Study on hedging strategies of Indian organizations

Organization - Axis Bank

By – Anupam Chaplot

Faulty Guide:Prof. Vrishali Bhat

Industry Guide: Mr. Sandesh C R

Various entities involved in Banks Forex operations

SWOT Analysis

Strengths:Market leadership position in the travel card segmentMarket leader in the prepaid cards segmentHigh quality of its assetsHigh level of service

Weakness:Market share is low as compared to other players.

Opportunity:Growing economy of the countryIncreasing no. of Indian going out of country

ThreatIncreasing competition in banking sectorForeign Banks

SWOT

ObjectiveTo learn about the major

FOREX related products provided by Banks.

Try to find out hedging strategies for the customers by analyzing data from recent past.

To study the forex strategy of market leaders in various sector and find out the instrument they use for forex risk management.

Hedging Strategies/InstrumentsForwardsOptionsFuturesSwapForeign debts

ForwardsAdvantage: can be tailored to the specific

needs of the firm and an exact hedge can be obtained.

Disadvantage: On the downside, these contracts are not marketable, they can’t be sold to another party when they are no longer required and are binding.

OptionsAdvantage: limited downside risk and the

flexibility and variety of strategies possible. Disadvantage: More expensive. The price is

therefore a disadvantage.

SwapsAdvantage: The advantages of swaps are that

firms with limited appetite for exchange rate risk may move to a partially or completely hedged position through the mechanism of foreign currency swaps, while leaving the underlying borrowing intact. Apart from covering the exchange rate risk, swaps also allow firms to hedge the floating interest rate risk.

Disadvantage: Not too useful for short term.

FutureAdvantage: There is a central market for futures. Disadvantage: only standard denominations of money can be

bought instead of the exact amounts that are bought in forward contracts.

Standardized currency futures shall have the following

features:a. Only USD-INR contracts are allowed to be traded.b. The size of each contract shall be USD 1000.c. The contracts shall be quoted and settled in Indian Rupees.d. The maturity of the contracts shall not exceed 12 months. e. The settlement price shall be the Reserve Bank’s Reference Rate on the last trading day.

Foreign Debt Foreign debt can be used to hedge foreign

exchange exposure. example: An exporter who has to receive a

fixed amount of dollars in a few months from present.

MethodologyFor the purpose of

analyzing which hedging instrument will suit the need of Indian organizations better data of last 4 years of rupee/dollar currency movement has been used.

The hedging instrument used by various organizations have been studied.

Firms studiedIT: Infosys, Wipro, TCSPharmaceutical: Ranbaxy, Dr. Reddy’s Automobiles: Tata Motors, TVS, Bajaj AutoTelecom service provider: Idea, AirtelSteel Manufacturer: Tata steel, JSPL

Findings/ Results

5/5/2010 16/11/2009 1/6/2009 3/12/2008 13/06/200827/12/200716/07/200725/01/200714/08/200635

37

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51

53

Currency movement

Series1

Rupee

per

Doll

ar

1 month 2 month 3 month 4 month 5 month 6 month 1 year 2 year

forward 31 35 32 33 32 31 24 15

Options 16 11 13 11 11 11 12 9

FORWARDS(exporter)Duration 1 month 2 month 3 month 4 month 5 month 6 month 1 year 2 year

SD 1.06417 1.772992 2.232811 2.58581 3.027273 3.609369 6.073091 4.054013

average 0.11234 0.203696 0.281333 0.357045 0.412093 0.44881 0.183333 -2.9075 OPTIONS

Duration 1 month 2 month 3 month 4 month 5 month 6 month 1 year 2 year

SD 0.744974 1.239559 1.469036 1.516969 1.70461 1.998449 2.827656 2.023584

average 0.252979 0.255435 0.164222 0.071591 -0.02674 -0.03024 -0.66 -6.26667 Unhedged

Duration 1 month 2 month 3 month 4 month 5 month 6 month 1 year 2 year

SD 1.06417 1.772992 2.232811 2.58581 3.027273 3.609369 6.073091 4.054013

average -0.04234 -0.0637 -0.07133 -0.07705 -0.06209 -0.02881 0.656667 4.5875

InfosysDerivative foreign currency (in millions) INR (crores)forward contract $245 1243  € 20.00 135  £15.00 109option contract    range barrier $113 573

TCSDerivative foreign currency (in millions) INR (crores)forward contract $153.50 775.71 Option      $907.60 4586.528464  £4.00 29.07  € 5.00 33.75

WIPROCategory Amount (in millions) Buy/Sell Forward contracts $1,374 Sell   € 79 Sell   £ 53 Sell   $438 Buy   ¥ 23,170 Buy Options $562 Sell   £ 54 Sell   ¥ 6,130 Sell Cross-currency interest rate swap ¥ 35,016 -

ConclusionCurrency swaps are more cost-effective for

hedging foreign debt risk, while forward contracts are more cost-effective for hedging foreign operations risk.

Forwards contracts can be tailored to the exact needs of the firm and this could be the reason for their popularity.

Conclusion(contd.)Swap usage is a long term strategy for

hedging and suggests that the planning horizons for these companies are longer than those of other firms.

Most Indian IT companies have increases use of Options instead of Forwards owing to high market volatility.

Conclusion ( contd.)Software firms have a limited domestic market

and rely on exports for the major part of their revenues and hence require additional flexibility in hedging when the volatility is high. Another implication of this is that their planning horizons are shorter compared to capital intensive firms.

Most Indian firms use forwards and options to hedge their foreign currency exposure. This implies that these firms chose short-term measures to hedge as opposed to foreign debt.

LimitationsOnly few firms specific to each sector has

been studiedThe firms are market leaders in respective

sector, the same conclusions might not hold true for small firms.

The data about the organizations have been studied for small time period.

Currency Movement of just rupee/dollar has been analyzed.

Other ObservationsCoordination among the branchesDifferent rates across branchesDocumentation ( for internal audit)

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