Forex Risk Management by Indian firms


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  • In this mode, the central bank would play an important role of keeping national trade accounts and a place to safe-keep gold. When India trades with China for example, the gold accounting is kept through the medium of central bank and only the net difference between the two is settled periodically. Hence every transaction in essence involves gold movement. However since bilateral and multilateral trades are ongoing processes, any gold that needs to be settled can always be brought forward and used for future transactions and settlements. On the ground, commercial banks that support gold accounts seem a viable partner in the implementation of the gold dinar. International trade participants - individuals, businessmen, corporations and traders - would deal with commercial banks that provide such gold accounts. These commercial banks would in turn deal with the central bank for their respective gold accounts.As an example, consider that India exports 100 bullion gold worth of goods and services to China while importing 80 bullion worth of goods and services. Hence India has a surplus trade of 20 bullion. China needs to settle only this difference of 20 bullion. However, this amount could be used for settling future trade imbalances between the countries and hence a physical gold movement between the countries is not necessary. This simple structure completely eliminates exchange rate risk. Even though international gold price may fluctuate, the participants realize that they have something that has intrinsic value that can be used for stable and continuous trade into the future. Therefore, even though with the existence of other national currencies, speculation and arbitrage on gold price could tempt a participating country to redeem or sell its gold, it should resist such temptation for the sake stability of future trades. At this juncture, one may ask the question, how does this structure differ from a simple barter trade between the countries? The advantage is that gold acts as unit of account and this eliminates problems associated with barter. This simple gold payment system has numerous advantages:1. Foreign exchange risk is totally eliminated. This means there is no need for forward, futures or options on the currencies of the participating countries. Here the hedging cost is fixed against gold, but note that even if hedging is done to fix the cash flow in any currency there is still risk in the fluctuation of that currency. Gold is superior here because it has intrinsic value. 2. Reduced currency speculation and arbitrage between the currencies. For example, if three countries agree to use the gold payment system, then it is akin that the three currencies become a single currency. Then speculation and arbitrage among these three currencies will be very much reduced. This unification of the three currencies through the gold dinar provides diversification benefits. It is like obtaining diversification through a portfolio of stocks. Individual currencies face risks that are unique to the issuer country. For example a political turmoil can cause a national currency to depreciate. But in a unified currency such unique risks would be diversified away. In fact, since people of all race, creed and nationalitytreasure gold, gold is a global currency that enjoys global diversification. This means no single country’s unique risk may be significantly embedded in gold. 3. Low transaction costs since only accounting records need to be kept. Transactions can be executed by means of electronic medium for which some commissions are charged. The cost of such electronic transactions is generally low. Hence for international trades in this system, one no longer needs to open a Letter of Credit (LC) with a bank, incur exchange rate transaction costs or even face exchange rate risk. 4. The gold dinar reduces the need to create a significant amount of national currencies through the banking sector. This therefore highly reduces the possibility of future attacks on the Ringgit like the one in 1997.  5. Since the gold accounts are kept internally through commercial banks and central bank, transactions costs would not incur a gold outflow from the country.
  • Infosys revenue in dollar terms grew by35% in2008, while it grew just by 19% in INR (functionalcurrency of Infosys). Infosys notionally lost around Rs.2000 crores in revenue and Rs. 1000crores in net profit.Infosys received 98.4% of its revenues from export, making it very much vulnerable tofluctuations in foreign exchange rates. The table below list the revenues from differentgeographieInfosys hedges its foreign currency risk in different currencies as different currencies do notappreciate/depreciate similarly. For ex while US Dollar appreciated 11.2% against INR,U.KPound appreciated only 6.4% and Euro appreciated just 1.8%Infosys uses forwards and options (including exotic options) to hedge its currency risk. Infosysoutstanding options & forward contracts as on31 March2008 are as followingobserve change in hedging strategy of Infosys with shift towards using forwards contractand using less of Options, specially decline in use of Range Barri
  • Forex Risk Management by Indian firms

    1. 1. Managing Forex Risk – Indian Firms <br />
    2. 2. 1<br />Value Addition<br />Practical Aspects <br />Indian Firms <br />Strategies<br />Suggestions <br />Variants of Options <br />
    3. 3. 2<br />Foreign Exchange Risk Management <br />External<br />Futures<br />Forwards<br />Options<br />Swaps<br />Gold Dinar <br />Transfer Pricing <br />Back to Back Loan<br />Internal <br />Multilateral & Bilateral Netting<br />Leading & Lagging<br />Invoicing<br />Sourcing<br />Borrowing & Lending<br />Commodity Hedging<br />Matching<br />
    4. 4. Internal <br />3<br />Creating a natural hedge - Netting<br />Invoicingin the home currency<br />Currency diversification<br />Leading and lagging FX transactions<br />Counter-trade and currency offsets<br />Mark-ups<br />
    5. 5. Trend<br />4<br />
    6. 6. 5<br />CONTRACTS <br />Protects from Currency appreciation and depreciation both<br />BIOCON entered into a contract at 50 with a right to participate at upper side.<br />
    7. 7. Ranbaxy <br />6<br />
    8. 8. What Went Wrong ?<br />7<br />
    9. 9. The Strategy Used<br />8<br />
    10. 10. Ranbaxy – Analysis of Strategy<br />9<br />
    11. 11. When the value of underlying declines!!<br />10<br />
    12. 12. 11<br />When the value of underlying increases!!<br />11<br />
    13. 13. Ranbaxy – Proposed Solution<br />12<br />Buy a “CALL” option<br />Write a “PUT” option<br />
    14. 14. Gold Dinar – To Rescue <br />13<br />
    15. 15. Case of Aggressive Hedging<br />14<br />
    16. 16. Cont…<br />15<br />
    17. 17. SUGGESTION<br />16<br />Back-2-Back Loan hedging<br />For e.g.: Infosys wants to buy into a project in US that will repay the investment and earnings in Dollars over the next N years. <br />If it can identify an US company that wants to make a similarly sized investment in the India , it can arrange offsetting loan.<br />Under this arrangement, the companies are entering into a purely bilateral arrangement outside the scope of the foreign exchange markets. <br />Neither company is affected by exchange rate fluctuations. <br />Nevertheless, both companies remain exposed to default risk because the obligation of one company is not avoided by the failure of the other company to repay its loan.<br />
    18. 18. 17<br />Flavors of Options <br />
    19. 19. Hhh<br />Basket Option<br />Cheaper method for multinational corporations to receive/sell a basket of several currencies for one specified currency. <br />An example would be MacDonald's buying a basket option involving Indian rupees and British pounds in exchange for U.S. dollars.<br />Contingent Premium<br />European option<br />The premium will be paid if the contingent premium option finishes "in the money".<br />Otherwise, if the option expires "at the money" then, no premium will be paid.<br />Chooser Option<br />Purchased by paying up-front premium.<br />Path dependent option.<br />The terminal value of Chooser Option depends on the value of the underlie.<br />18<br />
    20. 20. Hhh<br />Compound Option<br />Option on an Option.<br />Compound Options are associated with two expiration dates and two strike prices.<br />Compound Option carries two types of option premiums. <br />Advantage: Allow for large leverage and are cheaper than straight options. <br />Ratchet Option<br />Also known as cliquet option.<br />Series of money options, with periodic settlement and resetting the strike value.<br /><ul><li>Regular Ratchet Options
    21. 21. Compound Ratchet Options</li></ul>Rainbow Option<br />Connected to more than two or two underlying assets. <br />Rainbow options may be used as instruments for hedging uncertainties pertaining to multiple assets.<br />19<br />
    22. 22. Barrier Options<br />There are single and double barrier options.<br />Is cheaper than plain vanilla option.<br />Basically of four types:<br /> > Up and in.<br /> >Up and out.<br /> >Down and in.<br /> >Down and Out.<br />
    23. 23. Knock-out:<br />Will be knocked out when the trigger price is reached, before the expiration date.<br />For call option, the trigger is set below the spot rate.<br />For put option, the trigger is set above the spot rate.<br />Premium gets cheaper as barrier gets closer to the spot rate.<br />
    24. 24. Knock-in:<br />Will be knocked in when the trigger price is met before the expiration date.<br />have an additional conditional component that cheapens the price of the premium.<br />The further the barrier to the spot rate, the cheaper the premium.<br />
    25. 25. Advantages & disadvantages of both Knock-In and Knock-out option<br />
    26. 26. Asian option:<br />Invented by David Spaughton and Mark Standish.<br />Reduced risk of market manipulation.<br />Is calculated by calculating underlier's average value through a specific period during the entire option life. <br />
    27. 27. Average option:<br />Pays out difference between its predetermined strike price and the spot rate of the underlying.<br />Average price/rate option:<br />Value is based on the difference between the strike and the average price of the underlying.<br />