Preface

This paper examines the different Derivatives instruments that are being used by corporate to hedge their risk. The economic climate and markets can be affected very quickly by changes in exchange rates, interest rates, and commodity prices. Counterparties can rapidly become problematic. As a result, it is important to ensure financial risks are identified and managed appropriately. The financial markets have created their own way of offering insurance against financial loss in the form of contracts called derivatives. It is necessary for the corporate to have fair estimate of the risk they will run into if conditions become unfavorable. One of the methods of identifying the Value at Risk (VaR) is Monte Carlo Simulation. The study is a sincere effort to understand these problems, analyze them and suggest ways to eliminate the same.

Derivatives as Risk Management Tool for Corporates

Derivatives as a Risk Management Tool for Corporate

Table of Contents
Table of Contents....................................................................................................... 2 1.Introduction............................................................................................................. 4 1.1 Factors that Impact Financial Rates and Prices.................................................6 1.2 Factors that Affect Interest Rates......................................................................6 1.3 Factors that Affect Foreign Exchange Rates......................................................6 1.4 Factors that Affect Commodity Prices...............................................................7 1.5 Transaction Exposure........................................................................................ 9 1.6 Translation Exposure......................................................................................... 9 1.7 Foreign Exchange Exposure from Commodity Prices......................................10 1.8 Strategic Exposure.......................................................................................... 10 1.9 Commodity Risk.............................................................................................. 11 1.10 Credit Risk..................................................................................................... 11 1.11 Operational Risk............................................................................................ 12 1.12 Derivatives.................................................................................................... 12 1.12.1 FORWARDS ............................................................................................. 13 1.12.2 Contingent Claims .................................................................................. 14 1.13 Indian Accounting Practices...........................................................................16 1.13.1 Foreign Exchange Forwards....................................................................16 1.13.2 Accounting of Index Futures....................................................................16 2

Derivatives as Risk Management Tool for Corporates
1.13.3 Regulatory Framework............................................................................17 1.13.4 Daily Mark to Market............................................................................... 18 1.13.5 Recognition of Profit or Loss....................................................................18 1.13.5 Accounting at Financial Year End............................................................19 1.13.6 Accounting for Derivatives as per FAS 133.............................................19 1.13.7 Derivatives used as hedging instruments...............................................20 1.13.8 Hedge Recognition .................................................................................20 1.14 Indian Market................................................................................................ 21 2.0 Review of Literature........................................................................................... 24 3.0 Data and Methodology....................................................................................... 29 3.1 Data................................................................................................................. 29 3.2 Methodology.................................................................................................... 31 4.0 Analysis and Interpretation................................................................................. 33 4.1 Manufacturing Industry................................................................................... 33 4.1.1 Buyers Credit............................................................................................. 33 4.1.2 Commodities Contract (Gain/Loss)............................................................36 4.1.3 Export Earnings......................................................................................... 40 4.1.4 Investments.............................................................................................. 41 4.2 Banking Sector................................................................................................ 44 4.2.1 Forex Transactions.................................................................................... 44 4.2.2 Currency Swaps......................................................................................... 47 4.2.3 Investments.............................................................................................. 49 4.2.4 Borrowings................................................................................................ 51 4.2.5 Deposits.................................................................................................... 53 4.2.6 Credit Exposure – Overseas.......................................................................55 4.2.7 Credit Exposure Domestic.........................................................................58 4.2.7 Currency Derivatives.................................................................................60 4.2.8 Interest Rate Derivative Assets.................................................................63 5.0 Main Findings/Inference...................................................................................... 64 6.0 Scope of Further Research.................................................................................64 7.0 Conclusion.......................................................................................................... 65 8.0 Bibliography....................................................................................................... 66 9.0 Appendix............................................................................................................ 67 3

Derivatives as Risk Management Tool for Corporates

1.Introduction
Although financial risk has increased significantly in recent years, risk and risk management are not contemporary issues. The result of increasingly global markets is that risk may originate with events thousands of miles away that have nothing to do with the domestic market. Information is available instantaneously, which means that change, and subsequent market reactions, occur very quickly. The economic climate and markets can be affected very quickly by changes in exchange rates, interest rates, and commodity prices. Counterparties can rapidly become problematic. As a result, it is important to ensure financial risks are identified and managed appropriately. Risk refers to the probability of loss, while exposure is the possibility of loss, although they are often used interchangeably. Risk arises as a result of exposure. Exposure to financial markets affects most organizations, either directly or indirectly. When an organization has financial market exposure, there is a possibility of loss but also an opportunity for gain or profit. Financial market exposure may provide strategic or competitive benefits. Risk is the likelihood of losses resulting from events such as changes in market prices. Identifying exposures and risks forms the basis for an appropriate financial risk management strategy. Financial risk arises through countless transactions of a financial nature, including sales and purchases, investments and loans, and various other business activities. It can arise as a result of legal transactions, new projects, mergers and acquisitions, debt financing, the energy component of costs, or through the activities of management, stakeholders, competitors, foreign governments, or weather.
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There are three broad alternatives for managing risk: • Do nothing and actively. reduce revenues. processes. price goods and services. other organizations such as vendors. Financial fluctuations may make it more difficult to plan and budget. or passively by default. and the board of directors are in agreement on key issues of risk. 5 . and allocate capital. There are three main sources of financial risk: • Financial risks arising from an organization’s exposure to changes in market prices. and systems Financial risk management deals with the uncertainties resulting from financial markets. Addressing financial risks proactively provides an organization with a competitive advantage. accept all risks. or otherwise adversely impact the profitability of an organization. and commodity prices • Financial risks arising from the actions of.Derivatives as Risk Management Tool for Corporates When financial prices change dramatically. particularly people. customers. Organizations manage financial risk using a variety of strategies and products. The passive strategy of taking no action is the acceptance of all risks by default. It involves assessing the financial risks facing an organization and developing management strategies consistent with internal priorities and policies. and counterparties in derivatives transactions • Financial risks resulting from internal actions or failures of the organization. Strategies for risk management often involve derivatives. It also ensures that management. exchange rates. stakeholders. such as interest rates. • Hedge a portion of exposures by determining which exposures can and should be hedged. it can increase costs. operational staff. and transactions with.

are 6 .3 Factors that Affect Foreign Exchange Rates Foreign exchange rates are determined by supply and demand for currencies. They are comprised of the real rate plus a component for expected inflation. Factors that influence the level of market interest rates include: • Expected levels of inflation • General economic conditions • Monetary policy and the stance of the central bank • Foreign exchange market activity • Foreign investor demand for debt securities • Levels of sovereign debt outstanding • Financial and political stability 1. impact the potential risk of an organization.1 Factors that Impact Financial Rates and Prices Financial rates and prices are affected by a number of factors. 1.Derivatives as Risk Management Tool for Corporates • Hedge all exposures possible. in turn. 1. Interest rates are particularly important to companies and governments because they are the key ingredient in the cost of capital. in turn.2 Factors that Affect Interest Rates Interest rates are a key component in many market prices and an important economic barometer. since inflation reduces the purchasing power of a lender’s assets. Interest rates are also reflective of supply and demand for funds and credit risk. Supply and demand.

Unlike financial assets. Some of the key drivers that affect exchange rates include: • Interest rate differentials net of expected inflation • Trading activity in other currencies • International capital and trade flows • International institutional investor sentiment • Financial and political stability • Monetary policy and the central bank • Domestic debt levels (e.Derivatives as Risk Management Tool for Corporates influenced by factors in the economy.4 Factors that Affect Commodity Prices Physical commodity prices are influenced by supply and demand. debt-to-GDP ratio) • Economic fundamentals 1. including: 7 . In some commodities.g. given their size and mobility. and the activities of international investors. are of great importance in determining exchange rates. Commodity supply is a function of production. seasonal variations of supply and demand are usual and shortages are not uncommon. foreign trade.. Commodity prices may be affected by a number of factors. Supply may be reduced if problems with production or delivery occur. Capital flows. such as crop failures or labor disputes. There may also be major shifts in consumer taste over the long term if there is supply or cost issues. the value of commodities is also affected by attributes such as physical quality and location. Demand for commodities may be affected if final consumers are able to obtain substitutes at a lower cost.

interest rates. particularly for precious metals • Interest rates • Exchange rates. Major market risks are usually the most obvious type of financial risk that an organization faces. particularly for energy and precious metals Major market risks arise out of changes to financial market prices such as exchange rates. depending on how prices are determined • General economic conditions • Costs of production and ability to deliver to buyers • Availability of substitutes and shifts in taste and consumption patterns • Weather. Major market risks include: • Foreign exchange risk • Interest rate risk • Commodity price risk • Equity price risk Other important related financial risks include: • Credit risk • Operational risk • Liquidity risk • Systemic risk 8 .Derivatives as Risk Management Tool for Corporates • Expected levels of inflation. particularly for agricultural commodities and energy • Political stability. and commodity prices.

contractual payments in other currencies. and sales to customers in currencies other than the domestic one. It arises from the ordinary transactions of an organization. are likely to be particularly impacted. and foreign currency debt. Translation exposure results wherever assets. 9 . or profits are translated from the operating currency into a reporting currency.Derivatives as Risk Management Tool for Corporates The interactions of several risks can alter or magnify the potential impact to an organization. Risks faced by an organization can be broadly classified as 1.5 Transaction Exposure Transaction risk impacts an organization’s profitability through the income statement. Organizations that buy or sell products and services denominated in a foreign currency typically have transaction exposure. liabilities. 1. increases in the value of the foreign currency vis-à-vis the domestic currency mean an increase in the translated market value of the foreign currency liability. such as those associated with foreign operations. Translation exposure affects an organization by affecting the value of foreign currency balance sheet items such as accounts payable and receivable. royalties or license fees. If an organization borrows in a foreign currency but has no offsetting currency assets or cash flows. particularly assets and liabilities on the balance sheet. Foreign currency debt can also be considered a source of translation exposure. foreign currency cash and deposits.6 Translation Exposure Translation risk traditionally referred to fluctuations that result from the accounting translation of financial statements. including purchases from suppliers and vendors. Longer-term assets and liabilities.

1. such as declining sales from international customers. In most cases.Derivatives as Risk Management Tool for Corporates 1. if the exchange rate moves favorably.S. By splitting the risk into currency and commodity components. an organization can assess both risks independently. Even when purchases or sales are made in the domestic currency.S. and a component of. though their impact appears in income statements. become cheaper by comparison without any action on their part. dollars.7 Foreign Exchange Exposure from Commodity Prices Since many commodities are priced and traded internationally in U. the buyer might be better off without a fixed exchange rate. 10 . like any other business. do not show up on the balance sheet. and obtain the most efficient pricing. suppliers of commodities. However. exchange rates may be embedded in. determine an appropriate strategy for dealing with price and rate uncertainties. are forced to pass along changes in the exchange rate to their customers or suffer losses themselves.8 Strategic Exposure The location and activities of major competitors may be an important determinant of foreign exchange exposure. The prices of goods exported by the firm’s competitors. Economic exposures. the commodity price. Strategic or economic exposure affects an organization’s competitive position as a result of changes in exchange rates. Protection through fixed rate contracts that provide exchange rate protection is beneficial if the exchange rate moves adversely. exposure to commodities prices may indirectly result in foreign exchange exposure for non-U. who are coincidentally located in a weak-currency environment. organizations.

although it depends to a certain degree on the legal environment and whether funds are owed on a net or aggregate basis on individual contracts. 11 . have exposure to commodity price risk.10 Credit Risk Credit risk is one of the most prevalent risks of finance and business. an options market may develop.9 Commodity Risk Exposure to absolute price changes is the risk of commodity prices rising or falling. if a forward market exists. either on an exchange or among institutions in the over-the-counter market. It also increases in an environment of rising interest rates or poor economic fundamentals. Organizations that produce or purchase commodities. The move by international regulators to shorten settlement time for certain types of securities trades is an effort to reduce systemic risk. In general. Some commodities cannot be hedged because there is no effective forward market for the product. 1. Credit risk that arises from exposure to counterparty. such as in a derivatives transaction. time to settlement. Generally. or time to maturity increase. The failure of counterparty is less of an issue when the organization is not owed money on a net basis. Credit risk increases as time to expiry. credit risk is a concern when an organization is owed money or must rely on another organization to make a payment to it or on its behalf. Organizations are exposed to credit risk through all business and financial transactions that depend on the payment or fulfillment of obligations of others.Derivatives as Risk Management Tool for Corporates 1. is often known as counterparty risk. or whose livelihood is otherwise related to commodity prices. which in turn is based on the risk of individual market participants.

Derivative contracts can be classified into two general categories: • Forward Commitments • Contingent Claims Within the category of forward commitments. A derivative is a financial instrument that offers a return based on the return of some other underlying asset. and technology and systems.11 Operational Risk Operational risk arises from human error and fraud. Operational risk is one of the most significant risks facing an organization because of the varied opportunities for losses to occur and the fact that losses may be substantial when they occur. A derivative also has a defined and limited life. specifically futures 12 . It trades in a market in which buyers and sellers meet and decide on a price.Derivatives as Risk Management Tool for Corporates 1. A derivative contract initiates on a certain date and terminates on a later date. a derivative's performance is based on the performance of an underlying asset. two major classifications exist: • Exchanged-traded contracts. the seller then delivers the asset to the buyer and receives payment. Often the derivative's payoff is determined are made on the expiration date.12 Derivatives The financial markets have created their own way of offering insurance against financial loss in the form of contracts called derivatives. The price for immediate purchase of the underlying asset is called the cash price or spot price. As the definition states. although that is not always the case. 1. Its return is derived from another instrument. processes and procedures.

12. A Futures contract is a variation of a forward contract that has essentially the same basic definition but some additional features that clearly distinguish it from a forward contract. the seller. Another important distinction between forward contracts and futures contracts lies in the ability to engage in offsetting 13 . standardized transaction that takes place on a futures exchange. and various other terms and conditions. it is a public. The underlying asset could be a security (i. agrees to buy from the other party. or sometimes an interest rate. the buyer. how many units of the underlying are included in one contract. These contracts call for the purchase and sale of an underlying asset at a later date. Any transaction involving a commitment between two parties for the future purchase or sale of an asset is a forward contract. a foreign currency. like a stock exchange.1 FORWARDS The forward contract is an agreement between two parties in which one party. such as when and where delivery will take place and the precise identity of the underlying. The contracts are standardized. The parties to the transaction specify the forward contract's terms and conditions. which means that the exchange determines the expiration dates. The forward market is a private and largely unregulated market. a stock or bond). A futures exchange.e. a commodity. the underlying. Each party is subject to the possibility that the other party will default. an underlying asset at a future date at a price established at the start. A futures contract is not a private and customized transaction.Derivatives as Risk Management Tool for Corporates • Over-the-counter contracts ( forward contracts and swaps) 1. is an organization that provides a facility for engaging in futures transactions and establishes a mechanism through which parties can buy and sell these contracts. or combinations thereof.. Instead.

enters into a swap that commits it to making a series of interest payments to the swap counterparty at a fixed rate. like forward contracts. such as an interest rate. One party agrees to pay the other a series of cash flows whose value will be determined by the unknown future course of some underlying factor. The floating components cancel. The other party promises to make a series of payments that could also be determined by a second unknown factor or. exchange rate. An option is a financial instrument that gives one party the right.2 Contingent Claims Contingent claims are derivatives in which the payoffs occur if a specific event happens referred as options.Derivatives as Risk Management Tool for Corporates transactions. but not the obligation. to buy or sell an underlying asset from or to another party at a fixed price over a specific period of time. an option that gives the right to sell is referred to as a put. A Swap is a variation of a forward contract that is essentially equivalent to a series of forward contracts. The fixed price at which the underlying can be bought or sold is called the exercise price. Specifically. Swaps are arguably the most successful of all derivative transactions.12. currently borrowing at a floating rate. Probably the most common use of a swap is a situation in which a corporation. alternatively. a swap is an agreement between two parties to exchange a series of future cash flows. Swaps. An option that gives the right to buy is referred to as a call. 1. 14 . stock price. are private transactions and thus not subject to direct regulation. while receiving payments from the swap counterparty at a rate related to the floating rate at which it is making its loan payments. resulting in the effective conversion of the original floating-rate loan to a fixed-rate loan. or commodity price. Forward contracts are generally designed to be held until expiration. could be preset.

Figure 1 Derivatives 15 . and is determined at the outset of the transaction. The payoff of the option is contingent on an event taking place. striking price. the buyer of the option must pay a price at the start to the option seller.Derivatives as Risk Management Tool for Corporates strike price. To acquire this right. In contrast to participating in a forward or futures contract. owning an option represents the right to buy or sell. which represents a commitment to buy or sell. This price is called the option premium or sometimes just the option price. or strike.

Further the profit or loss arising on cancellation or renewal of a forward exchange contract should be recognized as income or as expense for the period.13 Indian Accounting Practices Accounting for foreign exchange derivatives is guided by Accounting Standard 11.Derivatives as Risk Management Tool for Corporates 1. ‘fair value accounting’ plays an important role in accounting for investments and stock index futures. the benefits or losses accruing due to the forward cover are not accounted. willing seller in an arm’s length transaction. As a result. 1. AS-11 suggests that difference between the forward rate and Exchange rate of the transaction should be recognized as income or expense over the life of the contract.2 Accounting of Index Futures Internationally.13.13. Simply stated. The Standard requires that the exchange difference between forward rate and spot rate on the date of forward contract be accounted. or another financial instrument that is in substance a forward exchange contract to establish the amount of the reporting currency required or available at the settlement date of transaction. 1. Accounting Standard 11 provides that the difference between the forward rate and the exchange rate at the date of the transaction should be recognized as income or expense over the life of the contract.1 Foreign Exchange Forwards An enterprise may enter into a forward exchange contract. Accounting for Stock Index futures is expected to be governed by a Guidance Note shortly expected to be issued by the Institute of Chartered Accountants of India. AS-11 suggests that profit/loss arising on cancellation of renewal of a forward exchange should recognize as income or as expense for the period. Fair value is the amount for which an asset could be exchanged between a knowledgeable. fair 16 . willing buyer and a knowledgeable.

Current investment is an investment that is by its nature readily realizable and is intended to be held for not more than one year from the date of investment. Any reduction in the carrying amount and any reversals of such reductions should be charged or credited to the profit and loss account. it is widely expected that stock index futures will also be accounted based on prudent accounting conventions. In countries where local accounting practices require valuation of underlying at fair value. The Institute is finalizing a Guidance Note on this area. size=2 index futures (and other derivative instruments) are also valued at fair value. In view of Indian accounting practices currently not recognizing fair value. Both the Bombay Stock Exchange and the National Stock Exchange have set up independent derivatives segments. These broker-members are required to satisfy net worth and other criteria as specified by the SEBI Committees. 1. accounting for derivatives follows a similar principle. On the disposal of an investment. Accounting Standard 13 provides that the current investments should be carried in the financial statements as lower of cost and fair value determined either on an individual investment basis or by category of investment.Derivatives as Risk Management Tool for Corporates value accounting requires that underlying securities and associated derivative instruments be valued at market values at the financial year end. where select broker-members have been permitted to operate. which is expected to be shortly released. the difference between the carrying amount and net disposal proceeds should be charged or credited to the profit and loss statement. In countries where local accounting practices for the underlying are largely dependent on cost (or lower of cost or fair value).3 Regulatory Framework The index futures market in India is regulated by the Reports of the Dr L C Gupta Committee and the Prof J R Verma Committee. This practice is currently not recognized in India.13. 17 .

Derivatives as Risk Management Tool for Corporates Each client who buys or sells stock index futures is first required to deposit an Initial Margin.13. This margin is generally a percentage of the amount of exposure that the client takes up and varies from time to time based on the volatility levels in the market. Each evening. The daily settlement system is an administrative mechanism whereby the stock exchanges maintain a healthy system of controls. 1.4 Daily Mark to Market Stock index futures transactions are settled on a daily basis. From an accounting perspective. For example. Alternatively. if the October series of SENSEX futures was purchased on 11th October and again on 12th October and sold 18 . If a series of transactions were to take place and the client is unable to identify which particular transaction was squared up. It is widely believed that daily settlement does not mean daily squaring up. a profit or loss would arise at the point of squaring up. profits or losses do not arise on a day to day basis. This profit or loss would be recognized in the Profit & Loss Account of the period in which the squaring up takes place.5 Recognition of Profit or Loss A basic issue which arises in the context of daily settlement is whether profits and losses accrue from day to day or do they accrue only at the point of squaring up. the payment made by the client towards Initial Margin would be reflected as an Asset in the Balance Sheet. Thus. the broker could settle with the client on a weekly basis (as daily fund movements could be difficult especially at the retail level). The exchange would collect or pay the difference to the member-brokers on a daily basis. At the point of buying or selling index futures. 1. the closing price would be compared with the closing price of the previous evening and profit or loss computed by the exchange. The broker could further pay the difference to his clients on a daily basis. the client could follow the First In First Out method of accounting.13.

This would be accounted net of the provision towards losses (if any) already effected in the previous year at the time of closing of the accounts. For example. it is taken as a Current Liability. a similar principle would be applied to index futures also. It is important to understand the purpose of the enterprise while entering into the transaction relating to the derivative instrument. A total of such profits and losses is struck. losses if any would be recognized at the year end.Derivatives as Risk Management Tool for Corporates on 16th October. these would be tracked separately and not mixed up with the October series of SENSEX. A global system could be adopted whereby the client lists down all his stock index futures contracts and compares the cost with the market values as at the financial year end.13. if November series of NIFTY are also purchased and sold. The derivative instrument could be used as a tool for hedging or could be a trading transaction unrelated to hedging. Thus.5 Accounting at Financial Year End In view of the underlying securities being valued at lower of cost or market value. while unrealized profits would not be recognized. If the total is a loss.13. The standard also calls for accounting the gains and losses arising from derivatives contracts. The actual profit or loss would occur in the next year at the point of squaring up of the transaction. 1. The FIFO would be applied independently for each series for each stock index future. If it is not used as a hedging 19 . 1. If the total is a profit. it will be understood that the 11th October purchases are sold first. a relevant provision would be created in the Profit & Loss Account.6 Accounting for Derivatives as per FAS 133 The standard requires that every derivative instrument should be recorded in the Balance Sheet as assets or liability at fair value and changes in fair value should be recognized in the year in which it takes place.

Derivatives as Risk Management Tool for Corporates instrument. • • Earlier there was no concept of partial effectiveness of hedge. the gain or loss on the derivative instrument is required to be recognized as profit or loss in current earnings. Ineffectiveness may be reported in the current financial statements earnings.13.7 Derivatives used as hedging instruments Derivative instruments used for hedging the fair value of a recognized asset or liability. 1. 20 .8 Hedge Recognition Accounting treatment for trading and hedging is completely different. The Statement requires that the assessment of effectiveness must be consistent with risk management strategies documented for that particular hedge relationship.13. 1. The gain or loss on such derivative instruments as well as the offsetting loss or gain on the hedged item shall be recognized currently in income. However FASB recognized that not all hedging transactions can be perfect. Further the assessment of effectiveness is required whenever financial statements or earnings are reported. hedge instrument and risks being hedged Expect hedge to be highly effective Lay down reasonable basis for assessment effectiveness. the company should at the inception of the transaction: • • • Designate the hedge relationship Document such relationship Identifying hedge item. are called Fair Value Hedges. In order to qualify as a hedge transaction. There can be a degree of ineffectiveness which should be recognized.

the regional rural banks. which operate in rural areas. more than 350 central cooperative banks. and a number of primary agricultural credit societies. At present the banking system can be classified into following categories: • Public Sector Banks • Private Sector Banks • Co-Operative Sector Banks • Development Banks India's manufacturing sector is on an uptrend with the majority of sectors recording positive trends in the first half of fiscal year 2009-10. dominate the banking sector.Derivatives as Risk Management Tool for Corporates 1. There are approximately 80 scheduled commercial banks. 1934. according to a Confederation of Indian Industry (CII) survey. 20 land development banks. which have been included in the Second Schedule of the Reserve Bank of India (RBI) Act. The buoyant manufacturing growth in the first half is led 21 . not covered by the scheduled banks. almost 200 regional rural banks. Some co-operative banks are scheduled commercial banks albeit not all co-operative banks are. They also have certain obligations like minimum cash reserve ratio (CRR) to be kept with the RBI. the public sector banks. In terms of business. Scheduled commercial banks constitute those banks. as compared with the corresponding period in 2008-09. namely the State Bank of India and the nationalized banks. These are the scheduled commercial banks. These banks enjoy certain privileges such as free concessional remittances facilities and financial accommodation from the RBI.14 Indian Market The banking system in India has three tiers. and the cooperative and special purpose rural banks. Indian and foreign.

The below extract from the speech of the Deputy Governor shows the derivative transaction volumes taken by the Indian Market “Derivative markets worldwide have witnessed explosive growth in recent past.2 trillion in April 2007.3 trillion per day. an increase of 71% at current exchange rates and 65% at constant exchange rates. Average daily turnover rose to $3. to 70 per cent 22 . the cumulative growth in the manufacturing index for the period April to September 2009 as compared to the same period last year has been 6. The traditional instruments also show an unprecedented rise in activity in traditional foreign exchange markets compared to 2004.85 billion at current prices. intermediate goods and consumer durables. thus outpacing the growth in 'traditional' instruments such as spot trades. the average daily turnover of interest rate and non-traditional foreign exchange contracts increased by 71 % to $2. their combined share has fallen by nearly 10 percentage points since the 2004 survey.Derivatives as Risk Management Tool for Corporates by a rise in production of basic goods. forwards or plain foreign exchange swaps. Relatively moderate growth was recorded in the much larger interest rate segment. According to data. where average daily turnover increased by 64 per cent to $1. According to the BIS Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity as of April 2007 was released recently and the OTC derivatives segment. according to the Central Statistical Organization data. Turnover of foreign exchange options and cross-currency swaps more than doubled to $0.7 trillion. maintaining an annual compound growth of 20 per cent witnessed since 1995. for manufacturing stood at US$ 40.3 per cent. Quarterly estimate of GDP for April-June (Q1) 2009-10.1 trillion in April 2007 over April 2004. While the dollar and euro clearly dominate activity in OTC interest rate derivatives.

amounted to nearly USD 1600 billion (Rs. the inter-bank Rupee swap market turnover. 64. the share of India at $34 billion per day increased from 0. Until the amendment to the RBI Act in 2006. 16.24. there was some ambiguity in the legality of OTC derivatives which were cash settled.4 in 2004 to 0. Indian Forex and derivative markets have also developed significantly over the years. As per the BIS global survey the percentage share of the rupee in total turnover covering all currencies increased from 0. total Forex contracts outstanding in the banks' balance sheet amounted to USD 1100 billion (Rs.000 crore) per day in notional terms. 2007. foreign currency derivatives and credit derivatives.00.9 percent in 2007.000 crore) in notional terms.000 crore). credit rating or 23 . 2. This has now been addressed through an amendment in the said Act in respect of derivatives which fall under the regulatory purview of RBI (with underlying as interest rate. The activity in the Forex derivative markets can also be assessed from the positions outstanding in the books of the banking system. as turnover growth in several non-core markets outstripped that in the two leading currencies. though from global standards it is still in its nascent stage. Broadly. 2007.3 percent in 2004 to 0. has averaged around USD 4 billion (Rs.Derivatives as Risk Management Tool for Corporates in April 2007. as on August 31. as reported on the CCIL platform. of which almost 84% were forwards and rest options. 2007. As of August end.7 percent in 2007. The size of the Indian derivatives market is clearly evident from the above data. The outstanding Rupee swap contracts in banks’ balance sheet. 44 lakh crore). Outstanding notional amounts in respect of cross currency interest rate swaps in the banks’ books as on August 31. As per geographical distribution of foreign exchange market turnover. foreign exchange rate. Reserve Bank is empowered to regulate the markets in interest rate derivatives. amounted to USD 57 billion (Rs. As regards interest rate derivatives.

Banking Regulation Act or Foreign Exchange Management Act (FEMA). it was typically assumed that the risk averse firms makes its production and export decision prior to the resolution of exchange rate uncertainty (e. Benninga et al 1985. Its profits are linear in the exchange rate.0 Review of Literature In the literature on the competitive exporting firm under exchange rate risk. Kawai and Zilcha. Using a sample of firms that initiate derivative use.Derivatives as Risk Management Tool for Corporates credit index or price of securities) provided one of the parties to the transaction is RBI. “ 2. and Jennifer Conrad” although data on derivatives usage are more widely available. the existence of futures contract is sufficient to derive a separation theorem which states that firm’s production decision is independent of its attitude towards risk and the exchange rate distribution. Guay (1999) finds that the total risk.In this case the firm is inflexible since it cannot react on the realized exchange rate. fairly priced currency options play no role for an inflexible firm. Brown. 24 . a scheduled bank or any other entity regulated under the RBI Act. the empirical evidence on the effects of derivative use on firms’ risk and value is still mixed. Bartram. Gregory W. but he finds no significant change in the market risk of these firms. and risk exposures to interest rate changes of these firms decline.g. idiosyncratic risk. Adam Muller 2000). the firm completely eliminates exchange rate risk by holding a full hedge position. As shown by Lapan al (1991) and Batterman (2000). 1986. In an unbiased future market. As per the paper “The Effects of Derivatives on Firm Risk and Value” written by “Sohnke M. Consequently.

Derivatives as Risk Management Tool for Corporates
In contrast, Hentschel and Kothari (2001) found that the difference in risk for firms that use derivatives is economically small compared to firms that do not use them. Allayannis and Weston (2001) present evidence that hedging foreign currency risk is associated with large (approximately 4%) increases in market value; Graham and Rogers (2002) found that hedging can add an economically significant 1.1% to their market value by allowing firms to increase their debt capacity. However, Guay and Kothari (2003) showed that the magnitude of the cash flows generated by hedge portfolios is modest and unlikely to account for such large changes in value. Consistent with this, Jin and Jorion (2006) used a sample of oil and gas producers and find insignificant effects of hedging on market value. Bartram and Brown in their paper on Derivatives said that there is strong evidence that the use of financial derivatives reduces both total risk and systematic risk. The effect of derivative use on firm value was positive but more sensitive to endogeneity and omitted variable concerns. However, hedging with derivatives was associated with significantly higher value, abnormal returns, and larger profits during the economic downturn in 2001-2002, suggesting firms are hedging downside risk. This might be because of a change in the (perceived) value of risk management, with the value of firms that hedged increasing during the economic decline. Alternatively, these results simply reflect the unstable nature of the value results. As per Modigliani and Miller (henceforth MM, 1958), a firm managed by value maximizing agents, in a world of perfect capital markets, with investors who have equal access to these markets, would not engage in hedging activities since they add no value. Anything the firm could accomplish through hedging could equally well be accomplished by the investor acting on his or her own account. If the perfect capital markets assumption is not met, however, there may be rational reasons for the firm to hedge. The
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Derivatives as Risk Management Tool for Corporates
theoretical literature on hedging relaxes the MM assumptions and develops specific reasons why individual firms may optimally choose to hedge. As one might expect, these reasons tend to involve either market frictions, such as taxes, transactions costs, and informational asymmetries, or agency problems. Smith and Stulz (1985) show that a convex tax function implies that a firm can reduce expected tax liabilities by using hedges to smooth taxable income. In addition, hedging may increase a firm’s debt capacity, enabling it to add value by increasing the value of the debt tax shield (Leland, 1998). Froot, Scharfstein and Stein (1993) showed that managers facing external financing costs may use hedging to reduce the probability that internal cash flows are insufficient to cover investments; Smith and Stulz (1985) show that hedging can reduce expected costs of distress. Empirical researchers have used data disclosed by firms to examine the question of whether and how hedging affects the risks of the firm. The evidence was mixed. Guay (1999) investigates a sample of 234 U.S. non-financial firms that begin using derivatives in the early 1990s and found that measures of total and idiosyncratic risk decline in the following year. He found no significant evidence for changes in systematic risk. Hentschel and Kothari (2001) examined the risk characteristics of a panel of 425 large U.S. non-financial firms from 1991 to 1993. Their results showed no significant relationship between derivatives use and stock return volatility even for firms with large derivatives positions. The evidence for the effect of derivative use on market value was also mixed. Allayannis and Weston (2001) found that firm value (as measured by Tobin’s q) is higher for U.S. firms with foreign exchange exposure that use foreign currency derivatives to hedge.
26

Derivatives as Risk Management Tool for Corporates
Brown and Conard conducted univariate results and found that derivative use is more prevalent in firms with higher exposures to interest rate risk, exchange rate risk and commodity prices. Despite this, firms that used derivatives had lower estimated values of both total and systematic risk, suggesting that derivatives are used to hedge risk, rather than to speculate. There are significant differences between derivative users and non-users along other dimensions, emphasizing the importance of multivariate tests. They employed three different types of multivariate tests but concentrated on propensity score matching, in which derivative users and non-users were matched on the basis of their estimated propensity to use derivatives. Compared to firms that do not use derivatives, they found that hedging firms had lower cash flow volatility, idiosyncratic volatility and systematic risk; these results were robust to a number of different matching specifications, and the differences were both statistically and economically significant. This suggests that nonfinancial firms overall employ derivatives with the motive and effect of risk reduction. Consistent with the evidence in Allayannis and Weston (2001), derivative use is associated with a value premium, although the statistical significance of this premium is weak. These results suggest that the estimated effects of derivative use on risk measures are robust. Even small differences in sample construction, control variables and testing method could change the estimated effect. A 1995 survey of major non-financial firms revealed that at least 70 percent were using some form of financial engineering to manage interest rate, foreign exchange, or commodity price risk (Wharton-Chase, 1995). Financial firms, including banks (Gunther and Siems, 1995, and Shanker, 1996), savings and loans (Brewer, et al., 1996), and insurers (Colquitt and Hoyt, 1997, Cummins, Phillips, and Smith, 1997), also were active in derivatives
27

Derivatives as Risk Management Tool for Corporates
markets. Although the types of risks confronting managers vary across industries, there was substantial commonality in the underlying rationale for the use of derivatives and the financial engineering techniques that were employed. Cummins, Phillips, and Smith (CPS) (1997) presented extensive descriptive statistics on the use of derivatives by U.S. life and property-liability insurers and conducted a probit analysis of the participation decision. Colquitt and Hoyt (CH) (1997) analyzed the participation and volume decisions for life insurers licensed in Georgia. The paper “Derivatives and Corporate Risk Management: Participation and Volume Decisions in the Insurance Industry” by David Cummins suggests the following regarding the usage of derivatives in Insurance Industry. In this paper, they formulated and tested a number of hypotheses regarding insurer participation and volume decisions in derivatives markets. We base our hypotheses on the financial theories of corporate risk management that have developed over the past several years. The two primary, and non-mutually exclusive, strands of the theoretical literature held that corporations were motivated to hedge in order to increase the welfare of shareholders and/or managers. Their results provided a considerable amount of support for the hypothesis that insurer’s hedge to maximize value. Several specific hypotheses were supported by their analysis. In terms of participation in derivatives markets, they found evidence that insurers were motivated to use financial derivatives to reduce the expected costs of financial distress — the decision to use derivatives was inversely related to the capital-to-asset ratio for both life and property-liability insurers. They also found evidence that insurers use derivatives to edge asset volatility, liquidity, and exchange rate risks. Life insurers appeared to use
28

they provided support for the hypothesis that there were significant economies of scale in running derivatives operations. which was positively but weakly. There was also some evidence that tax considerations play a role in motivating derivatives market participation decisions by insurers. Interestingly.1 Data The data come from Schedules and Notes to Accounts and Managerial Discussion of the 2009 Annual statements released by 29 . they found that. conditional on being a user of derivatives. Their analysis provided only weak support for the utility maximization hypothesis. Thus. related to both the participation and volume decisions for property-liability insurers.0 Data and Methodology 3. the relationship between the volume of derivatives activities and these same risk measures often displayed exactly the opposite result to those found in the participation regression. however.Derivatives as Risk Management Tool for Corporates derivatives to manage interest rate risk and the risk from embedded options present in their individual life insurance and GIC liabilities. Finally. 3. only large firms and/or those with higher than average risk exposure would find it worthwhile to pay the fixed cost of setting up a derivatives operation. The only variable that carried significant implications regarding utility maximization was the ratio of surplus notes to assets.

Banks primary Income is influenced by interest rates as its assets consists of domestic loans and foreign currency loans. The relevant table also contains the details about the collateral required for entering into those transactions. It also speaks about the split of domestic and foreign exposure taken by the bank and the capital requirement for different kind of risks taken by the bank during the last financial year. The groups are • Hedging Transaction • Trading Transaction It also gives details about the Notional Amount involved in the Derivative Transactions. It also contains the details about the FRA and Interest Rate Swap Agreements taken by the bank during the last financial year. Data list for banks has been grouped under different heads for analysis. It also speaks about Buyers 30 .Derivatives as Risk Management Tool for Corporates Banks (ICICI and Indian Bank) and Manufacturing Companies (Hindalco and Tata Iron and Steel Company). Impact of interest rate in each of these currencies has an impact on the net interest income of the bank. This effect is also provided in the data set collected for the purpose of evaluating Translation Risk. It also shows about the mark to market value of the assets and liabilities that arise because of the derivative transaction. For the data pertaining to manufacturing sector the samples that were considered were Hindalco and that of Tata Iron and Steel Company. The data shows the export contracts that these companies had during the last financial year.

are smaller than −VaR over a period of time (horizon) T .2 Methodology VaR method of calculation is used to calculate the risk involved in the transaction and suitable derivative instrument of relevant value is used. 31 . MS Excel addin will be the software used for calculation using this method. VaR defines the loss in market value of say. Monte Carlo Simulation method of calculating VaR will be used. In other words. 3. it is the probability that returns (losses).Derivatives as Risk Management Tool for Corporates Credit. or: where PT (ξ) is the probability distribution of returns over the time period (0. T ). imports and foreign currency earnings made by the organization. One of the tables shows the split of the income the company makes from domestic market and foreign market. a portfolio. Details also include the extent to which raw materials are imported for the production and operation of the company. Data set also contains the Foreign Currency Exposure that is not hedged by derivative instruments. over the time horizon T that is exceeded with probability 1 − PVaR. say ξ . It also contains the details about the various derivative contracts entered by the company for hedging foreign currency exposures which includes commodity.

The simulated values form a probability distribution for the value of a portfolio which is used in deriving the VaR figures. By using Monte Carlo techniques one can overcome approaches based solely on a Normal underlying distribution. 32 . expiry of the instrument and VaR arrived earlier.Derivatives as Risk Management Tool for Corporates Hypothetical value will be assumed for minimum and maximum value for each of the transaction that a company (Bank and Manufacturing) undergoes where minimum and maximum value will be based on the value obtained from the data collected. Based on the nature of the transaction and VaR arrived suitable derivative instrument is opted. The value of the derivative contract is determined based on the nature of the instrument. Hypothetical sample size will be assumed which is one of the constraints in the calculation of VaR The scenario will be simulated for different confidence level and VaR of each hypothetical transaction will be arrived.

1 Buyers Credit Buyers Credit is the credit availed by an importer from the overseas lender. Exchange Rate and Credit Values.95 million USD. Manufacturing industries avail these options for purchasing raw materials etc…In this case Hindalco has taken buyers credit on an average of 48. By running Monte Carlo Simulation and converting the input sample as a normal function with mean of 48. 33 . The mean so obtained from last one year data was 48.525 million USD with a standard deviation of 21.Derivatives as Risk Management Tool for Corporates 4. This method is Variance-Covariance Approach as the mean and standard deviation is determined based on historical value. 4.4922 VaR so obtained with 99% confidence level with right tail suggests that there is a 1% probability that credit value will go above 99.512 million USD.95 for sample of 30.1 Manufacturing Industry Hindalco and JSW Steel were the companies that were considered for deriving the base value for the hypothetical situations.0 Analysis and Interpretation 4.e.525 and standard deviation of 21. Below figures show the normal distribution of input data i.1. 0000 VaR is arrived. The Exchange rates that have been used in the conversion are also converted as normal distribution for arriving at Indian Rupee.339 INR and standard deviation so obtained was INR 1.

Derivatives as Risk Management Tool for Corporates Figure 2 Buyers Credit MTM Figure 3 Buyers Credit 34 .

727385 Buyers Credit Present 64.Derivatives as Risk Management Tool for Corporates Figure 4 Exchange Rate Probability Buyers Credit(million USD) Mean SD 48.05 Value Table 2 Buyers Credit VaR 35 .55124051 Buyers Credit MTM(INR Crores) 4828.95566556 Exchange Rate 48.49223283 Table 1 Buyers Credit Buyers Credit( million USD) VaR 99.304403 2995.525 21.33938821 1.

44 Crores in INR with a standard deviation of INR 12 Crores. This hedge comes with a cost of initial margin. If not the company should be prepared to VaR level at the worst case scenario. Hindalco on an average has 24.Derivatives as Risk Management Tool for Corporates Company could hedge itself by entering into Forex Forwards for the credit taken at the specified Exchange rate.2 Commodities Contract (Gain/Loss) Manufacturing companies enter into these types of contracts to hedge their position against commodity price risk which they might face because of uncertain conditions. Monte Carlo simulation is executed with these mean values and standard deviation was decided using variance method. Instrument Forex Forwards Currency Futures Disadvantage Counter Party Risk Initial Margin Table 3 Buyers Credit and Derivative Instruments to be used 4. Company could hedge its position using Commodity Futures and Forward Contracts. 36 . Company should enter into currency futures by buying dollars at the desired risk level.1. But these contracts have counter party risk. Input is varied as normal distribution using random number generation and VaR is calculated as INR 3.561 Crores. It can also hedge its position using Currency Futures.

Commodity Contracts are also entered in foreign Currency for which hedging has to be done with currency futures along with Commodity Futures to hedge the position.56561 Crores in its worst case.Derivatives as Risk Management Tool for Corporates Figure 5 Commodities Contract Commodities(INR Crores) Mean SD 24.56561 Table 5 Commodities Contract VaR Company should be ready to face a loss of INR 3.44 12 Table 4 Commodities Contract Commodities(INR Crores) VaR -3. 37 .

It has to be noted that company has been incurring loss on these type of contracts based on historical data which is reflected in its mean data.Derivatives as Risk Management Tool for Corporates Monte Carlo Simulation is run with exchange rates being normally distributed along with the mean commodity contracts entered into in the foreign currency. The below graph shows the Commodities Contract MTM values in INR (millions) which is obtained by simulating the exchange rate which is also assumed to be distributed normally. Contracts which are taken for hedge should theoretically result in no loss or no gain position. Figure 6 Commodities Contract MTM The below graph is obtained by considering the gain/loss value of the contracts in USD and is normalized based on the mean value which is obtained based on historic data. But these contracts which have been taken is consistently showing loss which shows the uncertainity in the commodity price movements in foreign market or it could be the wrong positions taken by the companies.This graph 38 .

Derivatives as Risk Management Tool for Corporates doesn’t consider the exchange rate fluctuation which was considered in the earlier case. Figure 7 Commodities Contract Figure 8 Exchange Rate 39 .

Mean value of export earnings made by the company is calculated using co variance approach and arrived as INR 5148.753 million.Derivatives as Risk Management Tool for Corporates VaR obtained by considering the transaction in USD is found to be -11.3 Export Earnings These manufacturing companies export their finished goods to different countries and expect their payment at future date.2 Crores. Figure 9 Export Earnings Monte Carlo Simulation when run based on these data showed VaR loss of INR 582. This shows that company 40 .1. Variation is little because of lesser fluctuation in exchange rates which could be considerable if a volatile currency is considered.18 Crore and standard deviation of INR 2500 Crore.701 million USD which is approximately INR 565.65 million while the VaR obtained by considering normal distribution of exchange rates comes to be INR 566. 4.

4 Investments Manufacturing Companies invest their excess cash at different investment centers to make effective use of them.1. Instrument Forex Forwards Forex Futures Disadvantage Counter Party Risk Initial Margin Table 8 Export Earnings and Derivative Instruments to be used 4. If 41 .Derivatives as Risk Management Tool for Corporates has to prepare itself for loss accounting 582. There is a greater possibility that companies could benefit out of it. Export Earnings(INR Crores) Mean SD 5148. Company could hedge its earning by entering into Forward Contracts and by selling Currency Futures.18 2500 Table 6 Export Earnings Export Earnings(INR Crores) VaR -582.2 Crores which has the probability of occurrence of 1%.2 Table 7 Export Earnings VaR Exchange rate fluctuation is not considered for analysis because of lack of availability of data in each currency.

7425 Crores which means there is a probability of 1% that the investment made could fall below this value. 42 . When Monte Carlo Simulation is run based on these values with normal distribution as Input variations VaR at 99% confidence level arrived to be INR 396.Derivatives as Risk Management Tool for Corporates the company has taken wrong decision or invested in poor performing sector it is bound to erode its investment value. If the company has invested in foreign companies it should hedge its position using currency futures and options.755 Crores. Company should hedge its position by investing in derivatives thereby preventing the erosion of the investment value.755 Crores with a standard deviation of INR 41. Kind of derivative instruments that the company should enter in highly depends on the type of investment that the company has made. Option Contracts are generally used as hedge instruments to protect itself from adverse movements and these option contracts should be at the VaR level to avoid further erosion. Below graph shows the normal distribution of the investment value with mean and standard deviation arrived using covariance method. If on the other hand if the investment is bound to fluctuate based on the interest rate variations then it should hedge itself by opting for Interest Rate Futures and Interest Rate options. Mean of investment value made by Hindalco is arrived using historical covariance approach as INR 492. Company should opt for Option contracts if the company has more positive view on the investment growth features.

755 Table 9 Investments Investment Value (INR Crores) VaR 396.755 41.Derivatives as Risk Management Tool for Corporates Figure 10 Investment Value Investment Value (INR Crores) Mean SD 492.7425 Table 10 Investments VaR 43 .

Derivatives as Risk Management Tool for Corporates Instrument Forex Futures Interest Rate Futures Scenario Investments are in Foreign Currency Investments vulnerable with adverse interest rate movements To serve as insurance at adverse movements Option Contracts Table 11 Investments and Derivative Instruments to be used 4.935 million with a standard deviation of INR 719.2 Banking Sector Banking industries use derivative instruments to hedge its position against different exposures it has taken in its business activity. 44 .5328 Crores. is taken into consideration for analysis. 4.1 Forex Transactions Forex Transactions that have been entered by the banks could be in different currencies. Some of the transactions that are taken by the banks are listed below. Based on historical variance approach mean of Forex Transaction Profit /Loss that the bank makes in its Forex Transaction is arrived to be INR 592. which is converted in INR.2. Because of the constraint in availability of individual split up in each currency the Forex Transaction value in denomination of USD. Banks that have been considered for arriving at the base values for the simulation are ICICI and Indian Bank.

It could also opt for option contracts if there is a high probability of its view going right and in this case it should enter into option contracts taking in its view VaR value arrived. The above statement implies that there is a 1% probability that these transactions could eat their profit books by a value of INR 1080.97 Million or more. Monte Carlo Simulation when run based on these values gave a VaR of INR -1080. Companies could hedge its position by using derivative contracts especially Forex Forwards and Forex Futures. Many of the transactions incurred a huge loss and saw huge swing in their values because of the crisis the world was going on.Derivatives as Risk Management Tool for Corporates Standard Deviation of these transactions is very high because of the huge fluctuations in the last financial year due to the financial crisis. Below graph shows the normal distribution of the investment value with mean and standard deviation arrived using covariance method. 45 .97 million at 99% confidence level.

9325 719.Derivatives as Risk Management Tool for Corporates Figure 11 Forex Transaction Profit/Loss Forex Transactions (Million INR) Mean SD 592.5328 Table 12 Forex Transactions Forex Transactions (Million INR) VaR -1080.97 Table 13 Forex Transactions VaR Instrument Scenario 46 .

6693 million at 99% confidence level.2 Currency Swaps Currency Swaps are the transactions that banks make to warehouse its position at different currency exposures and also as trading instruments for profit making. 47 . VaR arrived based on these values for the above transaction using normal distribution arrived to be INR 674.Derivatives as Risk Management Tool for Corporates Forex Futures Interest Rate Futures Investments are in Foreign Currency Investments vulnerable with adverse interest rate movements To serve as insurance at adverse movements Option Contracts Table 14 Forex Transactions and Derivative Instruments to be used 4. Mean Value of Swap value made by the bank on these transactions arrived to be INR 523.3435 million with a standard deviation of INR 65.48445 million.2. Below graph shows the normal distribution of the investment value with mean and standard deviation arrived using covariance method.

48 .6693 Table 16 Currency Swaps VaR This VaR value is necessary in calculation of ALM in banks.Derivatives as Risk Management Tool for Corporates Figure 12 Currency Swaps Currency Swaps(Million INR) Mean SD 523.48445 Table 15 Currency Swaps Currency Swaps(Million INR) VaR 674.3435 65.

3 Investments Banks invest their excess cash at different investment centers to make effective use of them. Company should opt for Option contracts if the company has more positive view on the investment growth features. If the company has taken wrong decision or invested in poor performing sector it is bound to erode its investment value. There is a greater possibility that companies could benefit out of it. Kind of derivative instruments that the company should enter in highly depends on the type of investment that the company has made. When Monte Carlo Simulation is run based on these values with normal distribution as Input variations VaR at 99% confidence level arrived to be INR 396. Mean of investment value made by ICICI is arrived using historical covariance approach as INR 1072.36869 Crores. Option Contracts are generally used as hedge instruments to protect itself from adverse movements and these option contracts should be at the VaR level to avoid further erosion.2. Company should hedge its position by investing in derivatives thereby preventing the erosion of the investment value.Derivatives as Risk Management Tool for Corporates 4. If on the other hand if the investment is bound to fluctuate based on the interest rate variations then it should hedge itself by opting for Interest Rate Futures and Interest Rate options. If the company has invested in foreign companies it should hedge its position using currency futures and options.563 million with a standard deviation of INR 59.7425 Crores which means there is a probability of 1% that the investment made could fall below this value. 49 .

Figure 13 Investments Outside India Investments (outside India) (Million INR) Mean SD 1072.4768 Table 18 Investments Outside India VaR 50 .Derivatives as Risk Management Tool for Corporates Below graph shows the normal distribution of the investment value with mean and standard deviation arrived using covariance method.36869 Table 17 Investments Outside India Investments (outside India) (Million INR) VaR 933.563 59.

51 . With mean value of INR 703.Derivatives as Risk Management Tool for Corporates Instrument Forex Futures Interest Rate Futures Scenario Investments are in Foreign Currency Investments vulnerable with adverse interest rate movements To serve as insurance at adverse movements Option Contracts Table 19 Derivative Instruments for Investment Outside India Transactions 4.978 million. When these rates go in adverse direction could impact the interest paid by the banks and reduce the profit levels.4 Borrowings Borrowings made by the banks in terms of ECB and other foreign currency loans come under this head. These values are highly impacted by change in Exchange Rates and interest rate fluctuations which could add up to the interest rate burden and also in terms of redemption.938 million and standard deviation of INR 141. This implies that there is 1 % probability that borrowings could increase above INR 1029.2.978 million at 99% confidence level.995 million Monte Carlo simulations run on these parameters produced a VaR of INR 1029.

Below graph shows the normal distribution of the investment value with mean and standard deviation arrived at using covariance method. Figure 14 Borrowings Outside India Borrowings (outside India) (Million INR) Mean SD 703.9955 Table 20 Borrowings 52 . These instruments would help the borrower in raising Interest rate scenarios.Derivatives as Risk Management Tool for Corporates The derivative instruments that could be used are series of FRA’s and Interest Rate Swaps.938 141.

354 Crores. Mean of the Deposits held by the bank is arrived as INR 88.2. 53 .5 Deposits These are the deposits made by the retail investors with the bank.978 Table 21 Borrowings VaR Instrument FRA Interest Rate Futures Scenario Likely change in interest rate scenario Borrowings vulnerable with adverse interest rate movements Cap contracts when there is a likely increase in interest rate Option Contracts Table 22 Derivative Instruments for Borrowings Made 4. Fluctuation of these deposits indicates the fluctuation in source of money for the bank.527 Crores and below. VaR so generated out of this method suggests that there is a 1% probability of deposits running lower to INR 34.586 Crores with a standard deviation of INR 23.Derivatives as Risk Management Tool for Corporates Borrowings (outside India) (Million INR) VaR 1029. These are the source of fund for the banks.

If the fluctuation in deposit is mainly due to FCNRB Deposits then bank should make necessary provisions to handle this liquidity problem. If the banks deposit level reaches this level along with other cash outflows or business requirements remaining constant it should look for other sources of generating income.Derivatives as Risk Management Tool for Corporates Bank should take up necessary measure to ensure the liquidity problem that might occur because of this adverse effect to be mitigated or reduced. Below graph shows the normal distribution of the investment value with mean and standard deviation arrived at using covariance method. Figure 15 Deposits Deposits (outside India) 54 .

Derivatives as Risk Management Tool for Corporates (Crores INR) Mean SD 88.35574 Table 23 Deposits Deposits (outside India) (Crores INR) VaR 34.g.57277 Table 24 Deposits VaR 4.586 23.2. of Fund based exposure are Cash Credit and Term loans.59 which implies that there is one percent probability that credit exposure could fall to such low value and below that.g. Non Fund Based exposures are where the banks are liable to pay in case of default made by the client e. Mean value of Fund based exposure taken by the bank arrived using historical covariance approach are shown below and the values are INR 874. 55 . of Non Fund Based Exposure are Bank Guarantee and Packing Credit.32 Crores with standard deviation of INR 103. These are classified under two heads Fund Based and Non Fund Based.91 Crores. Fund Based exposures are where the banks have paid in cash in behalf of client which implies cash has left the system e.6 Credit Exposure – Overseas Credit Exposures are the exposures that bank has taken in overseas market. Monte Carlo Simulation when run based on these values produced a VaR of INR 627. Company could hedge its position using Credit Default Swaps with other banks or other financial institutions to hold its position at the worst case.

Fund Based 56 . Figure 16 Credit Exposures (Overseas) .32 which implies that there is one percent probability that credit exposure could fall to such low value and below that. On Fund Based Credit Exposure are source of high income for the banks as they don’t have charge on the capital.91 Crores. Company could hedge its position using Credit Default Swaps with other banks or other financial institutions to hold its position at the worst case.72 Crores with standard deviation of INR 118. Monte Carlo Simulation when run based on these values produced a VaR of INR -105.Derivatives as Risk Management Tool for Corporates Mean value of Non-Fund based exposure taken by the bank arrived using historical covariance approach are shown below and the values are INR 169.

Overseas Transactions Fund Based (INR) VaR 627.321 Table 26 Credit Exposure-Overseas Transactions VaR 57 .Non Fund Based Fund Based (Crores INR) Mean SD 874.5952 Non Fund Based (Crores INR) -105.9 Table 25 Credit Exposure.91 Non Fund Based (Crores INR) 169.Derivatives as Risk Management Tool for Corporates Figure 17 Credit Exposures (Overseas) .32 103.72 118.

Mean value of Non-Fund based exposure taken by the bank arrived using historical covariance approach are shown below and the values are INR 1478.038 Crores.595 which implies that there is one percent probability that credit exposure could fall to such low value and below that.Derivatives as Risk Management Tool for Corporates Instrument Credit Swaps Forex Futures Scenario When Credit Rating of the assets are poor To avoid Translation Risk Table 27 Derivative Instruments for Credit ExposureOverseas Transactions 4.2. Company could hedge its position using Credit Default Swaps with other banks or other financial institutions to hold its 58 .09 Crores with standard deviation of INR 47. Monte Carlo Simulation when run based on these values produced a VaR of INR 737.7 Credit Exposure Domestic This is similar to Credit Exposure in Overseas Market except for the absence of Translation risk. Mean value of Fund based exposure taken by the bank arrived using historical covariance approach are shown below and the values are INR 2663.22 Crores.532 Crores with standard deviation of INR 321.981 which implies that there is one percent probability that credit exposure could fall to such low value and below that. Monte Carlo Simulation when run based on these values produced a VaR of INR 2552. Company could hedge its position using Credit Default Swaps with other banks or other financial institutions to hold its position at the worst case.

Derivatives as Risk Management Tool for Corporates position at the worst case. On Fund Based Credit Exposure are source of high income for the banks as they don’t have charge on the capital. Figure 18 Credit Exposures (Domestic) .Fund Based Figure 19 Credit Exposures (Domestic).Non Fund Based 59 .

2.Derivatives as Risk Management Tool for Corporates Fund Based (Crores INR) Mean SD 2663.981 Non Fund Based (Crores INR) 737.09 47.532 321. Banks use this value in calculation of risk parameters in BASEL II norms. Similarly MTM Value of Notional Principal Amount on Trading Exposures has 1% probability of going below USD -862. Notional Principal MTM value suggests that there is a 1% probability of this value going below USD – 8.577 million.7 Currency Derivatives These are the existing instruments with the bank. Notional Principal amount is just the indication of risk that bank will get exposed to if it goes in the worst case. Mean and Standard Deviation are arrived using Covariance method.595 Table 29 Credit Exposure Domestic VaR 4.038 Table 28 Credit Exposure Domestic Fund Based (Crores INR) VaR 2552. 60 .22 Non Fund Based (Crores INR) 1478.0258 million.

Hedging MTM Figure 21 Currency Derivatives Notional Principal Amount .Derivatives as Risk Management Tool for Corporates Figure 20 Currency Derivatives Notional Principal Amount .Trading MTM 61 .

Hedging(Million Principal USD) Amount 62 .2576 Exchange Rate 48.33939 1.718675 Notional Principal AmountTrading (Million USD) 28.Derivatives as Risk Management Tool for Corporates Figure 22 Exchange Rate Notional Principal AmountHedging (Million USD) Mean SD 0.492233 Table 30 Currency Derivatives Notional Principal Notional Amount .30608 378.498072 3.

8 Interest Rate Derivative Assets These are the interest rate derivative assets that the bank holds.577 Table 31 Currency Derivatives VaR 4. Bank should revisit its position in interest rate futures and swaps that it has got exposed to.2.891 63 .Derivatives as Risk Management Tool for Corporates Trading (Million USD) VaR -8.02518 -862.23 Crores is 1%.65 2409. The probability of these assets falling below INR 3770. Figure 23 Interest Rate Derivative Assets Interest Rate Derivative Assets (Crores INR) Mean SD 1888.

Input feed for simulation should be varied if the input is going to be biased and then corresponding VaR has to be evaluated and suitable derivative hedge value has to be arrived.0 Scope of Further Research VaR which has been evaluated for each transaction is based on 5 year historical mean and Standard Deviation.23 Table 33 Interest Rate Derivatives VaR 5. VaR so arrived varies depending on the input variables that are being fed to the system for its calculation.Derivatives as Risk Management Tool for Corporates Table 32 Interest Rate Derivative Assets Interest Rate Derivative Assets (Crores INR) VaR -3770. 6. 64 . The input data that has been used is normalized based on the above mentioned mean and standard deviation. Different scenarios can be simulated by using different input distribution based on the conditions.0 Main Findings/Inference Based on the VaR arrived using simulation method organization should take up the necessary derivative instrument to hedge its position.

rather than to speculate. firms that use derivatives have lower estimated value of both total and systematic risk. to analyze the effect of derivative use on measures of risk and value. Monte Carlo Simulation that is being run is based on the historical data which is generally 5 years with availability of data for 20 years or more many scenarios can be simulated and VaR at each scenario can be evaluated. suggesting that derivatives are used to hedge risk. 65 . The paper focuses on the different kinds of transactions that Manufacturing Companies and Banks undertake. Despite this.With more information available VaR can be calculated at 95% and 90% confidence level to reduce hedging cost. Moreover mean and standard deviation calculated using more samples will help to get the data identical to real life scenario. exchange rate risk and commodity price. Derivatives use is more prevalent in firms with higher exposure to interest rate risk. It also discusses about the different types of derivative instruments that are present in the market which are being used for hedging and speculation. 7.0 Conclusion In this paper a large sample of 30000 records has been used in calculation of VaR. There are certain situation which doesn’t follow normal distribution hence the data fed has to be modified based on that to arrive at proper Value.Derivatives as Risk Management Tool for Corporates Confidence level that has been used for the calculation was 99%. VaR calculation could also be employed in identifying the risk involved in non securitized loan transactions undertaken by the bank with the availability of data.

0 Bibliography • White Paper “Risk Management with Derivatives by Dealers”. For each transaction Monte Carlo simulation is run based on simulated input data which is normally distributed with mean and SD calculated for that transaction. Monte Carlo simulation along with VaR calculation will help in determining the risk which each transaction will be exposed to if the unwanted event happens and it will help in taking necessary precautionary measures to handle those scenarios.Derivatives as Risk Management Tool for Corporates Input data that is being used for VaR calculation is normalized with mean and standard deviation calculated based on historical data.Axel FA Adam Miller from SSRN website • White Paper “Effect of Derivatives on Firms Risk and Value”. Based on the above calculated VaR derivative instrument for each transaction is suggested. This has been done for Manufacturing and Banking Industry separately. VaR is calculated at 99% confidence level for each of the transaction.Narayan y Naik from SSRN website • White Paper “Restricted Export Facility and Risk Management with Options and Futures”.Gregory W Brown from SSRN website • White Paper “Risk Analysis and Monte Carlo Simulation”. 8.Lawrence Goldman from Google 66 .

wikipedia.Derivatives as Risk Management Tool for Corporates • Reference Book “Essentials of Financial Risk Management” by Karen A Horcher • Reference Book “The Hand Book of Risk ” by BenWarWick • Reference Book “Investment Risk Management” by Yen Yee Chong • Reference Book “Mathematics for Finance” by Marek Capenski • Reference Book “Options Futures and Other Derivatives” by Hull • Reference Book “Risk Aversion and Portfolio Choice” by Donald D Hester • Reference Book “Risk and Financial Management” by Charles Tapiero • http://en.org/wiki/Wiki • http://economictimes.answers.com/news/economy/ • http://wiki.indiatimes.0 Appendix Below are the sample data for performing Monte Carlo Simulation ICICI Bank 67 .com/ 9.

Derivatives as Risk Management Tool for Corporates 68 .

Derivatives as Risk Management Tool for Corporates Hindalco 69 .

Derivatives as Risk Management Tool for Corporates 70 .

Derivatives as Risk Management Tool for Corporates Sample Hypothetical Data and VaR Calculation 71 .

09961 0.857686 49.265831 2734.233431 2454.922301 0.110623 1975.275318 0.80895 0.37615 0.18342 0.860313 0.67609 0.000236328 0.51046 0.351517 47.345257 0.010963 2331.034165 45.00044 43.466722 0.8678 0.743846 49.5710897 0.31807 0.718329 49.301226 47.279109 47.119365 2918.578409 0.089742 0.67815 0.001183345 0.32177 0.004502852 0.1946878 0.87775 50.883038 0.001059 2757.002168555 0.147195 2152.08522 0.3657 0.2054867 0.082982 46.26472 2158.95334 50.004728493 0.747574 0.004601492 72 .001753603 0.762931 0.000136756 0.002668307 0.152364 46.86298 0.049404 45.135818 3783.145945 2263.81703 0.001032109 0.004310095 0.200325 47.6975 0.25756 0.212094 0.001020462 0.003546737 0.000832764 0.187796 2798.970007 0.54904 0.500075 48.44436 0.558049 0.638372 48.267299 4249.907988 50.88731 0.70911 0.004197271 0.002222183 0.165254 46.34702 47.880326 0.263365 1811.265134 1679.00019628 0.24744 1595.00130141 0.494302 48.80784 0.457551 48.050764 1701.27221 0.698019 0.87622 0.226234 1383.002971054 0.001057087 0.70533 0.14702 0.994255 52.49254 48.93605 0.003192 0.47597 0.000517731 0.102414 3212.135604 46.07606 0.4657 0.003238694 0.225235 2752.046198 0.065396 2283.77051 0.568762 48.124586 2647.004527436 0.593503 0.003730138 0.00239854 0.002452059 0.95946 0.079497 4155.75238 0.002658233 0.815181 49.000967112 0.9497 0.150824 421.555865 48.674885 0.157882 1656.163873 2205.48364 0.00193176 0.137305 46.000809445 0.20173 0.39699 47.999304 0.0935 0.837592 0.01532 0.95918 0.166516 2942.267346 1390.404717 0.004689642 0.161235 46.002651855 0.001839071 0.215696 640.263741 3663.260794 2620.265992 0.068457 2107.78444 0.865926 0.536464 48.002646215 0.31148 0.31717 0.001156499 0.11092 0.068046 0.17877 3109.613505 0.001235318 0.255716 381.61931 0.588142 48.221239 606.003015491 0.448713 48.004200088 1.59788 0.248608 2639.224357 0.927153 50.270773 0.Derivatives as Risk Management Tool for Corporates Exchange Rate(USD/INR) Buyers Credit MTM(INR) Random Variable Z P(z) Z P(z) 0.04135 0.00137 0.003972247 0.102055 46.266228 1964.258383 2276.267319 2766.001523232 0.279228 0.263917 -482.092773 1339.891725 50.43617 48.058581 46.7860082 0.011756 44.964082 0.617242 48.67181 0.801862 0.56212 0.059682 46.434559 48.106334 2465.912753 50.33967 0.406443 0.0044884 0.08543 0.020561 1864.52095E-05 0.730823 49.18031 0.078345 1804.84357 0.251099 3960.000354775 0.00117237 0.

940490249 557.612728722 504.7364 0.007265533 0.004962349 0.009522416 0.009215563 0.710226283 515.605925431 503.0026 0.008925218 0.69772276 514.005950127 0.6966 0.009318836 0.1723 0.00935602 0.0644 0.610284812 504.008194917 0.3783 0.9599 0.9752 0.9938 0.913339576 549.857036115 537.852990722 536.354457322 477.905507563 547.208203982 458.001578305 0.009529433 0.094016319 437.2023 0.006867377 0.009272015 0.1261759 444.328 0.4521 0.Derivatives as Risk Management Tool for Corporates Investment Value (INR) RandomVariable Z P(z) 0.449 0.009170338 0.8531 0.3746 0.008071871 0.5705 0.9093 0.009474218 0.008355391 0.3921 0.847 0.44836442 487.7731 0.008326143 0.4121 0.822 0.008299882 0.008474384 0.008911261 0.004984872 0.41160151 483.195079626 456.0195 0.687860503 513.908882106 548.8737 0.1673 0.008849854 73 .700065769 514.3846 0.005406754 0.005509276 0.1667 0.1455 0.702144183 514.003781066 0.229627084 461.7878 0.502956356 493.347751162 476.7285 0.006993936 0.00396346 0.719282126 517.10812374 441.609 0.971132665 571.007426595 0.003310062 379.238904445 463.004031912 0.4258 0.6039 0.418852711 484.000239398 0.007598052 0.7152 0.007755039 0.834779656 533.8892 0.3354 0.82449191 531.002834624 0.004016918 0.006703573 0.785200671 525.1221 0.750769416 521.907672805 548.643972798 508.3117 0.006184879 0.005968873 0.6592 0.403253026 482.006604655 0.800064409 527.9065 0.003924934 0.873001072 540.740858688 519.532613482 496.833974015 533.5277 0.009554097 0.2569 0.009522234 0.116 0.004447967 0.528811366 495.009186916 0.467293915 489.2064 0.

017159987 -142.850669967 7746.000141182 0.786765664 7136.43 0.049 0.000116317 0.761636084 6927.554832885 5492.659745832 6177.93079E-05 0.160443737 2666.2531 1.668 0.689674607 6385.668937294 6240.582391666 5668.378153478 4372.955349638 9395.27268E-05 0.055883105 1172.980072265 10286.591 9.000146606 0.713470961 6557.76773E-05 0.000159577 0.275252041 3655.611972427 5859.976 7.000142233 0.638 0.258 0.000147081 0.061 6.000153771 0.379613664 4381.303 0.677461828 6299.000136146 0.81857E-05 0.116 0.632 0.000152075 0.7501E-05 0.000153249 0.219 0.018572207 -62.600215653 5782.8007 3.458 9.10291E-05 0.074 5.29 1.419 4.902 0.933083611 8896.883 0.000133741 0.193729922 2987.673 9.69994E-05 0.292039304 3779.55 1.276140548 3662.828835717 7522.000123885 0.501 0.000146338 0.000133529 0.092544541 1835.000158782 0.667609247 6231.941 0.000138964 0.022 8.000125498 0.000156162 0.154576053 2605.Derivatives as Risk Management Tool for Corporates Export Earnings(INR) Gain /Loss RandomVariable Z P(z) 0.607286563 5828.000154515 0.943 0.499157783 5142.074 0.000151572 0.000109846 0.572 0.712 0.000152255 0.013328371 -393.6313E-05 0.684279671 6347.36819E-05 0.51428E-05 0.50599E-05 0.035167148 623.815 0.874160918 8013.299459715 3833.000145046 0.345 0.000145277 74 .837 8.000158067 0.28805E-05 0.18725E-05 0.925 3.873825532 8009.000137371 0.118 0.129731065 2329.539807067 5398.339 0.000143516 0.292 0.66136206 6188.44968E-05 0.94778E-05 0.597 0.588 0.604 0.09 1.887 8.881142678 8099.064 0.343164015 4138.29854E-05 0.316 0.62583091 5950.000101665 0.483 0.755894653 6881.

270639628 17.547243 0.014115341 -1.19942551 14.337526605 19.017598608 0.08683 0.014485305 0.91003 0.357827592 20.026822634 0.785382677 33.15142 0.05022 0.76621 0.3159 0.13715 0.0158832 0.08485 0.032553721 0.01685 0.854711 0.002861436 0.031111054 0.870321002 37.542013962 25.023289819 0.41045 0.61717547 28.02834889 0.89876 0.030527695 0.90814 0.917792456 41.031866847 0.854036173 37.027586406 0.73974101 32.70611 0.007772359 0.72629 0.330986388 19.030215108 0.Derivatives as Risk Management Tool for Corporates Commodities Contract(INR) Gain /Loss RandomVariable Z P(z) 0.190108127 13.022621682 0.10322 0.37238 0.0301371 0.033054745 0.681513309 30.03306066 0.27807 0.002995011 0.385521191 20.027360315 0.014103306 0.90035 0.219451006 15.30278 0.959727902 45.75678 0.93047 0.286211711 17.10944 0.92602 0.012645976 0.40932 0.031304615 0.671140504 29.03139 0.027044311 0.733753816 31.095168853 8.030448483 0.031944884 0.382094236 20.008256619 0.013388182 -2.19371 0.02893201 0.660188955 29.73916 0.380106125 20.186320582 13.031800658 0.024323997 0.029741664 0.06874 0.007220809 0.411177 0.39575 0.008413824 0.022342507 0.74156 0.94786 0.02115716 0.883290358 38.650648169 29.031782459 0.497751829 24.033244662 0.700967094 30.84018 0.364360567 20.15057 0.901302971 39.048686012 4.112099013 9.026547195 0.542681341 25.748634069 32.026557912 0.019078367 0.17087395 13.581225231 26.016345593 0.024639095 0.77758 0.1245 0.031732327 75 .030845724 0.48959 0.725031 0.388786962 21.66617 0.047551895 4.748825884 32.48237 0.97492 0.955893157 44.743840576 32.88879 0.

028219777 76 .077121412 -9.40355 0.12505248 0.74059 0.6514 0.5674542 0.020414713 0.151572955 -9.037024101 0.047955 -354.25158 0.134706 -523.8709839 0.183065 46.01535008 0.22899 -510.322382 47.048782588 0.028996 45.023040612 0.006900846 0.7613805 0.98843 0.1477 0.916709 50.486726 48.78699 0.84143 0.78486 0.002521309 0.75498 0.012396935 0.07965 0.8085367 0.817663891 -5.9027079 0.005987274 0.0293183 0.622816 48.102701 -344.07872 0.940118 50.0732 0.003963581 0.448370702 -7.037322911 0.183440163 0.10569 0.069871 46.442016526 -7.194370119 0.612835494 -6.8750328 0.190465948 0.87736 50.033001123 0.072551 46.92476 0.803705 0.25635 0.81086009 0.045447548 -10.159587102 0.13573 0.565955389 -6.3138467 0.6288911 0.9374711 0.799897885 -5.110308 46.140023922 0.166929383 -8.80629 0.13375968 0.189273 -361.792734075 -5.094652959 0.53695 0.252925 47.763542 49.75895 0.00018 0.7905854 0.44726 0.57599 0.43776 0.814341093 -5.6615351 0.117472856 0.54846 0.213896 -369.039237027 0.175364284 0.4789586 0.114669501 0.942927 50.199469479 0.1474 0.166360343 0.355092 47.753 0.057448361 0.05144 0.593413 48.7512842 0.124585 46.044327 -324.231356 -355.02085068 0.47947 0.249509 -247.206638 -285.126263 -480.252094 47.129489 46.1026471 0.30951 0.3427 0.034039338 0.027152108 0.34658 0.6684733 0.998444998 -1.033206259 0.265539 -432.92775 0.878236 50.3734 0.20401 0.041561919 -10.25579 0.147356902 0.257856 -329.148901 -230.145175 -267.439730735 -7.8649745 0.47215864 -7.74336 0.049400233 0.226386 -283.4022 0.000193522 0.5379714 0.145435118 0.380578813 -7.047772254 0.15306 0.13226402 0.044798398 0.198860518 0.198175966 0.344791 47.68325 0.116118 46.13763 -242.911295 50.214267 -346.61979 0.242711 -306.1905496 0.018868665 -11.017491805 0.879172 50.019957734 0.037197571 0.008820319 0.027304917 0.029511908 0.0268443 0.22135 -278.168539023 0.4577 0.218220107 -8.947252 50.797037 49.512240904 -6.99079 0.747917768 -5.50891 0.025948258 0.57956 0.288924 47.6289009 0.1953304 0.6983876 0.107657 -366.14863 0.141378 -253.012154919 0.24039 -431.9687012 0.133672766 0.10511821 0.044447098 0.51157 0.139647 46.29532 0.6876935 0.69686 0.5510181 0.08658 0.246628 -346.021247215 0.147481669 0.9445337 0.7649244 0.00779468 0.018409364 0.086578869 0.93064 0.6989804 0.265652 -255.128840982 -9.006237414 0.039699987 0.341143811 -7.17902 0.6096411 0.65985 0.240157 -83.2196845 0.65612 0.95152 0.197798392 0.257365 -435.0818455 0.001562169 0.076755 -54.280781701 -8.962472 50.0071664 0.391329 47.010242616 0.468792391 -7.51047 0.60598 48.16513 0.092484 -343.199377235 0.74003 0.330076 47.498371892 -7.098181013 -9.436928703 -7.005513493 0.017976223 0.93394 0.198777284 0.30954 0.403722673 -7.59994 0.137307 -357.057301655 -10.047384846 -10.030019528 -10.0590496 0.63678 0.995558649 -1.042204768 0.034962829 0.034376306 0.198985195 0.09652 0.072296739 0.968116 51.239295 -531.196738862 0.193633871 0.78666654 -5.259983 -505.136122 -350.13171 0.142991732 0.7800066 0.94305 50.Derivatives as Risk Management Tool for Corporates Commodities Contract(USD) Gain/Loss Exchange Rate(USD/INR) Commodities MTM(INR) RandomVariable Z P(z) RandomVariable Z P(z) Z P(z) 0.130973 -439.246848 -441.76374 0.006504794 0.3335 0.47879 0.97692 0.975784 0.5996993 0.694115955 -5.34397 47.135438 -428.111038059 -9.196973083 0.54543744 -6.012419976 0.046464295 0.64827 0.318875 47.730554 49.267198 -490.079706 -485.51319 0.36013 0.1037879 0.1288671 0.117391872 0.072119 -413.35207 0.20255 0.66095 0.81453545 -5.41859 0.177712 -312.726584986 -5.409970904 -7.5215455 0.28973 0.009561102 0.282065 47.295377 47.7768353 0.65494 0.32163 47.08985 -350.19736054 0.69205 0.017113421 0.197190528 0.03532457 0.865438 49.81071 0.054824 -501.546361 48.076625 -263.455109 48.99575 0.875833 50.28374 0.69846 0.146342335 -9.41043 0.8482697 -4.19143843 0.254575 -263.82506 0.55674 0.17112 0.020758871 0.781459021 -5.53326548 -6.051100851 0.72493 0.06203 0.43407 0.

Derivatives as Risk Management Tool for Corporates Bank Data 77 .

000547972 0.0791 0.000508082 0.711634962 994.000526824 0.087104428 -384.000157277 0.000547999 0.092983453 -358.000327447 0.000469387 0.288912515 192.000474892 0.818 0.00054624 0.4661 0.418933977 445.8399 0.853400131 1349.338004436 292.560907015 703.1939 0.3038 0.72872554 1031.152375247 -145.323 0.965653572 1902.9647 0.008661022 -1119.000544095 0.244 0.101 0.524 0.356417579 328.807171192 1217.1077 0.718607853 1009.842134661 1314.000426046 0.000518137 0.000551529 0.625400864 822.000220257 0.540905762 666.983341952 2124.000447673 0.439218736 482.633581501 838.888358926 1469.213 0.646383006 863.5522 0.6599 0.000355718 0.41 3.761255131 1104.901385057 1520.056208001 -549.000185315 0.2908 0.846 0.2147 0.00031911 0.576970029 732.000554119 0.00010574 0.273 0.00051669 0.281924636 177.795 0.7007 0.56855533 717.1699 0.192330038 -32.263547972 137.000523067 0.000430813 0.334 0.00046061 0.00023121 0.826944188 1270.771 0.285 0.000532002 0.000549699 0.000493376 0.000241431 0.513707326 617.017023026 -932.6284 0.75837E-05 0.552167022 687.Derivatives as Risk Management Tool for Corporates Forex Transactions RandomVariable Z P(z) 0.766032325 1115.762199469 1106.758 0.05 0.141 0.000453945 0.256531588 122.00054296 0.8661E-05 0.00037997 0.28 5.000429879 0.8674 0.254 0.000380572 78 .386871276 386.000264118 0.725 0.000376808 0.00046896 0.2 0.26631E-05 0.1231492 -241.136 5.314508897 245.000474468 0.949122058 1770.376 0.069372242 -472.8797 0.548 0.3192 0.666 0.5876 0.2286 0.189727478 -39.4656 0.000283123 0.000335189 0.000145339 0.

373075588 502.632446193 545.003845338 0.145 0.981650309 660.17906541 463.4995 0.168700092 460.629899084 545.529949577 528.19824285 467.Derivatives as Risk Management Tool for Corporates Currency Swaps RandomVariable Z P(z) 0.8151 0.006074993 0.4976 0.5602 0.6964 0.1677 0.00546967 0.00585007 0.6028 0.3514 0.005071842 0.1331 0.004939472 0.411814222 508.000687186 0.004252575 0.003993969 0.606469844 541.123808065 447.005959243 0.004698758 0.0328 0.001817702 0.8183 0.933008872 621.005866116 0.7483 0.9862 0.4799 0.00544657 0.2335 0.002574687 0.004389522 0.1466 0.5717 0.3481 0.6676 0.003197369 79 .005873901 0.003122557 0.750233594 567.005781176 0.005347265 0.006091725 0.317990921 492.002902588 0.3226 0.609820769 541.741404444 565.612094443 541.8637 0.9923 0.005840885 0.5753 0.111668266 443.209064628 470.11131178 443.005172135 0.774340476 572.6331 0.128083762 448.385813544 504.001218082 0.5753 0.8991 0.12361661 447.67878236 553.005766293 0.716413866 560.004849541 0.347153928 497.750306698 567.005942715 0.2892 0.001982048 0.7477 0.006065183 0.000908069 0.304772696 489.059941008 421.5383 0.003119175 0.8412 0.537535004 529.0985 0.583185639 537.004587501 0.5233 0.727568237 562.003747126 0.0572 0.96361602 640.2642 0.005859855 0.6071 0.608340165 541.7814 0.005753264 0.2066 0.155005354 456.604 0.764453608 570.4773 0.905317551 609.5138 0.630760069 545.084402702 433.002363737 0.004850295 0.504810535 524.7566 0.3368 0.025521262 395.005761918 0.005639375 0.162087247 458.001972124 0.003638927 0.9927 0.002895954 0.933442072 621.

101483474 996.003080529 0.006637513 0.25 0.00349701 0.005564042 0.006332825 0.615 0.006519396 0.180645501 1018.743 0.006580856 0.004429778 0.365 0.40282532 1057.006171609 0.735 0.951950736 1171.419029347 1060.524 0.703869019 1104.006674938 0.574 0.7033 0.952 0.003353332 0.590428264 1086.224 0.006407681 0.037 0.572238825 1083.006429636 0.937783114 1163.9781 0.012614619 939.779 0.006704463 0.683399843 1100.006614426 0.003974988 0.562347407 1081.043 0.117 0.570538731 1083.001874035 0.21664213 1026.005045282 0.744 0.628559421 1092.32 0.359 0.116 0.003369502 0.002410577 0.944989218 1167.000549365 0.727 0.481065201 1069.137 0.00582196 0.005378801 0.252319115 1032.005996506 0.62352783 1091.696 0.956 0.047464741 973.Derivatives as Risk Management Tool for Corporates Investments (outside India) RandomVariable Z P(z) 0.004440599 0.414 0.054 0.567985974 1082.875 0.004943373 0.006712172 0.923915249 1157.001682845 0.383197939 1054.879997953 1142.047995126 973.4203 0.1913 0.00636774 0.181350257 1018.001269983 0.895 0.006609274 0.730514461 1109.879 0.473101757 1068.006394979 0.006621929 0.925 0.777337654 1117.002716578 0.378892498 1054.006546367 0.001681328 0.006390189 0.001666433 0.660024343 1097.005684687 0.429 0.152747083 1011.666985366 1098.373 0.960352676 1176.564 0.005021797 80 .357 0.187 0.375572101 1053.44 0.002064208 0.105840138 998.00144109 0.73 0.873465631 1140.417 0.453956617 1065.281496799 1038.002987993 0.22449652 1027.7372 0.465 0.557 0.910827031 1152.038 0.119186452 1002.033970199 964.254 0.365275138 1052.006122122 0.

1653 0.002629997 0.002529483 0.4856 0.323378789 638.092163662 515.7948 0.341289109 645.629 0.5612 0.034949095 446.6454 0.578035942 731.002584164 0.002295301 0.000902875 0.727634913 789.065933605 489.9209 0.931082485 914.002760342 0.0638 0.640244007 754.604 4.002417867 0.002755619 0.675983117 768.2508 0.1263 0.1335 0.797421766 822.6429 0.8929 0.5779 0.1794 0.203463971 586.2884 0.734 0.9412 0.001048322 0.781399752 814.000934297 0.002037638 0.360190943 653.4285 0.5538 0.5425 0.002730223 0.000308034 0.788589184 817.000414414 0.466515831 692.001863709 0.002634098 0.291856233 626.001992006 0.002635196 0.38065758 660.4218 0.4321 0.505 0.002709202 0.002806913 0.831 0.002793172 0.182457772 575.8693 0.543043786 719.482745781 697.982251782 1002.749126617 799.002790659 0.390566631 664.2268 0.022112851 418.002784171 0.001986823 0.157280675 561.393698544 665.737565157 794.001728755 0.080135832 504.8063 0.9821 0.162185572 563.001927638 293.1287 0.546226727 720.9302 0.641855741 755.267467251 615.00233871 0.000371227 0.2585 0.574550191 730.143223241 552.667492048 765.1109 0.339471831 645.001163961 0.9993 0.001694365 0.025204199 426.553572796 723.3226 0.594572625 737.002558132 0.7583 0.002754663 0.002242074 0.3639 0.9472 0.001495909 81 .002317564 0.006 0.869228845 863.3181E-05 0.002799639 0.002077596 0.000543523 0.1418 0.00159185 0.42127766 675.002703164 0.589175382 735.Derivatives as Risk Management Tool for Corporates Borrowings (outside India) RandomVariable Z P(z) 0.002682872 0.7525 0.002739055 0.2846 0.002531538 0.002578899 0.8655 0.

2307 0.31272 0.824958301 110.49036118 88.015143206 0.013724024 0.015909412 0.64691195 97.713716859 101.918174526 121.36598 0.1219 0.0595 0.1181 0.676981806 99.745871141 104.204710158 69.95164 0.85308 0.016858878 0.31872 0.2247 0.Derivatives as Risk Management Tool for Corporates Deposits (outside India) RandomVariable Z P(z) 0.01707614 0.006474641 0.58226 0.858377967 113.01626505 0.104242113 59.041788311 48.577363782 93.011038583 0.465167597 86.009306066 0.26424 0.01690425 0.191426213 68.7411 0.134835286 62.015371377 0.65067 0.846207422 112.26858391 74.6828211 99.5793954 93.007744738 82 .21613 0.236860721 71.011672233 0.897781388 118.00770393 0.006486017 0.76868189 105.02165 0.007637075 0.17314 0.482860278 87.954750604 128.007459143 0.20455 0.016964605 0.912756783 120.17356 0.787607766 107.69404 0.003822881 0.80544 0.0121549 0.009604626 0.7651 0.31952 0.2273 0.007635282 0.00928837 0.54417 0.76069 0.688201498 100.01456717 0.017015976 0.017059535 0.6481 0.442637861 85.39103 0.0371 0.015254961 0.93100924 123.784407016 106.017065359 0.005684885 0.012530437 0.14396 0.016741734 0.008998848 0.564285536 92.102251614 58.903249295 118.098999885 58.546571585 91.247528587 72.52083 0.6926 0.871213525 115.622824392 95.9708 0.01242181 0.89651441 118.9552 0.004076484 0.016182577 0.014119644 0.3014 0.917983683 121.682799072 99.21045 0.520056497 89.006793657 0.3263 0.007334552 0.0887 0.013214741 0.4102 0.0281 0.628828391 96.26525 0.013042582 0.048 0.013534148 0.016758935 0.89418 0.4159 0.015254513 0.864789999 114.01014992 0.

56130334 188.001762289 0.003468441 0.000647401 0.00135976 0.3531448 0.5679691 0.5846216 0.3828 0.0633 0.001338794 0.284 0.002287131 0.183448776 62.370300872 130.259431 5.012684163 -96.673913913 921.942692127 1038.819439224 278.003347256 0.527577071 177.0931 0.003670156 0.001056782 0.8779 0.603945057 201.584026281 896.2418899 0.398842993 847.671 0.78958343 0.3236471 0.7569 0.524099444 176.002120086 0.002773385 0.816722156 968.948791886 1044.334430132 118.003730124 0.003759303 0.76446E-05 0.938128082 352.0012802 0.190655457 65.001201429 0.408124197 850.267 0.2767171 0.2451156 0.219798922 794.000275615 0.491981846 872.9206 0.334011803 829.573245711 191.8719 0.3573721 0.418699488 852.003349152 0.003737037 0.924098757 340.617984532 905.003707726 0.8649536 0.017784806 655.168980033 55.1009 0.001105827 0.003678354 0.5839 0.003753828 0.874751563 306.1119444 0.731447183 243.003712104 0.405084162 849.4877 0.003302004 0.147274924 45.384889204 843.1129 0.003611634 0.001999172 0.753587802 945.003126778 0.002718141 0.476589107 868.7365515 0.9900516 0.0326847 0.003061989 0.003832693 0.699447889 928.003813523 0.478295698 868.0632353 0.709441825 235.357868902 836.002412486 0.3155 0.9375167 0.1267323 0.003348876 0.256593769 806.796028367 268.694629164 230.003101545 0.925182448 1024.002540477 0.426770975 855.479826413 869.0648 0.5701 0.000797522 0.9662251 0.6532 0.001446005 0.002233258 83 .48776343 0.43653575 0.9092 0.003833623 0.6834 0.031 0.871776837 304.003176356 0.2072421 0.003003256 0.002959617 0.003774443 0.704343563 930.225930306 796.258176526 92.1449 0.3030554 0.2314 0.003034706 0.002881518 0.003385749 0.003070827 0.231577831 82.453165438 862.544531722 0.670668105 222.42705836 0.1468 0.001630233 0.001099066 0.002786203 0.003063366 0.003501986 0.334813267 118.001573982 0.227864407 81.003837967 0.003043349 0.08989184 0.66576894 0.48 0.154423325 48.002886815 0.034837811 -45.34584273 122.002992681 0.002947584 0.918866618 1019.683765945 226.036 0.000421676 0.5129 0.6672304 0.001011604 0.5565998 0.3463 0.62501854 0.002382477 0.7893 0.087620427 8.9455743 0.038124986 690.0108 0.943136902 1038.002211209 0.922659733 338.510536907 877.1571 0.30803398 822.003715212 0.003323912 0.00102623 0.003015459 0.003834396 0.6455 0.72896272 242.002042142 0.4118 0.6741252 0.77492533 952.9069266 0.003592991 0.3702 0.001218714 0.003240731 0.3599 0.002984311 0.54620879 886.685834274 227.00383853 0.678005871 224.992316 0.0633325 0.003026874 0.324957462 115.002563581 0.1381 0.533 0.109276224 23.1045718 0.001937077 0.003298564 0.3751 0.7536226 0.003100336 0.002131019 0.664 0.832473328 974.002553941 0.138944744 761.2108168 0.2188 0.1741 0.39759126 847.002893021 0.353613938 125.001733719 0.003315584 0.9954 0.840503294 288.Derivatives as Risk Management Tool for Corporates Overseas Fund Based Non Fund Based Random Variable Z P(z) RandomVariable Z P(z) 0.7391887 0.6513518 0.002848025 0.003812819 0.636703334 910.082541595 4.002179356 -169.395853519 846.2163 0.0586878 0.1103603 0.251955695 804.72199855 0.3188837 113.764678049 949.570995541 190.095289426 738.054106534 707.

609706715 1567.095 0.811 0.133674718 2610.707583553 1653.97122563 2088.83322732 2708.00085334 0.896413 0.721 0.005143265 0.919092885 2729.000847798 0.008026161 0.000826917 0.43228 0.863725 0.911047459 1911.000717836 0.676235 0.002182457 0.689254951 2686.604 0.927598 0.398 0.001071202 84 .870324 0.255364 0.054792666 964.978 0.837305877 1794.564082682 1530.958648 0.001025307 0.6624298 0.007659988 0.336109444 2643.5191159 0.Derivatives as Risk Management Tool for Corporates Domestic Fund Based Non Fund Based Random Variable Z P(z) RandomVariable Z P(z) 0.045108 0.715976541 2690.006216453 0.085 0.85 0.003229617 0.559 0.000906854 0.001010692 0.000254642 0.001058874 0.221588 0.741757909 2693.863004 0.271 0.000345474 0.673 0.005293382 0.816715 0.004566975 0.006890477 2546.029975014 874.025422314 2570.000442192 0.007177984 0.049 0.000222646 0.739836119 1684.037494131 906.008383624 0.062362752 985.488733015 1469.008036711 0.001233969 0.6078519 0.007096912 0.4438388 0.32899367 2642.340250367 1346.026 0.449835941 1438.751743 0.624060368 2678.8520237 0.001239518 0.007133452 0.000415477 0.327618766 2642.481972576 1464.000995187 0.00107038 0.08274824 2597.852596855 1814.381 0.000846374 0.374374198 2647.007647042 0.008222649 0.329 0.001114935 0.100544519 2602.008286326 0.450559111 2657.893553138 1878.252560046 1264.404 0.334995 0.056423866 969.578062442 2672.498221415 2662.008418251 0.00747908 0.797331234 1745.001241395 0.000204729 0.846487 0.277717 0.006993259 0.038446 0.816620411 1768.008100295 0.05686 0.000211797 0.628 0.335921 0.930598077 1953.223 0.227 0.000406978 0.99683825 2792.207 0.452834064 1440.913 0.001056555 0.387934 0.111 0.000554421 0.038924465 912.126 0.007358308 0.267594158 1279.574506 0.454563 0.007049239 0.337794274 2643.000341763 0.703504 0.861 0.007725221 0.687939516 1635.656624 0.512947 0.700444405 2687.007740235 0.054049642 962.001854764 0.243924218 1255.714 0.4116 0.471684052 1455.879 0.487633 0.007673079 0.022080352 2568.809075282 1759.455115559 1442.001232827 0.669603797 2683.388 0.273654797 2634.019978 0.528378265 1501.0076501 0.472659159 1456.057 0.001311477 0.186 0.019 0.719625175 2690.045 0.825748384 1779.592056533 2674.324596 0.791 0.667857174 1617.001226597 0.000353567 0.001242168 0.503996 0.000203139 0.003731371 0.216717889 2626.169435 0.150598471 2614.277430923 2635.026790742 2571.000382426 0.385843926 2649.008239371 2549.28823 0.924718346 1940.533797062 2667.000262536 0.725 0.001255215 0.151 0.730690416 2692.968160238 2073.369686039 2647.752 0.025 0.898047164 1886.001239744 0.016124681 2561.463993 0.24190017 2630.879 0.946 0.220004822 2626.001141651 0.000879009 0.389 0.000572031 0.327942425 2642.003175308 0.285773041 1296.9122409 0.726342 0.6896582 0.000976894 0.004950832 0.007993747 0.213666336 1223.040806502 2580.001130972 0.00123479 0.00076619 0.001239532 0.008448503 0.006270591 0.006 0.000501445 0.101 0.966 0.159551154 2616.006845182 0.476302 0.190402194 1197.284461696 1295.908148 0.006611806 0.049951358 2585.707100309 1653.007186352 0.000800761 0.001102079 0.284716795 2636.001195376 0.000476385 0.049 0.

014910516 13698.000207304 0.009724274 -11903.021982233 -9223.000200282 0.017391481 16483.009789868 -4629.00027116 0.35744 0.000186057 0.1584914 0.000167124 0.000130368 0.Derivatives as Risk Management Tool for Corporates tional Principal Amount .000177733 0.021498214 -33539.28632 0.02265289 7084.000152533 0.095709 0.000199768 0.98836 0.89332 3.011232056 6114.004218611 16796.005992423 12674.775657 0.9335 0.47852 0.00013757 0.004455304 -2264.024919616 10288.01040887 13313.54465 0.70622E-05 0.024777947 17544.08107E-05 0.49874 0.910676 0.000201607 0.025747515 -20318.020323684 -24391.000198936 0.000227175 0.021437667 18872.05406 6.39628 0.000128352 0.57888 2.000160394 0.000206244 0.82442 0.000162331 0.40422 0.80977 0.0672 0.000130707 0.33337 0.015597954 6777.020683768 -19083.021337744 -16837.000110326 0.013124653 -15302.31469 0.000198285 0.5185E-05 0.018755318 6856.006392936 7802.002411876 -20097.014478442 16604.005385685 -12380.015183622 -10945.000177199 0.5307 0.837579 0.58792 0.000108987 0.637561 4.016812381 13325.026513617 24631.019182044 5371.000119865 0.892692 9.000246303 0.000232149 0.40937E-05 0.000171791 0.001690883 -4632.69357 0.63461 2.000124555 0.008633136 481.6013E-05 0.018991938 -19237.024355078 15636.93137 0.787687 0.940386 0.003316838 -17172.77764E-05 85 .667357 0.78206 0.000112183 0.31465 0.Trading MTM(INR) P(z) Z P(z) 0.15022 0.95878 7.017890758 20523.000233437 0.85066E-05 0.40387 0.018934975 -21568.022878094 23036.42476E-05 0.79976 0.000122514 0.0002155 0.000105988 0.021604127 3592.002490657 1880.017947043 -1215.893789 0.75646 0.683134 0.025193372 -498.000211077 0.00014859 0.020765776 -24169.36403 0.000246607 0.Hedging MTM(INR) Notional Principal Amount .000104425 0.731437 4.011645517 32481.49689 0.

425 0.85432E-05 0.48697068 1809.5393 0.96 5.000142773 0.000162999 0.000151946 0.364809244 1055.718 9.000165472 0.712 0.03089E-05 0.3707101 1093.69 6.089779902 -1345.428 0.94 0.277865293 468.3648 0.511736054 1959.148 0.000145889 0.000158411 0.43241061 1478.34 4.389979929 1215.808 8.569855534 2312.9592E-05 0.000127323 0.78350518 3778.951219347 5881.806 0.66399814 2908.710982455 3229.225 9.00010539 0.244313994 219.624525316 2653.0321 0.000120387 0.555 0.000159208 0.495 0.31085E-06 0.000163162 0.07639E-05 0.383314875 1173.454491486 1613.248 6.660575168 2886.133904111 -781.15 9.947448436 5794.000156772 0.656527616 2859.93 0.000156899 0.121 0.000155945 0.45254E-05 0.90384109 5030.787610267 3812.055069832 -1961.552 7.000129324 0.13 0.179 0.307563406 677.655 6.000152632 0.910304512 5124.219951088 27.19615E-05 0.72155E-05 0.287 9.000151351 0.169 0.00012285 0.549796397 2190.212 0.234355316 142.000102133 0.31 4.61 4.310389501 696.000146474 0.241111072 195.000164252 0.24 0.919996063 5274.00015376 0.Derivatives as Risk Management Tool for Corporates Interest Rate Derivative Assets (INR) RandomVariable Z P(z) 0.000164465 0.000139165 0.864531625 4541.30209E-05 0.150667673 -602.6156 0.39 0.396 0.000130251 0.3507 0.000121734 0.72625E-05 86 .1403 0.16923E-05 0.451 0.050328638 -2067.62068E-05 0.122 4.70375E-05 0.000157412 0.293213036 577.845795935 4343.279457344 480.7549 0.554 0.847 0.000139553 0.000165455 0.52 0.851723587 4404.350379626 962.004360801 -4431.170970816 -401.837151057 4257.000141815 0.997 0.628363158 2677.60068E-05 0.8184 0.