NARSEE MONJEE COLLEGE OF

COMMERCE AND ECONOMICS

INTERNATIONAL FINANCE ASSIGNMENT

GROUP NO. 3

Team members:

SHALIN BHANSALI, A- 009

SEJAL BOHRA, A- 010

SHAYERI BOSE, A- 011

EKTA CHAUHAN, A- 012

SEMESTER V

SUBMITTED TO: PROF VIRANI CHARMI

 SEJAL BOHRA

A010

45203190008
INTRODUCTION TO RISKS

There has been a tremendous growth in international trade after the World
War II. During this period, efforts were made to facilitate free flow of goods
and services across the world. As a result, world trade grew at a faster rate
and so did the companies and its environment. As the companies grew it
started to get exposed to various type of risks such as financial risk,
Operational risk, Market and Liquidity risk, foreign exchange risk etc. So, the
one Risk that is going to be our focus today is Foreign Exchange Risk.

DIFFERENCE BETWEEN RISK AND EXPOSURE

In simple terms Risk is the probability, i.e., the chance that an event or
situation will come to pass, and mainly lead to a loss or an undesired
outcome, whereas exposure is the extent to which the risk can have an effect
that is how much value is at risk. Risk may or may not lead to a loss, but
exposure is always thought from the perspective of the potential damage.

FOREIGN EXCHANGE RISKS

Foreign exchange risk also known as currency risk is the likely or probable
loss arising due to adverse fluctuations in exchange.

This happens When a company has assets or liabilities denominated in a

foreign currency or contracts to receive or pay in a foreign currency, then it
has an exposure to that currency. Now the changes in foreign currency can be
due to various factors happening in that country to which the currency
belongs as well as some global factors. Factors can be inflation/ Interest rates,
Governments monetary and fiscal policy, Political factors etc.
Example of which can be the risk involved for exporters while receiving the
payment in foreign currency. He/ she may anticipate a different amount and
might receive different amount due to fluctuation.

TYPES OF FOREIGN EXCHANGE RISK

1. Transaction Risk-. The risk is the change in the exchange rate before
transaction settlement. Essentially, the time delay between transaction and
settlement is the source of transaction risk. Transaction risk can be
mitigated using forward contracts and options.
Example- Let’s suppose an Indian company Infosys has signed a contract
with a US company to acquire some asset from the US company at the
contract value of $1 Million and promise to make the payment after 3
months. Currently, the exchange rate is $ 1 = INR 75. So, at the current
rate, the contract value in INR will be $ 1 million multiplied by 75, which
means INR 75,000,000.
Now, after 3 months, assume the exchange rate is changed to $1 = INR
80. But in US Dollar, the company must pay $1 Mn, which will be
translated into INR 80,000,000. That means Indian company will have to
spend INR 50 lakh more because of currency fluctuations.
2. Economic Risk- It is the risk of change in the market forecast of the
company’s business and future cash flows resulting from a change in the
exchange rates.
k. E.g., when a monopoly product of the company starts facing
competition when the lower exchange rate renders the imported product
cheaper. This type of foreign exchange risk is also termed as Forecast
Risk.
 Also, Indian Furniture seller who sells locally will face economic risk
from other furniture importers when Indian INR strengthens i.e. for every
1 USD they pay in India terms they are spending Rs 70 rather than Rs75.
3. Translation Risk- Translation risk is the exchange rate risk resulting
from converting financial results of one currency to another currency.
Translation risk is incurred by companies who have business operations in
multiple countries and conduct transactions in different currencies. If
results are reported in different currencies, it becomes difficult to compare
results and calculate results for the entire company. For this reason, all the
results in each country will be converted into a common currency and
reported in financial statement
The effect is mainly on the multinational firms which operate in
international transactions intentionally because of their customer and
supplier base
For example, if FMCG major Unilever reports a consolidated financial
statement for its US, UK, and Europe subsidiary, it will face translation
risk. However, if it keeps these subsidiary companies independent, there is
no translation risk. Simply put, translation risk is not a change in the cash
flow but only a result of reporting consolidated financials

FOREIGN EXCHANGE RISK MANAGEMENT

Foreign exchange risk management (FERM) helps to hedge foreign currency

assets, liabilities, income, and expenditure. FERM involves using both internal
techniques such as selection of the right currency for invoicing, prepayment and
delayed payments of payables, post payment of receivables, judicious matching
of imports and exports and external techniques such as forwards, futures,
options, and swaps that are called as currency derivatives. The firms with
greater growth opportunities and tighter financial constraints are more inclined
to use currency derivatives.

COMPANY- TATA CONSULTANCY SEVICES OVERVIEW

Particulars 2018-2019
Foreign exchange earnings (export revenue constituted 93.3% of total 119,499
unconsolidated revenue) Crores
Cost insurance freight Value of Imports 447 Crores
49,336
Expenditure in foreign currency
Crores

TCS is largest service provider in India.

Major earning of TCS is in foreign Exchange i.e., 93.3% which gives very high
currency exposure, and the company must have Forex Risk management
strategy in place. The company operates over 30 currency baskets. The 3 Major
currencies of TCS are USD 53.6%, GBP 13.9% and EUR 11.1%. According to
data given by company movement in exchange rate throughout the year resulted
in positive impact of 7.6% on revenue whereas the rupee depreciated nearly 9%
against the dollar in FY 2019.

47.98% currency risk is mitigated by derivatives in TCS.

Three important INTERNAL TECHNIQUES FOR

FOREX MANAGEMENT

1. Matching- When a business has income and expenditure in a foreign

currency then it can operate a bank account in that currency and match
them against each other, removing the need to translate them all back to
their home currency first. The business then only needs to translate the
surplus back into their home currency, saving on transaction costs.
2. Leading and lagging- It refers to the adjustment of the times of
payments that are made in foreign currencies. Leading is the payment of
an obligation before due date while lagging is delaying the payment of an
obligation past due date. The purpose of these techniques is for the
company to take advantage of expected devaluation or revaluation of the
appropriate currencies. Now if any Importer who has a payment due
expects that that the currency in which in he needs to pay is due
EKTA CHAUHAN
will depreciate in future then he/she may will choose to pay 45203190010
after the due date whereas if an exporter expects the currency it A-012
is due to receive will depreciate in future it may obtain payment
on immediate basis.
3. Invoicing in Domestic Currency- By invoicing in domestic currency, an
exporter can shift transaction risk to his customer abroad. One would
therefore expect a strong interest from the side of exporters for invoicing
in domestic currency. This is basically billing the customer in local
currency of the organisation to avoid exchange fluctuations and therefore
here the risk gets transferred to the third party.
Sometimes splitting of invoice currency is also done that is the total value
of the trade is divided into two portions and invoiced in currency of bott
the parties in ratio of 1:1 or as per agreed by the trading people.
4. Pricing Policy and adjustments- There can be two types of pricing
tactics: price variation and currency of invoicing policy. Price variation
can be done as increasing selling prices to offset the adverse effects of
exchange rate fluctuations. However, it may affect the sales volume. So
proper analysis should be done regarding customer loyalty, market
position, competitive position before increasing price. Secondly, foreign
customers can be insisted to pay in home currency and paying all imports
in home currency.
INDIA’S EXCHANGE RATE POLICY AND MANAGEMENT

The Reserve Bank of India intervenes in the currency market to support the
rupee as a weak domestic unit can increase a country’s import bill. In contrast, a
weak rupee is considered good for exports as they become cheap for other
nations, which is why exports-dependent nations love to keep the currency low.
There are a variety of methods by which RBI intervenes. But basically, what
were The Exchange rate systems that were followed in India before 1991?

1. 1947-71
During this time, India followed a fixed exchange rate system under the
Bretton Woods System. 
2. 1971-91
Bretton Woods system broke down, India moved towards the pegged
exchange rate system. The Indian Rupee was linked to U.K. Pound
Sterling

So, till 1991, RBI’s role was more of a regulator, controlling the rates, making
sure it does not fluctuate too much. Country had too much of trade deficit and
thus, to control it, India took a lot of loans. There was retaliation in 1960s and
our country was affected a lot and currency was devalued too. So many foreign
companies were also shut down during this period. Then Bretton woods system
collapsed. America denied linking US dollar with gold. Thus, Later India
adopted Basket pegged System. Then India moved on to Macroeconomic
stabilization of our economy.

What was RBI’s role post Reforms 1991: these reforms are called LPG
(liberalization, globalization, privatization)

Objectives:
 1. To bring stability and control the fluctuations
2. Develop market- so market works based on demand and supply (market
mechanism): not to regulate the currency anymore but regulate the
demand and supply of the currency. RBI also decided to regulate Export
and import levels to manage the currency well
3. Focus on Creating Reserves
4. Avoid Speculation- there was not any more speculative activities

Exchange Rate Systems based on these objectives:

1. 1991-1992
RBI followed Dual Exchange Rate System- whatever you earn, or you
spend from or on imports and/ or exports, will be 20-30% converted
based on market forces. Remaining 70-80% to be converted in other
currency based on the fixed rate by RBI. In short, there were different
conversion quotas for different sectors, so that economy is stable.
2. 1992
When stability was being achieved, RBI brought in LERMS (Liberalized
Exchange Rate Management System. Here all the quotas were removed
from the imports and exports, and they increased the conversion rate from
20-30% to 60%
3. 1994
Till 1993-94, high level of investments was not allowed because our
economy was still unstable. So, the Foreign Investments were gradually
being opened from 1994, so at that time RBI decided that they will allow
full Current Account Convertibility. So, using this Current Account, be it
import or export of services or goods or payments unilateral, profits,
dividend etc. any amount you bring in there will not be any restrictions.
So, all those rates 60%, 20-30% etc. were removed. It all changed to
100% current account convertibility. Current and capital accounts
 represent two halves of a nation's balance of payments. The current
account represents a country's net income over a period, while the capital
account records the net change of assets and liabilities during a particular
year. In short, whatever you earn from any and every type of trading, you
can convert them from or to Indian currency.
4. From 1994
From 1994, foreign investments started to come into India. So,
government set up a high-level committee called Committee on Capital
Account Convertibility (CAC) or Tarapore Committee. This committee
suggested that India should have a Capital account convertibility too i.e.,
for the investments that were coming in. note that Foreign investments
are not decided based on the market rates. It is decided by RBI. RBI
decided how much rupees it will be per dollar because the investments
are made in bulk or else this might affect the market heavily, so, for this
committee was set up to suggest whether our country is prepared for this
or not. It pointed out that the economy is not yet ready but as and when
the economy develops then this can be done. As a result, in early 2000s,
RBI allowed Partial Convertibility Account which was same as LERMS
just that the percentage was 50-50. 50% to be converted based on the
market and 50% to be converted based on rate by RBI.
Capital account convertibility is related to investments. India was not that
stable macro-economically where currency could be 100% converted
based on the market. However, as, and when new sectors gradually
opened, 100% convertibility came in, but we still have to achieve more
stability as per RBI.

RBI in India does Manage Float. There are two types: managed float and free
float. Free float is when currency fluctuates completely based in market demand
and supply forces. No government intervention at all. But to keep our economy
stable, RBI does Manage Float. RBI decides the upper and lower limits. For ex
upper limit of dollar is Rs.68 and lower limit is say Rs. 48. If currency
fluctuates between these limits only, RBI doesn’t intervene but if it goes up to
say 69 or 47 or 46, then RBI will take a step, because even if it goes down to 47
or 46, exports might get affected. So, RBI intervenes to keep the market demand
and supply stable if this crosses the limits.

Now, how RBI intervenes?

There are two ways of intervention by RBI.

 Direct Intervention- Direct Intervention is when RBI itself buys and sells
dollars or controlling exchange reserves, so basically direct steps are
taken.
 Indirect Intervention - Indirect Intervention means RBI makes policies,
restrictions etc. RBI itself does not take any action but it restricts other
people from taking actions.

There is something also called as Sterilized and Unsterilized Intervention.

In Unsterilized Intervention, RBI acts directly or indirectly. RBI here must take
care that its buying and selling of INR does not result into inflation as money
supply gets effected. So, like Unsterilized means that due to these actions of
RBI, economy is exposed to some dangers.

But if, along with this, RBI starts taking monetary steps like increasing the
CRR, selling more govt securities in Open market Operations or Currency
appreciation or Depreciation. It is nothing but when a currency rises constantly
during a period in comparison to another currency, in most cases it is US
Dollars, it appreciates; when it falls, it depreciates. Thus, on one hand, it
controls the Foreign Exchange and on the other, it controls the credit.
When both these steps are taken together, it is called Sterilized Intervention. So,
to conclude, in unsterilized, just one step is taken but the economy is still
exposed to dangers. And when these monetary steps are taken to protect the
economy, they come under sterilized intervention, this is the role of RBI in
developing our country through FOREX.

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