Indian Forex Market

Daily volume approximately $ 5 bn

Market lot $ 1.0 mln
 9:00 a.m - 5:00 p.m market
Main centres - Mumbai, Calcutta, Delhi, Chennai
Real market only in USD/INR - other currency rates are
derived
Thin market
Indian Forex Market….
Participants
Individuals
Corporate and FIIs
Banks and FIs
RBI
Brokers
FEDAI
Indian Forex Market….
Forward market active up to 1 year
Getting more integrated with money markets
Market dominated by a few banks
Exchange controls being liberalized
Derivatives market growing, but slowly
Transaction costs high
 Business is Risk
 Business is all about taking risks
 Rewards are proportional to the risks taken
 To run the business right, risks need to be assessed
and managed.
Need for Risk Management
Increasing cross border trades & investments with large
scale
dismantling of trade barriers
Increased competition
Domestic
Overseas

Access to International markets

Increased Volatility in Currency & Interest rates in the

International markets
With liberalization, more flexibility and hedging tools made
available to corporate
 Objectives of Risk
Management
Protect budgeted rates
Play for improving returns while
protecting budgeted rates
Profit maximization
 Prepared to take on more risks to earn
exchange profits
 Active Trading
What is Foreign Exchange
Management?
Proper management of foreign currency trade receivables, payables
and loan liabilities with the objective of optimizing rupee earnings in
the case of receivables and reducing the rupee cost in the case of
payables with budgeted rates as risk limits.

Involves selecting the right currency of invoicing or loans, where the

freedom of choice exists, prepayment/delayed payment for imports,
postponement of receivables, judicious matching of imports and
exports, proper usage of hedging instruments and facilities available
for the purpose.
Necessitated by the volatility of foreign exchange and interest rates
which impose risk as well as offer opportunities.
 WHO NEEDS IT ?
Exporters

Importers

Corporate With Foreign Currency Loans

Foreign Institutional Investors (FIIs)

Non-Resident Indians (NRIs)

 What is required for successful
forex management?
Requires a good understanding of hedging methods and
instruments available and the Regulations governing their
use.
Requires access to sufficient, relevant, and timely
information on the forex markets and ongoing market rates
to be able to take appropriate and timely action.
Requires a good Management Information System (MIS)
to monitor performance.
It requires sound judgment, discipline, and a helping hand
from bankers and consultants.
 Hedging vs. Speculation
 Hedging
 Transaction undertaken to offset some exposure
arising out of the firm’s usual operations.
 Reduces the exchange rate risk.

 Speculation
 Deliberate creation of a position for the purpose of
gaining from exchange rate fluctuations.
 Increases the exchange rate risk
 Decision not to hedge an exposure arising out of
operations is equivalent to speculation (Passive).
 Naturally Hedged?
Having export and import positions
No need to manage?

Zero some approach

What about amount mismatch?

Tenor mismatch may expose the company to exchange risk

Sell an equivalent amount of exports each time dollars are

bought for import/loan payments
Zero sensitivity to spot
Net cash flow equals premier received
Eliminates risk of losses in a volatile environment
Factors affecting the
Rupee Exchange Rate
 Relative Inflation
 Nominal Exchange rates of major trading partners and
competitors
 Budget Deficit
 Current Account Deficit
 Politics
 Ratings
 Investment outlook for India
Factors affecting the
Rupee Exchange Rate
Capital Flows
FDI/FII/NRI
GDR/ECB
Official Transactions
Reserves
Herd Mentality - Leads & Lags
Random Shocks - Unexpected Events (Pokhran/Kargil)
RBI policy
 Rupee Forwards
 Supply : Exporters
 Demand : Importers
Borrowers (ECB cover)
FCNR (B)
 Demand outstrips supply
 Banks and RBI can be on either side

Influenced by
 Outlook on the future $/Re spot rate
 Rupee interest rates vs. foreign currency interest rates to
a certain extent.
 RBI operations
 Corporate Risk
Management Approaches
Full hedge (100% cover )
No hedge (0% cover )
Partial hedge (say, 50% automatic
hedge)
Selective hedge
Trading
Full hedge (100% cover )
 Certainty of cash flows
 Costing protected
 Little management time and effort required
 Opportunity loss
Too conservative a strategy

No hedge (0% cover )

 Destabilization of cash flows
 Costing rate could be threatened
 Potential for windfall profits/huge losses
 Little management time and effort required
Most speculative strategy
Partial hedge (fixed ratio)
Not the optimal strategy

Selective hedge
Covering when rates are attractive or when
rates are expected to move adversely
Discretionary management
Requires more management time and effort
Optimal strategy
Recommended strategy
Most popular strategy among the world’s
corporate treasurers
Trading

 Frequent bookings and cancellations of both $/Re

and cross currencies
 Requires more management time and effort
 Works well for companies with the ability to absorb
more risks and invest time and money in the
infrastructure and control systems required for this
activity
 Not riskier than the zero percent cover strategy
Pricing
Choice of invoicing currency
Netting and Offsetting
Leading and Lagging
Asset and Liability Management
Pricing
Factor the cost of hedging in the price, if you can

Choice of invoicing currency

 Home currency - Buyer has a risk and may not be able to
cover it
 Dollar - Buyer (outside the U.S) has a risk and may
not agree unless that is the currency of the trade
 Non-Dollar - Additional risk for the Indian corporate
$/Re - systematic risk and
“cross currency” unsystematic risk
 Exports in strong currency and Imports in weak currency
 Examine the currency offers from foreign sellers for arbitrage
gains
Netting and Offsetting
 Netting receivables with payables in each currency and managing
risk on the net exposures.
 Offsetting one currency exposure with another closely related
currency.

Leading and Lagging

 Advance payables and postpone receivables in strong currencies
& vice versa.
 Extending credit period for exports/ preponing import payments
when the rupee is expected to weaken sharply or when the
forward premium is very high - play on interest differentials and
forward premiums.
 Arranging L/C financing (Supplier Credit) when the rupee is
stable and forward premiums are very low.
Asset and Liability Management
 Borrow in a currency in which you have assets or
receivables or in your competitor’s currency
 External Exposure
Management Tools
 Forward Contracts
Fixed Rate Contracts
Option Forwards
Splitting Exposures
Short Term Covers
Rollovers

Third Currency Covers

 Exchange Rate Quotations
Direct Q uote Indirect Q uote
Variable Unit Home Currency Foreign Currency

Direct Quote
 Buy Low and Sell High
 Buy Dollar at 45.29 and Sell Dollar at 45.30.

Indirect Quote
 Buy High and Sell Low
 Buy Dollars 2.2080 against Rs.100
 Sell Dollars 2.2075 against Rs.100
 Purchase and Sale
Transaction
 Spot Dollar / Rupee : 45.29 – 45.30

 From Banker’s point of view

 Purchase - Bank acquires foreign currency and parts with
home currency at 45.29
 Sale - Bank parts with foreign currency and acquires home
currency at 45.30

 From Customer’s point of view

 Purchase - Customer acquires foreign currency and parts
with home currency at 45.30
 Sale - Customer parts with foreign currency and acquires
home currency at 45.29
 Spot Rate Calculations
Currency Bid Ask
USD/INR 45.29 45.30
EUR/USD 1.2535 1.2540
USD/JPY 105.50 105.55
 Bank’s Spot Buying Rate ( Euro Exports)
USD 1 = INR 45.29 - Margin
EUR 1 = INR (45.29 - Margin )*(1.2535 – Margin)
= INR 56.77 - Margin
 Bank’s Spot Selling Rate ( JPY Imports)
USD 1 = INR 45.30 + Margin
JPY 100 = INR (45.30 + Margin) / (105.50 - Margin )
= INR 42.94 + Margin
 Delivery - Value Dates
Cash/Ready - Settlement today

Tom - Settlement on the next working day

Spot - Settlement on the 2nd working day

Forward - Settlement any date beyond spot

Forward Forex Contracts
 Contract to sell or buy a currency at a rate agreed today;
for delivery at a pre-determined future date or time period
 Difference between the spot and the forward rate is
called, forward points, swap points, or forward margin.
 Outright forward rate = spot rate + forward points
Interest Parity Principle
Between two freely convertible currencies, the
difference between the spot rate and the forward rate is
determined by the interest rate differential between the
two currencies.
Spot : 1 EUR = 1.2535 USD
6m Interest Rates : USD 1.2 % ; EUR 2.10 %
6m Forward 1 EUR = 1.2480 USD

Spot Rate * Interest Rate Differential * Forward Period

=
100
= * No. Of days in the year
1.2535*(2.10- 1.2)*6
100*12
= 0.00564
Interest Parity Principle….
To Verify

Borrow 1.2535 USD at 1.2 % Int. payable 0.007521

Sell 1.2535 USD against EUR Spot
Invest 1 EUR at 2.10 % Int. receivable 0.0105
To eliminate arbitrage today’s 6m forward should be such
that
USD 1.26102 = EUR 1.0105
1 EUR = (1.261021/1.0105) = USD 1.247917
 Interest Parity Principle….
 Currency with low interest rate will be at a premium
 Currency with high interest rate will be at a discount
 Forward rate is no indication of future spot rate
Calculation of
Annualized Premiums
Spot $/Re = Rs.45.29
3M - Fwd.Premium = Rs. 0.12

Annualized Premium : Premium * 100 * 365

Spot * n
n = Premium period in days
0.12 * 100 * 365
45.29 * 90

Result : 1.0745 %
 Short Rates
Value Today
Spot USD/INR 45.29 45.30
Cash / Spot .01 .02
Cash USD/INR 45.27 45.29

Value TOM
Spot USD/INR 45.29 45.30
TOM / Next .005 .01
TOM USD/INR 45.28 45.2950
 Fixed Date Forward
Calculations
Spot Rate USD/INR EUR/USD
45.29 45.30 1.2535 1.2540
28-Feb 0.04 0.05 1M -11 -9
31-Mar 0.08 0.09 2M -21 -20
30-Apr 0.12 0.13 3M -31 -30
31 May 0.15 0.16 4M -41 -40
Euro Exports for 22/03/04, Spot date 24/03/04
 USD/INR = 45.29 + 0.06 (0.04+0.0283) = 45.35 (A)
$/Re premium up to 28/02/04 (0.04) + premium for 22 days in March
= (0.08-0.04) * 22/31= (0.0283)

 EUR/USD = 1.2535 - 0.0017 (11+ 6) = 1.2518 (B)

EUR/USD discount up to 06/03/04 (11) + discount for 18 more days in
March
= (21-11) * 18/30 = (6)
 EUR/INR = A* B = 56.7691 - Bank’s margin
 Option Forwards – Time Options
USD/INR EUR/USD
Spot Rate 45.29 45.30 1.2535 1.2540
28-Feb 0.04 0.05 1M -11 -9
31-Mar 0.08 0.09 2M -21 -20
30-Apr 0.12 0.13 3M -31 -30
31 May 0.15 0.16 4M -41 -40
 USD Imports for April 2nd half
 USD/INR = 45.30 + 0.13 + Bank’s Margin
 Premium charged up to 30/04/04
 USD Exports for April 2nd half
 USD/INR = 45.29 + 0.10 - Bank’s Margin
 Premium provided up to 15/04/04 = 0.08 + (0.12-
0.08)* 15/30
 Merchant Rates
Date of shipment - 28/02/04

USD/INR EUR/USD
Spot Rate 45.29 45.30 1.2535 1.2540
28-Feb 0.04 0.05 1M -11 -9
31-Mar 0.08 0.09 2M -21 -20
30-Apr 0.12 0.13 3M -31 -30
31 May 0.15 0.16 4M -41 -40
Export bill with 60 days usance from the B/L date (28/02//04)
The exporter, while negotiating, will receive premium till 30/04/04.
 Forward rate = 45.29 + 0.12 = 45.41

Export bill with 60 days usance from sight, discounted on

1/03/04
The exporter, while negotiating, will receive premium for the usance
period + 20 days of transit period, i.e. till 20/05/04
Forward rate = 45.29 + 0.14 = 45.43
 Merchant Rates
USD/INR EUR/USD
Spot Rate 45.29 45.30 1.2535 1.2540
28-Feb 0.04 0.05 1M -11 -9
31-Mar 0.08 0.09 2M -21 -20
30-Apr 0.12 0.13 3M -31 -30
31 May 0.15 0.16 4M -41 -40
Date of Export order -- 1/02/04
Date of shipment – 31/03/04
Date of booking forward - 4/2/04
Forward contract rate for a 60 days usance from B/L. The exporter
while booking a forward contract will receive premium from the date
of booking forward, till the earliest due date i.e. 31/05/04. Thus,
forward rate will be equal to 45.29 + 0.15 = 45.44
Cancellation
Difference between the contract rate and ruling
cash/spot/forward rate for the account of the
customer
Cancellation at reverse TT/forward rate
 Exports at TT/forward selling rate
 Imports at TT/forward buying rate
Automatic cancellation after 15 days
-Banks will recover cost but gains will not be passed
on
-Inform before due date
Cancel import contract for last day and export for
first day in the case of option forward contracts
 Cancellation
• On 1st Jan, an exporter sold $100000 for 31st March delivery @
45.50

I Contract cancelled 2 months before maturity

On 31/1, with the 2 month forward rate from cancellation date to
31st Mar at say 45.55, the cancellation loss of Rs.5,000 i.e.
(45.55-45.50)*100,000) will be recovered from the customer.

II Automatic cancellation on the 15th day from the

date of maturity - 15.04.2002 @ 45.35
In this case, the cancellation gain, will not be passed on to the
customer but the loss will of course be recovered
 Splitting non-dollar exposures
Import of Yen 100,000,000.
Spot $1 = Rs. 45.30 $1= Yen105.55
Fwd Pt. = Rs. 0.10 - Yen 0.20
Mar Outright Rs.45.40 Yen105.35
Yen/Re import rate prevailing Rs.42.92.
View :Good level to cover $/Yen leg as it could fall to 104.00 by maturity.
But expect the $/Re leg to remain steady. So, cover only $/Yen.
On maturity, $/Re remains at 45.30 and $/Yen falls to 104.00.
Case I : Covered both legs on day1(45.40/105.35)*100
- Effective rate - Rs.43.09.
Case II : Covered both legs on maturity (45.30/104)*100
- Effective rate - Rs.43.55.
Case III: Covered $/Yen leg only (45.30/105.55)*100
- Effective rate - Rs.42.92.
 Third Currency Cover
Exporter who has $ exports can sell dollars against rupee or any other
permitted third currency.
Example
Currently 1 EUR = $1.2535
View: He expects the $ to trade steady Vs. the rupee. However, he
expects the Euro to strengthen in the next 3 months.
He can buy Euro 100,000 @ 1.2535 against $
His current position is long EUR 100,000 against INR.

At the end of 3 months, 1EUR= $ 1.2750

He can now unwind his long EUR position i.e. sell the 100,000 EUR
and buy the Dollars - he will receive $127,500

Gain: $2,150 (127,500-125,350)