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INTERNATIONAL FINANCE ASSIGNMENT

FOREIGN EXCHANGE & RISK MANAGEMENT PRACTICES IN INFOSYS


Symbiosis Institute of Operations Management

Prepared By:

1. 2. 3. 4. 5.

Amit Sharma Aravind Raj Reddy Chetan Vartak Gaurish Natekar Mohan Kumar S

066 068 072 073 077

Table of Contents

Introduction to Forex Risk ....................................................................................................................... 2 Infosys Ltd ............................................................................................................................................... 2 Types of Foreign Exchange Exposure ....................................................................................................... 3 Foreign Currency and Functional Currency .............................................................................................. 3 Transactions and Translations ................................................................................................................. 4 Derivative Financial Instruments.............................................................................................................. 4 Foreign Exchange Transactions ................................................................................................................ 6 Forward and Option contract in foreign currencies .................................................................................. 6 Financial Risk Management ..................................................................................................................... 7 Market Risk ............................................................................................................................................. 8 Conclusion ............................................................................................................................................ 11 References ............................................................................................................................................ 13

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Introduction to Forex Risk


In the light of globalization and internationalization of world markets, foreign exchange risk has become one of the most difficult and persistent problems with which financial executives must cope. This risk cannot be avoided, but can be managed by hedging in currency forwards and options. The need and approach for managing it depends on the size of exposure and fluctuations in exchange rate. Companies dealing in multiple currencies face a risk (an unanticipated ga in/loss) on account of sudden/unanticipated changes in exchange rat es, quantified interims of exposures. Exposure is defined as a contracted, projected or contingent cash flow whose magnitude is not certain at the moment and depends on the value of the foreign exchange rates. The process of identifying risks faced by the firm and implementing the process of protection from these risks by financial or operational hedging is defined as foreign exchange risk management. Many of the emerging Indian MNCs are struggling to manage the exchange rate risk. The current exchange rate is favorable for exports, but imports are working out costly. In this paper we will study in detail foreign exchange exposure faced by Infosys and strategy followed by Infosys to mitigate the risk. The important data sources constitute Annual Reports and Notes to Accounts of the selected company, which were sourced from Prowess Database.

Infosys Ltd
Infosys Ltd provides business consulting, technology, engineering and outsourcing services. In addition, the group offers software products for the banking industry. In June 2011, the name of the company was changed from Infosys Technologies Limited to Infosys Limited, following approval of the name change by the companys board of directors, shareholders and the Indian regulatory authorities. The company is a public limited company incorporated and domiciled in India and has its registered office at Bangalore, Karnataka, India. The company has its primary listings on the Bombay Stock Exchange and National Stock Exchange in India. As of December 12, 2012, the companys American Depositary Shares representing equity shares are also listed on the New York Stock (NYSE) following the companys voluntary delisting from the NASDAQ Global Select Market on December 11, 2012.
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Types of Foreign Exchange Exposure


There are three kinds of foreign exchange exposure which are dealt by Infosys Ltd: Transaction Exposure Transaction exposure arises both in case of MNCs as well as domestic companies having transactions in foreign currency. The sources of transaction exposure are: payables and receivables in foreign currency. This may be due to imports, exports, capital flows across the country, debt servicing in foreign currency, dividend payments as well as receipts in foreign currency. Translation Exposure Translation exposure is also known as accounting exposure, is applicable for MNCs. As per the accounting standards, the holding company, having foreign subsidiary needs to prepare the consolidated financial statements. In this process, the foreign subsidiarys financial statements which are in foreign currency are to be translated into the home currency of the parent. This process leads to translation gain or loss and it is known as translation exposure. Economic Exposure Economic exposure arises due to the cash flows in foreign currency. This exposure is concerned with risk of exchange gain/loss associated due to changes in future cash flows or costs of capital arising from unexpected exchange rate changes.

Foreign Currency and Functional Currency


The functional currency of Infosys and Infosys BPO is the Indian rupee. The functional currencies for Infosys Australia, Infosys China, Infosys Consulting, Infosys Mexico, Infosys Sweden, Infosys Infosys Shanghai and Lodestone are the respective local

Brazil, Infosys Public Services,

currencies. These financial statements are presented in U.S. Dollars.

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Transactions and Translations


Foreign-currency denominated monetary assets and liabilities are translated into the relevant functional currency at exchange rates in effect at the balance sheet date. The gains or losses resulting from such translations are included in net profit in the statement of comprehensive income. Non-monetary assets and non-monetary liabilities denominated in a foreign currency and measured at fair value are translated at the exchange rate prevalent at the date when the fair value was determined. Non-monetary assets and non- monetary liabilities denominated in a foreign currency and measured at historical cost are translated at the exchange rate prevalent at the date of transaction. Transaction gains or losses realized upon settlement of foreign currency transactions are included in determining net profit for the period in which the transaction is settled. Revenue, expense and cash-flow items denominated in foreign currencies are translated into the relevant functional currencies using the exchange rate in effect on the date of the transaction. The translation of financial statements of the foreign subsidiaries to the functional currency of the company is performed for assets and liabilities using the exchange rate in effect at the balance sheet date and for revenue, expense and cash-flow items using the average exchange rate for the respective periods. The gains or losses resulting from such translation are included in currency translation reserves under other components of equity. When a subsidiary is disposed of, in part or in full, the relevant amount is transferred to net profit in the statement of comprehensive income. Goodwill and fair value adjustments arising on the acquisition of a foreign entity are treated as assets and liabilities of the foreign entity and translated at the exchange rate in effect at the balance sheet date.

Derivative Financial Instruments


The company uses derivative financial instruments such as foreign exchange forward and option contracts to mitigate the risk of changes in foreign exchange rates on trade receivables and forecasted cash flows denominated in certain foreign currencies. The counterparty for these contracts is generally a bank or a financial institution. These derivative financial instruments are valued based on quoted prices for similar assets and liabilities in active markets or inputs that are directly or indirectly

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observable in the marketplace. The following table gives details in respect of outstanding foreign exchange forward and option contracts: (In Millions) March 31,2012 729 38 22 23

December 31,2012 Forward Contracts In US Dollars In Euro In Pound Sterling In Australian dollars Option Contracts In US.Dollars 886 54 55 55

50

The company recognized a loss on derivative financial instruments of $28 million and $53 million for the three months ended December 31, 2012 and December 31,2011 respectively and a loss on derivative financial instruments of $23 million and $102 million for the nine months ended

December 31, 2012 and December 31,2011, respectively, which are included under other income. The foreign exchange forward and option contracts mature between 1 to 12 months. The table below analyzes the derivative financial instruments into relevant maturity groupings based on the remaining period as of the balance sheet date: (Dollars in Millions) December March Not later than one month Later than one month and Not later than three months Later than three months And not later than one year 31,2012 $192 402 509 $1,103 31,2012 $68 155 666 $889

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Foreign Exchange Transactions


Foreign currency denominated monetary assets and liabilities are translated into the relevant functional currency at exchange rates in effect at the Balance Sheet date. The gains or losses resulting from such translations are included in the Statement of Profit and Loss. Non-monetary assets and non-monetary liabilities denominated in a foreign currency and measured at fair value are translated at the exchange rate prevalent at the date when the fair value was determined. Non-monetary assets and non-monetary liabilities denominated in a foreign currency and measured at historical cost are translated at the exchange rate prevalent at the date of transaction. Revenue, expense and cash-flow items denominated in foreign currencies are translated into the relevant functional currencies using the exchange rate in effect on the date of the transaction. Transaction gains or losses realized upon settlement of foreign currency transactions are included in determining net profit for the period in which the transaction is settled. The functional currency of Infosys, Infosys BPO and Infosys Consulting India is the Indian rupee. The functional currencies for Infosys Australia, Infosys China, Infosys Mexico, Infosys Sweden, Infosys Brasil, Infosys Public Services, Infosys Shanghai and Infosys Lodestone are their respective local currencies. The translation of financial statements of the foreign subsidiaries from the local currency to the functional currency of the Company is performed for Balance Sheet accounts using the exchange rate in effect at the Balance Sheet date and for revenue, expense and cash-flow items using a monthly average exchange rate for the respective periods and the resulting difference is presented as foreign currency translation reserve included in Reserves and Surplus. When a subsidiary is disposed off, in part or in full, the relevant amount is transferred to Profit or Loss.

Forward and Option contract in foreign currencies


The Group uses foreign exchange forward and options contracts to hedge its exposure to movements in foreign exchange rates. The use of these foreign exchange forward and options contracts reduce the risk or cost to the Group and the Group does not use those for trading or speculation purposes. Effective April 1, 2008, the Group adopted AS 30, Financial Instruments : Recognition and Measurement, to the extent that the adoption did not conflict with existing accounting standards and other authoritative pronouncements of the Company Law and other regulatory requirements.
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Forward and options contracts are fair valued at each reporting date. The resultant gain or loss from these transactions are recognized in the consolidated Statement of Profit and Loss. The Group records the gain or loss on effective hedges, if any, in the foreign currency fluctuation reserve until the transactions are complete. On completion, the gain or loss is transferred to the consolidated Statement of Profit and Loss of that period. To designate a forward or options contract as an effective hedge, the Management objectively evaluates and evidences with appropriate supporting documents at the inception of each contract whether the contract is effective in achieving offsetting cash flows attributable to the hedged risk. In the absence of a designation as effective hedge, a gain or loss is recognized in the consolidated Statement of Profit and Loss. Currently hedges undertaken by the Group are all ineffective in nature and the resultant gain or loss consequent to fair valuation is recognized in the consolidated Statement of Profit and Loss at each reporting date.

Financial Risk Management


Financial Risk Factors The Companys activities expose it to a variety of financial risks: market risk, credit risk and liquidity risk. The company's primary focus is to foresee the unpredictability of financial markets and seek to minimize potential adverse effects on its financial performance. The primary market risk to the company is foreign exchange risk. The company uses derivative financial instruments to mitigate foreign exchange related risk exposures. The company's exposure to credit risk is influenced mainly by the individual characteristic of each customer and the concentration of risk from the top few customers. The demographics of the customer including the default risk of the industry and country in which the customer operates also has an influence on credit risk assessment.

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Market Risk
The Company operates internationally and a major portion of the business is transacted in several currencies and consequently the company is exposed to foreign exchange risk through its sales and services in the United States and elsewhere, and purchases from overseas suppliers in various foreign currencies. The company uses derivative financial instruments such as foreign exchange forward and option contracts to mitigate the risk of changes in foreign exchange rates on trade receivables and forecasted cash flows denominated in certain foreign currencies. The exchange rate between the rupee and foreign currencies has changed substantially in recent years and may fluctuate substantially in the future. Consequently, the results of the companys operations are adversely affected as the Indian rupee appreciates/ depreciates against these currencies.

The following table gives details in respect of the outstanding foreign exchange forward and option contracts: (Dollars in millions) December 31,2012 Aggregate amount of outstanding forward and option contracts Gains/Losses on outstanding forward and option contracts $1,103 March 31,2012 $889

$(9)

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The outstanding foreign exchange forward and option contracts as of December 31, 2012 and March 31, 2012, mature between one to twelve months. The following table analyzes foreign currency risk from financial instruments as of December 31, 2012 (in millions): U.S. Euro Dollars Cash and cash equivalent Trade receivables Unbilled revenue Other assets Trade payables Client deposits Accrued expenses Employee benefit Obligation Other liabilities Net assets/(liabilities) $72 813 235 102 -1 -8 -90 -39 161 $9 23 $2 2 15 7 50 6 -4 -3 15 -7 57 $149 United Kingdom Pound Sterling $10 107 31 11 -7 3 $155 Australian dollars $20 85 19 3 -5 -13 -7 $102 Other Total currencies $71 54 29 27 -6 -1 -19 -13 -23 $119 $19 5 121 6 364 149 -11 -12 129 -79 245 $1,448

The following table analyzes foreign currency risk from financial instruments as of March 31, 2012(in millions): U.S. Cash and cash equivalent Trade receivables Unbilled revenue Other assets Trade payables Client deposits Accrued expenses Employee benefit Obligation Other liabilities Net assets/(liabilities) Euro United Kingdom Sterling Pound $7 110 24 5 -1 $145 Australian dollars $16 78 12 -1 -1 -5 $99 Total currencies $20 $32 3 112 47 1 327 31 22 159 -2 -2 (3)) -13 107 -18 -57 -17 $82 314 $1,327 Other

Dollars $1 $1 37770 1 11 6 59 201 128 4 -3 -85 -8 -38 242 $8 68 49 $133

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For the nine months ended December 31, 2012 and December 31, 2011, every percentage point depreciation / appreciation in the exchange rate between the Indian rupee and the U.S. dollar has

affected the company's operating margins by approximately 0.6%.Sensitivity analysis is computed based on the changes in the income and expenses in foreign currency upon conversion into functional currency, due to exchange rate fluctuations between the previous reporting period and the current reporting period. The accounting policy of the company requires marking and recognizing the effect in profit immediately of any derivative that is either not designated a hedge, or is so designated but is ineffective as per IAS 39.The company generate substantially all of its revenues in foreign currencies, particularly the U.S. dollar, the United Kingdom Pound Sterling, Euro and the Australian dollar, where as it incur a majority of its expenses in Indian rupees. The exchange rate between the Indian rupee and the U.S. dollar has changed substantially in recent years and may fluctuate substantially in the future. Consequently, the results of the companys operations are adversely affected as the Indian rupee appreciates against the U.S. dollar. Foreign exchange gains and losses arise from the appreciation and depreciation of the Indian rupee against other currencies in which the company transact its business and from foreign exchange forward and option contracts.

The following table sets forth the currency in which the revenues of the company for the nine months ended December 31, 2012 and December 31, 2011 were denominated:

Percentage of Revenues Nine months ended Currency U.S. dollar United Kingdom Pound Sterling Euro Australian dollar Others December31, 2012 71.3% 6.4% 8.2% 8.4% 5.7% December31, 2011 72.1% 6.7% 7.5% 7.4% 6.3%

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Conclusion
The functional currency of the company is the Indian rupee, although it transacts a major portion of its business in several currencies, and accordingly faces foreign currency exposure through its sales in the United States and elsewhere, and purchases from overseas suppliers in various foreign currencies. The company expect that a majority of its revenues will continue to be generated in foreign currencies, including the U.S. dollar, the United Kingdom Pound Sterling, the Euro and the Australian dollar, for the foreseeable future and that a significant portion of its expenses, including personnel costs, as well as capital and operating expenditures, will continue to be denominated in Indian rupees. Consequently, the results of its operations are adversely affected as the Indian rupee appreciates against the U.S. dollar and other foreign currencies. The company uses derivative financial instruments such as foreign exchange forward and option contracts to mitigate the risk of changes in foreign exchange rates on accounts receivable and forecast cash flows denominated in certain foreign currencies. Additionally, the hedging activities of the

company have also contributed to increased losses in recent periods due to volatility in foreign currency markets. If foreign currency markets continue to be volatile, such fluctuations in foreign currency exchange rates could materially and adversely affect the profit of the companys margins and results of operations in future periods. Also, the volatility in the foreign currency markets may make it difficult to hedge its foreign currency exposures effectively.

Further, the policies of the Reserve Bank of India may change from time to time which may limit the ability of the company to hedge its foreign currency exposures adequately. In addition, a high-level committee appointed by the Reserve Bank of India recommended that India move to increased capital account convertibility over the next few years and proposed a framework for such

increased convertibility. Full or increased capital account convertibility, if introduced, could result in increased volatility in the fluctuations of exchange rates between the rupee and foreign currencies. Fluctuations in the exchange rate between the Indian rupee and the U.S. dollar will also affect the dollar conversion by Deutsche Bank Trust Company Americas, the Depositary with respect to the
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ADSs of Infosys, of any cash dividends paid in Indian rupees on the equity shares represented by the ADSs. In addition, these fluctuations will affect the U.S. dollar equivalent of the Indian rupee price of equity shares on the Indian stock exchanges and, as a result, the prices of the companys ADSs in the United States, as well as the U.S. dollar value of the proceeds a holder would receive upon the sale in India of any equity shares withdrawn from the Depositary under the Depositary Agreement. Holders may not be able to convert Indian rupee proceeds into U.S. dollars or any other currency, and there is no guarantee of the rate at which any such conversion will occur, if at all.

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References

1. Annual report(2013) - Infosys Ltd 2. Fozia Mehtab (Vol 3, April 2013), "Foreign Exchange Risk Management at Infosys Technologies Ltd" 3. Whitepaper on "Managing Foreign Exchange risk" Available at "http://www.edc.ca/EN/Knowledge-Centre/Economic-Analysis-and-

Research/Documents/managing-foreign-exchange-risk-guide.pdf" (2010)
4. http://www.wikipedia.com/

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