Presentation By:

Avinash Lakhotia
U11EC028
Ravi Panchal
U12EC005
Burhanuddin Batliwala U12EC049
Manan Vasani
U12EC077
Vikash Periwal
U12EC078
Dheeraj Sairam Posina U12EC079

FINANCIAL RISK
MANAGEMENT IN
INTERNATIONAL

WHAT IS FINANCIAL
RISK ?
Financial riskis an umbrella term for multiple types
ofriskassociated withfinancing, includingfinancial
transactionsthat include company loans in risk
ofdefault.Risk is a term often used to implydownside
risk, meaning the uncertainty of a return and the
potential for financial loss.

TYPES OF FINANCIAL RISK

CREDIT RISK

EXCHANGE
RISK

LIQUIDITY
RISK

MARKET RISK

OPERATIONAL
RISK

DERIVATIVES AS A
TOOL FOR RISK
MANAGEMENT

TYPES OF DERIVATIVEES

Futures

A futures market is an auction market in which participants

buy and sell commodity and futures contracts for delivery
on a specified future date.

Forwards

Forward rates can be defined as the way the market is

feeling about the future movements of interest rates. They
do this by extrapolating from the risk-free theoretical spot
rate.

Options

An option is a financial derivative that represents a

contract sold by one party (option writer) to another party
(option holder). The contract offers the buyer the right, but
not the obligation, to buy (call) or sell (put) a security or
other financial asset at an agreed-upon price (the strike
price) during a certain period of time or on a specific date
(exercise date).

FUTURES vs FORWARDS
Forward

Futures

Over the Counter i.e. not regulated

Exchange Market i.e. Regulated

High Counterparty Risk

Low Counterparty Risk

No Margin Needed

Margin Needed

Fixed Maturity Period

No such obligation

Primary and Secondary Market

Only Primary Market

OPTION STRATEGIES
Elementary
Excercising only a
single option i.e Either
call or put at a time
and not using any sort
of
combination.

Long Call
Short Call
Long Put
Short Put

(C+)
(C-)
(P+)
(P-)

Combinational
Involves
taking
a
position in both calls
and puts on the same
stock.
Straddle
(Both
Same)
Strangle (Diff. SP)
Strip (1 Call + 2
Put)
Straddle (2 Call+ 1
Put)

Spreads
Created
by
the
simultaneous
purchase and sale of
options of
the same class on the
same
underlying
security
but
with
different strike prices
and/or
expiration
dates.
Vertical
(~Strike
Price)
Bull (C+ < C- &
P+>P-)
Bear (C+ > C- &
P+<P-)
Butterfly

TYPES OF
EXPOSURE

Exposure is different from risk. Exposure tells you What is at

Risk? It refers to the degree to which a company is affected by
exchange rate changes

Transactional
Measures effect of
an Exchange rate
change on
outstandng
obligations which
existed before the
change but were
settled after the
change.

Translational
Therisk
that
a
company's equities,
assets, liabilities or
income will change in
value as a result
ofexchange
ratechanges.
This
occurs when a firm
denominates
a
portion of its equities,
assets,
liabilities
orincome in a foreign

Operational/Econo
mical
Caused by the effect
of
unexpectedcurrency
fluctuations
on
a
companys
future
cash flows.

MANAGING THE
RISK

FOREIGN EXCHANGE RISK

Foreignexchange
risk is the risk of an
investment's value
changing due to
changes incurrency
exchangerates.

The risk that an

investor will have to
close out a long
orshort position in a
foreign currency at a
loss due to an
adverse movement
in exchange rates.

HEDGING
Aforeign exchange hedge(also called a FOREX hedge) is
a method used by companies to eliminate or "hedge"
theirforeign exchange riskresulting from transactions in
foreign currencies.
Hedge transfers the foreign exchange risk from the trading or
investing company to a business that carries the risk, such as a bank.
There is cost to the company for setting up a hedge. By setting up a
hedge, the company also forgoes any profit if the movement in the
exchange rate would be favourable to it.

HEDGING STRATEGIES

Selling short - selling shares without owning them, hoping to buy

them back at a future date at a lower price in the expectation that
their price will drop.
Using arbitrage - seeking to exploit pricing inefficiencies between
related securities.
Trading options or derivatives
Investing in anticipation of a specific event - merger transaction,
hostile takeover, spin-off, exiting of bankruptcy proceedings, etc.
Investing in deeply discounted securities - of companies about
to enter or exit financial distress or bankruptcy, often below
liquidation value.

Types of Hedging
Internal
Netting
Matching
Leading and
Lagging
Pricing Policy

External
Forward Market
Future Market
Money Market
Option Market

Example
Good Morning Ltd. is expecting a payment of UK 1 million in 90 days time. It is currently 1st October.
The company is considering the various choices it has in order to hedge its transaction exposure.
Spot rate

$1.5500/

90 days forward rate

$1.5600/

Spot rate after 90 days

$1.5620/
Borrow (%)

Deposit (%)

US

10

UK

Call option (March)

Put Option (March)

$0.02530

$0.0235

Exercise Price
$1.55

By making the appropriate calculations and ignoring time value of money (in case of Premia) decide which
of the following alternative is preferred to the company?
(a) Forward market:
(b) Cash (Money) market:
(c) Currency options:
(d) No Hedging

Solution:
A Forward Market:
Particulars

Computation

Amount ($)

Amount Receivable

Given

10,00,000

Amount under Forward Contract

10,00,000 X 1.5600 (Forward Rate)

$15,60,000

B Money Market:
Requisite: Money Market Hedge is possible only in case of difference in rates of interest for borrowing and
investing.
Cash Flows
Particulars
Amount
Amount receivable in 90 days

10,00,000

Amount to be borrowed at 6% p.a. for realizing UK 10,00,000 / (1+ Interest Rate at 6% p.a. * 3/12)= 9,85,222
10,00,000 / 1.015
Amount be invested = Amount to be borrowed in UK 9,85,222 * 1.5500 (Spot Rate)

$15,27,094

Interest receivable On money invested @ 8% p.a. for 3 months= Rs. $15,27,094 *8% *3 months/ 12 $30,541.88
months
Total Amount Receivable after 90 days

$15,57,636

C Currency Options
This being a case of receivable, we need an option that would give us the right to sell the receivables on receipt.
Cash Flow under options
Particulars

Amount

Maximum Gain = Spot price(90 days) Option Premium

Premium Payable (Maximum Loss)

$0.02325

Expected Spot Price (90 days)

$1.5620

As Expected Spot price is higher than the exercise price, Company will not use the option and hence maximum loss
is equal to premium payable.
D No Hedging
Settlement at expected spot rate
Therefore, Amount receivable after 90 days = 10, 00,000* $1.5620

=$15, 62,000

Conclusion: The Cash inflow under No Hedging is the highest and hence it may be taken.

PORTFOLIO
INVESTMENT

International Portfolio Investment

Benefits

Constraints

Attractive Opportunities
Diversification Benefits
Exposure to Growth

Taxation
Foreign Exchange
Controls
Capital Market
Regulations
Transaction Costs
Familiarity with Foreign
Markets

Channels for International Portfolio

Investment
Direct Foreign Portfolio
Investment

Indirect Foreign Portfolio

Investment

Purchase of Foreign
Securities in Foreign
Markets

Equity-linked Eurobonds

Purchase of Foreign
Securities in the
Domestic Market

International Mutual
Funds

THANKS
!