Description
The doc about topics like internetional financial management,invoicing in foreign currency, RBI Regulations.
INFM Group Assignment: Indian Software Development Firm
International Financial Management
Executive Summary
The software development firm is operating out of India. The firm has clients in US, Europe and Singapore. As of now the invoicing is in USD to all our clients, but recently clients from Europe and Singapore have requested to be invoiced in Euro and Singapore Dollars respectively. Since, the software company is operating out of India it is governed by regulations from Reserve Bank of India and the Ministry of Corporate affairs, Government of India. The regulation allows a firm to transact in foreign currency. It if does so then according to accounting standard AS 11 it will have to report the transaction preferable in domicile currency i.e. INR in our case. The standard also state that the monetary items on the balance sheet be recorded in INR with the exchange rate on the day the balance sheet is prepared. If the firm makes use of any of the financial instruments to hedge its risk then the premium or discount should be amortized over the life of the contract. It can enter into OTC products like forwards, swaps and options, for hedging their currency risk. Since, the Small and Medium Enterprises might not have a good understanding of the risk with such products; it is recommended that only the banks with whom they have the credit relationship is allowed to offer such facilities. The currency futures in India are available in MCX, it can hedge its risk in the USD and Euro but Singapore Dollars cannot be hedged. The outlook of USD indicates that it will hover around Rs 46 to Rs 47. Since, the general market practice is to hedge the USD risk. It is advisable that the software company hedges its USD exposure. We prefer going in for options at the minimum exchange rate and minimum premium. According to the outlook in Singapore Dollars we believe that SGD will appreciate against INR in the near future. Hence, we will be better off by invoicing our Singapore clients in SGD and not hedging this transactions. Also, since MCX does not offer hedging in SGD even if the company wanted it will not be able to hedge its risk. The outlook of Euro is that it will appreciate in near future hence it is better to keep the exposure un-hedged in the near future.
Feasibility of Invoicing in Foreign Currency
The software company is governed by the regulations from the Reserve Bank of India and the Ministry of Corporate affairs, Government of India. The accounting standard AS11 by MCA and the Foreign Exchange Management Act, 1999 and its amendments in the later years by RBI are the important regulations to be followed by the software company. Ministry of Corporate Affairs and AS111 AS11 deals with the accounting for foreign currency transactions and foreign operations for Indian Companies. AS11 also deals with the treatment of forward exchange rate contracts entered by the company. If the company deals with foreign currencies, then the company should ensure that the transaction should be mentioned in the reporting currency in its financial statements. The company can state its financial statements in any currency, but using the domicile currency that is INR is the general practise.
If the company wants to invoice in different currencies, it can do so provided, the foreign currency transaction should be recorded, on recognition (income, expense, hedging or any other purposes) in the reporting currency by using the appropriate exchange rate between the reporting currency that is INR and the foreign currency at the date of the transaction .The exchange rate used is generally the average rate in the week or month in which the transaction takes place.
The standard specifies that when the balance sheet is made for the company, the monetary items, that is cash receivable and payables should be converted into INR using the closing exchange rate on the day the balance sheet is prepared or the expected amount that would be received in future if the closing rate does not reflect the true realisable value. If there is any change in the exchange rate after the transaction is recorded, then the net increase or decrease in value should be reported as income or expense for the period. Hence if the company goes for invoicing in different currencies, it has to keep track of the exchange rates of different currencies. This is an additional effort required for invoicing in different currencies.
If the company is invoicing in different currencies, then it would also want to hedge the exchange rate risks from fluctuations in these currencies. Hence it would enter into foreign exchange derivatives of all the different currencies for hedging purposes. This would need considerable expertise and hence might not be suitable for the software company in question. If the company intends to hedge its risks, then AS 11 suggests that the premium or discount arising at the beginning of a contract should be amortised as expense or income over the life of the contract. Exchange differences on such a contract should be recognised in the profit and loss statement in the reporting period in which the exchange rates vary. Any profit or loss arising on cancellation or renewal of such a forward exchange contract should be recognised as income or as expense for the period.
RBI regulations
The foreign exchange transactions are governed by the Foreign Exchange Management Act 19992. Section 7 of FEMA deals with the exporters of goods and services. The software company can enter in to current account and capital account transactions in foreign currency. The act insists that the company should furnish details about the contract to RBI or any other authority regarding the true and correct material particulars, including the amount representing the full export value or, if the full export value of the goods is not ascertainable at the time of export, the value which the exporter expects to receive on the sale of the goods in a market outside India. The RBI3 allows the company to enter into OTC products, such as forwards, swaps and options, for hedging their currency risk. With respect to forex derivatives involving rupee, the company has access to foreign exchange forward contracts, foreign currency-rupee swap instruments and currency options – both cross currency as well as foreign currency-rupee. In the case of derivatives involving only foreign currency, a range of products such as interest rate swaps, Forward rate agreements, option are allowed. The company can use it only if it has an underlying exposure to foreign exchange risk whether on current or capital account. In order to simplify procedural requirements for Small and Medium Enterprises (SME) sector, RBI granted flexibility for hedging the underlying as well as anticipated and economic exposures. In order to
ensure that SMEs understand the risks of these products, only banks with whom they have credit relationship are allowed to offer such facilities. These facilities should also have some relationship with the turnover of the entity. Assuming that the software company is registered as an SME, it will have to go through its bank for hedging its risks. From August 2008 onwards, companies can enter in to hedging their currency risk4 through currency futures. Currency futures in India are available in MCX. It started with US dollar – rupee contracts but from 19 th January 20105, currency futures in Euro, Pound and yen paired with INR was allowed by RBI. Hence the company can hedge its risk in the US dollar and Euro in the Indian market itself, but Singapore dollars cannot be hedged. Hedging through currency futures would need sufficient expertise which has to be developed by the software company. The contract sizes and time to maturity are fixed in currency futures unlike in OTC contracts. The Software Company needs to be prudent in selecting the contracts as per its needs. This would require sufficient knowledge and expertise in currency futures which might not be available inhouse.
Outlook of USD/INR
INR is managed float (or dirty float). It is managed by the Reserve Bank of India. So, we can expect RBI trying to manage the USD/INR in the range of Rs. 44 to Rs. 47 again for the next 3yrs (similar to that of 2006-07 period). USD is bound to maintain a balance because of its own depreciation (near term – due to the effects of recession and more outsourcing) and appreciation because countries like China6 would still add more dollars to their reserves or change policies – reasons include more exports to US, countries would want their dollar value to be high.
Based on forwards/futures The futures price of USD/INR is hovering around Rs. 47 for Jan 2011 contract while in the short term it’s hovering around 46. While spreads are lower in the short and longer term they are higher in the medium term.
For the next one year we can say that the USD/INR will hover around Rs. 46 to Rs. 47.
Market practices Most (if not all) the software export companies use USD for the transactions. And most of the non-US companies also transact with USD for different reasons. Considering these, we have to manage currency risks with USD, if necessary.
Hedging strategies Using Futures contracts (MTM) NSE provides currency futures7 exchange. The spreads are around 6500 pips and the bid rates are around Rs. 47 for a Jan 2011 contract. This could be used as a hedging strategy depending on the perceived risk of the exporters. [Right now, the futures market indicate a depreciating INR]
Using Forwards contracts Banks and financial institutions like HSBC8, ICICI Bank9, and Kotak Securitites10 provide forward contracts for the exporters/importers. The pricing of the contracts (in case of HSBC) are done by considering the interest rates of the respective currencies. The pricing would also depend on the size of contract, time period, credibility, etc.
Using currency options Certain Indian banks11 and financial institutions also provide currency options facilities. The pricing of these depend on factors like the size of contract, time period, credibility, prices in the futures market etc.
Assuming minimum required margins are met when USD/INR is at least Rs. 42.5. (Basic idea is to calculate VaR and see how much risk the exporter would have to face if USD depreciates). Currently, the perception of USD depreciating to Rs. 42.5 is too low. So, the premiums for options would be low/affordable, but the risk faced by the exporter if it depreciates below Rs. 42.5 is higher (Assuming VaR was around 5% for the same). So, it would be a good idea to buy put option at this price. Similarly, forward contracts also would be easier to enter into – but would eliminate the spot market gains if USD appreciates. This might create other problems like disadvantage (lower profit) in comparison with other competitors. But this is difficult to predict or forecast. Currently, the futures/forward market prices predict depreciating INR. So, its a business question if the exporter wants to hedge at the current price or not (around Rs. 47 for Jan 2011 contract).
Outlook on EURO for the next three years
We can get a broad outlook on Euro for the next few years by comparing the interest rates on euro-denominated deposits and the interest rates in India. From the RBI press release statement, we observe that the interest rate for 2014 G-sec is 7.32%. The historical data for the MFI interest rates on euro-denominated bonds for the last one year is shown in the table below. MFI interest rate statistics cover those interest rates that resident monetary financial institutions (MFI) apply to euro-denominated deposits and loans by households and non-financial corporations which are residents of the euro area.
MFI interest rates on new business of euro-denominated deposits and loans by euro area residents (Percentage per annum; period average rates)
Dec 08 Jan 09 Feb 09 Mar 09 Apr 09 May 09 Jun 09 Jul 09 Aug 09 Sep 09 Oct 09 Nov 09 Dec 09
Maturity over 2 years
3.69
3.52
3.23
3.07
2.87
2.71
2.57
2.61
2.64
2.52
2.55
2.56
2.48
Considering the interest rate during Dec 2009, i.e. 2.48 and applying to the interest rate parity theory. Thus investing 1 Euro should yield 1.0763 Euro at the end of 3 years. The exchange rate
as on 12th February 2010 was 1 Euro = Rs. 64.02. Thus investing the same in India should yield Rs. 79.133 at the end of 2013 (i.e. 64.02 * 1.0732^3). The forward rate for Euro/INR should thus be 79.133/1.0763 = Rs. 73.523 by the end of 2013. The recent NSE trading data for Euro-INR currency derivative for the contract EURINR expiring on 27-01-2011 is shown in the table below, which also indicates towards an appreciating Euro in the near term.
Trade Date 11-Feb-10 10-Feb-10 9-Feb-10 8-Feb-10 5-Feb-10 4-Feb-10 3-Feb-10 2-Feb-10 1-Feb-10 Underlying EURINR 270111 EURINR 270111 EURINR 270111 EURINR 270111 EURINR 270111 EURINR 270111 EURINR 270111 EURINR 270111 EURINR 270111 Close Price 66.0075 66.0075 66.0075 66.0075 66.0075 66.0075 66.0075 66.0075 66.0075 Daily Settlement Price 65.165 65.6025 65.2975 65.5475 65.6475 65.6375 65.935 66.09 66.045
As such, the broad outlook would be an appreciating Euro in the next 3 year duration and the approximate value for Euro at the end of three years, using the interest rate parity theory, would be – 1 Euro = Rs. 73.523.
Outlook on Singapore Dollar (SGD) for the next three years
Here we first try to understand how the exchange rates of the Singapore dollar vs. The Indian rupee (INR) have changed over the past few years. We have taken a trend of the exchange rates from 1st January 2004 till 12th February 2010. We consider this data to be a representative sample of the long term behaviour of SGD vis a vis the INR. The trend is shown below.
SGD/INR
40 35 30 25 20 15 10 5 0 INR per SGD
SGD/INR
Date
We can see that the evolution is approximately linear apart from the period between 2007 and 2008 where the SGD seems to have depreciated. Considering a linear pattern, we take a slope of this trend and get a value of 0.002729. Applying the same slope for the next three years we make a naive estimation that the INR would depreciate by 2.9887 rupees. Thus from the naive forecast of the previous trend we estimate the SGD to appreciate to Rs. 35.9484 by the end of 2013. We try to estimate the same result using the interest rate calculations. We observe from the RBI press release statement that the interest rate for 2014 G-sec is 7.32%. We estimate the same interest rate for a risk free investment up to 3 years. Similarly the 3 year bond rate in Singapore is 1.625% compounded on a semi annual basis. Thus investing 1 SGD should yield 1.1015 SGD at the end of 3 years (ie. 1.01625^6*1). The exchange rate as on 12th February 2010 was 1 SGD = Rs. 32.9597. Thus investing the same in India should yield Rs. 40.7404 at the end of 2013 (ie. 32.9597*1.0732^3). The forward rate for SGD/INR should thus be 40.7404/1.1015 = Rs. 36.9862 by the end of 2013. Taking the historic volatility into consideration, we observe that the standard deviation is Rs. 2.7606 for the period 01-01-2004 to 02-12-2010 (dates specified in mm-dd-yyyy format). Thus we estimate the Exchange rate to vary between Rs. 34.2256 and Rs. 39.7468.
Trend showing USD/SGD over the past five years Our findings are supported by the trend observed between U.S. Dollar and the Singapore dollar (as shown in the chart above). Since we see that the SGD has appreciated against the USD since 2005 till date we can expect the SGD to remain strong in the next three years as well. Since the RBI maintains the Rupee exchange rate with U.S. dollar, we can expect the SGD to appreciate against the INR as well. Considering this scenario, the software firm can invoice its clients in Singapore in SGD and can take the risk of not hedging their exposure as it is highly likely that the SGD will appreciate against the INR in the next three years.
Conclusion
We have to invariably bill many customers in USD because of the industry practices. With the current outlook, we prefer going in for options at the minimum exchange rate and minimum premium rather than any of the other methods (like swaps, forwards or futures). For SGD and Euro it is better to not to hedge as it is highly likely that the both SGD and Euro will appreciate against the INR in the next three years
References 1. Accounting Standard (AS) 11- Ministry of Corporate Affairs, Government of India 2. FEMA 1999, Ministry of Finance, Government of India. 3. “Indian Derivatives Market - A Regulatory and Contextual Perspective”Smt. Shyamala Gopinath, Deputy Governor, RBI, Keynote address at the Euromoney Inaugural India Derivatives Summit, 2007, Mumbai on October 24, 2007 4. RBI Guidelines on trading of Currency Futures in Recognised Stock / New Exchanges 5. http://www.ecb.int/stats/money/interest/interest/html/index.en.html 6. http://www.nseindia.com/marketinfo/fxTracker/fxTracker.jsp# 7. http://www.business-standard.com/india/news/currency-futures-permitted-in-euro-pound/83504/on 8. http://www.actionforex.com/action-insight/market-overview/mid%11day-report%3adollar-higher-as-china-raised-reserve-requirements-again-20100212106649/ 9. http://www.nseindia.com/marketinfo/fxTracker/fxTracker.jsp 10. http://www.hsbcnet.com/treasury/foreign-exchange/fx_spot_forward_contracts.html 11. http://ebusiness.icicibank.com/imarkets/products/treasury/products.asp?left=treasury&su b=prod 12. http://www.kotaksecurities.com/landingpage/CurrencyDerivative/CurrencyDerivative.ht m 13. http://www.icicibank.com/corporate/forex-treasury-ser/Derivatives-Desk/Options.html 14. http://www.mas.gov.sg/data_room/Financial_Databases.html 15. http://in.finance.yahoo.com/q/bc?s=USDSGD=X&t=5y&l=on&z=m&q=l&c
doc_152410092.docx
The doc about topics like internetional financial management,invoicing in foreign currency, RBI Regulations.
INFM Group Assignment: Indian Software Development Firm
International Financial Management
Executive Summary
The software development firm is operating out of India. The firm has clients in US, Europe and Singapore. As of now the invoicing is in USD to all our clients, but recently clients from Europe and Singapore have requested to be invoiced in Euro and Singapore Dollars respectively. Since, the software company is operating out of India it is governed by regulations from Reserve Bank of India and the Ministry of Corporate affairs, Government of India. The regulation allows a firm to transact in foreign currency. It if does so then according to accounting standard AS 11 it will have to report the transaction preferable in domicile currency i.e. INR in our case. The standard also state that the monetary items on the balance sheet be recorded in INR with the exchange rate on the day the balance sheet is prepared. If the firm makes use of any of the financial instruments to hedge its risk then the premium or discount should be amortized over the life of the contract. It can enter into OTC products like forwards, swaps and options, for hedging their currency risk. Since, the Small and Medium Enterprises might not have a good understanding of the risk with such products; it is recommended that only the banks with whom they have the credit relationship is allowed to offer such facilities. The currency futures in India are available in MCX, it can hedge its risk in the USD and Euro but Singapore Dollars cannot be hedged. The outlook of USD indicates that it will hover around Rs 46 to Rs 47. Since, the general market practice is to hedge the USD risk. It is advisable that the software company hedges its USD exposure. We prefer going in for options at the minimum exchange rate and minimum premium. According to the outlook in Singapore Dollars we believe that SGD will appreciate against INR in the near future. Hence, we will be better off by invoicing our Singapore clients in SGD and not hedging this transactions. Also, since MCX does not offer hedging in SGD even if the company wanted it will not be able to hedge its risk. The outlook of Euro is that it will appreciate in near future hence it is better to keep the exposure un-hedged in the near future.
Feasibility of Invoicing in Foreign Currency
The software company is governed by the regulations from the Reserve Bank of India and the Ministry of Corporate affairs, Government of India. The accounting standard AS11 by MCA and the Foreign Exchange Management Act, 1999 and its amendments in the later years by RBI are the important regulations to be followed by the software company. Ministry of Corporate Affairs and AS111 AS11 deals with the accounting for foreign currency transactions and foreign operations for Indian Companies. AS11 also deals with the treatment of forward exchange rate contracts entered by the company. If the company deals with foreign currencies, then the company should ensure that the transaction should be mentioned in the reporting currency in its financial statements. The company can state its financial statements in any currency, but using the domicile currency that is INR is the general practise.
If the company wants to invoice in different currencies, it can do so provided, the foreign currency transaction should be recorded, on recognition (income, expense, hedging or any other purposes) in the reporting currency by using the appropriate exchange rate between the reporting currency that is INR and the foreign currency at the date of the transaction .The exchange rate used is generally the average rate in the week or month in which the transaction takes place.
The standard specifies that when the balance sheet is made for the company, the monetary items, that is cash receivable and payables should be converted into INR using the closing exchange rate on the day the balance sheet is prepared or the expected amount that would be received in future if the closing rate does not reflect the true realisable value. If there is any change in the exchange rate after the transaction is recorded, then the net increase or decrease in value should be reported as income or expense for the period. Hence if the company goes for invoicing in different currencies, it has to keep track of the exchange rates of different currencies. This is an additional effort required for invoicing in different currencies.
If the company is invoicing in different currencies, then it would also want to hedge the exchange rate risks from fluctuations in these currencies. Hence it would enter into foreign exchange derivatives of all the different currencies for hedging purposes. This would need considerable expertise and hence might not be suitable for the software company in question. If the company intends to hedge its risks, then AS 11 suggests that the premium or discount arising at the beginning of a contract should be amortised as expense or income over the life of the contract. Exchange differences on such a contract should be recognised in the profit and loss statement in the reporting period in which the exchange rates vary. Any profit or loss arising on cancellation or renewal of such a forward exchange contract should be recognised as income or as expense for the period.
RBI regulations
The foreign exchange transactions are governed by the Foreign Exchange Management Act 19992. Section 7 of FEMA deals with the exporters of goods and services. The software company can enter in to current account and capital account transactions in foreign currency. The act insists that the company should furnish details about the contract to RBI or any other authority regarding the true and correct material particulars, including the amount representing the full export value or, if the full export value of the goods is not ascertainable at the time of export, the value which the exporter expects to receive on the sale of the goods in a market outside India. The RBI3 allows the company to enter into OTC products, such as forwards, swaps and options, for hedging their currency risk. With respect to forex derivatives involving rupee, the company has access to foreign exchange forward contracts, foreign currency-rupee swap instruments and currency options – both cross currency as well as foreign currency-rupee. In the case of derivatives involving only foreign currency, a range of products such as interest rate swaps, Forward rate agreements, option are allowed. The company can use it only if it has an underlying exposure to foreign exchange risk whether on current or capital account. In order to simplify procedural requirements for Small and Medium Enterprises (SME) sector, RBI granted flexibility for hedging the underlying as well as anticipated and economic exposures. In order to
ensure that SMEs understand the risks of these products, only banks with whom they have credit relationship are allowed to offer such facilities. These facilities should also have some relationship with the turnover of the entity. Assuming that the software company is registered as an SME, it will have to go through its bank for hedging its risks. From August 2008 onwards, companies can enter in to hedging their currency risk4 through currency futures. Currency futures in India are available in MCX. It started with US dollar – rupee contracts but from 19 th January 20105, currency futures in Euro, Pound and yen paired with INR was allowed by RBI. Hence the company can hedge its risk in the US dollar and Euro in the Indian market itself, but Singapore dollars cannot be hedged. Hedging through currency futures would need sufficient expertise which has to be developed by the software company. The contract sizes and time to maturity are fixed in currency futures unlike in OTC contracts. The Software Company needs to be prudent in selecting the contracts as per its needs. This would require sufficient knowledge and expertise in currency futures which might not be available inhouse.
Outlook of USD/INR
INR is managed float (or dirty float). It is managed by the Reserve Bank of India. So, we can expect RBI trying to manage the USD/INR in the range of Rs. 44 to Rs. 47 again for the next 3yrs (similar to that of 2006-07 period). USD is bound to maintain a balance because of its own depreciation (near term – due to the effects of recession and more outsourcing) and appreciation because countries like China6 would still add more dollars to their reserves or change policies – reasons include more exports to US, countries would want their dollar value to be high.
Based on forwards/futures The futures price of USD/INR is hovering around Rs. 47 for Jan 2011 contract while in the short term it’s hovering around 46. While spreads are lower in the short and longer term they are higher in the medium term.
For the next one year we can say that the USD/INR will hover around Rs. 46 to Rs. 47.
Market practices Most (if not all) the software export companies use USD for the transactions. And most of the non-US companies also transact with USD for different reasons. Considering these, we have to manage currency risks with USD, if necessary.
Hedging strategies Using Futures contracts (MTM) NSE provides currency futures7 exchange. The spreads are around 6500 pips and the bid rates are around Rs. 47 for a Jan 2011 contract. This could be used as a hedging strategy depending on the perceived risk of the exporters. [Right now, the futures market indicate a depreciating INR]
Using Forwards contracts Banks and financial institutions like HSBC8, ICICI Bank9, and Kotak Securitites10 provide forward contracts for the exporters/importers. The pricing of the contracts (in case of HSBC) are done by considering the interest rates of the respective currencies. The pricing would also depend on the size of contract, time period, credibility, etc.
Using currency options Certain Indian banks11 and financial institutions also provide currency options facilities. The pricing of these depend on factors like the size of contract, time period, credibility, prices in the futures market etc.
Assuming minimum required margins are met when USD/INR is at least Rs. 42.5. (Basic idea is to calculate VaR and see how much risk the exporter would have to face if USD depreciates). Currently, the perception of USD depreciating to Rs. 42.5 is too low. So, the premiums for options would be low/affordable, but the risk faced by the exporter if it depreciates below Rs. 42.5 is higher (Assuming VaR was around 5% for the same). So, it would be a good idea to buy put option at this price. Similarly, forward contracts also would be easier to enter into – but would eliminate the spot market gains if USD appreciates. This might create other problems like disadvantage (lower profit) in comparison with other competitors. But this is difficult to predict or forecast. Currently, the futures/forward market prices predict depreciating INR. So, its a business question if the exporter wants to hedge at the current price or not (around Rs. 47 for Jan 2011 contract).
Outlook on EURO for the next three years
We can get a broad outlook on Euro for the next few years by comparing the interest rates on euro-denominated deposits and the interest rates in India. From the RBI press release statement, we observe that the interest rate for 2014 G-sec is 7.32%. The historical data for the MFI interest rates on euro-denominated bonds for the last one year is shown in the table below. MFI interest rate statistics cover those interest rates that resident monetary financial institutions (MFI) apply to euro-denominated deposits and loans by households and non-financial corporations which are residents of the euro area.
MFI interest rates on new business of euro-denominated deposits and loans by euro area residents (Percentage per annum; period average rates)
Dec 08 Jan 09 Feb 09 Mar 09 Apr 09 May 09 Jun 09 Jul 09 Aug 09 Sep 09 Oct 09 Nov 09 Dec 09
Maturity over 2 years
3.69
3.52
3.23
3.07
2.87
2.71
2.57
2.61
2.64
2.52
2.55
2.56
2.48
Considering the interest rate during Dec 2009, i.e. 2.48 and applying to the interest rate parity theory. Thus investing 1 Euro should yield 1.0763 Euro at the end of 3 years. The exchange rate
as on 12th February 2010 was 1 Euro = Rs. 64.02. Thus investing the same in India should yield Rs. 79.133 at the end of 2013 (i.e. 64.02 * 1.0732^3). The forward rate for Euro/INR should thus be 79.133/1.0763 = Rs. 73.523 by the end of 2013. The recent NSE trading data for Euro-INR currency derivative for the contract EURINR expiring on 27-01-2011 is shown in the table below, which also indicates towards an appreciating Euro in the near term.
Trade Date 11-Feb-10 10-Feb-10 9-Feb-10 8-Feb-10 5-Feb-10 4-Feb-10 3-Feb-10 2-Feb-10 1-Feb-10 Underlying EURINR 270111 EURINR 270111 EURINR 270111 EURINR 270111 EURINR 270111 EURINR 270111 EURINR 270111 EURINR 270111 EURINR 270111 Close Price 66.0075 66.0075 66.0075 66.0075 66.0075 66.0075 66.0075 66.0075 66.0075 Daily Settlement Price 65.165 65.6025 65.2975 65.5475 65.6475 65.6375 65.935 66.09 66.045
As such, the broad outlook would be an appreciating Euro in the next 3 year duration and the approximate value for Euro at the end of three years, using the interest rate parity theory, would be – 1 Euro = Rs. 73.523.
Outlook on Singapore Dollar (SGD) for the next three years
Here we first try to understand how the exchange rates of the Singapore dollar vs. The Indian rupee (INR) have changed over the past few years. We have taken a trend of the exchange rates from 1st January 2004 till 12th February 2010. We consider this data to be a representative sample of the long term behaviour of SGD vis a vis the INR. The trend is shown below.
SGD/INR
40 35 30 25 20 15 10 5 0 INR per SGD
SGD/INR
Date
We can see that the evolution is approximately linear apart from the period between 2007 and 2008 where the SGD seems to have depreciated. Considering a linear pattern, we take a slope of this trend and get a value of 0.002729. Applying the same slope for the next three years we make a naive estimation that the INR would depreciate by 2.9887 rupees. Thus from the naive forecast of the previous trend we estimate the SGD to appreciate to Rs. 35.9484 by the end of 2013. We try to estimate the same result using the interest rate calculations. We observe from the RBI press release statement that the interest rate for 2014 G-sec is 7.32%. We estimate the same interest rate for a risk free investment up to 3 years. Similarly the 3 year bond rate in Singapore is 1.625% compounded on a semi annual basis. Thus investing 1 SGD should yield 1.1015 SGD at the end of 3 years (ie. 1.01625^6*1). The exchange rate as on 12th February 2010 was 1 SGD = Rs. 32.9597. Thus investing the same in India should yield Rs. 40.7404 at the end of 2013 (ie. 32.9597*1.0732^3). The forward rate for SGD/INR should thus be 40.7404/1.1015 = Rs. 36.9862 by the end of 2013. Taking the historic volatility into consideration, we observe that the standard deviation is Rs. 2.7606 for the period 01-01-2004 to 02-12-2010 (dates specified in mm-dd-yyyy format). Thus we estimate the Exchange rate to vary between Rs. 34.2256 and Rs. 39.7468.
Trend showing USD/SGD over the past five years Our findings are supported by the trend observed between U.S. Dollar and the Singapore dollar (as shown in the chart above). Since we see that the SGD has appreciated against the USD since 2005 till date we can expect the SGD to remain strong in the next three years as well. Since the RBI maintains the Rupee exchange rate with U.S. dollar, we can expect the SGD to appreciate against the INR as well. Considering this scenario, the software firm can invoice its clients in Singapore in SGD and can take the risk of not hedging their exposure as it is highly likely that the SGD will appreciate against the INR in the next three years.
Conclusion
We have to invariably bill many customers in USD because of the industry practices. With the current outlook, we prefer going in for options at the minimum exchange rate and minimum premium rather than any of the other methods (like swaps, forwards or futures). For SGD and Euro it is better to not to hedge as it is highly likely that the both SGD and Euro will appreciate against the INR in the next three years
References 1. Accounting Standard (AS) 11- Ministry of Corporate Affairs, Government of India 2. FEMA 1999, Ministry of Finance, Government of India. 3. “Indian Derivatives Market - A Regulatory and Contextual Perspective”Smt. Shyamala Gopinath, Deputy Governor, RBI, Keynote address at the Euromoney Inaugural India Derivatives Summit, 2007, Mumbai on October 24, 2007 4. RBI Guidelines on trading of Currency Futures in Recognised Stock / New Exchanges 5. http://www.ecb.int/stats/money/interest/interest/html/index.en.html 6. http://www.nseindia.com/marketinfo/fxTracker/fxTracker.jsp# 7. http://www.business-standard.com/india/news/currency-futures-permitted-in-euro-pound/83504/on 8. http://www.actionforex.com/action-insight/market-overview/mid%11day-report%3adollar-higher-as-china-raised-reserve-requirements-again-20100212106649/ 9. http://www.nseindia.com/marketinfo/fxTracker/fxTracker.jsp 10. http://www.hsbcnet.com/treasury/foreign-exchange/fx_spot_forward_contracts.html 11. http://ebusiness.icicibank.com/imarkets/products/treasury/products.asp?left=treasury&su b=prod 12. http://www.kotaksecurities.com/landingpage/CurrencyDerivative/CurrencyDerivative.ht m 13. http://www.icicibank.com/corporate/forex-treasury-ser/Derivatives-Desk/Options.html 14. http://www.mas.gov.sg/data_room/Financial_Databases.html 15. http://in.finance.yahoo.com/q/bc?s=USDSGD=X&t=5y&l=on&z=m&q=l&c
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