This document discusses the requirement for a foreign exchange policy for a company with international operations. It outlines the risks such as exchange rate risk, sovereign risk, and liquidity risk that the policy needs to address. It provides details on key parameters for defining and implementing the policy, including objectives, exposure priorities, risk thresholds, and responsibility allocation. Finally, it discusses various hedging techniques that can be used to manage transaction exposures, including forwards, money market hedges, options, cross hedging, and swaps. The policy aims to minimize foreign exchange risk and reduce volatility in costs, profits, and company valuation from currency fluctuations.

1. By
Saumya Gyan

2. AGENDA
Requirement of the
Policy
Risk -Overview
Parameters for defining
and Implementation
Techniques
Impact of various
Exposures

3. Requirement of Policy
Impact
• Fluctuations affect cost competitiveness, Profitability and Valuation of Co’s
International Operations
• Absence of policy leave company unprepared to adverse effects of currency
movements
Objective
• Resulting in Increased cost, Reduced Market share and hit on profit
• Documentation of policy required in tune with defined treasury Objectives,
Business Activities
Action
• Broad Feature of the Policy shall be to minimise and manage foreign exchange risk

4. Major Risks in FE Operations
Exchange
Risks
Sovereign
Risk
Contagion
Risk
Currency
Risk
Position
Risk
Liquidity
Risk
Gap Risk

5. Critical Parameters in Setting up and Implementation
Definition of Objectives-Managements Tolerance and
attitude towards risk shall be stated
Ranking of Exposure Priorities-Rank the focuses on
protective action to employ
Establishment of Risk Threshold-Parameters on exposure
level, degree of fluctuation and limit of expenditure to
curb situation
Allocation of Treasury Responsibilities-Level of Hedging
control and decision making flexibility
Development of Control Procedures and Policies-Limitation
on Type of product and documentation of confirmations,
Strong MIS

6. Techniques to Eliminate Transaction Exposure
EXPOSURE DERIVATIVE PRODUCTS
(EXTERNAL HEDGING TOOLS)
Trade (Exports /
Imports)
Forwards
Buyers Credit / FCTL Options
ECBs / FCCB Interest Rate Swaps
Rupee Term Loans Currency Swaps
EEFC Balances etc., Forward sale contracts

7. Unhedged Positions
• Nothing to do Today
• FX receipt date: sell
FX at that day’s spot
rate
Future FX
Receipts
• Nothing to do Today
• FX payment date: buy
FX at that day’s spot
rate
Future FX
Payments
Thus Co Assumes FX Risk

8. MANAGING EXPOSURE
Various Instruments

9. Forwards
• The party agreeing to buy the underlying asset in the future assumes along position,
and the party agreeing to sell the asset in the future assumes a short position. The
price agreed upon is called the delivery price, which is equal to the forward price at
the time the contract is entered into
Money
Market
Hedge
• It’s more efficient to buy the present value of the foreign currency payable today.
• Invest that amount at the foreign rate.
• At maturity your investment will have grown enough to cover your foreign currency payable
Options
Market
Hegde
•To hedge a foreign currency payable buy calls on the currency.
•If the currency appreciates, your call option lets you buy the currency at the exercise price of the call.
•To hedge a foreign currency receivable buy puts on the currency.
•If the currency depreciates, your put option lets you sell the currency for the exercise price.
Cross
Hedging
•Cross-Hedging involves hedging a position in one asset by taking a position in another (highly correlated)
asset eg:
•Use a Yen contract to cross-hedge Korean won currency risk (AR in won for a US firm), assuming that the
Yen/Won correlation is high

10. Swap
Contracts
• Firms that have recurrent exposure can very likely hedge their exchange risk at a lower cost with
swaps than with a program of hedging each exposure as it comes along.
Hedging through
Invoice Currency
• The firm can shift, share, or diversify:
• shift exchange rate risk
• by invoicing foreign sales in home currency
Lead and Lag
• If a currency is appreciating, pay those bills denominated in that currency early; let customers in
that country pay late as long as they are paying in that currency
• If a currency is depreciating, give incentives to customers who owe you in that currency to pay
early; pay your obligations denominated in that currency as late as your contracts will allow
Cross Hedging
•Cross-Hedging involves hedging a position in one asset by taking a position in another (highly correlated)
asset eg:
•Use a Yen contract to cross-hedge Korean won currency risk (AR in won for a US firm), assuming that the
Yen/Won correlation is high

11. Management of Exposures
Transaction
Exposure
Translation
Exposure
Economic
Exposure
-Current Non Current
Method
-Monetary and Non
Monetary Method
-Temporal Method
Current Rate Method
Exposure to be manage
by Various types of
Hedging
-Forwards
-Money Market Hedge
-Options
-Cross Hedging
-Hedging Contingent Exp
-Hedging Recurrent Exp
-Lead and Lags
-Exposure Netting
-Select Low cost
production Sites
-Flexible Sourcing
Policy
-Diversification of
Market
-R & D and Product
Diversification
-Financial Hedging

13. Critical View on Open FE Exposure
Corporate
Earnings
Exposure
Impact on Co’s
targeted after tax
consolidated
earnings
Translation
Exposure
B/S Impact from
the consolidations
of Financials
Transaction
Exposure
Impact on
Payables and
receivables In FE
Operating
Exposure
Impact on Projected
v/s Actual Cash In
flow and outflow