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MANAGEMENT OF FOREIGN
EXCHANGE RISK BY THE
ORGANISATIONS
How Do They Do It ?
Rishav Mehta
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The F reign Exchange Market
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WHAT IS FOREIGN
EXCHANGE?
The f reign exchange currenc r f rex
r FX market exists herever ne
currenc is traded f r an ther. It is b
far the largest financial market in the
rld, and includes trading bet een
large banks, central banks, currenc
speculat rs, multinati nal c rp rati ns,
g vernments, and ther financial
markets and instituti ns.
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WHAT IS FOREIGN
EXCHANGE?
The currency in your pocket isliterally stock in your country, and
like a share, its value fluctuates on
the international market providing
knowledgeable traders withsubstantial opportunities for profit
or loss.
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SOURCES OF FOREIGN EXCHANGE
Overseas Sales Operations
Manufacturing Facilities
Outsourced Development or Support
Balance Sheet Conversions
Changing competitive position in the economy
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SOURCES OF FOREIGN
EXCHANGE
Every international transaction
across national boundariesexposes either the importers orthe exporters to foreignexchange risk.
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TYPES OF FOREIGN EXCHANGE
RISK!!
Transactional - Extent to which the future cashtransactions of the firm may be affected by anychanges in the currency exchange rate.
Economic It measures the impact of changesin exchange rate on the firm's cash flows and
earnings.
Translation - It measures the impact of changesin exchange rate on the financial statements ofthe group of company.
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HEDGING INSTRUMENTS
Forwards
Money Market Hedge
Futures
Options
Swaps
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FORWARDS
This can be analyzed by 2 points of view :
Exporter - An exporter who is expecting to receive the foreignexchange after 6 months can sell the amount to bank under aforward contract so that the receivable can be realized by him at theforward rate irrespective of the prevailing rate on the date ofrealization.
Importer - An importer can make the payment at a future dateunder forward contract at the forward rate.
The main advantage of a forward is that it can be tailored to
the specific needs of the firm and an exact hedge can be
obtained.
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MONEY MARKET HEDGE
The risk is c vered b b rr ing in
f reign currenc c nverting the same
int home currenc and investing in themone market to neutralize the
position.
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FUTURES
A futures contract is similar to the
for ard contract but is more liquid
because it is traded in an organizedexchange i.e. the futures market.
epreciation of a currenc can be
hedged b selling futures and
appreciation can be hedged b bu ing
futures.
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OPTIONS
A currency Option is a contract giving the right, not the obligation, to buy or
sell a specific quantity of one foreign currency in exchange for another at a
fixed price; called the Exercise Price or Strike Price. The fixed nature of the
exercise price reduces the uncertainty of exchange rate changes and limits the
losses of open currency positions. There are two types of Options :
1. Call
2. Put
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Call Option It is the right to bu anunderl ing securit at a given price. Call Options
are used if th
e risk is an up ard trend in price.
Put Option It is the right to sell an
underl ing securit at a given price. Put Optionsare used if the risk is a downward trend.
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OptionsExchange Rate
>
Strike Price
Exchange Rate