Foreign Exchange Risk Management - A Case Study 4u1q5m

Foreign Exchange Risk Management – A Case Study of TCS Technology Ltd

GROUP-6 DUSHYANT|LALITHA|APARNA|MANASA|RAHUL|SANTHOSH|USHA|ABHIRUP|JYOTHI

Foreign Exchange Risk 

Foreign exchange risk is a financial risk that exists when a financial transaction is denominated in a currency other than that of the base currency of the company.

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One of the most difficult and persistent problems for the firms exposed to forex risk

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Frequent fluctuations in exchange rates – a major source of uncertainty for multinational and domestic firms

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Current exchange rates are favourable for exports but imports are working out to be pricey.

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Indian IT sector – export oriented sector which requires frequent management and measurement of exchange rate risk.

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Analysis of the forex exposure and its management of TCS Technologies Ltd.

Types of foreign exchange exposure Transaction Exposure Foreign exchange Sources - Payables risk (also and Receivables in FX risk, exchange foreign currency known as rate risk or currency risk) is a financial risk that Imports,exports,capital the country,debt in foreign exists flows whenacross a financial transaction isservicing denominated in a currency other currency,dividend payments receipts in foreign currency. than that of the base currencyand of the company. Translation Exposure  If the holding company has a foreign subsidiary or foreign currency assets or liabilities, there is a need for the financial statements of the foreign subsidiary which are in foreign currency to be translated into the home currency of the parent.  This leads to translation gain or loss Economic Exposure  Operating exposure applicable for both MNCs and domestic companies.  Risk of exchange gain/loss due to future cash flows or costs of capital arising from unexpected exchange rate changes.

LITERARTURE REVIEW OF FOREIGN EXCHANGE RISK MANAGEMENT

ALPA DHANANI(2003)

• Reviewed the foreign exchange risk management practices of a single large UK MNC. • Instances were observed where corporate practices deviates from normative prescriptions do not necessarily imply sub-optimal behavior.

BRNGT PRAMBORG(2005)

• Throws light on Korean & Swedish non-financial firms on their foreign exchange risk exposure & hedging practices. • Korean firms more likely to focus on minimizing fluctuations of cash flows. • Swedish firms minimizing on alternative hedging methods

ALINE MULLER & WILLEM F.C VERSCHOOR (2006)

• Assessing the sensitivity of firm value to exchange rates. • Focus on 2 primary areas of enquiry theoretical foundation of exchange risk exposure & empirical evidence on the link between stock returns & currency fluctuations. • More complete understanding of time varying, horizondependent & non linear nature of exchange risk

 Empirical evidence :- There is a positive relationship between bank size & foreign exchange exposure: ERIC WRONG (2008)  Reason:- Larger banks tends to have more significant foreign exchange operations & trading positions.  Larger banks also have more businesses with large and international corporations of which competitiveness & sensitivity to exchange rates movements BIANCA DE POLI & JENS SINDERGAARD (2009)  Examined the properties of foreign exchange rate risk in a canonical general equilibrium small open economy model.  Features assure that not only risk aversion but also precautionary savings are counter-cycle.  Helps generate forex risk that co-varies negatively. TIGRAN POGHOSYAN (2010)  Provides the first empirical evidence on the relationship between US macroeconomic variables, international oil prices & foreign exchange risk in GCC countries.  Analysis performed using stochastic discount factor methodology impose no arbitrage relationship on the risk and its theoretically grounded macroeconomic determinants.  Estimation result suggested macroeconomic development in US constitute

VIJ MADHU (2009)

MANISHA GOEL (2011)

ANU JOSY JOY & Dr G S Gireesh Kumar (2011)

• Surveyed the hedging techniques used in Indian firms • He observed the 2 techniques famous among Indian companies for hedging Long dated & Short dated forward exchange contracts • Indian companies hedge their risks foreign currency forwards, swap & options agreements in Over the Counter (OTC) markets. • A sketch of foreign exchange exposure management as practiced by various multinational companies in India. • A comparative analysis of management of foreign exchange exposure by banking & non banking as well as foreign & Indian MNC’s operating in India. • Most of the companies faced all three exposures Transaction, economic & translation

• Research study globalization and increased cross border flow of funds have increased the exposure to market risk hedging of such exposures has become critical • Introduction of currency derivatives is a landmark achievement benefiting importers, exporters & companies with foreign exchange exposure

Indian IT sector

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Indian IT and ITES sector lead the economic growth

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Direct and Indirect employment opportunity of nearly 2.8 million and 8.9 million respectively

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Market size of the industry is expected to rise to $ 225 billion by 2020

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Localized and clustered in 7 cities-Bangalore, Hyderabad, Chennai, New Delhi, Kolkata, Mumbai and Pune

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Expansion to newer places due to infrastructure limit and scarcity of land

Factors leading to growth in the IT/ITES sectors are: 

Low operating cost abd tax advantage

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Favorable government policies

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Technically qualified personnel in the country

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Rapid adoption of IT technologies in major sectors

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Strong growth in export demand

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Use of new and emerging technology

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SEZ are growth drivers

FE Exchange exposure of TCS 

Income and expenses in foreign currencies are converted at exchange rates prevailing on date of transaction

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Exchange differences arising on a monetary item is accumulated in a foreign currency translation reserve

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or discount on foreign exchange are amortised and recognised in the statement of P&L over the period of the contract

Sales and Exports

Particulars Percent of export sales

For the year ended March 31 2012

2011

2010

91.84

91.02

92.18

Activity in foreign currency

Forex exposure Hedge 

Enters into foreign currency forward contracts and currency option contracts (accordance with the risk management policies ).

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Contract period varies from 1 days to 8 years

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Hedge risk associated with foreign currency fluctuation relating to firm commitments and forecasted transactions Cash flow Hedges- March 31, 2012

Foreign Currency

USD

PS

E

AUD

Currency option contract (Rs in crores)

218.5

21.75

21.0

3.0

Fair Value (Rs in crores)

29.56

14.66

18.64

3.34

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Hedging instruments are initially measures at fair value and are remeasured at subsequent reporting dates.

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Changes in fair value of the derivatives that are effective as hedges of future cash flows are recognized in shareholder’s funds

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When a hedge is discontinued, for forecasted transaction, any cumulative gain or loss on heading instrument recognized is retained in shareholder’s fund until the forecasted transaction occurs

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If the hedge transaction is not expected to occur, recognized gain or loss is transferred to the profit and loss statement for that period

Conclusion 

In international business, Exchange rate risk is one of the most important risks that firm faces

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IT sectors mainly depends on exports. Hence exposed to the forex risk

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Companies manage exchange rate risk by hedging in currency forward and options market

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Exports of TCS s for more than 90%. (Majority: US)

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Its major challenge is to hedge USD exposure

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Based on the data, it can inferred that the exposure of next 8 years can be hedged through foreign currency forwards and options

Thank You