Description
A Multinational company with high currency risk is likely to face financial difficulties which tend to have a disrupting on the operating side of the business.
A STUDY ON Foreign Exchange and its Risk Management
Project submitted in partial fulfillment for the award of Degree of
MASTER OF BUSINESS ADMINISTRATION
DECARATION
I hereby declare that this Project Report titled “A STUDY ON FOREI!N E"C#AN!E
AND ITS RIS$ MANA!EMENT” submitted by me to the Department “"""""” is a
bonafide work under taken by me and it is not submitted to any other University or
Institution for the award of any degree diploma certificate or published any time before!
"ame and #ddress of the $tudent $ignature of the $tudent
Date
AC$NO%ED!EMENT
I e%press my profound gratitude to &&&&' (aculty )!*!# for his guidance and support all
through the completion of the project!
I also e%press my hurtful thanks to &&&&& for providing valuable suggestions in
completions of the project!
I take this opportunity to acknowledge unreserved support e%tended to me by the Project and
+raining team of ,-. +/-,"0.01I/$!
I am very much indebted to the dedicated and e%perienced staff of )*#!
It is indeed a pleasant task and small effort to thank all the people especially some of my
friends who have contributed towards the successful completion of this project work!
(inally' I would like to e%press my gratitude to my parents for their endearing support and
cooperation which has made me complete this project fruitfully!
SUMMARY
# )ultinational company with high currency risk is likely to face financial difficulties
which tend to have a disrupting on the operating side of the business!
# disrupted financial conditions are likely to2
• Result in the problem of adverse incentives!
• 3eakens the commitment of various stake holders!
(oreign e%change e%posure and risk are important concept in the study of international
finance! It is the sensitivity of the home currency value of asset' liabilities' or operating
incomes to unanticitpated changes in the e%change rates!
/%posure e%ists if the home currency values on an average in a particular manner! It also
e%ists where numerous currencies are involved!
(oreign e%change risk is the variance of the home currency value of items arising on account
of unanticipated changes in the e%change rates!
+he derivative instruments like forwards' futures and options are used to hedge against the
foreign e%change risk of the )ultinational companies!
+he original derivatives contract of International (inance is the 4(orward e%change contract5!
(orward (oreign e%change is a traditional and popular risk management tool to obtain
protection against adverse e%change rate movements! +he e%change rate is 4locked in5 for a
specific date in future' which enables the person involved in the contract to plan for and
budget the business e%penses with more certainty!
(orward e%change market' has since the 6789s' played the role of linking international
interest rates! +oday' however' (orward contract have to share other instruments and markets
for arbitrage and for hedging! +hese newer derivative instruments include (utures' 0ptions
and $waps!
TABE OF CONTENTS
S&no 'artic()ars 'age no&
* O+,ecti-es o. the st(d/
0 Research 1Methodo)og/
2 imitations 1Ass(m3tions
4 Introd(ction to com3an/
5 Need 1 im3ortance o. the st(d/
6 Ind(str/ 3ro.i)e
7 Introd(ction to .oreign exchange
8 The .oreign exchange market
9 The .oreign exchange transactions
*: Introd(ction to .oreign exchange risk management
** Too)s1 techni;(es .or the management o. risk
*0 Findings o. the st(d/
*2 Conc)(sions
*4 Bi+)iogra3h/
IST OF TABES
S&no 'artic()ars 'age no&
* Ta+)e88>
+his type of ;uotation which gives the ;uality of foreign currency per unit of domestic
currency is known as indirect ;uotation! In this case' the ;uoting bank will receive U$D
8> per Rs!699 while buying dollars and give away U$D 8< per Rs!699 while selling
dollars In other words' “*uy high' sell low” is applied!
+his buying rate is also known as the 4bid5 rate and the selling rate as the 4offer5 rate! +he
difference between these rates is the gross profit for the bank and known as the 4$pread5!
S3ot and .or@ard transactions
+he transactions in the Inter *ank market )ay place for settlement=
• 0n the same dayM or
• +wo days laterM
• $ome day lateM say after a month
3here the agreement to buy and sell is agreed upon and e%ecuted on the same date' the
transaction is known as cash or ready transaction! It is also known as value today!
+he transaction where the e%change of currencies takes place after the date of contract is
known as the $pot +ransaction! (or instance if the contract is made on )onday' the delivery
should take place on 3ednesday! If 3ednesday is a holiday' the delivery will take place on
the ne%t day' i!e!' +hursday! Rupee payment is also made on the same day the foreign
e%change is received!
+he transaction in which the e%change of currencies takes place at a specified future date'
subse;uent to the spot rate' is known as a forward transaction ! +he forwards transaction can
be for delivery one month or two months or three months' etc! # forward contract for
delivery one month means the e%change of currencies will take place after one month from
the date of contract! # forwards contract for delivery two months means the e%change of
currencies will take place after two months and so on!
S3ot and For@ards rates
$pot rate of e%change is the rate for immediate delivery of foreign e%change! It is prevailing
at a particular point of time! In a forward rate' the ;uoted is for delivery at a future date'
which is usually C9' 89' 79 or 6F9 days later! +he forward rate may be at premium or
discount to the spot rate' Premium rate' i!e!' forward rate is higher than the spot rate' implies
that the foreign currency is to appreciate its value in tae future! )ay be due to larger demand
for goods and services of the country of that currency! +he percentage of annuali:ed discount
or premium in a forward ;uote' in relation to the spot rate' is computed by the following!
(orward Premium O (orward rate=spot rate Q 6<
Gdiscount H $pot rate "o! of months forward
If the spot rate is higher than the forward rate' there is forward discount and if the forward
rate higher than the spot rate there is forward premium rate!
For@ard marginFS@a3 3oints
(orward rate may be the same as the spot rate for the currency! +hen it is said to be 4at par5
with the spot rate! *ut this rarely happens! )ore often the forward rate for a currency may be
costlier or cheaper than its spot rate! +he difference between the forward rate and the spot
rate is known as the 4(orward margin5 or 4$wap Points5! +he forward margin may be at a
premium or at discount! If the forward margin is at premium' the foreign currency will be
costlier under forward rate than under the spot rate! If the forward margin is at discount' the
foreign currency will be cheaper for forward delivery than for spot delivery!
Under direct ;uotation' premium is added to the spot rate to arrive at the forward rate! +his is
done for both purchase and sale transactions! Discount is deducted from spot rate to arrive at
the forward rates!
Other rates
*uying rate and selling refers to the rate at which a dealer in fore% is willing to buy the fore%
and sell the fore%! In theory' there should not be difference in these rates! *ut in practices' the
selling rate is higher than the buying rate! +he fore% dealer' while buying the fore% pay less
rupees' but gets more when he sells the fore%! #fter adjusting for operating e%penses' the
dealer books a profit through the 4buy and sell5 rates differences!
+ransactions in e%change market consist of purchases and sales of currencies between dealers
and customers and between dealers and dealers! +he dealers buy fore% in the form of bills'
drafts and with foreign banks' from customer to enable them to receive payments from
abroad!
+he resulting accumulated currency balances with dealers are disposed of by selling
instruments to customers who need fore% to make payment to foreigners! +he selling price
for a currency ;uoted by the dealer Ga bankH is slightly higher than the purchase price to give
the bank small profit in the business! /ach dealer gives a two=way ;uote in fore%!
Sing)e Rate refers to the practices of adopting just rate between the two currencies! # rate for
e%ports' other for imports' other for transaction with preferred area' etc' if adopted by a
country' that situation is known as multiple rates!
Fixed rate refers to that rate which is fi%ed in terms of gold or is pegged to another currency
which has a fi%ed value in terms of gold! (le%ible rate keeps the e%change rate fi%ed over a
short period' but allows the same to vary in the long term in view of the changes and shifts in
another as conditioned by the free of market forces! +he rate is allowed to freely float at all
times!
C(rrent rateA -urrent rate of e%change between two currencies fluctuate from day to day or
even minute to minute' due to changes in demand and supply! *ut these movements take
place around a rate which may be called the 4normal rate5 or the par of e%change or the true
rate! International payments are made by different instruments' which differ in their time to
maturity!
A Te)egra3hic Trans.er DTTE is the ;uickest means of effecting payments! # +!+ rate is
therefore' higher than that of any other kind of bill! # sum can be transferred from a bank in
one country to a bank in another part of the world by cable or tele%! It is thus' the ;uickest
method of transmitting funds from one center to another!
S)ight rates applicable in the case of bill instrument with attending delay in maturity and
possible loss of instrument in transit' are lower than most other rates!
$imilarly' there are other clusters of rates' such as' one month5s rate' Cmonth5s rate! .onger
the duration' lower the price Gof the foreign currency in terms of domesticH!
+he e%change rate between two given currencies may be obtained from the rates of these two
currencies in terms of a third currency! +he resulting rate is called the -ross rate!
Ar+itrage in the foreign e%change market refers to buying a foreign currency in a market
where it is selling lower and selling the same in a market where it is bought higher! #rbitrage
involves no risk as rates are known in advance! (urther' there is no investment re;uired' as
the purchase of one currency is financed by the sale of other currency! #rbitrageurs gain in
the process of arbitraging!
D#+# #".#N$I$ #"D I"+R/PR/+#+I0"
,-.
DATA ANALYSIS
Table:1 CURRENCY EXCHANGE BETWEEN TWO RATES
PROFIT&LOSS A/C FOR THE YEAR ENDED JUNE 2!
Pa"#$%&la"' (R')$* %"+"e', I*%+-e a*. E/0e*'e'1 23 4"+- 4+"e$5*
(I* .+lla"',
A6e"a5e
E/%7a*5e "a#e
1R')81
I4 #7e
E/%7a*5e
"a#e181
I4 #7e
E/%7a*5e
"a#e18
INCO9E
Ne# +0e"a#$*5 I*%+-e :!2
22 2221)1! 2221)1! 222)2
EXPENSES
9a#e"$al %+*'&-0#$+* ) ) )
9a*&4a%#&"$*5 e/0e*'e' e. E/0e*'e' ) ) )
C+'# +4 Sale' 2;:1)@E!9C to >8C!@E!9C to >F6!C>!simultaneously all these values are changing the net income! If the
/%change rate had fi%ed R Rs!@6' the revenues would have been same!
The r(3ee
A Multinational company with high currency risk is likely to face financial difficulties which tend to have a disrupting on the operating side of the business.
A STUDY ON Foreign Exchange and its Risk Management
Project submitted in partial fulfillment for the award of Degree of
MASTER OF BUSINESS ADMINISTRATION
DECARATION
I hereby declare that this Project Report titled “A STUDY ON FOREI!N E"C#AN!E
AND ITS RIS$ MANA!EMENT” submitted by me to the Department “"""""” is a
bonafide work under taken by me and it is not submitted to any other University or
Institution for the award of any degree diploma certificate or published any time before!
"ame and #ddress of the $tudent $ignature of the $tudent
Date
AC$NO%ED!EMENT
I e%press my profound gratitude to &&&&' (aculty )!*!# for his guidance and support all
through the completion of the project!
I also e%press my hurtful thanks to &&&&& for providing valuable suggestions in
completions of the project!
I take this opportunity to acknowledge unreserved support e%tended to me by the Project and
+raining team of ,-. +/-,"0.01I/$!
I am very much indebted to the dedicated and e%perienced staff of )*#!
It is indeed a pleasant task and small effort to thank all the people especially some of my
friends who have contributed towards the successful completion of this project work!
(inally' I would like to e%press my gratitude to my parents for their endearing support and
cooperation which has made me complete this project fruitfully!
SUMMARY
# )ultinational company with high currency risk is likely to face financial difficulties
which tend to have a disrupting on the operating side of the business!
# disrupted financial conditions are likely to2
• Result in the problem of adverse incentives!
• 3eakens the commitment of various stake holders!
(oreign e%change e%posure and risk are important concept in the study of international
finance! It is the sensitivity of the home currency value of asset' liabilities' or operating
incomes to unanticitpated changes in the e%change rates!
/%posure e%ists if the home currency values on an average in a particular manner! It also
e%ists where numerous currencies are involved!
(oreign e%change risk is the variance of the home currency value of items arising on account
of unanticipated changes in the e%change rates!
+he derivative instruments like forwards' futures and options are used to hedge against the
foreign e%change risk of the )ultinational companies!
+he original derivatives contract of International (inance is the 4(orward e%change contract5!
(orward (oreign e%change is a traditional and popular risk management tool to obtain
protection against adverse e%change rate movements! +he e%change rate is 4locked in5 for a
specific date in future' which enables the person involved in the contract to plan for and
budget the business e%penses with more certainty!
(orward e%change market' has since the 6789s' played the role of linking international
interest rates! +oday' however' (orward contract have to share other instruments and markets
for arbitrage and for hedging! +hese newer derivative instruments include (utures' 0ptions
and $waps!
TABE OF CONTENTS
S&no 'artic()ars 'age no&
* O+,ecti-es o. the st(d/
0 Research 1Methodo)og/
2 imitations 1Ass(m3tions
4 Introd(ction to com3an/
5 Need 1 im3ortance o. the st(d/
6 Ind(str/ 3ro.i)e
7 Introd(ction to .oreign exchange
8 The .oreign exchange market
9 The .oreign exchange transactions
*: Introd(ction to .oreign exchange risk management
** Too)s1 techni;(es .or the management o. risk
*0 Findings o. the st(d/
*2 Conc)(sions
*4 Bi+)iogra3h/
IST OF TABES
S&no 'artic()ars 'age no&
* Ta+)e88>
+his type of ;uotation which gives the ;uality of foreign currency per unit of domestic
currency is known as indirect ;uotation! In this case' the ;uoting bank will receive U$D
8> per Rs!699 while buying dollars and give away U$D 8< per Rs!699 while selling
dollars In other words' “*uy high' sell low” is applied!
+his buying rate is also known as the 4bid5 rate and the selling rate as the 4offer5 rate! +he
difference between these rates is the gross profit for the bank and known as the 4$pread5!
S3ot and .or@ard transactions
+he transactions in the Inter *ank market )ay place for settlement=
• 0n the same dayM or
• +wo days laterM
• $ome day lateM say after a month
3here the agreement to buy and sell is agreed upon and e%ecuted on the same date' the
transaction is known as cash or ready transaction! It is also known as value today!
+he transaction where the e%change of currencies takes place after the date of contract is
known as the $pot +ransaction! (or instance if the contract is made on )onday' the delivery
should take place on 3ednesday! If 3ednesday is a holiday' the delivery will take place on
the ne%t day' i!e!' +hursday! Rupee payment is also made on the same day the foreign
e%change is received!
+he transaction in which the e%change of currencies takes place at a specified future date'
subse;uent to the spot rate' is known as a forward transaction ! +he forwards transaction can
be for delivery one month or two months or three months' etc! # forward contract for
delivery one month means the e%change of currencies will take place after one month from
the date of contract! # forwards contract for delivery two months means the e%change of
currencies will take place after two months and so on!
S3ot and For@ards rates
$pot rate of e%change is the rate for immediate delivery of foreign e%change! It is prevailing
at a particular point of time! In a forward rate' the ;uoted is for delivery at a future date'
which is usually C9' 89' 79 or 6F9 days later! +he forward rate may be at premium or
discount to the spot rate' Premium rate' i!e!' forward rate is higher than the spot rate' implies
that the foreign currency is to appreciate its value in tae future! )ay be due to larger demand
for goods and services of the country of that currency! +he percentage of annuali:ed discount
or premium in a forward ;uote' in relation to the spot rate' is computed by the following!
(orward Premium O (orward rate=spot rate Q 6<
Gdiscount H $pot rate "o! of months forward
If the spot rate is higher than the forward rate' there is forward discount and if the forward
rate higher than the spot rate there is forward premium rate!
For@ard marginFS@a3 3oints
(orward rate may be the same as the spot rate for the currency! +hen it is said to be 4at par5
with the spot rate! *ut this rarely happens! )ore often the forward rate for a currency may be
costlier or cheaper than its spot rate! +he difference between the forward rate and the spot
rate is known as the 4(orward margin5 or 4$wap Points5! +he forward margin may be at a
premium or at discount! If the forward margin is at premium' the foreign currency will be
costlier under forward rate than under the spot rate! If the forward margin is at discount' the
foreign currency will be cheaper for forward delivery than for spot delivery!
Under direct ;uotation' premium is added to the spot rate to arrive at the forward rate! +his is
done for both purchase and sale transactions! Discount is deducted from spot rate to arrive at
the forward rates!
Other rates
*uying rate and selling refers to the rate at which a dealer in fore% is willing to buy the fore%
and sell the fore%! In theory' there should not be difference in these rates! *ut in practices' the
selling rate is higher than the buying rate! +he fore% dealer' while buying the fore% pay less
rupees' but gets more when he sells the fore%! #fter adjusting for operating e%penses' the
dealer books a profit through the 4buy and sell5 rates differences!
+ransactions in e%change market consist of purchases and sales of currencies between dealers
and customers and between dealers and dealers! +he dealers buy fore% in the form of bills'
drafts and with foreign banks' from customer to enable them to receive payments from
abroad!
+he resulting accumulated currency balances with dealers are disposed of by selling
instruments to customers who need fore% to make payment to foreigners! +he selling price
for a currency ;uoted by the dealer Ga bankH is slightly higher than the purchase price to give
the bank small profit in the business! /ach dealer gives a two=way ;uote in fore%!
Sing)e Rate refers to the practices of adopting just rate between the two currencies! # rate for
e%ports' other for imports' other for transaction with preferred area' etc' if adopted by a
country' that situation is known as multiple rates!
Fixed rate refers to that rate which is fi%ed in terms of gold or is pegged to another currency
which has a fi%ed value in terms of gold! (le%ible rate keeps the e%change rate fi%ed over a
short period' but allows the same to vary in the long term in view of the changes and shifts in
another as conditioned by the free of market forces! +he rate is allowed to freely float at all
times!
C(rrent rateA -urrent rate of e%change between two currencies fluctuate from day to day or
even minute to minute' due to changes in demand and supply! *ut these movements take
place around a rate which may be called the 4normal rate5 or the par of e%change or the true
rate! International payments are made by different instruments' which differ in their time to
maturity!
A Te)egra3hic Trans.er DTTE is the ;uickest means of effecting payments! # +!+ rate is
therefore' higher than that of any other kind of bill! # sum can be transferred from a bank in
one country to a bank in another part of the world by cable or tele%! It is thus' the ;uickest
method of transmitting funds from one center to another!
S)ight rates applicable in the case of bill instrument with attending delay in maturity and
possible loss of instrument in transit' are lower than most other rates!
$imilarly' there are other clusters of rates' such as' one month5s rate' Cmonth5s rate! .onger
the duration' lower the price Gof the foreign currency in terms of domesticH!
+he e%change rate between two given currencies may be obtained from the rates of these two
currencies in terms of a third currency! +he resulting rate is called the -ross rate!
Ar+itrage in the foreign e%change market refers to buying a foreign currency in a market
where it is selling lower and selling the same in a market where it is bought higher! #rbitrage
involves no risk as rates are known in advance! (urther' there is no investment re;uired' as
the purchase of one currency is financed by the sale of other currency! #rbitrageurs gain in
the process of arbitraging!
D#+# #".#N$I$ #"D I"+R/PR/+#+I0"
,-.
DATA ANALYSIS
Table:1 CURRENCY EXCHANGE BETWEEN TWO RATES
PROFIT&LOSS A/C FOR THE YEAR ENDED JUNE 2!
Pa"#$%&la"' (R')$* %"+"e', I*%+-e a*. E/0e*'e'1 23 4"+- 4+"e$5*
(I* .+lla"',
A6e"a5e
E/%7a*5e "a#e
1R')81
I4 #7e
E/%7a*5e
"a#e181
I4 #7e
E/%7a*5e
"a#e18
INCO9E
Ne# +0e"a#$*5 I*%+-e :!2
22 2221)1! 2221)1! 222)2EXPENSES
9a#e"$al %+*'&-0#$+* ) ) )
9a*&4a%#&"$*5 e/0e*'e' e. E/0e*'e' ) ) )
C+'# +4 Sale' 2;:1)@E!9C to >8C!@E!9C to >F6!C>!simultaneously all these values are changing the net income! If the
/%change rate had fi%ed R Rs!@6' the revenues would have been same!
The r(3ee