1. Foreign Exchange Risks Management -Vikram Tyagi

2. Risk Management Foreign Exchange Risks 1) Transaction Exposure Any deferred receipt or payment has exchange rate fluctuation exposure 2) Translation Exposure Companies like Infosys who have operations in many countries have all the time receivables and payables in many currencies-the exchange management of such companies is an important functions of treasury 3)Economic Exposure and Political Risks Cross currency rates which depends upon economic conditions and performance of economies of the world could have an economic bearing of the competitiveness of India’s exports or imports

3. Foreign exchange Risks Management Terms and Concepts ( Legal Tender ) Currency conversion types –Convertible/inconvertible –Unrestricted/Restricted –Two-tier market ( most Common in developing world) –illicit exchange market Rate of exchange Exchange rate Quotations: - Direct : US$ 1 = Rs 40/- -Indirect : US$ 2.50 = Rs100/-

4. ..Contd Foreign exchange Risks Management Inter-Bank Rates (FEDAI Guidelines) Merchant rates (Market Conditions) Buying and Selling rate Spot and forward rates Mechanism of Foreign Exchange operations: –Base Rate : RBI official day’s Spot rate –Spread as per FEDAI/ RBI Guide lines (Approx 2%) –Profit margin( Must be with in approved Spread

5. Various types of spot rates TT Selling Rates: This rate is applied for all clean remittance outside by Banks for drafts, mail/telegraphic transfers TT Buying rates: The rate is applied for purchase of sight export bills which will result in inward remittance-it is worse than TT selling rates Bill Selling Rate: This rate is applied for remittance outwards for import bills-it is worse than TT selling rates

6. Various types of spot rates Bills Buying Rate: The rate is applied for purchase of sight export bills Purchase of Travelers Cheques Sale of Travelers Cheques Purchase and sale of currency notes Rate Calculations of rates -Base rate is authorized RBI - Authorized dealers can set rates within two percent band between buying and selling rates

7. An Example of Currency Risk When getting order: 1$=Rs 45/- When goods shipped: 1$= Rs 40.0/- Size of order USD 1 Million –Loss due to currency movement= Rs 5.0 Million

8. Exchange Rate Quotations

9. Hedging the Risk Internal Risk Management option –Opening Foreign currency account –Netting Group exposure –Relocate manufacturing base External Risk Management option - Forward Contracts - Option Contracts - Cross currency Options

10. Forward Covers Foreign Exchange can be booked in advance based on the forward rates by Dealers Put contracts (sell) an exporter can commit to a bank to give documents by a certain date and ensure a definite exchange rate Call Contract ( Buy) an importer can cover his payments to suppliers on due dates by forward cover Rollover permitted. However failure of submission of documents for purchase by banks or enough funds for paying an import bills will lead to penalties in addition to reverting to spot rates (Dates, Rate and total amount are all fixed values )

11. Risk Reduction by Forward Currency Contracts Original Risk : Order Size 1 Mill Pcs ; When getting order: 1$=Rs 45/-;When goods shipped after 3 months: 1$= Rs 40.0/-; Loss due to adverse currency movement= Rs 5.0 Million Forward Currency Contract Cover for the Order : Spot rates on date of business- $1=Rs 45/- 3 months forward rates- $1=Rs 44/- Order finalized assuming currency- $1=Rs 44/- Sales remittance received based on- $1=Rs 44/- Result : No loss due to currency rate fluctuation

12. Disadvantages of Forward Contracts Cost of cancellation is high- any loss must be paid to AD, Automatic Cancellation 15 th day, any gains retained by AD. Examples: Original 3 months contract cancelled early : ($100,000x46.35=Rs46,35,000)-(100000x46.55=46,55,00 )= Rs 20,000/ must be paid to AD Automatic Cancellation on 15 th day : -Any loss to be recovered from buyer - Any gain retained by AD. Importer Can not take advantage of favorable currency movement

13. Option Currency Contracts The Option buyer has right to buy or sell at agreed rate, but The Option buyer has no obligation to buy or sell at agreed rate. Option Buyer- Seller; Expiration Period; Strike Price Option pricing ( Price diff, period, volatility, interest rates) Example: Spot rates on date of business- $1=Rs 45/- 3 months forward Contract rates $1=Rs 44/- Order finalized assuming currency- $1=Rs 44/- Option Contract taken at$ 1=Rs44/- Actual spot price on delivery date $1=Rs45/- (do not exercise) Sell at pot price; Profit earnedRs.10,00000 International Currency option markets (ICOM) RBI guide lines;FIDAI guidelines

14. Cross currency options This hedging method involve future options contact in third currency. Rupee is not involved – no risk of adverse currency movement while advantage of favorable movement can be taken Example of Indian Importer holding USD position: Buy 3 months DM option contract at- 1 USD=DM 2.200 If DM weakens to 1 USD=DM 2.30, Do not exercise option If DM strengthens 1 USD= DM 2.1, Exercise option, make profit

15. Cross Currency Options Are Better? Rupee is not an involved currency Option Buyer can take advantage of adverse movement, befit from favorable movement ( Unlike forward Contacts) Still not very common in India as commission needs to paid up front Need more knowledge and attention

16. Assignment – 5 marks Please refer to your Export business contract for shirts. At the time contract Spot price Rs.45/USD. You had 3 choices (i) No currency cover (ii) Forward currency contract at Rs. 45/- (iii) Option Currency Contract at Rs. 45/USD. What would be your gain or loss for these choices if spot currency rates on the date of payment was: (A) Rs. 43/USD (B) Rs. 45/USD (B) Rs. 48/USD Please clearly mention your name, ID, Number of shirts, price per unit and Invoice Values as per contract

18. Foreign Exchange regulations and Export Trade Foreign Exchange Management Regulations 2000 governs the trade with respect to FE Export proceeds should be brought to India with six months normally. Special Status Holders -365 days – Authorized dealers can give extension up to an invoice value of USD100,000/- subject to some conditions Otherwise RBI has to give permission for extension-elongated credit terms also may be permitted prior by RBI Submission of export documents-the remittance inward is tracked by Authorized Dealers and hence export documents must be submitted within 21 days from date of exports to Authorized Dealers for collection or information-if later we call it Stale Documents-exceptions with convincing reasons may be handled BY AD’s Trade discounts are permitted if declared by shippers in GR/SDF/Softex forms-these forms are decalarations and guarantee to the Govt by exporters that they would bring back the income to India within specified period Exports of goods on lease or hire, exports under trade agreements/rupee credits and counter trade adjustments require prior permission of RBI