historical rate is used to translate

inventory. Under the temporal method, an average exchange rate for the period is used to translate income statement items. However, historical rates help in translating cost of goods sold and depreciation

The Current/Non-current Method

It is perhaps the oldest approach. No longer allowable under generally accepted accounting practices in the United States, it was nevertheless widely used prior to the adoption of FAS #8 in 1975. Its popularity gradually waned as other methods were found to give more meaningful results. Under the current/non-current method, home currency at the current exchange rate are used to translate all current assets and current liabilities of foreign affiliates a while non-current assets and non-current liabilities In the balance sheet, net of current assets less current liabilities helps in determining exposure to gains or losses from fluctuating currency values. Gains or losses on long-term assets and liabilities are not shown currently. Items in the income state-ment are generally translated at the average exchange rate for the period covered

Operating Exposure:

Unanticipated exchange rate changes not only affect assets and liabilities but also have significant impact on future cash flows from operations. Operating Exposure is a measure of the sensitivity of future cash flow and profits of a firm to unanticipated exchange rate changes.

Consider a firm that is involved in producing goods for export and or import substitutes. It may also import a part of its raw materials, components etc. A change in exchange rate (s) gives rise to a number of concerns for such a firm.

1. What will be the effect on sales volume if prices are maintained? If prices are changed? Should prices be changed? For instance, a firm exporting to a foreign market might benefit from reducing its foreign currency price to the foreign customers following an appreciation of the foreign currency. A firm that produces import substitutes may contemplate an increase in it domestic currency price to its domestic customers without hurting its sales.

2. Since a part of the inputs are imported, material costs will increase following a depreciation of the home currency.

3. Labour costs may also increase if cost of living increases and wages have to be raised.

4. Interest costs on working capital may rise if in response to depreciation the authorities resort to monetary tightening.

In general, an exchange rate change will affect both future revenues as well as operating costs and hence the operating income. As we will see later, the net effect depends upon the complex interaction of exchange rate changes, relative inflation rates at home and abroad, price elasticities of export and import demand and supply and so forth. Operating exposure and the related risk are extremely difficult to analyse, estimate and hedge against.

5.3 THE INDIAN FOREX MARKET

Indian foreign exchange market as compared with their American and European counterparts is till in its infants. The post liberalisation period has witnessed many exchange controls been lifted and introduction of few “hedging” tools like cross currency option, Range forwards, currency swaps etc. which provide a degree of flexibility to corporates in using the forex markets effectively. The Rupee has been made fully convertible on current account accepting the article VIII status laid down by IMF. This step has seen increased volume of trade in the Indian forex market.

Tarapore committee has put the proposal for capital account convertibility. It proposes to deregulate the foreign exchange by year 2002 in three phases.

5.4 PRESENT STATUS

Exchange control in India is administered by the Reserve Bank of India, which is empowered by the Foreign exchange regulation Act. The shows the players involved in the foreign exchange market from administrative point of view.

Foreign Exchange

Management Act, 1999

Govt. of India

Reserve Bank of India

Foreign Exchange Dealers

Association of India

Authorised Dealers

Authorised Money

Changers

Full Fledged Restricted

Þ Administration of Foreign Exchange in India.

The foreign exchange market in India functions with a three-tier structure which includes (1) Reserve Bank of India, at the apex level, (ii) authorised dealers/money changers conducting foreign exchange trading activities, and (iii) customers which include exporters/importer, corporates and other foreign exchange earners like NRI's etc.

The market is highly influenced by State Bank of India and Reserve Bank of India because of their Sheer Size. The RBI constantly intervenes to keep the rupee from appreciating and is responsible for highly liquid spot market as it is a last resort buyer of dollars.

The forward market in India is fairly liquid and quotes are easily available up to six months. The RBI prohibits any international speculative access to rupee.

The daily turnover in the Indian Foreign exchange market is over US $4.5 trillion that is dominated by dealings in dollars. The foreign exchange reserve of $285 billion provides the market with enough liquidity.

5.5 INDIAN EXCHANGE CONTROLS

Exchange Controls refer to the regulation, restrictions, guidelines that a country issues with respect to foreign exchange transactions. In the absence of any exchange control one would expect to do anything with the foreign exchange reserves that the company has-convert to any other currency, speculate, buy or sell option, freely export foreign exchange etc. etc.

In India, forward contract is the single largest product which the companies employ as a tool to manage their foreign exchange risks, though the cost has changed over the period of time. Before LERMS (liberalised exchange rate management system) importers rushed to book forward contracts expecting a devaluation of Re against US$. The cost was as high as 18% in Feb.'92. The cost of the forward premium came down sharply reflecting a more stable foreign exchange markets.

The Indian exchange market do not provide frequent quotations for ore than 6 months so for any long term forward cover rollover of the contract after every 6 months is needed. Rollover means cancellation of the old contract and re-booking of 6-month forward contract. Under this, care should be taken to cancel the old contract and re-book the next at the time when the cost of rebooking is least i.e. forward dollar is relatively cheap.

Further, in December 1994, RBI has allowed the corporates to bet on the third currency movement even if one does not have an underlying transaction exposure in the “third currency”. This means that a corporate with an underlying exposure in Dollar-Re can bet on the Dm-Dollar rate and book a forward contract for Dm against Re and on the maturity may change Dm to Dollar at the spot rate. This has been allowed as Indian Re has been pegged with US$ and there has not been many fluctuations on which the companies could speculate. There can be other ways to take advantage of this RBI circular. Consider an importer with $ payable after 6 months. He may buy $ forward against Yen (third currency) and after 6 months may buy Yen against Rupee at the spot rate. This position may be taken if the company expects Yen to depreciate against the Dollar within these 6 months. Nevertheless the speculative attempts to earn profits may also backfire to give losses if the exchange rate moves in the opposite direction. RBI has also made it obligatory upon the banks, which extend the third currency cover, to maintain “initial” and “variation” margins before offering such a facility. This has been done to avoid any default risk.

Another peculiar feature of ‘The Indian Exchange Control is that the “hedging” can be put through in case of transaction and translation exposures only. Economic exposures cannot be hedged.

Cross Currency option was introduced on 1st Jan. 1994, under which companies could enter option contract for hedging non-dollar exposure against dollar. As for now Rupee option does not exist in India. Essar Gujarat has been one of the innovative corporates who discovered this new concept and has benefited considerably by writing option in Dm- Dollar in Jan 1994. Indian Exchange controls do not allow cancellation of cross currency options in parts and once the option is cancelled it cannot be re-booked, unlike forwards. In the overseas markets minimum lot traded is $ 3m whereas Indian corporate by for lesser amount, this increases the premium paid by them for the option. Recently, ANZ Grindlay has offered to arrange a loan of $ 50m to Ranbaxy by making effective use of call and put options to defend both the parties against unfavourable movements in exchange rates.

Cross currency forward cover for importers who have taken $ loan for their imports but receive goods invoiced in say a Dm. They can enter forward cover for the delivery of Dm against the currency of loan i.e. -$. This is the cross currency forward cover.

Some of the foreign Exchange controls are that export of foreign currency is not permitted, unless it has special RBI permission. “Exchange controls also they list the permitted currency“ and a method of payment as approved by RBI for translation across the countries. It also contains guidelines relating to “ Foreign currency assets” covering permission as for repatriation of capital profits dividends etc. Exchange controls also allow FC to be retained up 50% (in case of EOU EPZ units) and 25% (in case of ordinary exporters with banks in Indian and also abroad under EEFC a/c and FCA a/c. Exchange controls also state under-invoicing and over-invoicing of exports as a crime attracting penal provisions. Further, all sale proceeds in FC should come into the country within 180 days. RBI permission is required for any extension beyond 180 days. In case of failure to get RBI's nod, the tax and other export incentives are not provided to the exporters.

Further, exchange controls give details and guidelines for different accounts for NRI and foreign investors such as Ordinary Non- Resident Rupee a/c, Non-Resident External; Rupee a/c FCNR (B) a/c etc.

Introduction of complex hedging tools like futures, options is still a long way to go, Recently, the government lifted the ban on futures, option trading in equity (stocks) after 40 years, This could be regarded as a step ahead to come closer to introduction of more complex tools in the currency markets in India. In the near future Standard Chartered plans to introduce rupee-based derivatives in India subject to the clearance and approval by exchange controls, with many companies now making use of different tools effectively, the Indian foreign exchange markets are moving ahead towards more relaxations and towards making the foreign exchange markets more vibrant and versatile, IDBI is one of the most active user of financial derivatives in Indian market. It made considerable savings over the last two year by using the entire range of products available in Indian forex markets.

5.6 FINANCIAL DERIVATIVES USED IN INDIAN MARKET

A derivative instrument is commonly defined as one whose price is derived from an underlying quantity that could be an interest or an exchange rate (in this case exchange rate) we refer to derivatives of money and foreign exchange market prices as “financial derivatives”.

The history of using financial derivatives to hedge foreign exchange exposures by corporates in India is fairly recent. Early 90s' witnessed few foreign currency call options written by some Indian corporates. The limited use and general lack of interest in the available instruments can be explained by the fact that dependence on external sources of funding was very limited and the external sector wasn't really developed.

But after liberalisation and current account convertibility, the whole scenario has changed. Risk management has under gone a paradigm shift, new financial derivatives have been allowed in the market to provide for exposures arising out of increased business activity in the external sector. We shall discuss the various hedging tools is operative.

5.6.1 FORWARD CONTRACTS

The Definition: A forward contract is simply an agreement to buy or sell foreign exchange at a stipulated rate at a specified time in the future. It is a contract calling for settlement beyond the spot date. The time frame can vary from a few days to many years.

Instrument: A forward contract locks you to a particular exchange rate, thereby insulating the CFO from exchange rate fluctuations. In India, the forward contract has been the most popular instrument employed by corporates to cover their exposures, and thereby, offset a known future cash outflow. Forward contracts are usually available only for periods up to 12 months. Forward premiums are governed purely by demand and supply, which provide corporates with arbitrage opportunities. The premiums in this market are quoted till the last working day of the month.

Internationally, the forward premiums or discounts reflect the prevailing interest rate differentials. Arbitrage opportunities are therefore limited. As a rule, a currency with a higher interest rate trades at a discount to a currency with a lower interest state. Since there is a forward market available for longer periods, the forward cover for foreign exchange exposures can stretch up to five years. The premiums or discounts are quoted on a month-to-month basis. That is, from the spot date to exactly one month, or two months, or even a year.

EXAMPLE.A corporate has to make a payment of US $I million on March 31, 2008. They can book a forward contract today, and fix the exchange rate at which he will make the payment. Assuming that the dollar-rupee spot rate is Rs 46.40, and the forward premium on the dollar for delivery on March31. 2008, is Rs 0.30 the effective exchange rate for the remittance becomes Rs 46.70 (46.40+30).

The opportunity cost depends upon future spot rate at settlement.

Shown as

f1 - e1

e0

Where f1 = forward rate

e0 = spot rate

e1 = future spot

For e.g.

G.E, a U.S. based gas turbine equipment unit, has entered into a contract for the sale of a turbine generator to a British firm for the sum of £1,000,000 in March but payment will be made in June.

Further Information

* Spot exchange rate: $1.7640/£.

* Three-month forward rate: $1.7540/£

* G.E's cost of capital: 12%.

* U.K. three-month borrowing and lending rate: 10% (8%) per annum respectively.

* U.S. three-month borrowing and lending rate: 8% (6%) per annum respectively.

Unhedged position

If in June spot rate is $1.76/£, G.E will receive

£1,000000x$1.76/£ = $1,760,000 in June.

However, if the June spot rate turns out to be $1.65/£, then G.E will receive only $1,650,000.

Hedging through Forward Contract

Most direct and popular way to hedge currency risk is a currency forward contract, sell the £1,000,000 forward at $1.75/£ for a guaranteed receipt of $1750, 000 (£1,000,000 x $1.75/£), regardless of what happens to the spot rate.

If £ depreciates to $1.70 (what G.E is worried about), they only receive $1,700,000 for the order (selling at the spot rate), but the profit on the forward contract is $50,000 to make up the difference and G.E nets $1,750,000. If £ appreciates to $1.76, G.E will receive $1,760,000 for the order, but will lose $10,000 on the forward contract, for a net of $1,750,000. No matter what happens to S, G.E will net $1,750,000 with a currency forward hedge, and will lock in ex-rate of $1.75/£.

The Regulations: In March 1992, in order to provide operational freedom to corporates, the unrestricted booking and cancellation of forward contracts, for all genuine exposures, whether trade-related or not, was permitted.

In January 1997, the RBI allowed the banks to quote rupee forward premiums for more than six months. This has resulted in the development of a local forward market for up to one year. However, as the link between the local money market and the foreign exchange markets is not strong, and as prices and determined by demand and supply, activity in the long -term forward market has been limited.

5.6.2 Money Market Contracts

The definition A Market Hedge involves simultaneous borrowing and lending activities in two different currencies to lock in the home currency value of a future foreign currency cash flow. The simultaneous borrowing and lending activities enable a company to create a home-made forward contract. The firm seeking the money market hedge borrows in one currency and exchanges the proceeds for another currency. If the funds to repay the loan are generated from business operation then the money market hedge is covered. Otherwise, if the funds to repay the loan are purchased in the foreign exchange spot market then the money market hedge is uncovered or open.

After Hedging in Money Market

Another strategy for G.E: Borrow for 3 months in the U.K. in pounds @ 10% P.A, with a £1m payoff, convert pounds to USDs at the spot rate, invest in the US and use the £1m receivable from British firm in 3 months to pay off the loan in U.K. and keep the USDs from the payoff in the U.S. money market.

1. Borrow in UK: £1,000,000/ 1.025 = £975,610 today for 3 months @ 10% P.A, pay back £1m in 3 months

2. Convert the pounds into dollars today @S=$1.7640/£, for $1,720,976 (£975,610 x $1.7640/£)

3. The loan proceeds i.e. $1,720,976 can be:

* Invested in T bills at the US rate of 6.0% per annum;

* Used instead of a loan that would have otherwise been taken for working capital needs at the rate of 8.0% per annum;

* Invested in the firm itself, the cost of capital being 12.0% per annum.

Payoff to each alternative:

Alternative Value in 3 Months

T-bill $1,720,976 x £1,015 = $1,746,791

Working capital $1,720,976 x £1,020 = $1,755,396

In the firm $1,720,976 x £1,030 = $1,772,605

4. Collect £1m in 3 months from British firm in UK and pay off the loan in U.K.

5.6.3 FORWARD TO FORWARD/SWAP CONTRACTS

The Definition: A forward -to-forward contract is a swap transaction that involves the simultaneous sale and purchase of one currency for another, where both transactions are forward contracts. It allows the company to take advantage of the forward premium without locking on to the spot rate.

The Instrument: A forward-to-forward contract is a perfect tool for corporates that want to take advantage of the opposite movements in the spot and the forward markets. By locking in the forward premium at a high or low level now, CFOs can defer locking on to the spot rate to the future when they consider the spot rate to be moving in their favour.

However, a forward-to forward contract can have serious cash-flow implications for a corporate. Before booking a forward-to forward contract a CFO should carefully examine his cash flow position bearing in mind the immediate loss that he would make if the spot rate did not move in his favour.

Example. An exporter believes that forward premiums are high, and will move down before the end of December 2009. Also he expects the spot rate to depreciate in the next few months. Then, the optimal strategy would be to lock in the high forward premium now, and defer the spot rate to a future date. So, he opts for a forward-to forward contract for year ending December. 2009, to year ending March of 2010. Paying a premium of say a Rs 0.64 By entering into such a contract the exporter has the opportunity to lock on to the spot rate any time till December 31, 2009. Alternatively, if the three-month premium between end-December and end-March moves below the Rs 0.64 level he can cancel the contract and book his profits.

Forward -to-forward contracts

The SCenario

Company A is due to receive the payment for goods exported three months earlier. Currently, three-month forward premiums are high, but Company A expects the sport rate to depreciate further.

The Instrument

The forward-to-forward pay-off matrix

DS>EF

DS>EF

Lack in the Current Premium By Purchasing A Forward-To-Forward Contact

EF>SF

Better Than Simple Forward, But Worse Than Uncovered Strategy

Optimal Strategy

Choose The Spot Rate Within A Stipulated Time-Period, Thus Determining Effective Forward Rate

SF>EF

Worst Strategy

Better than Uncovered Strategy,

At the end of the months, Convert Export Proceeds to Rupee at the Effective Forward Rate

SF : Simple Forward Rate EF: Forward-to-Forward Rate

DS : Sport Rate at The Time of Delivery

5.6.4 OPTIONS

The Definition: An option is a contract that gives the holder the right, but not the obligation to buy (call) or sell (put) a specified underlying instrument at a fixed price-called the strike-or exercise price before, or at, a future date. The option holder has to compensate the writer (the issuer of the instrument) for this right, and the cost bome is called the premium, or the option price.

The premium should be adequate for the risk bome by the writer and yet, from the holder's point of view, must be worth paying. If the option contains a provision to the effect that it can be exercised any time before the expiry of the contract, it is termed an American contract if it can be exercised only on the expiry date, it is termed a European contract.

The Instrument: Options can be used for hedging currency exposures when a corporate is not sure which way the currency is going to move. By entering into an option contract, the CFO gets the best of both worlds his downside is restricted to the premium that he pays, and he enjoys an unlimited upside. For the buyer of an option, the gains are unlimited and the losses are limited .For the writer of the option, the losses are unlimited and the gains are limited to the extent of the premium he gains.

The value of a currency option consists of two components.

* The intrinsic value, or the amount, by which an option is in the money. A call option whose exercise price is below the current spot price if the underlying instrument, or a put option whose exercise price is above the current spot price of the underlying instrument, is said to be in the money.

* The extrinsic value or the total premium of an option less the intrinsic value. It is also known as the time value or the volatility value. As the expiry time increases, the premium on an option also increases. However, with each passing day the rate of increase in the premium decreases. Conversely, as an option approaches expiry the rate of decline in its extrinsic value increases. The decline is known as the time decay. Therefore, the more volatile a currency, the higher will be its option value.

The Example: Company X is importing machinery for DM I million. At the time the deal was struck, the DM was trading at 1.7600 to the dollar. Payment has to be made by April 30, 1998, The DM has already depreciated to 1.7700, and the company has made a tidy profit. The CFO believes that the dollar will continue to gain against the DM, but he would not like to lose the gains already made. Therefore, he buys an in-the-money DM call option by a paying an upfront premium of 2.01 percent. If on April 30, 1998, the DM is above 1.7900, he will let the option lapse, on the other hand, if the DM is 1,7200 he would exercise the option, and buy DM at the pre-determined rate of 1.7600.

The Regulations: In January 1994. Corporates were permitted to use currency options as hedging products. In the absence of a rupee yield curve, rupee-based currency options were not permitted since the pricing of such options would have been arbitrary. Therefore the banks were allowed to offer only cross currency options on a fully covered basis. And the option could be cancelled only once. CFOS were not permitted to re book options against the same exposure. They could however, hedge the exposure using the forward market.

Currency Options

The Scenario

Company A has to import equipment three months hence but is unsure of which way the dollar-rupee exchange rate will move.

The instrument

The Currency options pay-offs

Purchase A dollar

CallOption By Paying

Upfront Premium



Strike Price ($)

Dollar Appreciations: Do Not Exercise Option And Buy Dollars Spot

Dollar Depreciations: Exercise Option And Buy Dollars At Strike Price

Upfront Premium

5.6.5 CURRENCY SWAPS

The Definition: A currency swap is a legal agreement between two parties to exchange the principal and interest rate obligations or receipts in different currencies. The transaction involves two counter parties who exchange specific amounts of two currencies at the outset, and repay them over time according to a pre determined rule that reflects both the interest payment and the amortisation of the principal amount.

The in vestment currency swaps unable us to exploit their comparative advantge using funds in one currency to obtain savings in other currency. Usually banks with a global presence act as intermediaries in swap transactions, helping to bring together the two parties, sometimes, banks themselves may become counter parties to the swap deal. Alternatively banks can hedge themselves by taking positions in the futures markets.

Currency swaps also permit corporates to switch their loans from a particular currency in another depending on their expectations of the future movement of the currency and interest rates. Thus, it offers tremendous flexibility to CFOs seeking to hedge the risks associated with a particular currency. A CFO no longer has to live with a bad decision; if he has selected a wrong currency for his overseas funding operations a currency swap can do the damage.

The Regulation: from august 1997 the banks have been permitted to offer currency swaps to corporates by booking the transaction overseas, or on a back to back basis. Unwinding from such hedge transactions and the payment of upfront premium, as well as the charges incidental to the transaction can also be effected without the prior approval of the RBI. However, the onus is on the banker to ensure that such hedge transactions are done purely for liability management- and not as stand alone deals.

Example Firm C, in U.S, and Firm D, in European, start a 5 year currency swap for U.S $50 million. Let's assume that the exchange rate is $1.25 per euro at that time (i.e. 1$ = 0.80 euro). Now, the companies would exchange principals. So, firm C pays $50 million, and firm D pays Euro 40 million. This transaction satisfies both companies need for funds in another currency (which is the objective for this swap).

OF-Swaps2bx

Þ Cash flows for a currency swap, Step 1.

Later, at intervals decided in the swap deal, the companies shall exchange interest pays on their principal exchanges. To understand in a simple term, let's assume companies make these payments annually, starting 1 year from the transfer of principal amount.As Firm C has borrowed in Euros, it will pay interest amount in Euros based on a Euro interest rate. Similarly, Firm B has borrowed $ and will pay interest in $, based on a $ interest rate. Here, let's assume the decided-$-denominated interest rate is 8.25%, and the euro-denominated interest rate is 3.5%. Thus, each year, Firm C pays Euro 40,000,000 * 3.50% = Euro 1,400,000 to Firm D. Firm D will pay Firm C $50,000,000 * 8.25% = $4,125,000. If, at the end of 1 year, the exchange rate is $1.40 per euro, then Firm D's payment equals $1,960,000, and Firm C will pay the difference ($4,125,000 - $1,960,000 = $2,165,000).

OF-Swaps3bx

Þ Cash flows for a currency swap, Step 2

At the end of the swap (the date of last interest pays), the companies re-exchange the main principal amounts. These principal payments are not affected by exchange rates at the final swap.

OF-Swaps4bx

Þ Cash flows for a currency swap, Step 3

5.6.6 range forwards

Definition: A rage forward contract involves simultaneous purchase and sale of call and put options on the same principal amount and of the same maturity but at different strike price. Here the hedger pays a premium on Purchase of option and receives a premium on the sale of the option. The net cost of the contract is the difference between the two premiums. The strike price of the two options may be adjusted to bring down the net cost to the hedger even to zero.

Example: Now, let us look at how a range forward is different from a forward cover. An Indian importer has to make a DM payment at the end of three months to a German company. To hedge his risks, the importer can take a three-month forward cover for three months. Assuming that the spot rate of one DM is Rs 23.25, he can take a forward cover at an annualized cost of 9.01 per cent. While he would get no benefit from any up ward movement of the Rs DM rate, he would incur no additional costs if the rate rises above the Rs 23.25 mark. But whatever he the spot rate after three months the importer has an obligation to but DM, at the forward rate. The importer has another option of going for a plain vanilla USD/DM cross currency call option at a price which is nearer to the forward price at say 1,5000. The importer pays a premium of 1.85 per cent for the same. While his down side risk is pegged at the amount of premium paid. He enjoys an unlimited upside gain potential. AS direct rupee options are not allowed in India, the importer needs to cover his dollar exposure by taking a Rs/USD forward cover.

Alternative if the importer feels that the 1.85 per cent premium he pays for a plain vanilla option is higher he can enter into a range forward contract, which would allow him to simultaneously purchase and sell options at different strike prices. In a range forward contract the importer buys a DM call option at a porter buys a DM call option at a strike price of 1,500 and pays a premium of 1.85 per cent for the same In addition to this, he also sells a DM put option at a strike price of 1,5250 and receives a premium of 1,41 percent. As a result, his net hedging costs would therefore, fall to 0.44 percent (1.85 percent minus 1.41 percent). This is the range within which both the parties operate, If on maturity the strike price lies within the range, the option will not be exercised by either of the parties.

This contract is structured in such a way that on maturity if the spot price is below 1.5000 the importer has a right to buy DM at the strike price of 1.5000. This importer by buying an option caps his downside loss at 15000 for which he pays a premium. Similarly if the price on maturity is above 1.5250, the importer has an obligation to buy at the strike price of 1.5250. Hence his gain potential is capped at 1.5250 for which it receives a premium. The importer is protected from adverse rate fluctuations. If the price on maturity is within the range, the importer buys DM at the spot rate.

The Regulation: In September, 1996 the RBI's Exchange Control Manual was amended to allow the banks to offer range forwards to corporates to hedge their foreign exchange exposures, provided that premium paid by the corporate was non negative.

Option exercised

1.5250 ----- Put

R

A

Option Not exercised

G

E

1,500 ------Call

Option exercised

Range Forwards

5.6.7 Ratio-range forwards

A ratio-range forward is a modification of the range forward in a ratio -range forward the importer will sell a put option not for the entire amount but for a part of it. Thus by varying the amount of the put option sold, he can vary the level of participation in the upside gains, If the importer has $10 million exposure, he would buy calls of $ 10 mn but sells puts on only $7 mn. The strike price may be adjusted so that the net out flow of premium is minimized or is zero., This way the importer will not lose the entire upside potential but only a part of it. He thus shares the upside gain potential with the bank. The ratio of sharing or participation will depend on the agreement between the bank and the customers.

5.7 OTHER methods OF EXCHANGE RISK MANAGEMENT

Contractual hedges sometimes fail to give safety net from currency fluctuations due to its temporary protection against exchange rate movement. There are chances where the currency through which international business is done, is not traded in forward or future market. Thus failure of contractual hedge has resulted to other exchange risk management techniques. The different techniques are:

5.7.1 Denomination in Local Currency

The exchange risk can be totally avoided of the transaction is denominated in local currency. In such a case the exchange risk will be borne by the other party to the transaction. For instance, if exports from Indian are invoiced in Indian rupees the obligation of the importer is to pay a fixed sum of rupees. The exporter is not affected by any movement in exchange. The importer, on the other hand, will he bearing the exchange risk entirely. He may have to pay more in terms of the currency of his country if that currency depreciates (or rupee appreciates). Similarly if an import into India is denominated in Indian rupees. The importer is free form exchange risk but it is borne fully by the exporter abroad.

Invoicing in local currency depends upon the relative bargaining capacity of the importer and exporter and the status of the currency in the international market. It may be noted that most of the foreign trade of Indian is denominated in foreign currency especially in currencies like US dollars, pound sterling, Deutsche mark and Japanese Yen. Denomination in rupees was found in trade with countries with which India had entered into bilateral trade agreements.

Denomination of the transaction in the currency of the importer or the exporter puts the other party at a disadvantage. To strike a balance, the transaction may be invoiced partly in the currency of the exporter's country and partly in the currency of the importer's country. Such a measure results only in sharing of the exchange loses between the two parties. It does not completely avoid the exchange risk. Similarly, denominating the transaction in a third currency, which a relatively stable (e.g. export from Indian to Indonesia is denominated neither in rupees nor in rupiah, but in US dollars) will only result spreading the exchange risk between parties.

5.7.2 Foreign Currency Accounts

To a trader who engages in both exports and imports or to a manufacturer exporter who imports sizable portion of raw materials components the exchange risk can be minimised of an account is maintained abroad, in the currency of trade through which all transactions can be routed. The arrangement has a dual advantage for the rule.

i) Since exports can pay for imports he is exposed no exchange risk only for the net balance.

ii) In normal course, the bank will apply baying rate the exports and selling rate for imports with the usual spread between the rates towards margin. The less of exchange in converting from foreign currency into local currency is avoided.

iii) In India under the Exchange Earners Foreign Currency (EEFC) account scheme the beneficiary of an inward remittance is entitled to retain in foreign currency up to 25% of the remittance received. The entitlement is 50% for 100% export oriented units and units in export-processing zones. The account holder can use the balance in this account for all purposes permitted in the exchange control manual, including for imports. Thus the loss of exchange in conversion can be avoided.

Reserve Bank of India permits exporters with good track record and net exchange earning of not loss than Rs 4 crores, to maintain foreign currency accounts or abroad subject to certain terms and conditions. The scheme is explained in the chapter or Export promotion

5.7.3 Leads and Lags

Exporters and importers keep making estimates as to whether the currency will weaken (devalued) or strengthen (revalued) in future. According to these expectations they may like to hasten or postpone the time of receipt or payment of foreign currency. This timing of payment of foreign currency depending upon the expectation of its change in value is know it as “leads and lags.

When the foreign currency is expected to be devalued, the exporter would press for payment earlier than the normal. This is because if the receives payment in foreign currency after devaluation, the amount he receives in rupee terms will be less. On the other hand, when the currency is expected to be revalued, the importer who has to pay in foreign currency would settle the debt earlier than the normal date. There by he would be paying less it terms of rupees when compared to the amount he will have to pay after the expected revaluation materializes. In both the case the exporter importer is said to ‘ lead' the payment.

When the foreign currency is expected to be revalued, the exporters would likes to delay the payments. Nor would they book forward contracts. If they receive payment after the revaluation the value in terms of rupees would be higher. Conversely when the foreign currency is expected to be devalued, the importers would like to delay the payment so that they may pay less in rupee terms, this postponing the payment is know as ‘lag'.

When the foreign currency is facing the threat of devaluation the exporters would secure early payment while importers would delay their payments. There fore, there is an increase in supply and decrease in demand for the foreign currency. This will further aggravate the forces weakening the currency. If the currency faces imminent revaluation exporters postpone payments while importers hasten their payments, the result is that the forces at work its strengthening the currency are further strengthened. Thus, the effect of ‘leads' and lags' is to further aggravate the forces causing change in the exchange rate of the currency.

As per the exchange control regulations in India payments, for exports and imports should be completed within six months from the date of shipment. Therefore the period up to which the exporters and importers can indulge in leads and lags' is restricted to six month.

5.7.4 Cross hedging

We know that a market for forwards, futures contracts and options in hedging of foreign currency is assumed to exist. But this is not true for all cases, especially for small and less developed countries whose currency trading in world business is not so much significant. In this scenario, cross hedging would be the only hedging option available to companies.

The term cross hedging means, it is a form of a safety made in a currency whose value is significantly associated with the value of the currency in which the receivable or payable is denominated. In certain situations, it may be easy to find highly associated currencies, because many less developed countries make an attempt to peg their currency with few major currencies such as $, franc or euro. However, these currencies may not be perfectly correlated because efforts to peg values frequently fail. Suppose, a firm has a payable or a receivable amounts in the currency for a small nation for which there is no strong currency or credit markets. The firm would explore the possibility for this currency to be pegged to the value of some basket of currencies. If peg is not found, the firm shall look at past data of changes in the value of the currency of the less developed country to see if they are correlated with changes in the value of any major currency. The firm would later make forward market agreement, futures contract, money market, or options hedging in this major currency which is most closely linked to the small nation's currency.

The success of Cross-hedging depends on the extent to which the major currencies change over a period along with the minor currency. Cross hedging is certainly not perfect but it may be the only option available for decreasing risk of transaction exposure.

Example Bangladesh TAKAmay be hedged by taking a futures position involving US $. In the event that TAKA begins to falter, there is a good chance that the $ will remain strong and may even begin to experience an upswing inmarket value. As a result, the investor may lose money on TAKA, but the performance of the $helps to offset the loss.

5.7.5 Risk Sharing

A contractual arrangement between the buyer and the seller to share the exposure is called risk sharing contract. These contracts prevail if both parties have long term relations with each other. The contract includes following conditions:

A. Base rate i.e spot rate prevailing at the time of contract.

B. Neutral zone is agreed which is few point positive or negative to the base rate.

Now if the exchange rate crosses the neutral zone, the risk is shared equally by both the parties.

Example A. Base Rate = Rs. 45/ US $

B. Neutral Zone = +1.0/-1.0%

Scenario: $ = Rs 47 for a transaction of US $ 500.Here the Rs. 2 difference will be taken by multiplying with US $ 500. Therefore Rs. 1000 difference will shared by both parties equally. Thus losses are shared in Risk sharing contracts.

5.7.6 Parallel Loan

Popularly known as back-to-back loan or rather credit swap loan, parallel loan are arrangements where the amount of loan moves within the country but it serves the purpose of a cross-border loan. The funds stay within the same nation.

Example:

i. Firm ABC in US has subsidiary in France.

ii. Firm XYZ in France has subsidiary in US

iii. ABC wants to lend to its subsidiary in France while XYZ wants to lend to its subsidiary in US. Both have same amount of US $ 10000.

The above transaction done through international borders will result to different charges and regulations. Here, the French company XYZ lends to the subsidiary of ABC in France by giving it a loan equivalent to US $ 10000 converted into EURO in spot market rate and similarly US Company, ABC lends to subsidiary of XYZ in US the equivalent amount. At the expiry, both the companies will repay to the respective lenders.

. Loan In $ Loan in Euro

Loan in $ Loan in Eur

This technique is difficult for transaction exposure hedging as we need to find firms that has to lend a similar amount for a same maturity period.

6. ANALYSIS

The analysis of has been done on the basis of questions put to the companies and banks to prove the hypothesis.

The analysis of the research has been divided into two parts. The first part of the analysts tries to prove the hypothesis in respect of the importers and exporters and companies involved both in importing and exporting. The second part of the analysis tries to prove the hypothesis taken in respect of banks.

PART I: Analysis of Export Import Units

The distribution of the respondents (companies), according to their status is as follows:

Status

No. Of Respondents

Exporters

9

Importer

7

Both

4

Total

20

Chart 6.1

Foreign Exchange Turnover

The forex turnover of the companies was mostly within Rs. 100 crores. Companies and their forex turnover range are shown in cross tabulation form:

Turnover in (Rs. crores)

Less than 20

20-50

50-100

100 and Above

Total

Status

Only exports

4

3

2

-

9

Only imports

3

3

1

-

7

Both

1

1

-

2

4

Dealing Currency

70% of the companies use dollars as currency for foreign exchange. This proves the dependence of the Indian economy on dollar. Euro and pound follows for behind with 10% each.

Chart 6.2

Currency Exposure

95% of the companies had exposure on revenue account while rest 5% had on both (i.e. current as well as capital) account. No company had its exposure solely on capital account. Capital account, in this context means foreign loan in terms of external commercial borrowings.

Chart 6.3

TESTING OF HYPOTHESIS

The assumption that forms the hypothesis of the project is that currency risk management has very few takers in Indian corporates. This hypothesis has been proved in various steps by taking up the other hypothesis, which together proves the main hypothesis.

HYPOTHESIS - I

The assumption in this hypothesis is that Indian importers do not go in for hedging even when the dollar is at a premium.

The importers face a constant danger of higher cash outflow but they do not try to hedge their risk.

( Note. Here the word ‘importers' is meant for companies that only have foreign currency outflow)

Dynamics: I have tried to prove the hypothesis by asking the respondents (i.e. importers) about the risk policy and their strategy to counter expected higher cash out flow as a result of rupee depreciation that is shown in forward dollar premium. The importers were also asked about their reasons for not going in for hedging. Those who have gone in for hedging have been asked about their hedging strategy.

Analysis:

* 5 out of 7 importers do not hedge their foreign currency outflow.

* These 5 companies have no currency risk policy that justifies their stand.

* Different importers give different reason for not hedging their exposure. They have more than one reason for their stand which has been shown in chart 6.4.

Chart 6.4

· Only 2 out of 7 importers hedged their cash outflow. Both these importers fully hedged their outflow which justified their risk policy of Insurance. Both these companies used forward contracts with the reason that it is convenient to use forward contract.

· 77% of the non-hedgers had, RBI's intervention during rupee depreciation, as one of the reasons.

· 62% of the non-hedgers had forward covers being unnecessary cost, as one of the reasons.

· 72% of the companies with exposure between Rs. 10-20 crores found their exposures insufficient, as one of their reasons.

Hence hypothesis has been accepted.

HYPOTHESIS - II

The assumption in this hypothesis is that Indian exporters do not hedge their exposure because of confidence in rupee not appreciating.

The exporters are sure of rupee not gaining against dollar which is why they do not want to carry out hedging tactics for their exposure.

Dynamics: The exporters have been asked about the risk policy, their strategy towards their currency exposure and how they manage their cash inflow. They have been asked about their reasons for not hedging.

Analysis:

The finding shows that 78% of the exporting has no risk policy. It includes all the companies with turnover between Rs. 10-Rs. 20 crs. The chart 6.5 shows the risk policy of different exporting companies.

Chart 6.5

* 8 out 9 exporters do not hedge their foreign currency inflow. It means 95% of companies involved in exporting stay away from hedging.

* Exporters hedging

* 1

* Exporters not hedging

* 8

* Total

* 9

* The only one exporting company hedges only a part of its exposure. Its strategy is justified by its risk policy of insurance. The company's turnover is over Rs. 50 crores.

* The reasons given by the companies for not hedging are as follows.

Reasons

No. of companies

1. Lack of awareness and confident of rupee not gaining

1

2. Insufficient revenue, unnecessary cost and confident of rupee not gaining

2

3. Unnecessary cost, wants to gain on open position and confident of rupee not gaining

1

4. Unnecessary cost and confident of rupee not gaining

2

5. Confident of rupee not gaining

1

6. Wants to gain through open position and confident of rupee not gaining

2

Total

9

* We can see from the table that the most important reason for companies not going for hedging is the confidence that rupee shall not appreciate. Constant RBI's intervention to check rupee's appreciation has led to exporters keeping themselves away from currency risk management.

Hence the hypothesis has been accepted.

HYPOTHESIS - III

The assumption, which forms the hypothesis, is that the companies going in for hedging are very conservative in their approach to currency risk management.

The companies do not go in for experimentation and cost effective method for hedging.

Dynamics: To prove the hypothesis the hedgers have been questioned about their method of hedging, the reasons for not using instruments other than forward contracts, their participation in the hedging process and their calculation method.

Analysis:

Out of total number of 20 companies only 7 companies go in for hedging. The break up is shown in the following table:

Chart6.6

* 1 out of 7 hedgers go in for complete hedging. The other 6 go in for partial hedging.

* 50% of the hedgers participate in the hedging process along with the banks. The other 50% stay away and leave it to the bank.

* The companies going in for hedging have the following break up in term of exposure.

Chart 6.7

* 50% of the hedgers go in for gross basis strategy for calculating their exposure. The other 50% base their exposure on netting out strategy.

* 75% of the companies involved in both import and export follow netting out strategy for calculation of their exposure.

* All the companies hedging their exposure go in for forward contracts as tool for hedging.

* 37.5% companies take forward contract because it is convenient in their dealing.

* 62.5% do not go in for other derivatives except for forward contracts because of lack of awareness and exposure.

Chart 6.8

* The forecasting techniques which the companies, going in for hedging, use are as follows:

No. Of Companies

Past trends

2

Past trends and sentiments

2

* No of company base its forecasting technique on the fundamentals factors.

The fact that 80% of the companies choose netting out strategy (which is a risky technique) and 62% of the companies are unaware and unexposed or lack experience in adopting other derivatives speaks of the inefficiencies of these companies.

Thus the hypothesis those companies are conservative and inefficient in the dealing has been proved.

Hence the hypothesis has been accepted.

Hypothesis - IV

The assumption forming this hypothesis is that the Indian companies are not ready to face the situation that may arise as a result of opening up of the Indian foreign market i.e. when capital account convertibility shall be brought into play.

Dynamics: The companies have been asked about the importance they accord to their back office. They have been asked about the importance of currency risk management in near future and their strategy to face the situation arising out of the currency exposure in near future.

Analysis:

* Only 2 out of 20 companies have a back office functioning.

* Out of these 2 companies, 1 company has an independent back office functioning and other 1 have merged their front office with the back office.

* Both the companies having independent back office functioning have a forex turnover of over Rs. 100 crores.

* No exporting company has a back office functioning.

* 55% of the companies feel that the importance of currency risk management will increase in the near future, which in a way should increase the importance of back office. The table shows the break-up of the companies.

Chart 6.9

Out of the companies realising the importance of currency risk management only 42.45 % are in the process of equipping their company to face the situation. The break-up of the respondents strategy, who felt the importance of currency risk management shall increase, regarding equipping their offices are :

Status

Yes

No

Total

Exporters

1

2

3

Importers

1

3

4

Both

3

1

4

Total

5

6

* 5 out of 7 importing companies foresee rupee devaluation in the near future.

* Out of these 5 companies only 1 company is in the process of equipping their office to face the situation. Rest other companies are dependent on RBI's intervention.

* The importing companies stand is justified by its opinion that Central bank's intervention does not act as a hindrances in the business. All the importers are of the same view.

From the analysis one can make out that very few companies, which realise the importance of currency risk management, are equipping their office to face the risk, and it is more so for the importing company which foresee rupee devaluation.

Hence, the hypothesis has been accepted.

Part II Analysis on Banking Sector

Analysis is based on the 6 banks from which I got the responses. The banks involved were both from the private sector as well as the public sector. The break up is as follows:

Public sector banks - 4

Private Sector banks - 2

Total - 6

The public sector banks led by the giant State Bank of India dominate the turnover in terms foreign exchange dealing. Chart 6.10 shows the distribution of forex turnover that takes place in the Indian foreign exchange market.

Chart 6.10

HYPOTHESIS - V

The assumption in this hypothesis is that the banking sector is inefficient to provide flexible hedging solution to corporate forex exposure. The banks, because of their organisational and functional problem are not equipped to supply the corporates with optimal solution to the exposure management.

Dynamics: The analysis has been performed by asking the bankers about the derivatives they offer to the corporate. The more variety they offer; the better they are.

Analysis:

For the purposes of analysis, I have taken 6 banks. The derivatives provided by these banks are shown in the table.

Derivatives

Public Sector

Private Sector

Total

1.

Forward contracts

4

2

6

2.

Currency options

1

2

3

3.

Forward to Forward contracts

4

2

6

4.

Range Forwards

2

2

4

5.

Ratio Range forwards

-

-

-

6.

Currency swaps

2

1

3

· No bank is providing ratio range forward as of now.

· Forward and forward-to-forward contracts are the only derivatives used by every bank.

Chart 6.11

* 58% of the banks rely on old technology and do not use state of the art technology D-2000. Out of the non-users 72% are from the public sector which forms a large portion of the total forex dealing in India.

* All the banks feel that inefficient technology acts a hindrance in carrying out business.

From the Analysis, one can make out that the Indian banks are very conservative in their dealings and offer minimal of other derivates. As public sector banks control majority of the forex market their is inefficiency will out weigh the efficiency of private sector banks. Which control only 25% of the market. This proves that over all the banking sector is inefficient in providing the companies with optimal hedging solutions.

Thus the hypothesis has been accepted.

Hypothesis - VI

The assumption forming this hypothesis is that Banks in India do not take currency risk management as a specialized job. The foreign exchange operation is given less of importance as compared to the other operations of the banks.

Dynamics: The banks have been asked about their operations in foreign exchange market and is it merged with the money market as efficient banks have a co-ordination between money market. The banks have also been asked about the importance of their treasury department and their recruitment of specialised personals.

Analysis:

* 50% of the banks have stand-alone forex operation. The other 50% of the banks have merged their forex operation with the money market operation.

The table shows the break-up of both the public sector and private sector banks.

Merged

Independent

Public Sector

2

2

Private sector

1

1

Total

3

3

* Treasury Department in Most of the Public sector banks is not taken as a separate profit centre whereas all the banks in the private sector take the treasury department as a separate profit centre. The break-up is shown in the table.

Separate Profit centre

Merged Unit

Public Sector

2

2

Private Sector

2

-

Total

4

2

* No bank in the public sector recruits specialised personals or conduct training programme for them. On the other hand all private sector banks recruit and train specialised personals for the job.

From the above findings it is clear that operations in the public sector banks are very distorted and orthodox. On the other hand, private sector banks consider their forex department as a profit centre and follow specialised methods to deal in currency risk management. But as public sector banks outweighs the private sector in terms of turnover, its working has a considerable affect on the whole market. So one can say that most of the banks do not take it as a specialised job.

Hence the hypothesis has been accepted.

7. Results and Findings

With completion of this paper it can be made out that most of the companies in India have no risk policy. It includes certain big companies with exposures over Rs 50 crores, many banks, even realising the importance of currency risk management do not take up awareness programmes for exporters and importers with whom they deal. Even those companies, which go in for hedging, opt nothing but forward contracts as the only derivative. The research showed that all the companies who went in for hedging opted for forward contracts 62.5% of the companies going for hedging put the reasons as lack of awareness and exposure for not opting for derivatives other than forward contracts. This reason is justified on their part as the banks that are required to play the father role; them selves are not able to offer much of other derivatives. Banks stay away from these derivatives mainly because of the lack of information technology and also because of their inexperience. This is more so with the public sector banks that have very inefficient and orthodox way of dealing in foreign exchange market. Under staffed and governed by bureaucratic rules, these banks are sometimes not even computerized leave alone using D- 2000, only 2 banks out of 7 in the public sector use D- 2000 technology.

The corporate are also not aware of the importance of back office dealing independently in foreign exchange. 50% of the companies growing for hedging have a bank office functioning. Out of these 50% only half of them have independent back office 50% of the companies hedging work hand in hand with the banks and the other 50% stay away after banking their contracts. These hedgers do not involve themselves in cancellation and re-bookings to gain on the currency movement. They abide by their risk policy of increasing cash flow.

The most astonishing factor is that the importers stay away from the market even when dollar starts climbing up and forward rates goes skyrocketing. This is a gift of controlled forex market. Importers are very much confident of RBI's intervention when rupee starts going down. Most of the importers take it as an unnecessary cost when one knows that RBI has to defend the rupee from sliding.

This reason is also forwarded by the exporters. Exporters are too sure of rupee not gaining which is why they stay away from this market.

Most of the companies who go in for hedging have both inflow and outflow of exchange. These are big companies that involve in import in raw materials and export of finished goods. There companies follow setting out strategy, which is very risky as the times of inflow and outflow are not definite. They normally hedge the balance amount that remains exposed. 55% of the companies feel that RBI‘s intervention in the foreign exchange market acts as a hindrance for the industry. It includes all the companies that are into exporting. On the other hand all importing countries feel that RBI's intervention is justified.

Banks on the other hand have their own problems. The public sector banks are in a very sad situation. They are not able to help the companies the risk management. Comparatively private sector banks are very much efficient and are very flexible in the operation. But as public sector banks dominate the 75% of the market, their inefficiency outweighs the efficiency of private sector banks. Barring state Bank of India and corporation bank, other banks in public sector do not seem to be serious in the foreign exchange operations.

Treasury dept. of foreign banks contribute as much as one third of profits. By contrast at most public sector banks (60% in the research) are not even a separate profit centre. Money market operation is not coordinated with forex market operation which speak of the opportunities lost by banks when either of the market is favourable.

The major reason for all this is the controlled foreign exchange market and bureaucracy in India. These all factors (includes both from corporate and banking sector) have led to the forex market being shallow and distorted. This proves the fact that currency risk management has few takers in Indian economy.

8. LEARNING'S

Ø Understanding of the Foreign Exchange scenario around the globe

Ø The recent trend in the market.

Ø The key drivers that for suitability analyzed by companies having global exposure.

Ø Challenges and Obstacles in Exchange risk management.

Ø Companies and Banks outlook toward hedging the currency risk.

9. CONCLUSION AND RECOMMENDATIONS

The advent of Globalization has witnessed a rapid rise in the quantum of cross border flows involving different currencies, posing challenges of shift from low-risk to high-risk operations in foreign exchange transactions.

In India, regulation has been steadily easing out. Turnover and liquidity in the foreign currency derivative markets has increased, although the use is mainly in shorter maturity contracts of one year or less. Forward and option contracts are the more popular instruments. There are many variants of these derivatives which investment banks across the world specialize in, and as the awareness and demand for these variants increases, RBI would have to revise regulations. For now, Indian companies are actively hedging their foreign exchanges risks with forwards, currency and interest rate swaps and different types of options such as call, put, cross currency and range-barrier options. But still there is lack of exposure among Indian companies about the currency risk management techniques. The use of forward contracts and other similar instruments by Indian firms is also complemented by the absence of a rupee futures exchange in India.

Both the corporate and banks will have an important role in currency market in the coming years of deregulation. With deregulation many more instruments will be available to manage risk.

My recommendation has been divided into two parts:

* Recommendations for corporate

* Recommendation for Banks.

9.1 Recommendations for Corporate.

Awareness about currency risk management is the basic requirement of many Indian corporates. The banks have to take lead in making aware the mid-sized and small sized companies in India. In the India economy it is more so with the importers as rupee is sure to slide against dollars (as shown by recent forward rates). Companies should start building up back offices to deal with foreign exchange.

A forex specialist should maintain the back office. It is not a big cost for companies with forex turnover of above Rs. 50 crores. Currency hedging is a specialised job that requires pragmatism and prudence. Effective hedging should begin with risk recognition that means identifying and measuring exposure. it foreign currency cash flows are both ways one should not merge it or set it off by cancelling the equal amounts. Netting out strategy proves using in situation when foreign exchange inflows may not exactly match that of the outflow. Companies should not go in for complete hedging. It will prove too costly for them. They should involve in selective hedging or partial hedging. The extent of such partial cover will be a function of the risk appetite of the company and its perception of currency movements.

The quantification of future currency movements is key to a successful hedging strategy. Financial executives of the bank and companies should build a range around a benchmark or budgeted rate for forecasting future exchange rate.

Companies having exposure in non -dollar currency are more vulnerable as both rupee -dollar movements and dollar - other currency movements, affect it. It has to be extra cautious and keep a watch on the international market. Companies should take cover even in stable environment as the forward “premium is too lord and probability of the spot rates suddenly shooting past forward rates is higher.

Big corporate who also involve in speculative activities should disentangle hedging and speculative activities by running trading function as an independent profit centre. Safe guards must be put in place to check trading (speculative) loses. First, ironclad limits on the net open position have to be laid down. Secondly, back office functions should be lived off separately/. The front-line activity of trading should not be mingled with the exchanging of contracts and the receipts and payment of money. These are several benefits of such a demarcation of functions. First trader will be forced to adhere to the position forced adhere to the position limits. Second, there will be better monitoring and review of trading activities since an independent department will evaluate trading profits and losses. Third, it will facilitate a tightening of accounting and disclosure norms.

Finally while taking decision on hedging the finance executive should look at the risk of the exposure and the reward from it and so hedge or speculate accordingly. The shows the various matrix of risk and reward.

The risk Management Matrix

High Active

Risk Trading

All Exposure

Left unhedged

Low reward High reward

Selective

Hedging

All exposure

Hedged Low

Risk.

9.2 Recommendations for Banks

All the banks are aware of the challenges that capital account convertibility will throw open but few are moving to accept the challenge. I would recommend the following points that should be adopted by the banks.

* Banks, mostly in public sector, should install Reuters on line information and state of the art D-2000.

* Public sectors banks should do away with bureaucratic rules that are hampering the banks efficiency.

* The banks, especially in public sector should start recruiting specialized dealers from management institutes and also chartered accountants. Public sectors banks should also conduct training for in house dealers to make them aware of the latest techniques.

* The banks money market and forex market operation should be merged so that they gain in either of the markets during currency movement.

* The various branches of the banks should be connected with the latest gadgets so that information is passed on time.

* Public banks should use the system of instituting loss limits and profit targets for each dealer and should do away with instituting stop loss limits for deal sizes.

* Banks should conduct awareness programmes for companies especially for big corporates who do not have independent offices and also for importers.

* Banks should start focusing on learning fundamental fore casting techniques and apply it in their forecasting.

* Banks should have centralized dealing rooms so that similar quotes are available for each branch.

* The dealers in the dealing room should be given more freedom to deal in the market.

* Banks should start using derivatives other than forward contracts more frequently and also make the companies aware of it.

10. LIMITATIONS

* Problem in gathering data from the target respondents.

* Problem in reaching out and convincing people to speak up honestly about the responses filled in for the purpose of survey.

* Meeting with banks finance executives.

References

1. Seth, A.K 2008, “International Financial Management” Page No- 301-347

2. Cummins, David J.; Phillips, Richard D. and Smith, Stephen D. : “Derivatives and Corporate Risk Management: Participation and Volume Decisions in the Insurance Industry” Journal of Risk & Insurance, Vol. 68, Issue 1, pp 51-90, March ( 2001)

3. Batten, Jonathan; Mellor, Robert and Wan,Victor : “Foreign Exchange Risk Management Practices and Products Used by Australian Firms”, Journal of International Business Studies, Third Quarter, pp 557-573 (1993)

4. Phillips, Aaron L., “Derivatives Practices and Instruments Survey”, Financial Management, Summer, Vol. 24, No. 2, pp 115-125 ,(1995)

5. Jeevanandam, C., 2000, Foreign Exchange: Practices and Control, Sultan Chand and Sons, New Delhi, India.

6. Apte, P.G., 2000, International Financial Management, Tata McGraw hills, New Delhi, India.

7. Sivakumar A and Sarkar R, “Corporate Hedging for Foreign Exchange Risk in India” 2008, Page no. – 14-16.

8. Hentschel, L. and S.P. Kothari: Are Corporations Reducing or Taking Risks with Derivatives? Massachusetts Institute of Technology Working Paper July (2000)

Newspapers, Journals & Reports:

* The Economic Times

* Financial Times

* Business Standard

* The Business Line

* Various reports on banking sector by private agencies like Morgan Stanley, PWC etc.

ANNEXURE - A

QUESTIONNAIRE FOR COMPANIES

(Foreign Exchange Risk Management)

Q1. Are you an?

1) Exporter

2) Importer

3) Both

Q2. What is your company's annual turn over (in Crores)?

Less than 20 20-50

50-100 Above 100

Q3. Which currency is mainly used to settle the trade transactions?

1) Dollar

2) Euro

3) Pound

4) Francs

5) Yen

Q4. With respect to your company which of the account is most exposed to foreign currency exposure?

1) Current Account transactions

2) Capital Account Transactions

3) Both

Q5. While entering into foreign contracts do you take into consideration the foreign currency exposure?

1) Yes

2) No

Q6. If yes, whether you take advantage of requisite hedging instrument present in the market to minimize your foreign currency exposure?

1) Yes

2) No

Q7. If yes then how do you hedge your foreign currency exposure?

1) Forward Contract

2) Netting

3) Past Trends

4) Matching

5) Money market contracts

6) Options

7) Any other instrument

Q7. What is the reason behind using a specific type of instrument to hedge foreign currency exposure?

_________________________________________________________

_________________________________________________________________________

Q8. As an Importer If not then please specify the reasons behind not hedging your exposure?

1) Insufficient for hedging

2) Confident of RBI Intervention

3) Unnecessary cost

Q9. As an Exporter If not then please specify the reasons behind not hedging your exposure?

4) Lack of awareness

5) Insufficient for hedging

6) Confident of rupee not gaining

7) Unnecessary cost

Q10. In your view, do you think with global meltdown the pace of Currency risk management would increase?

1) Yes

2) No

Q11. In your outlook what will be the trend of Currency risk management that will follow in the Indian economy?

1) Positive

2) Neutral

3) Negative

Q12. If positive, then are you geared to face the situation arising due to currency risk management?

1) YES

2) NO

Q13. What is the biggest challenge firms counter when dealing with Foreign Exchange Exposure?

1) Compliance control

2) Risk management

3) Tracking payments

4) Country payment formats

Q14. In your view which of the following is most responsible for fueling current risk management in India?

1) Volatile exchange rate fluctuations

2) Globalization

3) Foreign Investments

4) Business operations across borders

Personal Details:

Name:

Organization:

Designation:

E-mail Id/Contact No. :

ANNEXURE - B

QUESTIONNAIRE FOR BANKS

(Foreign Exchange Risk Management)

Q.1. Are you?

1) Public Sector Bank

2) Private Sector Bank

Q2. What instruments do you offer to the corporate to hedge their currency risk exposure?

1) Forward contract

2) Forward-to-Forward contract

3) Currency option

4) Currency swap

5) Range forward

6) More than one instruments

Q.3. Do you treat foreign exchanges transactions as a specialized job?

1) Yes

2) No

Q.4. Do you treat treasury department as a separate profit centre?

1) Yes

2) No

Q5. In your outlook what will be the trend of Currency risk management that will follow in the Indian economy?

1) Positive

2) Neutral

3) Negative

Q6. If positive, then are you geared to face the situation arising due to currency risk management?

1) YES

2) NO

Q7. In your View which of the following is most responsible for fueling current risk management in India?

1) Volatile exchange rate fluctuations

2) Globalization

3) Foreign Investments

4) Business operations across borders

Q8. In your view, do you think with global meltdown the pace of Currency risk management would increase?

1) Yes

2) No

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