Bonfring International Journal of Industrial Engineering and Management Science, Vol. 2, No.
3, September 2012 8
Exchange Rate Risk in the Foreign Exchange
Market: A Challenge on Corporate Profitability
P. Sivarajadhanavel and Dr.S. Chandrakumaramangalam
Abstract--- Foreign exchange market is the largest traded
market across the globe. In India, foreign exchange market
opened for trade during the decade of 1970’s and most of the
transaction done through banks. Many companies in India
emerged as a global player during this period, but they need
to face the exchange rate risk of volatility in the global trade
as the exchange rate against US dollar has raised five folds
during this period. Importantly the risk exposure of Indian
companies to its foreign trade has also increased
dramatically. Conceptually the foreign exchange market faces
risks of transaction exposure, translation exposure, and
operating exposure which seems to be part of the exchange
rate determination system. The hedging measures to be part of
the risk management practices in the foreign exchange system
across the global market. The exchange currency of US dollar
is taken in the account of the foreign exchange market and its
impact corporate profitability is being discussed with
reference to information technology major Infosys. As
exchange rate has challenged Indian corporate at many
periods of interval, due to volatile movement of exchange rate
directly impact on the corporate profitability. Infosys risk
hedging being analyzed to know how it manages the exchange
risk volatility and impact on corporate profitability is studied
reference to information technology (IT) industry. The
historical picture of the exchange rate of INR against major
currencies like US dollar, Euro, Pound sterling, and Yen,
surprised many corporate as it had direct impact on the
corporate profit. This paper brings out the problem of
exchange rate risk and its effect on corporate profitability on
IT industry.
Keywords --- Corporate Profitability, Exchange Rate,
Foreign Exchange Market, Risk, Volatility
I. INTRODUCTION
G LOBAL foreign exchange market is the largest traded
market in terms of trade volume, value, volatility and
risk management. A foreign exchange system was considered
to be a nascent market during the pre-liberalization period of
India. Global market has seen many challenges after breakup
in Bretton Woods administered fixed exchange rate system in
P. Sivarajadhanavel, Assistant Professor, School of Management Studies,
Kongu Engineering College, Perundurai, Erode, TamilNadu, India. E-mail:
sivarajadhanavel@gmail.com
Dr.S. Chandrakumaramangalam, Professor, School of Management
Studies, Anna University of Technology, Coimbatore. E-mail:
ckmaucbe@gmail.com
DOI: 10.9756/BIJIEMS.1403
ISSN 2277 - 5056 | © 2012 Bonfring
1971[1]. Due to this market determined exchange rate system
was introduced in 1972. In the market based exchange rate
determined system there was more fluctuation in the exchange
rate around the global markets due to increased effect of
inflation, interest rate changes, oil price shock, political
tension between Middle East countries, and Asian crises.
Corporates at global level needs to go through these
challenges in their cross broader trade activities as the means
of impact on their profitability.
Indian foreign exchange market had similar situation as
that of global market till pre-liberalization of economy. Post-
liberalization of an economy has brought significant changes
in the exchange rate system during 1990s through monetary
policy reforms. Till February 1992, Reserve Bank of India
(RBI) deemed to be a decision maker in fixing the exchange
rate in the foreign exchange market in India. But the external
pressure over the call money rate pressure had thereafter
brought a dual exchange rate system in March 1992, which
was famous said to be Liberalized Exchange Rate
Management System (LERMS). Then Unified Exchange rate
was introduced in 1st March 1993. Even today, RBI fixes the
reference rate for the exchange of foreign currencies at the end
of the everyday.
The foreign exchange market faces the risks of transaction
exposure, translation exposure, and operating exposure which
seems to be part of the exchange rate determination. But these
exchange rate movements had influenced over the corporate
profitability. Firms in the international business needs to face
the risks of exchange rate volatility over its import or export of
raw materials, cash inflows and outflows of business
transactions, which need to be managed at every level of its
business operations. This paper brings out the problem of
exchange rate risk and its effect on corporate profitability as
major cause to be exchange rate scenario. The impact of
foreign exchange rate movement on Indian IT (Information
Technology) firms’ revenue and its profitability is discussed in
this paper. This would give wide representation of exchange
rate impact on corporate profitable and strengthening the
growth scenario of future IT businesses in India.
II. FOREIGN EXCHANGE (FX) MARKET
The FX market plays significant role in the global trade in
determining the strength of an economy and its growth. World
have moved into transition of foreign exchange practices after
Bretton Woods in 1944, fixed to flexible exchange rate regime
in 1972. During this period India has been following the
global practices moving from peg exchange rate regime to
floating rate exchange system and currently following market
Bonfring International Journal of Industrial Engineering and Management Science, Vol. 2, No. 3, September 2012 9

based exchange system. Even though, the Indian exchange Table: 1 - Foreign Exchange Rate of Indian Rupee (INR) Vs
rate is being controlled by Reserve Bank of India (RBI). US Dollar ($)
Global FX market comprises of the spot market, the Year INR/USD Year INR/USD Year INR/USD
forward market, the future market, and the options in the 1973 7.66 1987 12.95 2001 47.23
derivatives market segment. In India during August 2008 first 1974 8.03 1988 13.91 2002 48.62
foreign currency trading system was introduced against US 1975 8.41 1989 16.21 2003 46.60
dollar, then Euro, British Pound Sterling and Japanese Yen in 1976 8.97 1990 17.50 2004 45.28
1977 8.77 1991 22.72 2005 44.01
the National Stock Exchange of India (NSE), later in the
1978 8.20 1992 28.14 2006 45.17
Multi-Commodity Exchange of India for currency trading 1979 8.16 1993 31.26 2007 41.20
(MCX-SX), and Bombay Stock Exchange of India (BSE). 1980 7.89 1994 31.39 2008 43.41
Now exclusive exchange started by BSE in the name of 1981 8.68 1995 32.43 2009 48.32
United Stock Exchange of India (USE)[4]. 1982 9.48 1996 35.52 2010 45.65
1983 10.11 1997 36.36 2011 46.61
III. FOREIGN EXCHANGE RATE RISK 1984 11.36 1998 41.33 2012 53.90
1985 12.34 1999 43.12
The risk of foreign exchange management is globally well 1986 12.60 2000 45.00
understood by the practioners in the industry. Foreign
exchange rate is unstable due to uncertainty over the interest
rate, flow of capital from the foreign countries, recently Source: http://www.forecast-chart.com/usd-indian rupee.html
problem of government policy and its uncertainty over the
taxation of foreign fund flow. For the last two decades global Foreign exchange rate of Indian currency shows historical
foreign exchange rates amid volatility against most of the depreciation of exchange value not only with the US dollar but
also against the Pound Sterling, Euro, and Japanese Yen. The
currencies, especially with the globally traded currency of US
dollar and EURO which turned out to be more volatile due to high volatile movement of these exchange rates has mostly
financial risks which shadow on the economy growth. During influenced the corporate earnings and economic growth
this period Indian currency not left behind the global potential too the larger extend. Due to this high risk
problems, as it needs to manage its exchange rate volatility involvement in the exchange of foreign currencies, even from
the early period of exchange system, this had direct impact on
risk against global currencies. Indian foreign exchange rate
which depreciated the most reaching all time low of corporate profitability. In last 20 years, after the liberalization
Rs.57.2165[2] against US dollar on 27th June 2012, due to the of the economy Indian currency have depreciated most
effect of global financial crisis in US, European slowdown, comparatively against all the global currencies refer to figure
and high crude oil price. The depreciation of the Indian 3, 4 & 5.
currency value had larger influence over the Indian corporate
profitability for the firms depending upon import of resources E Exchnage
Exchange Rate INRVs
Rate INR VsUSD
USD
from the foreign country by adding production cost and for an X 60
exporter it is said to be favour as rupee depreciates. But the C
H 50
risk of volatile exchange rate in the future market has its
negative impact on fixing the exchange rate in the spot market, A 40
then covering the same in the futures market by the hedgers. N
G 30
E 20
IV. HISTORICAL FOREIGN EXCHANGE RATE
The historical trend of foreign exchange rate in India R 10
shows continuous depreciation of Indian rupee against the US A 0
dollar and other major currencies. Foreign exchange rate of T
2003
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000

2006
2009
Indian currency against US dollar shows that exchange rate E 2012
was only Rs.7.66 Vs 1US $ during 1973, but the economic
scenario which had brought more fall in the rupee value, refer Year
to table – 1 listed on showing year wise historical changes in
the Indian foreign exchange rate. Average exchange rate of Figure: 1 - Foreign Exchange Rate of Indian Rupee (INR) Vs
Indian rupee standards at Rs.52.68 for the period ending US Dollar
March 2012, having depreciated the most against US dollar of
Rs.53.90 Vs 1US $ as on 23rd September 2012[4]. These one
sided movement on exchange rate boosted the domestic firms
which is based on export oriented businesses, and pain for
importing firms which dependent on import of raw material or
finished goods from the foreign country.

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Bonfring International Journal of Industrial Engineering and Management Science, Vol. 2, No. 3, September 2012 10

Source: Chart prepared using Table: 1 data in this paper liberalized. On the same period foreign exchange rate of India
depreciated most between the periods 1988 to 1993. Later
E Exchange Rate INR Vs Pound Sterling Asian financial crisis in 1997, which also coincided with Dot-
X100 com bubble in 1995-2000 peaking out after rapid growth in
C 90
80 economic activities, had impact on the foreign currency
H 70
A 60 exchange rate. In 2008 house bubble which started in US have
N 50 spread into European nations which created financial
G 40 instability and liquidity problems against the exchange of
E 30 rupee against US dollar, depreciated from 43.41 to 48,32 in
20 2008-2009.
R 10
A 0 V. BASIC FRAME WORK OF RISK MANAGEMENT
Apr/93

May/98

May/03

May/08
Sep/96

Sep/01

Sep/06

Sep/11
Jan/95

Jan/00

Jan/05

Jan/10
T
E Risk management is basically practiced to minimize the
Year loss of the notional loss of the currency fluctuations in the
international market. For this a validated framework is
adopted by many firms based on the model developed for
Figure: 2 - Foreign Exchange Rate of Indian Rupee (INR) Vs understanding and hedging the risk exposure [5]. It starts with
Pound Sterling the forecast of the business value, and trend of the exchange
rate risk analysis. Based on this finding benchmarking is done
Source: Prepared from Reserve Bank of India Data to cover-up the cost or to profitability of the hedging the
E 80 exposure of the business value. Validation and review on the
X Exchange Rate INR Vs Euro profitability is done finally. The basics the risk management
70
C technique is to solve the systematic risk involved in the
H 60 exchange market.
A 50
N Figure: 5 – Basics of Risk Management
40
G
E 30
Forecast Risk Estimation Benchmarking
20
R Hedging Stop Loss Reporting and Review
10
A
T 0 Figure: 4 - Foreign Exchange Rate of Indian Rupee (INR) Vs
E JPN Yen
Source: www.fin-stream.com
Year
Figure: 3 - Foreign Exchange Rate of Indian Rupee (INR) Vs VI. CORPORATE RISK MANAGEMENT
Euro For Corporates, managing foreign exchange risk in a
Source: Prepared from Reserve Bank of India Data volatile market is a great work. Corporates need to anticipate
the exchange rate risk to offset the market loss in the foreign
E 70
Exchange Rate INR vs JPN YEN exchange market. The instruments used for managing foreign
X 60 exchange rate risk is done through forward contract, Over The
C
H 50 Counter Exchange rate system, future contract, swap, and
A options by hedging the value of trade in foreign exchange
40
N market. Many firms try to hedge their business transactions to
G 30 minimize the notional loss, which could be gained through
E 20 currency future in the foreign exchange market. The hedging
opportunity exists for the firms to take-up the position either
R 10
in the long or short side, based on the market trend. The
A 0 hedging instruments offer the benefit of managing the risk, if
T the traders do not know the direction of the market to
E
movement. In the case of information technology firms, the
revenue flow comes through the foreign currencies. These
Year firms are directly influenced by the exchange rate fluctuations.
Taking the case of Infosys [6], its primary revenue comes as
Figure: 4 - Foreign Exchange Rate of Indian Rupee (INR) Vs US dollar, Euro or Pound. Infosys manages its revenue by
JPN Yen hedging in the foreign currency market against the US dollar
Source: Prepared from Reserve Bank of India Data or Euro [7].
During 1990-91 Indian economy had faced foreign
exchange crisis, which had forced Indian economy to be

ISSN 2277 - 5056 | © 2012 Bonfring

Bonfring International Journal of Industrial Engineering and Management Science, Vol. 2, No. 3, September 2012
VII. IMPACT ON CORPORATE PROFITABILITY
The impact of foreign exchange rate volatility could
influence on the economy performance and next it could be on
the corporate earnings directly. The corporate earnings of the
IT (Information Technology) industry depend on the exchange
rate system compared with the agreed contract price and date
of bill generation for the service delivered. But the question is
that, does the same exchange rate exist as that of agreed
contact date. It doesn’t exist as that of agreed price; this might
benefit either person based on the contract rate and exchange
rate. The most benefited industry might be large IT and the
small size firms could not bear this problem initially. Even the
large scale IT firms like Infosys faces exchange rate volatility
problem as their revenue comes from the US dollar, the United
Kingdom Pound Sterling, Euro and from the Australian dollar,
where as the firms expenses are meet through Indian rupees.
The exchange rate between the rupee and the foreign currency
like US dollar has major impact on the profit margin of the
firm substantially. The key factors affecting the exchange rate
fluctuations, mainly due to
Country in which firm operates in the business
Size and time of the project operation during the
economic cycle
Pricing policy of the competitors and a firm position
Economic strength of the operating nation and vis-
visa
Inflation pressure over the salary payment to the
employees
Political stability of the nation were the firm operates
Government control over the exchange rate system
Unanticipated move of the economic developments
through political pressures
VIII. A CHALLENGE ON CORPORATE PROFITABILITY
Corporate profitability of the firm is directly linked with
the exchange rate movement for the firms engaged in the
foreign trade. Infosys being engaged in the foreign exports of
information technology oriented services its revenue model is
through foreign currency which directly influenced by the
foreign exchange rate. So its profitability has correlation with
the foreign exchange movement. Infosys has reported
currency rate guidance for the year 2012-13 which stands
around 1.60 for Great Britain Pound (GBP), 1.38 for Euro and
1.05 for Australian Dollar (AUD). Though Infosys has
projected its revenue guidance on the basics of the current
exchange rate trend, the years like 2008 US housing crisis had
impacted on its profitability due to constant currency
guidance, though rupee had sequentially depreciated.
IX. CONCLUSION
The exchange rate fluctuations could have major
implications on the corporate profits. It is an attempt to know
the impact of exchange rate which could impact over the
corporate profitability. Though the majority of the firms could
not avoid the volatility of exchange rate scenario, this could be
managed through proper hedging system adopted by the firm
systematically [8]. It is a fine example how most of the IT
firms operate across the globe, but they do earn in differences
ISSN 2277 - 5056 | © 2012 Bonfring
11
in the currency rate as part of their earnings [9]. All being
hedged systematically and some may lead to marked to market
loss which can be notional loss in the books of the accounts. In
real situation, the exchange rate volatility could add high
pressure on the corporate profits. So it is better to go with the
circumstances and follow the global rule to get profit out the
differences and volatility in the foreign exchange market. Thus
it is concluded that the corporate needs to manage their
foreign revenues by hedging their positions in the foreign
currency future market. This strategy could improve the
corporate profitability by minimizing the exchange rate risk in
the foreign exchange market.
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[3] “India in the World Trading System: A Quantitive assessment”,
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P. Sivarajadhanavel, born in Erode, Tamilnadu. He
has completed BA (Economics), Bharathiyar
University, Coimbatore, Tamilnadu, 2002, MBA
(Finance & Marketing) University of Madras, 2004,
Chennai, Tamilnadu, M.Phil (Management),
Bharathiyar University, Coimbatore, Tamilnadu, 2008.
He has got 10 years of experience in teaching,
research, and publications. He is presently working in
the Department of Management Studies, Kongu Engineering College,
Perundurai, Erode, Tamilnadu – 638 052, previously he has worked in
Southern India Rajasthan Chamber of Commerce, Icfai University Press,
K.S.R Business School. To his credit he had published 4 books, more than 25
papers in various Journals, Magazines, book chapters, and presented papers in
the national and international conferences. (E-mail:
sivarajadhanavel@gmail.com)
Dr.S. Chandrakumaramangalam, born in Erode,
Tamilnadu. He has completed MBA, Ph.D Bharathiyar
University, Coimbatore. Presently Professor, School of
Management Studies, Anna University of Technology,
Coimbatore, Email: ckmaucbe@gmail.com