Tech Mahindra LimitedProfit/Loss on Account of Forex ExposureThe Company enters into Foreign Exchange Forward Contracts and CurrencyOption Contracts to offset the foreign currency risk arising from the amountsdenominated in currencies other than the Indian rupee. The counter party to theCompany’s foreign currency Forward Contracts and Currency Option Contracts isgenerally a bank. These contracts are entered into to hedge the foreign currencyrisks of certain forecasted transactions. Forward Exchange Contracts and CurrencyOption Contracts in UK Pound exposure are split into two legs, which are GBP toUSD and USD to INR. These contracts are for a period between 1 day and 4 years.The following are the outstanding GBP:USD Currency Exchange Contracts enteredinto by the company which have been designated as Cash Flow Hedges as at March31, 2010:The following are the outstanding USD:INR Currency Exchange Contracts enteredinto by the company which have been designated as Cash Flow Hedges as at March31, 2010:Forex Profit against total profit is 10.75 %
Quarter to Quarter Profit/LossHedging Policy of the companyForeign currency transactions:Transactions in foreign currencies are recorded at the exchange rates prevailing onthe date of transaction. Monetary items are translated at the year end rates. Theexchange difference between the rate prevailing on the date of transaction and onthe date of settlement as also on translation of monetary items at the end of theyear/period is recognised as income or expense, as the case may be. Any premiumor discount arising at the inception of the forward exchange contract is recognized asincome or expense over the life of the contract, except in the case where thecontract is designated as a cash flow hedge.Derivative instruments and hedge accounting:The Company uses foreign currency forward contracts / options to hedge its risksassociated with foreign currency fluctuations relating to certain forecastedtransactions. Effective April 1, 2007 the Companydesignates some of these as cash flow hedges applying the recognition andmeasurement principles set out in the Accounting Standard 30 “FinancialInstruments: Recognition and Measurements”(AS-30). The use of foreign currencyforward contracts/options is governed by the Company’s policies approved by theboard of directors, which provide written principles on the use of such financialderivatives consistent with the Company’s risk management strategy. The counterparty to the Company’s foreign currency forward contracts is generally a bank. TheCompany does not use derivative financial instruments for speculative purposes.Foreign currency forward contract/option derivative instruments are initiallymeasured at fair value and are re-measured at subsequent reporting dates. Changesin the fair value of these derivatives that are designated and effective as hedges offuture cash flows are recognized directly in reserves and the ineffective portion isrecognized immediately in Profit and Loss Account. The accumulated gains and
losses on the derivatives in reserves are transferred to Profit and Loss Account inthe same period in which gains or losses on the item hedged are recognized in Profitand Loss Account. Changes in the fair value of derivative financial instruments thatdo not qualify for hedge accounting are recognized in the Profit and Loss Account asthey arise. Hedge accounting is discontinued when the hedging instrument expiresor is sold, terminated or exercised or no longer qualifies for hedge accounting. Whenhedge accounting is discontinued for a cash flow hedge, the net gain or loss willremain in reserves and be reclassified to Profit and Loss Account in the same periodor periods during which the formerly hedged transaction is reported in Profit andLoss Account. If a hedged transaction is no longer expected to occur, the netcumulative gain or loss recognized in reserves is transferred to Profit and LossAccount.Split of RevenueDuring the year, 58.6% of your Company’s revenue came from Europe, 29.4% camefrom USA and 12.0% came from Rest of the World (ROW) in which 4.6 % came fromIndia.As the country operates majorly in UK and rest of Europe, the 2 currencies whichdominates are GBP and EURO.Exchange rate risks ForecastThe exchange rate between the Indian rupee and the British pound and the rupeeand the U.S. dollar has changed substantially in last year and may continue tofluctuate significantly in the future. The value of the rupee as on March 31, 2010against the British pound appreciated by approx 4% and against U.S. dollar byapprox 11% over March 31, 2009. Accordingly, our operating results have been andwill continue to be impacted by fluctuations in the exchange rate between the Indianrupee and the British pound and the Indian rupee and the U.S. dollar, as well asexchange rates with other foreign currencies. Any strengthening of the Indian rupeeagainst the British pound, the U.S. dollar or other foreign currencies could adverselyaffect our profitability.
OracleProfit/Loss on Account of Forex ExposureThe following table includes the U.S. Dollar equivalent of cash, cash equivalents andmarketable securities denominated in certain major foreign currencies as of May 31,2010:If overall foreign currency exchange rates in comparison to the U.S. Dollar weakenedby 10%, the amount of cash, cash equivalents and marketable securities we wouldreport in U.S. Dollars would increase by approximately $695 million, assumingconstant foreign currency cash, cash equivalent and marketable securities balances.Quarter to Quarter Profit/LossHedging Policy of the companyWe transact business in various foreign currencies and are subject to risksassociated with the effects of certain foreign currency exposures. We have a
program that primarily utilizes foreign currency forward contracts to offset these risksassociated with foreign currency exposures. Our program may be suspended fromtime to time.This program was active for the majority of fiscal 2010 and was suspended duringour fourth quarter of fiscal 2010. When this program is active, we enter into foreigncurrency forward contracts so that increases or decreases in our foreign currencyexposures are offset by gains or losses on the foreign currency forward contracts inorder to mitigate the risks and volatility associated with our foreign currencytransactions. Our foreign currency exposures typically arise from intercompanysublicense fees and other intercompany transactions that are expected to be cashsettled in the near term. Although we have suspended our historical foreign currencyforward contract program as of May 31, 2010, our subsidiaries continue to enter intocross-currency transactions and create cross-currency exposures via intercompanyarrangements and we expect that these transactions and exposures will continue.Our ultimate realized gain or loss with respect to currency fluctuations will generallydepend on the size and type of cross-currency transactions that we enter into, thecurrency exchange rates associated with these exposures and changes in thoserates, whether we have entered into foreign currency forward contracts to offsetthese exposures and other factors.Historically, we have neither used these foreign currency forward contracts fortrading purposes nor have designated these forward contracts as hedginginstruments pursuant to ASC 815. Accordingly, we recorded the fair value of thesecontracts as of the end of our reporting period to our consolidated balance sheet withchanges in fair value recorded in our consolidated statement of operations. Thebalance sheet classification for the fair values of these forward contracts was prepaidexpenses and other current assets for unrealized gains and other current liabilitiesfor unrealized losses. The statement of operations classification for the fair values ofthese forward contracts was non-operating income (expense), net, for both realizedand unrealized gains and losses. As of May 31, 2010, we had a nominal amount offoreign currency forward contracts outstanding. As of May 31, 2009, the notionalamounts of the forward contracts we held to purchase and sell U.S. Dollars inexchange for other major international currencies were $860 million and $1.1 billion,respectively, and the notional amounts of the foreign currency forward contracts weheld to purchase European Euros in exchange for other major internationalcurrencies were €142 million ($198 million).
Split of RevenueDisclosed in the table below is geographic information for each country thatcomprised greater than three percent of our total revenues for fiscal 2010, 2009 or2008.Exchange rate risks ForecastForeign Currency Transaction RiskWe transact business in various foreign currencies and are subject to risksassociated with the effects of certain foreign currency exposures. We have aprogram that primarily utilizes foreign currency forward contracts to offset theserisks. Our program may be suspended from time to time. This program was active forthe majority of fiscal 2010 and was suspended during our fourth quarter of fiscal2010. When the program is active, we enter into foreign currency forward contractsso that increases or decreases in our foreign currency exposures are offset by gainsor losses on the foreign currency forward contracts in order to mitigate the risks andvolatility associated with our foreign currency transactions. Our foreign currencyexposures typically arise from intercompany sublicense fees and other intercompanytransactions that are expected to be cash settled in the near term.Although we have suspended our historical foreign currency forward contractprogram as of May 31, 2010, our subsidiaries continue to enter into cross-currencytransactions and create cross-currency exposures via intercompany arrangementsand we expect that these transactions and exposures will continue. Our ultimaterealized gain or loss with respect to currency fluctuations will generally depend onthe size and type of cross currency transactions that we enter into, the currencyexchange rates associated with these exposures and changes in those rates,whether we have entered into foreign currency forward contracts to offset theseexposures and other factors.Historically, we have not used foreign currency forward contracts for tradingpurposes and have not designated these forward contracts as hedging instrumentspursuant to ASC 815. Accordingly, we have recorded the fair value of these historicalcontracts as of the end of our reporting period to our consolidated balance sheet withchanges in fair value recorded to non-operating income (expense), net in ourconsolidated statement of operations. As of May 31, 2010, we estimate that certainof our U.S. Dollar and Euro functional subsidiaries have the equivalent of
approximately $2.0 billion and approximately €410 million (approximately $500million) of net intercompany receivables whereby the amounts to be received bythese subsidiaries are in currencies other than U.S. Dollars or Euros, respectively,and are therefore subject to remeasurement as of each balance sheet date. As ofMay 31, 2010, we have no financial instruments in place to mitigate the risksassociated with these foreign currency exposures. If overall foreign currencyexchange rates weaken (strengthen) against both the U.S. Dollar and Euro by 10%,we estimate that we would incur approximately $250 million of remeasurementlosses (gains) in connection with these intercompany balances assuming thebalances remained constant with those as of May 31, 2010. Net foreign exchangetransaction (losses) gains included in non-operating income (expense), net in theaccompanying consolidated statements of operations were $(149) million, $(65)million and $17 million in fiscal 2010, 2009 and 2008, respectively. Included in thenet foreign exchange transaction losses for fiscal 2010 were foreign currency lossesrelating to our Venezuelan subsidiary’s operations, which are more thoroughlydescribed under “Non-Operating Income (Expense), net” in Management’sDiscussion and Analysis of Financial Condition and Results of Operations above. Asa large portion of our consolidated operations are international, we could experienceadditional foreign currency volatility in the future, the amounts and timing of whichmay vary.Foreign Currency Translation RiskFluctuations in foreign currencies impact the amount of total assets and liabilities thatwe report for our foreign subsidiaries upon the translation of these amounts into U.S.Dollars. In particular, the amount of cash, cash equivalents and marketablesecurities that we report in U.S. Dollars for a significant portion of the cash held bythese subsidiaries is subject to translation variance caused by changes in foreigncurrency exchange rates as of the end of each respective reporting period (the offsetto which is recorded to accumulated other comprehensive income on ourconsolidated balance sheet). Periodically, we hedge net assets of certaininternational subsidiaries from foreign currency exposure and provide a discussion in“Foreign Currency Net Investment Risk” below.As the U.S. Dollar fluctuated against certain international currencies as of the end offiscal 2010, the amount of cash, cash equivalents and marketable securities that wereported in U.S. Dollars for these subsidiaries as of May 31, 2010 declined relative towhat we would have reported using a constant currency rate as of May 31, 2009. Asreported in our consolidated statements of cash flows, the estimated effect ofexchange rate changes on our reported cash and cash equivalents balances in U.S.Dollars for fiscal 2010, 2009 and 2008 was a (decrease) increase of $(107) million,$(501) million, and $437 million, respectively.Foreign Currency Net Investment RiskPeriodically, we hedge net assets of certain of our international subsidiaries usingforeign currency forward contracts to offset the translation and economic exposuresrelated to our foreign currency-based investments in these subsidiaries. Thesecontracts have been designated as net investment hedges pursuant to ASC 815. Weentered into these net investment hedges for all of fiscal 2009 and the majority of
fiscal 2010. We suspended this program during our fourth quarter of fiscal 2010 and,as of May 31, 2010, we have no contracts outstanding.We used the spot method to measure the effectiveness of our net investmenthedges. Under this method for each reporting period, the change in fair value of theforward contracts attributable to the changes in spot exchange rates (the effectiveportion) was reported in accumulated other comprehensive income on ourconsolidated balance sheet and the remaining change in fair value of the forwardcontract (the ineffective portion, if any) was recognized in non-operating income(expense), net, in our consolidated statement of operations. We recordedsettlements under these forward contracts in a similar manner. The fair values ofboth the effective and ineffective portions were recorded to our consolidated balancesheet as prepaid expenses and other current assets for amounts receivable from thecounterparties or other current liabilities for amounts payable to the counterparties.Net gains (losses) on our net investment hedges reported in stockholders’ equity, netof tax effects, were $(131) million, $(41) million and $(53) million in fiscal 2010, 2009and 2008, respectively. Net gains on our net investment hedges reported in non-operating income (expense), net were $1 million, $10 million and $23 million in fiscal2010, 2009 and 2008, respectively.Discussion on Hedging PolicyThe move from a fixed exchange rate system to a market determined one as well asthe development of derivatives markets in India have followed with the liberalizationof the economy since 1992. In this context, the market for hedging instruments is stillin its developing stages. In order to understand the alternative hedging strategiesthat Indian firms can adopt, it is important to understand the regulatory framework forthe use of derivatives here.The recent period has witnessed amplified volatility in the INR-US exchange rates inthe backdrop of the sub-prime crisis in the US and increased dollar-inflows into theIndian stock markets. In this context, the paper has attempted to study the choice ofinstruments adopted by prominent firms to stem their foreign exchange exposures.All the data for this has been compiled from the 2006-2007 Annual Reports of therespective companies. A summary of the foreign exchange risk hedging behaviour ofselect Indian firms is given in Table 1.
From Table 1, it can be seen that earnings of all the firms are linked to either USdollar, Euro or Pound as firms transact primarily in these foreign currencies globally.Forward contracts are commonly used and among these firms, Ranbaxy and RILdepend heavily on these contracts for their hedging requirements. As discussedearlier, forwards contracts can be tailored to the exact needs of the firm and thiscould be the reason for their popularity. The tailorability is a consideration as itenables the firms to match their exposures in an exact manner compared toexchange traded derivatives like futures that are standardised where exact matchingis difficult.RIL, Maruti Udyog and Mahindra and Mahindra are the only firms using currencyswaps. Swap usage is a long term strategy for hedging and suggests that theplanning horizons for these companies are longer than those of other firms. Thesebusinesses, by nature involve longer gestation periods and higher initial capitaloutlays and this could explain their long planning horizons.
Another observation is that TCS prefers to hedge its exposure to the US Dollarthrough options rather than forwards. This strategy has been observed among manyfirms recently in India11. This has been adopted due to the marked high volatility ofthe US Dollar against the Rupee. Options are more profitable instruments in volatileconditions as they offer unlimited upside profitability while hedging the downside riskwhereas there is a risk with forwards if the expectation of the exchange rate (theguess) is wrong as firms lose out on some profit. The use of Range barrier optionsby Infosys also suggests a strategy to tackle the high volatility of the dollar exchangerates. Software firms have a limited domestic market and rely on exports for themajor part of their revenues and hence require additional flexibility in hedging whenthe volatility is high. Another implication of this is that their planning horizons areshorter compared to capital intensive firms.It is evident that most Indian firms use forwards and options to hedge their foreigncurrency exposure. This implies that these firms chose short-term measures tohedge as opposed to foreign debt. This preference is possibly a consequence oftheir costs being in Rupees, the absence of a Rupee futures exchange in India andcurbs on foreign debt. It also follows that most of these firms behave like NetExporters and are adversely affected by appreciation of the local currency. There area few firms which have import liabilities which would be adversely affected by Rupeedepreciation.However it must be pointed out that the data set considered for this study does notindicate how the use of foreign debt by these firms hedges their exposures to foreignexchange risk and whether such a strategy is used as a substitute or complement tohedging with derivatives.ConclusionDerivative use for hedging is only to increase due to the increased global linkagesand volatile exchange rates. Firms need to look at instituting a sound riskmanagement system and also need to formulate their hedging strategy that suitstheir specific firm characteristics and exposures.In India, regulation has been steadily eased and turnover and liquidity in the foreigncurrency derivative markets has increased, although the use is mainly in shortermaturity contracts of one year or less. Forward and option contracts are the morepopular instruments. Regulators had initially only allowed certain banks to deal in thismarket however now corporates can also write option contracts. There are manyvariants of these derivatives which investment banks across the world specialize in,and as the awareness and demand for these variants increases, RBI would have torevise regulations.For now, Indian companies are actively hedging their foreign exchanges risks withforwards, currency and interest rate swaps and different types of options such ascall, put, cross currency and range-barrier options. The high use of forward contractsby Indian firms also highlights the absence of a rupee futures exchange in India.However, the Dubai Gold and Commodities Exchange in June, 2007 introducedRupee- Dollar futures that could be traded on its exchanges and had providedanother route for firms to hedge on a transparent basis. There are fears that RBI’s
ability to control the partially convertible currency will be subdued by this introductionbut this issue is beyond the scope of this study. The partial convertibility of theRupee will be difficult to control if many exchanges offer such instruments and thatwill be factor to consider for the RBI.