International Finance -

7/29/2019 International Finance -

http://slidepdf.com/reader/full/international-finance- 1/13



What is hedging ?.....

• Hedging means reducing or controlling risk.

• This is done by taking a position in the futures

market that is opposite to the one in the

physical market with the objective of reducing

or limiting risks associated with price changes.

• The purpose of hedging is loss minimization,

not profit maximization.



How hedging works.

Define Measure Manage Monitor

Corporate Risk Management



Business Setup

USAG5 International Corp.

EuropeG5 International Co. Ltd.

G5 Italiana SpA.

AsiaG5 Asia pacific Pte. Ltd.

G5 International (I)Pvt. Ltd.



Types of foreign exchange risk

exposure

Revenue mismatch risk exposure

Translation risk exposure

Revaluation risk exposure

Interest rate risk exposure

Economic risk exposure



Revenue mismatchRevenue mismatch risk arises, when the revenues are denominated in currency

other than the functional currency. This exposure arises from the movement of exchange rate between the date of the transaction to the date of the cash outflow

or inflow.

G5 International (I) Pvt. Ltd. G5 Italiana SpA.

Sale in Currency Euro

Paid in Currency Euro

Euro 1 M booked as sales (credit

period 45 days ) on 1st Sept 2012,

Spot rate Euro 1 = Rs. 67.00

Revenue recognised Rs. 67 M

Euro 1 M paid against sales on 15th

Oct. 2012,

Spot rate Euro 1 = Rs. 65.00

Rs. Credited in bank Rs. 65 M & 2 M

loss booked in P & L

Revenue mismatch

Rs. 2M



Translation Risk ExposureTranslation risk is the risk of profit erosion of a parent company, on consolidation

of statement of accounts of subsidiary companies that have a functional currencydifferent from the parent company’s currency, due to adverse movements in the

currency exchange rate.

USA

G5 International Corp.

Europe

G5 International Co. Ltd.

G5 Italiana SpA.

Asia

G5 Asia pacific Pte. Ltd.

G5 India Pvt. Ltd.

For eg. At the time of budget it is been forecasted that G5 International Corp. will

get profit of US$ 2 M ( budget rate 49 ) hence Rs. 98 M, same has been

communicated to G5 India Pvt. Ltd. at the end of financial year Indian entity has

achieved profit of 98 M but US$ is depreciated to Rs. 51 hence profit earned in

rupees Converted in US$ @ 51 hence achieved US$ 1.92 M & lost US$ 0.08 M.



Revaluation Risk ExposureRevaluation risk arises when a company is required to hold cash in currencies

other than their Balance sheet currency and also have monetary assets/liabilitiesdenominated in other currencies.

For eg. G5 International (I) Pvt. Ltd. holdscash & Bank balance, monitory assets &

liabilities in various currencies like INR,

USD, EUR, GBP, SGD etc. which need to

be revalued at the end of each financial

year. Revaluation difference will be

accounted in profit & loss account whichwill impact profit of the company.



Interest Rate Risk exposureInterest rate risk arises when a company borrows funds at the floating interest

rate. Risk of fluctuation in the floating interest rate increases the exposure.

Floating interest rate comprises of LIBOR

interest rate (floating) + fixed rate.For eg. LIBIOR 0.25 + fixed rate 5.00 so

total interest rate will be 5.25 which will

float according to changes in LIBOR rate.



Economic Risk exposureEconomic risk is the extent to which a firm’s market value, in any particular

Currency is sensitive to unexpected changes in foreign currency. Exchange ratefluctuations determine competitiveness or affect future cash flows and

profitability, even though the firm may not have any direct exposure to the

exchange rate.

For example, ABC Ltd. can be

outperformed by its Philippinescompetitor’s if PHP depreciates more

than INR.



For eg. : India company expected to receiveUS$ 2 M after three months. The anticipated

sum is Rs. 108 M at the rate of US$ 1 = Rs.

54 ( spot rate ).

Suppose US$ expected to depreciate against

rupee in near future to Rs. 50 Indiancompany will loose Rs. 8 M

But the forward rate is Rs. 52.5 & company

opt to buy forward contract then company is

restricting the loss to Rs. 3 M

For eg. : India company expected to Pay US$2 M after three months. The anticipated sum

is Rs. 108 M at the rate of US$ 1 = Rs. 54 (

spot rate ).

Suppose US$ expected to appreciate against

rupee in near future to Rs. 58 Indiancompany will loose Rs. 8 M

But the forward rate is Rs. 56.5 & company

opt to buy forward contract then company is

restricting the loss to Rs. 3 M



Hedging instruments…

Hedginginstruments

Spot Transaction

Forward Transaction

Outright market

Forward swap market

Futures transactions

Options TransactionCall options

Put options

Exotic option

Swap transaction

Foreign debt

EEFC accounts

International Finance -

Documents

Transcript of International Finance -