1. Managing Exposures
And Exchange Rate Fluctuations

2. Our Road Map
Introduction &
Overview
Managing
currency risks
Raising Funds
Abroad or in Fx
Opportunities &
Risks
BOP
Understanding
Currency
Exposures & Risk
Managing the risks
Fx Markets
Exchange Rate
Determination &
Forecasting
Capital Budgeting
Fx Quotes
Parity Theories
Summation

3. Foreign Exchange Exposure
• A measure of the potential for a firm’s
– Profitability
– Net cash flow
– Market value of assets and liabilities
to change because of a change in exchange rates
• Objective to measure and manage these 3
parameters

4. Cross Border Risks
• Cross Border Activities are exposed to risks
– Political
• Can affect short term as well as long term
– Sovereign
• Government not honoring commitments , country credit risk
– Performance
• Government not giving clearances or new unfavorable rules enforced
– Payment
• Customer not paying , unable or unwilling or disputing
– Counter Party
• One of the parties not honoring commitment
– Liquidity
• Assets cannot be sold at market prices or in a timely manner
– Foreign Exchange or Currency Risk

5. Foreign Exchange or Currency Risk
Whom does it affect?
• Anyone with exposure to foreign currency
– Exporters
– Importers
– Foreign Currency Borrowers /Lenders
– Asset holders
– Remittances to India
– Remittances out of India
– Others

6. Why do exchange rates change ?
• Demand and Supply
• Interest Rates
• Flows into and out of the country
•
•
•
•
Trade Flows
Invisibles
Investments (inbound and outbound)
Borrowings/Lending
• Political & Other Factors
– Stability
– Policies
– Outlook
• Speculation

7. How do changing exchange rates affect
• A falling local currency
– Increases cost of imports
– Costlier servicing of
foreign debt
– Exports become more
competitive
– Investing outside India
becomes more
expensive
• A rising local currency
– Imports become cheaper
– Cheaper servicing of
foreign debt
– Exports become less
competitive
– Investing outside India
becomes cheaper

8. Objectives of Forex Risk Management
• Protect Realizations/Outflows
• Avoid or minimize negative surprises
• Bring in more predictability
• Capture opportunities
• Stay competitive

9. Types of exposures
• Transaction Exposure
– Measures changes in the value of the outstanding financial obligations
• Incurred or contracted before exchange rate change but not due to be settled till
after the exchange rate change
– Sensitivity of domestic currency value of foreign currency denominated costs and
revenues
• Economic Exposure
– Also called operating, competitive or strategic exposure
– Measures the change in PV of the firm resulting from changes in expected CF’s caused
by unexpected changes in exchange rates
• Translation Exposure
– Also called accounting exposure
– Potential for accounting derived changes in owner’s equity to occur because of the need
to “translate” foreign currency financial statements of foreign subsidiaries for
consolidated financial statements
Currency Exposures do not always result in losses to the firm
– Not due to firm’s true operations or core competence
– But from timing associated with exchange rate changes and currency movements

10. Comparison of the 3 exposures
Moment in time when
exchange rate changes
Transaction Exposure
Economic Exposure
Translation Exposure
Time

11. Defining Hedging
• Value of the firm
– NPV of all expected future cash flows
• One element of financial risk management
– Exchange rate or Currency rate changes
• Currency Risk – Variance in expected cash flows
arising from unexpected exchange rate changes
• Hedging
– Taking of a position that will rise or fall to offset the
fall or rise of an existing position
– Attempts to reduce risk , not add value or return
– Hedging not “free”

12. Arguments to hedge or not
• Shareholders are capable
of diversifying currency
risk better
• CRM does not increase
the expected cash flow of
the firm
• Hedging benefits
managers rather than SH
(agency problem)
• Managers cannot
outguess market
• Improves planning
capability of the firm
• Reduces risk of CF falling
below a necessary
minimum
• Management knows
currency risk better
• Management is better
aware of “disequilibrium”
factors in market and can
take advantage of the
same through “selective
hedging”

13. Transaction Exposure
A more detailed look

14. Transaction Exposure – How does it
arise
• Purchasing or selling of goods where prices
are stated in foreign currencies
• Borrowing or lending in foreign currencies
• Being a party to an unperformed foreign
exchange forward contract
• Acquiring assets or incurring liabilities
denominated in foreign currencies

15. Basic question
• An Indian company has
–
–
–
–
payables of $ 10,000 for inputs due in one month,
receivables of € 10,000 due in two months.
The current exchange rate is Rs 43/ USD and Rs 55/ €.
The expected spot rate on the date of payment is Rs 44/ $, and
Rs 56/ €
What is the cash outflow and inflow in rupees on the maturity
date, if the actual spot rate on that day is identical to the
expected spot rate.
Is the transaction exposure favorable or unfavorable?

16. A simple costing example
• I want to manufacture a product in India and sell to a
customer in USA
– I can produce 1 unit at Rs 1,50,000
– I want a profit margin of Rs 15,000
– I therefore need a selling price of Rs 1,65,000
• My customer is in USA and needs a price quoted in USD.
– I therefore need to calculate my Rs 1,65,000 in USD and quote
to him.
• What do I do: Divide Rs 1,65,000 by the $ exchange rate
of Rs 55 (on that date) and quote $3,000 to the customer
• But, I want my money eventually converted back to INR
when I receive payment from him .

17. What happens after that?
• I now have an export order at $ 3,000 on hand , on
which I expect / target to get Rs 1,65,000
• I need to Buy-Store-Process-Store-Ship-Collect
• USD may not be Rs 55/ $ on the date of realization
• If it goes to Rs 60/$, I gain
– Because I now get $3,000 *60 =Rs 1,80,000
• If it goes to Rs 40/$,I lose
– Because I now get $3,000 *40 =Rs 1,20,000

18. A typical transaction exposure
Seller
quotes
Buyer
orders
Quotation Exposure
Seller
ships
Backlog Exposure
Buyer
pays
Billing Exposure

19. Borrowing and Lending - Example
• I borrow $ 1.0 Million from a US bank to buy some
equipment in India with a repayment after 3 years
• On the day of receiving the $ , I give it to my bank and
convert it into INR at 45.00/$ , I get Rs 45 Million
• I pay my supplier in India Rs 45 Million and get my
equipment
• After 3 years ,USD/INR has moved to Rs 60.00
• I now need Rs 60 Million to buy $ 1.000 Million and
repay my loan
• Questions: Who runs a risk ?

20. 01/Jan/93
01/Jan/94
01/Jan/95
01/Jan/96
01/Jan/97
01/Jan/98
01/Jan/99
01/Jan/00
01/Jan/01
01/Jan/02
01/Jan/03
01/Jan/04
01/Jan/05
01/Jan/06
01/Jan/07
01/Jan/08
01/Jan/09
01/Jan/10
01/Jan/11
01/Jan/12
01/Jan/13
USD/INR
70.00
65.00
60.00
55.00
50.00
45.00
40.00
35.00
30.00

21. USD/INR
70.00
69.50
69.00
68.50
68.00
67.50
67.00
66.50
66.00
65.50
65.00
64.50
64.00
63.50
63.00
62.50
62.00
61.50
61.00
60.50
60.00
59.50
59.00
58.50
58.00
57.50
57.00
56.50
56.00
55.50
55.00
54.50
54.00
53.50
53.00
52.50
52.00
51.50
51.00
50.50
50.00

22. What happens when
•
•
•
•
•
•
•
RBI signals reduction in interest rates
US announces a likely curb on outsourcing
An EU country reports serious problems
China expected to grow faster
India announces reduced tax on equity gains
Key political ally withdraws support
Likely downgrade of US by Rating agencies

23. Same Data , Different Analysis
CRISIL & BOA - Appreciation
Std Chartered - Depreciation
• Capital inflows will resume
because QE threat recedes
and GOI promises reforms
• CAD softens and expected to
fall to 4.5%
• However, there will be
volatility in the path
• BOA ML feels GOI/RBI will try
to defend Rs 60/$
• Reform prospects are bleak and
investors likely to get jittery
• NRI bonds likely to have only
short term impact
• RBI unwilling to take on currency
risk on such bonds
• Trade deficit direction looks +ve
• Gold imports and improved
scenario in markets abroad
• Need for much needed and
reforms in natural gas, FDI policy
and insurance / pension reforms
– Sees it peaking at 59-60
– RBI will try for 54-58 if Euro
trades between 1.30 to 1.20

24. What do I do ?
61?
56?
59

25. Background
• In March 2007, the CFO of an Indian IT major stated that
– ‘a 1% change in the rupee– dollar rate will have a fifty
basis point impact on the margins’
– Impacts vary from company to company , directly or
indirectly
• Companies cannot afford to
– sit on the sidelines and allow exchange rate volatility to
ravage their bottom lines and balance sheets.
– they adopt a proactive approach and use a variety of
methods.
• Hedge through contractual & non contractual methods
– Requires the balancing of costs versus benefits

26. Profit Motive
Philosophy of Risk Management
Selective
Hedging
Speculate
All Risks
Hedged
All Risks
Open
Risk Appetite

27. Managing Risk - Steps
Identify
Risk
Review &
Rebalance
Probability
Impact
Hedge or not ?
Partial or fully
Contractual or NC
Natural hedges
Corporate philosophy
Hedging
Strategy &
Alternatives
Quantify
Risk
Set Risk
Strategy

28. Scenarios
• Sure of $/Rupee direction
– Confident of upper/lower expected level
– Not confident of upper/lower expected level
• Unsure of $/Rupee direction
• Known Exposure
• Unknown Exposure
• The Dilemma : Should I cover or not?

29. What should we do?
• Depends on individual business/contract
characteristics
• Pricing models
• Competitive pressures
– From within India
– From outside India –where is your competition?
• Risk taking capacity/appetite
• “Hindsight” factor !

30. Techniques used
•
•
•
•
•
•
•
•
•
Forwards or Futures
Money Market Hedge
Currency Option Hedge
Leading & Lagging
Cross Hedging
Choice of Currency
Currency Diversification
Nontraditional Hedging Techniques
Stay un-hedged

31. Forward Covers
• A forward exchange contract is an agreement to
exchange currencies at a future date at a precontracted exchange rate.
• We contract to buy or sell $ ( for example) at a
particular rate at a particular time in future
– Could be a fixed date or a period
– Currency where we want to hedge
• Banks normally quote for up to 1 year forward
• Forward rates may be higher or lower than the spot
rate
• Once booked , they are binding on us

32. 22 Oct 2013 Rs/USD @
9.33.36 am
Bid (Exporter)
Ask (Importer)
Spot
61.80
61.82
Oct
61.92
61.96
Nov
62.37
62.41
Dec
62.85
62.90
Jan
63.31
63.37
Feb
63.68
63.74
Mar
64.05
64.11
Apr
64.52
64.58
May
64.86
64.92
Jun
65.22
65.28
Jul
65.58
65.64
Aug
65.90
65.96
Sep
66.25
66.31

33. Forward Covers
– We lock in to a rate , for a future maturity date , for a specified $
amount
– Example
• Spot rate on 22 Oct 2013 = Rs 61.80/82
• Forward premium till April 2014 = Rs 2.72/2.76
• Assume Bank Charges = Rs0.03
• Forward rate for April 2014 for an exporter
– 61.80+2.72-0.03 = 64.49
• Forward rate for April 2014 for an importer
– 61.82+2.76+0.03 = 64.61
– On April 30 2014 , whether spot is Rs 50.00 or Rs 70.00, an
exporter sells $ at Rs 64.49 and an importer buys $ at Rs 64.61
– We can cover for a date
• (example :April 30th )
– We can cover for a period
• (example : April 1st to April 30th ) .

34. Hedging of Forwards
• In most foreign exchange markets , the spot
market is more liquid than forwards
– Standard and non standard maturities
• Banks may face 2 risks till squaring off
– A change in spot rate (bigger risk)
– A change in forward margin (may be done later by
some banks sometimes)
• Long term hedges
• Non dollar quotes

35. Advantages /Disadvantages of a cover
• We have a fixed rate for $ for the future date
• Brings in predictability to the future earnings /
outflows
• We lose potential gains above (exporter)/below
(importer) forward cover rates
• You have to deliver on the date or cancel or
rollover
– Risk of underlying transaction not happening /delayed
• Changes in RBI policies ? !

36. Some other practical aspects
• Running account (past performance based) versus
order based availment
• Branch or Treasury Desk
• Level of automation at the bank/interface
• Export Bill Discounting
• Import Bill Acceptance
• At sight and with credit
• Discounting and collection basis
• Through bank and documents in trust
• Advance payments
• EEFC account

37. Forwards & Futures
Forwards
• Flexible amount
• Flexible maturity
• OTC phone/fax/mail
• Settlement or honoring
normally by delivery
• Counter party risk may exist
Futures
• Standard amount
• Standard maturity
• On exchanges ,same price
• Settlement or honoring
normally by cash settlement
• Counter party risk lower
due to MTM corrections

38. Scenarios
• Sure of $/Rupee direction
– Confident of upper/lower expected level
– Not confident of upper/lower expected level
• Unsure of $/Rupee direction
• Known Exposure
• Unknown Exposure
• The Dilemma : Should I cover or not?

39. Money Market Hedge
• Transaction exposure can also be hedged by
lending or borrowing in the domestic and
foreign money markets
– Lend to hedge ?
– Borrow to hedge ?
•
•
•
•
What have we achieved by doing so ?
What can be constraints to do so ?
What else do we need to consider ?
When will forwards be better than MMH ?

40. Example of a money market hedge
•
•
•
•
•
•
•
•
•
•
•
I have a receivable of $1,000,000
Current spot rate : Rs 43
INR interest rate 9 % , US interest rate 3%
Step 1 : Borrow $ 970874 (1,000,000/1.03)
Step 2 : Convert $970874 into INR
Step 3: Receive Rs 41.748 Mio
Step 4: Invest 41.748 Mio @ 9 %
Step 5: Receive 45.505 Mio at maturity
Step 6 : Customer pays me $ 1.000 Mio receivable
Step 7 : Use that $1.000 Mio to repay Step 1 loan
Step 8: I now have 45.505 Mio rupees left with me
• WHAT FACTORS DO WE NEED TO CONSIDER TO CHOOSE THIS ?

41. Indian Context
• Regular working capital borrowings
• Export packing credit in INR
• Pre shipment credit in Foreign Currency
(LIBOR based rates)
• Export Bill Discounting

42. Options – How is it different from a forward
cover
• As the name suggests , it gives the buyer of
the option , an option without an obligation
• On the future date, you can decide whether or
not you want to use the option contract that
you bought
• This is useful when you want to protect a rate
but also feel that there is potential for further
gain in the $/Rupee equation

43. Parties to an option contract
• Writer or seller of the option : The party who
has an obligation to buy/sell the asset
underlying the contract ,at the agreed price
and time , if the option is exercised by the
buyer of the option
• Buyer of the option : The party who has the
right but not the obligation to sell/buy the
asset underlying the contract at the agreed
price and time

44. Types of options
• Call Option : The right , without the obligation, to
buy an asset
• Put Option : The right , without the obligation, to
sell an asset
• American Option : An option , which can be
exercised at any time until the expiry date
• European Option : An option , which can be
exercised only on expiry
• Bermudan Option : An option , which can be
exercised only during a predefined portion of its
life

45. What do we do ?
CALL
PUT
BUY
CALL
SELL
CALL
BUY
PUT
SELL
PUT
BUY
SELL

46. Expiry
• Expiry : The last date on which the option may
be exercised
• Expiration time : Specified in the contract .
Current practice generally specifies it as 10am
New York time or 3pm Tokyo time

47. Exercise or Strike Price
• Exercise or Strike Price : The specified price at which the
buyer of the contract can exercise his right to buy or sell
the asset
• At-The-Money (ATM) : An option with a strike price equal
to the current price of the asset. In currency terms , this
can refer to the current spot rate (ATM spot) or the forward
rate for the expiry date (ATM forward)
• In-The-Money (ITM) : The strike price is more favorable to
the buyer than the current market rate. Premium will be
higher than in ATM
• Out-Of The-Money (OTM) : The strike price is less favorable
to the buyer than the current market rate. Premium will be
lower than in ATM

48. Value/Price of an option
• Option Premium : Fee or price paid by the buyer
of the option to the seller of the option
• Value of an option : The market price of the
option
• Intrinsic Value : The difference between the
strike price and the current market exchange rate
, in the case of an American style option it is
profit available on immediate exercise.
• Time Value : The difference between option
premium and intrinsic value reflecting the value
arising from time left until its expiry

49. How do options in Fx Work?
– When an exporter buys a USD put option , he has
the right ,but no obligation to sell USD at the
“strike” price
• For example , if he bought an option at a strike price of
Rs 60 for April 2014, he can sell USD at 60 if the USD is
below Rs 60 on due date
• If it is above Rs 60,he can ignore his option and sell in
the market at a higher price
• His only cost is the option premium he paid
– Some people buy and sell options to reduce cost
• can work better than forwards if understood well
• but that can be very risky if done without knowledge!

50. Simple Option - example
• I want to protect an expected outflow of $ 1
Million using an option
• Data as on date
– Spot price Rs 60.00
– Forward Rate after 6 months 62.00
– Strike rate requested for 62.00
– Option premium (price) quoted by bank 1.00
• Let’s discuss these #’s first

51. I now own an option
• I have spent Rs 1.00 *$ 1 Mio = Rs 1.000 Mio
• I have the right to buy USD 1 Mio at Rs 62.00
• What happens after 6 months
– If USD is > 62.00 , I will exercise my option
– If USD is <62.00 , I will ignore my option (let it
lapse) (I will not exercise it)
• How is this different from a forward cover ?

52. Payoffs Call Option
Option
Fwd Cover
-
7
6
5
4
3
2
1
0
-1
-2
-3
-4
-5
-6
-7
56
57
58
59
60
61
62
63
64
65
66
67
68

53. Payoffs Put Option
Option
Fwd Cover
-
7
6
5
4
3
2
1
0
-1
-2
-3
-4
-5
-6
-7
56
57
58
59
60
61
62
63
64
65
66
67
68

54. Leading & Lagging
• Operational technique to reduce transaction
exposure
• Lead – pay or collect early
• Lag – pay or collect late
• Which will we lead and which will we lag ?
• A word of caution
– why will counter party want to do so ?
– will it affect business model or relations ?
– Original invoice price already made assumptions
• Can be used effectively between “related” parties

55. Cross Hedging
• Method used when the currency in question
cannot be hedged directly or cost effectively
• Also called a proxy hedge because the
currency chosen for hedging serves as a proxy
for target currency
• What will the effectiveness of this depend on?
• What are the risks ?

56. Currency Diversification
• Can limit the impact of a single currency
movement
• MNC’s may have this advantage being in
different countries
• How could smaller companies manage this ?
• What basic characteristic is required between
currencies for this strategy to be effective as a
hedge ?

57. Choice of currency
• Choosing which currency you would like your
billing in ?
• Scope may be limited especially where you do
not call the shots in the relationship

58. Scenarios & what would you prefer
• Basic Data
– Spot 61.80/82
– March Forwards 64.05/11
• Your views as of now about March likelihood
– Confident it will go above 65.00
– Confident it will stay steady at around 62.00
– Confident it will go below 60.00
– Confident Re will depreciate but not sure (63-70)
– Not sure of direction (55-68)

59. Payoffs Call Option
Option
Fwd Cover
-
7
6
5
4
3
2
1
0
-1
-2
-3
-4
-5
-6
-7
56
57
58
59
60
61
62
63
64
65
66
67
68

60. Variations of simple options
• Achieved through combining more than one
option ,usually buying and selling options
• Motives could be to :
– Reduce or eliminate option premium
– Achieve a different target range
• Involve giving up “potential gains “ to achieve
“savings in up front costs”

61. Payoff of the range forward option
Eff Rate
51.5
51
50.5
50
49.5
49
48.5
48
47.5
47
46.5
Eff Rate
45
46
47
48
49
50
51
52
53
54
55
56
57

62. Range Forward
• Also called a tunnel option
• Example:
– We want to hedge a $100 payable
• Buy a call option @ 51.00 strike price : pay a premium of Rs
0.70 p
• Sell a put option @ 48.00 strike price : receive same
premium of Rs 0.70 p
– On expiry
• If spot is 53.00 , we exercise at 51.00
• If spot is less than 48.00 , buyer of option exercises at 48.00

63. Ratio Range Forward
• If end user wants a better rate for the bought
option
– say 49.00 instead of 51.00 in earlier example
• He will have to give up something
– Either pay a higher premium
• (1.55 vs 0.70 earlier example)
OR
– He will need to sell more options
• 3.1 puts at 47.00 vs 1 put at 48.00 earlier example
• Now , let’s look at payoffs

64. What happens at expiry
• If spot rate is above 49.00 , call purchased will be
exercised
• Between 47 & 49 , neither will be exercised
• If spot is below 47.00 , (say 46) , put of 310$ will
be exercised by counter party
• We need only $100 so we will have to sell $210 at
spot rate (46.00) and receive 9660
• Effective cost 49.10 (310*47 -9660)= 4910
• 4910/100 =49.10

65. Payoff of the ratio range forward
Eff Rate
52.00
51.00
50.00
49.00
48.00
Eff Rate
47.00
46.00
45.00
44.00
45
46
47
48
49
50
51
52

66. Payoff of the participating forward
33% participation
50.50
50.00
49.50
49.00
48.50
48.00
47.50
45
46
47
48
49
50
51
52

67. Participating Forward
• Combination of forward contract and option
– Forward rate on that day 49.38
– Price of 50 put 1.87
– Gap of 62 p used to buy a put option for 1/3rd of the
contract
• If spot on expiry is 46 , put option will be
exercised with a profit of Rs 4
– Gain 4*1/3 =1.33
– Our effective cost of buying $ = 48.67
• Larger the participation required, greater will be
the rate !

68. Payoff of the seagull
0.80
0.60
0.40
0.20
(0.20)
(0.40)
(0.60)
(0.80)
(1.00)
(1.20)
46
47
48
49
50
51
52

69. Seagull Option
• A zero cost structure but more complicated than
simple range forward
– Buy call @ 50.00 (1.40 outflow)
– Sell put @ 47.00(0.50 inflow)
– Sell call @ 50.70 (0.90 inflow)
• If spot 50-50.70 , call option we bought will be
exercised but not the call sold
• If spot > 50.70, both calls will be exercised and
payoff stabilizes at 0.70p
– Actual cost = (spot-0.70)
• Gets its name from payoff graph

70. Choices & Considerations
•
•
•
•
•
•
Forward contracts versus Money Market
Forward contracts versus Options
Forward contracts versus not hedging
Options versus not hedging
Options versus money markets
What do we do when there are timing
mismatches
• What do we do when there is uncertainty
regarding timing of inflows and outflows

71. Economic Exposure
• Also called operating exposure, competitive
exposure and sometimes strategic exposure
• Measures any change in the PV of the firm
resulting from changes in future operating CF
caused by any unexpected changes in
exchange rates
• Goal is to identify strategies or techniques
that will enhance value in the face of
unexpected exchange rate changes

72. Economic / Operating Exposure
• Depends on
–
–
–
–
Change in nominal exchange rate
Change in the selling price (output price)
Change in the quantity of output sold
Change in operating costs (quantities & input price)
• Impact of real exchange rates
• Combination of 2 effects
– Conversion Effect
– Competitive Effect

73. Factors that influence
•
•
•
•
•
Geographical extent of market
Who are the dominant players
Market power & demand elasticity
Impact on input prices
Currency composition of operating costs

74. Attributes of Economic Exposure
• Requires forecasting and analyzing firm’s
– future individual transaction exposures
– future exposures of competitors ,present and
likely
• Analysis of longer term than transaction
exposure
– Transaction exposures
– Anticipated transaction exposures
– Longer term exposures

75. Operating & Financial Cash Flows
• Operating cash flows arise from
– Intercompany & Intra-company receivables &
payables , rent , royalties, license fees
, management fees
• Financial cash flows arise from
– Payments for loans
• Principal & Interest
– Equity related
• Equity investments & Dividends

76. Expected versus Unexpected changes
in Cash Flow
• Economic Exposure is far more important for
long term health of the business
• Subjective - estimation over long time horizon
• Not from accounting process –total
management responsibility – all functions
• Only unexpected changes should cause
changes --- why ?
• Macroeconomic uncertainty

77. Strategic management of Economic
exposure
• Objective of transaction & economic exposure
management
– Anticipate and influence the effect of unexpected
changes in exchange rates on a firm’s future cash
flows
• To meet this objective, firms can
– Diversify the firm’s operating base
– Diversify the firm’s financing base
– Change the firm’s operating and financial policies

78. Proactive management of economic
exposure
•
•
•
•
•
•
•
Matching currency cash flows
Risk sharing agreements
Back to back or parallel loans
Currency Swaps
Leads & Lags
Reinvoicing Centres
Contractual approaches

79. How is it different from transaction
exposure
• Transaction exposure – exchange rate risk on
converting inflows or outflows
• Economic exposure
– any impact of exchange rate fluctuations on a
firm’s cash flow
– More far reaching and encompassing than
transaction exposure
– May need strategic moves and changes

80. STEPS IN MANAGING ECONOMIC EXPOSURE
• 1. Estimation of planning horizon
• 2. Determination of expected future spot rate.
• 3. Estimation of expected revenue and cost streams, given the
expected spot rate.
• 4. Estimation of effect on revenue and expense streams for
unexpected exchange rate changes.
• 5. Choice of appropriate currency for debt denomination.
• 6. Estimation of necessary amount of foreign currency debt.
• 7. Determination of average interest period of debt.
• 8. Selection debt denomination.
• 9. Decision on trade-off from exposure in markets where rates are
distorted by controls.
• 10. Decision about "residual" risk: business strategy.

81. Possible strategies to hedge economic
exposure
•
•
•
•
•
•
Pricing
Import or Export strategy
Relocation or Multi Location
Financing
Closure or Hiving Off
Long Term Hedging

82. Translation Exposure
Some aspects and methods

83. Translation Exposure
• Also called accounting exposure
• Arises because financial statements of foreign
subsidiaries must be restated to parent’s
reporting currency
• Potential for an increase/decrease in parent’s
net worth due to exchange rate changes
• Also used to evaluate subsidiary performance

84. Overview of translation
• Foreign currency financial statements restated
• Different exchange rates for different line items
– Historic & Current
• Methods differ based on
– Level of independence
• Integrated foreign entity
• Self sustaining foreign entity
– Which currency is most important for subsidiary
• Dominant currency day to day

85. Corporate Risk Management System
• Issues to be addressed
– Strategic business posture
– Attitude towards risk
– Risk tolerance
– Organizational design
– Monitoring & Control mechanisms
– Performance evaluation
– Conflicts of interest and resolution mechanisms