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STRATEGIES AND HEDGING INSTRUMENTS USED TO MITIGATE FOREIGN CURRENCY RISK AKBAR BROTHERS (PVT) LTD

(Group Assignment)

COURSE

: International Finance

COURSE CODE : BEC 2304 LECTURER : Dr. H. N. Prabath Jayasinghe

BACHELOR OF BUSINESS ADMINISTRATION LEVEL II (SEMESTER VI) DEPARTMENT OF ECONOMICS FACULTY MANAGEMENT AND FINANCE UNIVERSITY OF COLOMBO

GROUP MEMBERS

Name 01. 02. 03. 04. 05. A. R. F Risliya J. C. Dassanayake B.J.R. Perea S. N. Suranika W. K. L. D Perera

Reg. No. 2009/MS/4234 2009/MS/3980 2009/MS/4185 2009/MS/4277 2009/MS/4204

Signature

ACKNOWLEDGEMENT

This report would not be possible if not for the support and guidance of certain individuals. First and foremost we wish to articulate our sincere appreciation to our course facilitator Dr. Prabath Jayasinghe, lecturer in Department of Economics for his co-operation and encouragement given in completion of this project report. Next we are highly indebted to Group treasurer Mr. K. Sudhagaran and Senior Accountant Mr. C. Balasuriya of Akbar Brothers (Pvt) Ltd for spending their valuable time and effort, amidst a busy schedule, to provide us the necessary information in completing this report. Last but not least we would like to thank our parents and friends for helping us in numerous ways to accomplish this report.

1. INTRODUCTION The increasing volatility of exchange rates in the foreign trade market and the risks associated in dealing with foreign currency transactions have compelled businesses to introduce various strategies and hedging instruments to mitigate such risks. The aim of this assignment is to identify the foreign currency risks faced by organizations in dealing with foreign transactions and the tools that are used to mitigate those risks. First this report gives a brief introduction about the company, its history, products/activities, key achievements, milestones etc. Then it illustrates the foreign currency risks the company is exposed to in terms of controllable and uncontrollable risks. The strategies and hedging instruments that are used by them to mitigate those risks are explained in detail while providing hypothetical examples for the understanding of how these strategies reduce the foreign currency risk. In order to carry out the project a company visit was made to the Akbar brothers (Pvt) Ltd, the largest tea exporter in the world, and necessary information was obtained through a face to face interview with the Group Treasurer of the company Mr. K. Sudhagaran.

A hypothetical example of the company using forward contract

Foreign Buyer Iraq

Tea exporter Akbar brothers

Iraq orders 50 000 Kg of bulk tea at $50 per Kg from the company for shipment after 3 months (Payment in USD)

Bank of Ceylon

Fwd rate 127. 62 Premium 0.85

Akbar brothers

Sampath Bank

Fwd rate 127.56 Premium 0.90

HSBC

Fwd rate 127. 59 Spot rate 0.88

Spot Rate Rs 127/ 1 USD The company would request for 3 months forward rates and premium from its bankers and would select the bank that match with its requirements. As per the above example the company accepts the BOC forward rate and enters in to a 3 month forward contract.

$2 500 000 (50 000 * $50)


Foreign Buyer Iraq

Tea exporter Akbar brothers

50 000 Kg of bulk tea at $50 per Kg

After 3 months period the company would ship the bulk tea to Iraq and Iraq would pay USD 2 500 000 in return.

Rs 3 19 050 000 (2 500 000 * 127.62) Bank of Ceylon Rs 2 125 000 (2 500 000 * 0.85) Akbar brothers

The bank converts the 2 500 000 USD to Rs at the 3 month forward rate and the company pays the premium of 0.85 to the bank. The company would decide on the forward rate based on the gut feeling and observing the trends of exchange rate changes. So even if the spot rate after 3 months is less than or greater than the forward rate the company would disregard its consequences as there will not be any physical loss. Thereby the company tries to mitigate its exposure to foreign currency risk and also to gain from the changes in exchange rates.

4. CONCLUSION This report highlights and illustrates how Akbar brothers Ltd uses the forward contracts and other strategies to mitigate the foreign currency risk arising from export transactions. It is apparent that the company which is a giant in the tea export market does not use many types of hedging instruments to mitigate risk. They basically carry out business based on their experiences and gut feelings rather than considering on the market fundamentals or theories. The practical application of theories as it is will not be possible in the real business context. Every business which is dealing with foreign currency transactions is vulnerable to risks but how they mange to overcome these risks make them survive in the market. According to the group treasurer Mr. Sudhagaran being too greedy will result in failure of business. When it comes to deciding on forward rates, if the company holds its hedging decision expecting the rates to go further upwards and upwards, then there can be a point where other businesses make a quick and coherent move first and enjoy the gains, whereas the company would lose for holding too long. Thereby it is possible to draw a conclusion that different organizations use different hedging instruments and strategies to mitigate risks based on their own set of experiences and industry analysis. There is no one best way to be used as a strategy to avoid currency risk but depends on factors such as level of exposure to foreign currency risk ,expectations of the company, the capacity of the company etc.