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PUNJAB AGRICULTURAL UNIVERSITY

Synopsis of Research Problem of Post Graduate Student (MBA)


Name of the student

CHARU GUPTA

Admission No.

L-2014-BS-11-MBA

Major Field

Business Management

Field of Specialization

Financial Management

Minor Subject

Economics

Major Advisor

Dr. Navdeep Aggarwal

1. Title:
FINANCIAL RISK MANAGEMENT-A STUDY OF PERCEPTIONS AND PRACTICES OF
MANAGERS IN SELECTED COMPANIES OF LUDHIANA
2. Introduction
Foreign Exchange Risk
Measuring and managing FOREX and interest rate risk in a volatile financial environment is a complex
task. Foreign exchange (FOREX) is a risk factor that is often overlooked by small and medium sized
enterprises (SMEs) that wish to enter, grow, and succeed in the global marketplace. Although most U.S.
SME exporters prefer to sell in U.S. dollars, creditworthy foreign buyers today are increasingly
demanding to pay in their local currencies. From the viewpoint of a U.S. exporter who chooses to sell in
foreign currencies, FOREX risk is the exposure to financial losses due to devaluation of the foreign
currency against the U.S. dollar. Obviously, this exposure can be avoided by insisting on selling only in
U.S. dollars. However, this may result in losing export opportunities for those who are willing to sell in
their local currencies. This approach could also result in the non-payment by a foreign buyer who may
find it impossible to meet U.S. dollar-denominated payment obligations due to the devaluation of the
local currency against the U.S. dollar. While coverage for non-payment could be covered by export credit
insurance, such what-if protection is meaningless if export opportunities are lost in the first place
because of the payment in U.S. dollars only policy. If FOREX risk is successfully managed or hedged,
can be a good option for U.S. exporters who wish to enter in the global marketplace.
FX Risk Management

A variety of options are available for reducing short-term FOREX exposure. The following sections list
FOREX risk management techniques considered suitable for SME companies. The FOREX risk
mentioned below are available in all major currencies.
Non-Hedging FOREX Risk Management Techniques
1.

The exporter can avoid FX exposure by using the simplest non-hedging technique: price the sale
in a foreign currency. The exporter can then demand cash in advance, and the current spot market
rate will determine the U.S. dollar value of the foreign proceeds. A spot transaction is when the
exporter and the importer agree to pay using todays exchange rate and settle within two business

2.

days.
Another non-hedging technique is to net out foreign currency receipts with foreign currency
expenditures. For example, the U.S. exporter who exports in pesos to a buyer in Mexico may
want to purchase supplies in pesos from a different Mexican trading partner. If the companys
export and import transactions with Mexico are comparable in value, pesos are rarely converted
into dollars, and FX risk is minimized.

Interest rate risk


Interest rate has a direct effect on financial market, an increase in interest rate leads investing decisions to
make a change in the structure of investment. Like, small firms are often financially constrained and also
they are sensitive to interest rate shocks. Although these firms make little use of derivatives, they do
borrow extensively from financial institutions. In some cases the interest rate on these loans is fixed while
in other case it adjust with the market interest rates. The management of interest rate risk is therefore
critical for the stability of any firm. Credit channel of the monetary policy argues that higher interest rate
leads to the decline in the availability of finance to the company and resulting in lower investments
amongst credit constrained firms. Last few years have witnessed volatility in interest rates and this has
resulted in the creation of concern of financial managers towards interest rate risk management.
Uncertainty increases when there is movements in the interest rates which results in a potential loss (or
gain) because of the mismatch exist between the maturity of the debts and of the assets which they are
financing. Traditionally this problem was solved by matching the maturity of debts and the life span of
the assets they are financing. But due to high uncertainty of inflation the cost of debt become uncertain.
As there is strong correlation between the changes in inflation and the movements in interest rates. That is
if inflation were known with certainty by both lender and borrower then, by adding an inflation premium
the long term interest could be kept relatively constant. But in practice, due uncertainty of inflation there
is to assess its long term exposure for managing the firms interest rate.

Principles for the management of interest rate risk


1.

Senior managers must ensure that appropriate policies and procedures are established to control

2.

these risks and the level of interest risk is effectively managed.


Interest rate risk policies and procedures should be clearly defined and consistent with the nature
and complexity of their activities. These policies should be applied at the level of individual,

3.

overseas branches and subsidiaries.


Companies must have an adequate system of internal controls over their interest rate risk
management process. A fundamental component of the internal control systems involves regular
independent reviews and evaluations of the effectiveness of the system and, where necessary,
ensuring that appropriate revisions or enhancements to internal controls are made.

OBJECTIVES:
1. To study the perception and practice of managers regarding Interest rate risk management
2. To study the perception and practice of managers regarding Foreign exchange risk management
Review of Literature:
A brief review of the relevant studies has been presented in this section.
Miller (1992) The study shows that the treatments of risk in the international management largely focus
on particular uncertainties to the exclusion of other interrelated uncertainties. This paper develops a
framework for categorizing the uncertainties faced by firms operating internationally and outlines both
financial and strategic corporate risk management responses.
Stulz (1996) The study presents a theory of corporate risk management. It argues that the primary goal of
risk management is to provide protection against the possibility of costly lower-tail outcomessituations
that would cause financial distress or make a company unable to carry out its investment strategy. By
eliminating downside risk and reducing the expected costs of financial trouble, risk management can also
help a company to achieve its optimal capital structure. The paper also departs from standard finance
theory in suggesting that some companies may have a comparative advantage in bearing certain financial
market risksan advantage that derives from information acquired through their normal business
activities. Although such specialized information may lead some companies to take speculative positions
in commodities or currencies, it is more likely to encourage selective hedging.
Froot and Stein (1998) The study develop a framework for analysing the capital allocation and capital
structure decisions facing financial institutions. Our model incorporates two key features: (i) valuemaximizing banks have a well-founded concern with risk management; and (ii) not all the risks they face

can be frictionless hedged in the capital market. This approach allows us to show how bank-level risk
management considerations should factor into the pricing of those risks that cannot be easily hedged. We
examine several applications, including: the evaluation of proprietary trading operations, and the pricing
of unhedgeable derivatives positions. We also compare our approach to the RAROC methodology that has
been adopted by a number of banks.
Hsieh (2009) They study has examined the behaviour of the exchange rate of the Indonesian rupiah
against the U.S. dollar. Four different models have been tested in empirical work.
Aggrawal and Srivastava (2010) This research empirically examines the dynamics between the movement
of Rupee-Dollar exchange rates, in terms of the extent of interdependency and causality. To begin with,
absolute values of data were converted to log normal forms and checked for normality. Application of
Jarque-Bera test yielded statistics that affirmed non-normal distribution of both the variables. This posed
questions on the stationary of the two series. Hence subsequently, stationary of the two series was
checked with ADF test and the results showed stationary at level forms for both the series. Then, the
coefficient of correlation between the two variables was computed, which indicated slight negative
correlation between them. This made way for determining the direction of influence between the two
variables. Hence, Granger Causality test was applied to the two variables, which proved unidirectional
causality running from stock returns to exchange rates, that is, an increase in the returns of Nifty caused a
decline in the exchange rates but the converse was not found to be true.
Jawaid and Haq (2012) The study investigates that the interest rate and foreign exchange rate are the two
important factors that affects the common stock price. This paper study the effects of exchange rate,
interest rates, and their effects on stock prices of banking industry of Pakistan. Results shows the
significant negative long run relationship between exchange rate and short term interest rate with stock
prices. On the other hand, positive and significant relationship exists between volatilities of exchange rate
and interest rate with stock prices. It is suggested that investors should invest in banking sector stocks
when exchange rate and interest rates are highly volatile. The result also supports the view that exchange
rate and interest rate can be used as an indicator for investment decision making in banking sector stocks.
Khan et al (2012) This research covers the impact of interest rate, exchange rate and inflation on stock
returns index. There are three macro variables which are considered as very important for the economy of
any country and any change among these variables effect the economy in various ways and the regulatory
authority take steps in order to make changes in their policies which can affect the economy in a positive
way. Multiple regression model is applied on the data and the result shows that there is a weak
relationship between the dependent variable and independent variables. The impact of interest rate and

inflation is insignificant on stock returns index while the exchange rate has significant impact on stock
returns index
Research Methodology:
The research involves a study of perception and practice of managers regarding management of interest
rate risk and foreign exchange rate risk. To do the same three industries will be selected from those
present in Ludhiana and a list of the units in each of the industries will be prepared with the help of
District Industrial Centre. Ten units from each of the selected industries will be selected on random basis.
Only those units will be selected which have the foreign rate exposure (either involved in imports or
exports).
Further, managers handling the financials of the selected units will be approached for their perception and
practices regarding interest rate and forex rate risk management. A pre-structured non-disguised
questionnaire will be used for this purpose. The data will be collected personally within managers and
will be analysed using different statistical techniques such as mean, standard deviation, correlation etc.
3. Collaboration (if any): Nil
4. References:
Aggarwal G, Srivastav A K and Srivastav A (2010) A Study of exchange rates movement and stock
market volatility. Intl J Bus and Mgt 5(12):62-73
Froot K A and Stein J C (1998) Risk management, capital budgeting, and capital structure policy for
financial institutions: an integrated approach. J Financial Eco 47(1):55-82
Hsieh W J (2009) Study of the behaviour of the indonesian Rupiah/US Dollar exchange rate and policy
implications. Intl J Applied Eco 6(2):41-50
Jawaid S T and Haq A U (2012) Effects of interest rate, exchange rate and their volatilities on stock
prices: evidence from banking industry of Pakistan. Theoretical and Applied Eco19:153-166
Khan Z, Khan S, Rukh L and Imdadullah (2012) Impact of interest rate, exchange rate and inflation on
stock returns of kse 100 index. , Intl J Eco Res 3:142-155
Miller K D (1992) A framework for integrated risk management in international business. J Intl Bus
Studies 23(2):311-331
Stulz R M (1996) Rethinking risk management. J Applied Corporate Fin 9:8-15

________________________
(Charu Gupta)

Advisory Committee
S.N

Name

Designation & Department

Signature

O
Dr. Navdeep Aggarwal
1
2

(Major Advisor)
Dr. Khushdeep Dharni
(Member)

Dr. Jatinder Mohan


(Member)

Assistant Professor
School of Business Studies
Associate Professor
School of Business Studies
Agricultural Economist
Department of Economics and
Sociology

Dr. Babita Kumar

Associate professor

(Nominee of Dean PGS)

School of Business Studies

Approved
________________
_______
(Director)
School of Business Studies