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TABLE OF CONTENTS

1. Significance of the study

2. Introduction 3. Company profile & organizational profile 4. Objective of the study 5. Trading procedure 6. Currency risk
7. What is foreign exchange

8. Foreign Exchange Market 9. FEMA Guidelines 10. Exposure 11. Tools and techniques for managing foreign exchange risk 12. Hedging risk in MMTC LTD 13. Techniques adopted in MMTC LTD 14. Decision taken related to FORWARD cover in MMTC LTD 15. Recommendations 16. Conclusion 17. Bibliography 18. Abbreviations

SIGNIFICANCE OF THE STUDY The study of foreign exchange risk management in MMTC is an effort to understand the foreign currency risks of MMTC Ltd., and also to examine its risk management policies. Talking about the risk involved in international business will take us nowhere unless we focus on the exchange rate risk. It is the single risk, which can change the value of the firm overnight. It is the exchange rate risk, which can enable a firm to earn huge profits or suffer heavy losses in its international transactions. So we can infer that it is the risk, which can make or break an organization. MMTC Ltd., which is involved in international trade there is always, a risk associated with payments. So the corporate those are involved in international business and trade should be able to manage those risks efficiently. Although hundred percent covering or as we can call it hedging or risk is not available yet there are several tools available these days, which can minimize these risks if not eliminated. The only thing that the organization needs to work upon is to have sound knowledge of the risk management tools available. Coming back to foreign exchange risk and its management, I would like to draw your attention to MMTC Ltd. It is no exception to it as it is trading company and is heavily involved in international trade. It also has to face those risks like any other international trading company. The present project is intended to look into the forex risks faced by MMTC and to suggest possible solutions.

Introduction The project takes study of various divisions of MMTC Ltd., which are directly or indirectly involved with its foreign exchange transactions. It is an effort to understand the international business transactions of MMTC Ltd. It also gauges the effects of foreign exchange fluctuations on the profitability of the international trade transactions of MMTC Ltd. and its impact on the profitability of the organization as a whole. Foreign Exchange is essentially about exchanging one currency to another. The complexity arises in foreign exchange transaction mainly from three factors. Firstly, what are the foreign exchange exposures, secondly what will be the rate of exchange, and thirdly when the actual exchange does occur. MMTC Ltd, Government of India Enterprise, a trading company having global operations, mainly performs three kinds of related transactions, these are as follows: Imports: Exports: and Borrowings.

MMTC Ltd. is involved in the imports of several commodities such as fertilizers, hydrocarbons, Coal, agricultural products, gemstones, Gold etc. from countries like South Africa, Australia, Indonesia, Malaysia, Canada, Switzerland, China, Japan etc. Similarly, it also exports products like minerals, iron ore, agricultural products, jewellery etc. These products are exported to countries like China, Japan, Korea, Malaysia, Singapore, Vietnam, Indonesia, and Kuwait etc. to meet the export obligations. MMTC Ltd. also involves itself in the short term borrowing of funds . Managing risk is a challenging task. Risk Management is a systematic approach in identifying, analyzing and controlling areas or events with a potential for causing unwanted change. It is through risk management that risks to any specific program are assessed and systematically managed to reduce risk to an acceptable level. Risk Management signifies the basic ideology to identify, analyze, evaluate and treat the different business and financial risks that are frequently tackled in day-to-day business operations. Risk is an allpervasive feature. Risk Management is the act or practice of controlling risk. It includes risk planning, assessing risk areas, and developing risk-handling options, monitoring risks to determine how risks have changed and documenting overall risk management programs.

There is no standard approach for risk management. However, there are some common elements of successful risk management efforts: Recognition that risks Management is a program management responsibility. The risk management process includes o Planning for risk management o Continuously identifying and analyzing program events o Assessing the likelihood of their occurrence and consequences o Incorporating handling actions to control risk events o Monitoring a programs progress towards meeting program goals Profit is the reward of Risk. An entrepreneur is always said to be a risk-taker. But in todays technology driven global village, unanticipated fluctuation in financial or business derivates may change the whole scenario unless the enterprise takes risk and take defensive steps to minimize the losses.

COMPANY PROFILE Established in 1963, MMTC is today India's leading international trading company, with a turnover of over Rs.12000 crores. It is the first international trading company of India to be given the coveted status "SUPER STAR TRADING HOUSE" and it is the first Public Sector Enterprise to be accorded the status of "GOLDEN SUPER STAR TRADING HOUSE" for long standing contribution to exports. MMTC is one of the largest non-oil importers in India. MMTC's diverse trade activities encompass Third Country Trade, Joint Ventures, and Link Deals - all modern day tools of international trading. Its vast international trade network, which includes a wholly owned international subsidiary in Singapore, spans more than 85 countries in Asia, Europe, Africa, Oceania and Americas, giving MMTC global market coverage. INDIA'S LEADING EXPORTER OF MINERALS: MMTC is major global player in the mineral trade and is the single largest exporter of minerals from India. With its comprehensive infrastructure expertise to handle minerals, the company provides full logistic support from procurement, quality control to guaranteed timely deliveries of minerals from different ports, through a wide network of regional and port offices in India, as well as international subsidiary. MMTC has won the highest export award from Chemicals and Allied Products Export Promotion Council (CAPEXIL) as the largest exporter of minerals from India for the eleventh year in a row. ONE OF THE WORLD'S LARGEST BUYERS OF FERTILIZERS: As a leading player in fertilizers and fertilizer raw material, MMTC has become a major fertilizer marketing company in India, through planned forward integration of its import activities with the direct marketing of Urea, DAP, MOP, Sulphur, Rock Phosphate, SSP and other farming and agricultural inputs.

THE SINGLE LARGEST SUBCONTINENT:

BULLION

TRADER

IN

THE

INDIAN

MMTC is the largest importer of gold and silver in the Indian sub continent, handling

about 146 MT of gold and 1250 MT of silver during 2008-09. MMTC supplies gold on loan and outright basis to the exporter, bullion dealers and jewellery manufacturers on all India bases. MMTC has retail jewellery & its own branded Sterling Silverware (Sanchi) showrooms in all the major metro cities of India. MMTC also supplies branded hallmarked gold and studded jewellery. Assay and hallmarking units have been set up at New Delhi, Ahmedabad & Kolkata for testing the purity of gold and gold articles duly accredited with Bureau of Indian Standards. Besides organizing major jewellery exhibitions in India & abroad, MMTC also has a medallion manufacturing unit for minting of Gold/Silver medallions.

THE BIGGEST IMPORTER OF NON-FERROUS METALS & INDUSTRIAL RAW MATERIAL TO INDIA: MMTC is India's largest seller of imported non-ferrous metals viz. copper, aluminum, zinc, lead, tin and nickel. It also sells imported minor metals like magnesium, antimony, silicon and mercury, as also industrial raw materials like asbestos and also steel and its products. MMTC imports quality products conforming to international specifications like ASTM or BSS or LME approved brands. Major institutional customers of MMTC in India are accredited with ISO-9002 status. MMTC sources its metals from empanelled suppliers including producers and traders throughout the world. MMTC is a proud winner of gold trophy for exports of Engineering and Metallurgical product in non-SSI Sector and also awarded the All India Trophy for highest export in the category of prime metal by EEPC.

GROWING INTEREST IN AGRO PRODUCTS WORLDWIDE: MMTC is amongst the leading Indian exporters and importers of agro products. The company's bulk exports include commodities such as rice, wheat, wheat flour, Soya meal, pulses, sugar, processed foods and plantation products like tea, coffee, jute etc. MMTC also undertakes extensive operations in oilseed extraction, from the procurement of seeds
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to the production of de-oiled cakes for export, as well as the production of edible oil for domestic consumption. It also imports edible oils. MMTC has won the gold trophy from FIEO for highest exports in agricultures & plantation product in non-SSI Sector.

GENERAL TRADING: MMTC also handles items like textiles, Mulberry raw silk, building materials, marine products, chemicals, drugs and pharmaceuticals, processed foods, hydro carbons, coal and coke. Information on above can be supplied on request. MMTC also exports engineering products. AN INTEGRATED CAPABILITIES: GLOBAL TRADER WITH BULK HANDLING

Its comprehensive infrastructure for bulk cargo handling, with well-developed arrangements for rail and road transportation, warehousing, port and shipping, operations, gives MMTC complete control over trade logistics, both for exports and imports. The company's countrywide domestic network is spread over 75 regional, sub-regional, port and field offices, warehouses and procurement centers. BROADBASED ACTIVITIES BEYOND TRADING: MMTC's progress in the recent past has taken it from monopoly status to a competitive open market player making a strong thrust towards broad basing its sphere of activities, while consolidating its core areas of business. To create synergy between its manufacturing, trading and technology partners and to bring optimum efficiency and expertise to its operations worldwide, MMTC has promoted along with government of Orissa, a million tones capacity Iron & Steel plant and a 0.8 million tone capacity Coke Oven battery with by product recovery plant and a captive power plant of 55 MW capacity.

SUPPORT SERVICES: MMTC lays emphasis on human resources development and related activities. Several training programmers are conducted to upgrade managerial skills in the latest developments in trade management, export marketing, general management.

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COMPUTERIZATION: MMTC has a Systems & ERP Division comprising a highly professional team to cope with the highly competitive environment. MMTC's operational offices are all equipped with modern computing tools. SOCIAL AND WELFARE ACTIVITIES: MMTC's social and welfare activities promote welfare of the employees through various schemes like sports activities, liberal loan facilities like house building advance, conveyance loan, house hold loan, marriage advance, etc. It also provides subsidized canteen facilities, medical treatment, and residential accommodation in some of the major cities for its employees. It also takes care of employees' families through merit scholarship, tuition fee reimbursement, etc. The Company is committed towards environmental upkeepment through forestation in the mining areas, development of tribal areas and infrastructure development through rail links, port facilities, etc.

Objectives of the Study Now, the question arises what is the risk faced by MMTC Ltd.? What MMTC Ltd. does and what is at risk? What MMTC Ltd. is doing to counter those risks? These are the

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questions besides many others that have been a cause of concern of the fund managers of MMTC Ltd. over the years. Foreign exchange market is known for its frantic pace at which it operates and the vast amount of money, which is transacted at lightening speed in response to miniscule differences in price quotations. The dynamics of foreign exchange market is such that it is highly volatile and very unpredictable at one point of time. Ever since the fixed exchange rate regime was abolished in 1973 and the world economy has stepped in to the floating rate regime, the foreign exchange markets have undergone several changes and now it has become the biggest financial market with an average daily turnover of $1.4 billion as per Basle Committees survey of Foreign exchange and the Derivatives Markets, 2001. An amount which the world greatest stock exchange i.e. the New York Stock Exchange takes almost two months to transact. With such a staggering amounts of funds being transacted daily across the globe does accompany certain risks with it. These daily transactions in the foreign exchange markets do affect the exchange rate from currency to currency. These exchange rate fluctuations can prove a boon as well as bane for any foreign exchange related transactions. Boon because the company has to pay less for its foreign exchange due to favorable exchange rates and bane because the company has to pay more to settle the foreign exchange transactions due to unfavorable exchange rates. These transactions have a bearing on the profitability of an organization. The same holds true for MMTC Ltd. as well. Since MMTC Ltd. performs three kinds of operations in the international business transactions, viz. Exports, imports and short-term borrowings. As a part of its risk management strategy, MMTC Ltd. books Forward Contracts to cover its international risks. Besides forward covers it also involves itself in the use of other hedging tools like Netting and Matching. The project is an effort to gauge the vulnerability of MMTC Ltd. with respect to its international business transactions and the means to control the risks attempts to explore new tools for hedging the foreign currency exposures of MMTC Ltd.

TRADE PROCEDURES MMTC Ltd. mainly performs three kinds of trade related transactions. These are as follows: Exports; Imports; and Borrowings

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1- EXPORTS MMTC Ltd. exports products to countries like USA, China, Japan, Korea, Singapore, Philippines, and Malaysia etc. The product ranges from mineral ore, agricultural products, jewelry etc. The procedure for trade that is followed at MMTC Ltd. is as follows: The buyer of the product floats tenders for the import of the requisite articles or else if the buyer is a regular customer of MMTC Ltd. then he may even directly place the order with the company. If the buyer floats a tender for the import of the required article then under such circumstances MMTC Ltd. files it quotation with the buyer and when it is accepted by the buyer then both the parties enter into the contract for the same article. The rates for the foreign exchange transactions are decided on the rates prevailing in the spot market on the date of finalization of the contract. After the finalization of the contract, the buyers bank will issue a letter of credit in favor of sellers bank. Then after the shipment of the material, the captain of the ship will give a bill of lading i.e. the proof of receiving the material. After getting the bill of lading the seller can get his payment from his bank showing this bill of lading with the condition that all the terms and conditions have been satisfied by the seller.

BILL OF LADING: A document issued by a carrier (railroad, steamship or trucking company), which serves as a receipt for the goods to be delivered to a designated person or to his order. The bill of lading describes the conditions under which the goods are accepted by the carrier and details that nature and quantity of the goods, name of vessel (if shipped by sea), identifying marks and numbers, destination, etc. The person sending the goods is the shipper or consigner, the company or agent transporting the goods is the carrier and and the person for whom the goods are destined is the consignee. Bills of lading may be negotiable or non-negotiable. If negotiable, i.e, payable to the

shippers order and properly endorsed, title of the goods passes upon delivery of the bill of lading.

LETTER OF CREDIT: Its a media that protects both parties so that seller can get guarantee and if the buyer is not making advance payments. L/C is issued by the buyers bank after the deal has been finalized in favor of sellers bank (name of the seller as specified). Its a bank-to-bank transaction. L/C is a negotiable instrument i.e. the seller can get his payment from any bank and anywhere in his country. It may be revocable or irrevocable document. An irrevocable L/C provides guarantee by the issuing bank in the

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event that all terms and conditions are met by the buyer of the goods (or drawee). A revocable L/C can be cancelled or altered by the drawee after it has been issued by the drawees bank. A confirmed L/C is one issued by a bank, which is validated or guaranteed by another bank. 2- IMPORTS MMTC Ltd. imports several commodities on its own and on behalf of the government. It imports goods from the countries like South Africa, China, Malaysia, Switzerland, United Kingdom, Indonesia, etc. It imports the products like fertilizers, gems, hydrocarbon, agricultural products, etc. MMTC Ltd. also floats tenders for the import of the requisite articles on which the quotation are received from the sellers from different countries. MMTC Ltd. scrutinizes the rates and once the company accepts the rate then it enters into an agreement with the seller whose rates have been accepted. The rates are decided on the basis of the exchange rates prevailing in the spot market on the date of the contract. The rest of the procedure is same as that in exports. 3- BORROWINGS MMTC Ltd. also goes for short-term loans in foreign currency generally US Dollars to meet its financial obligations in the international trade transaction i.e. the exports and the imports. The procedure that is adopted is that it receives the quotes from the Authorized Dealer Banks for the purchase of requisite currency once it gets the best rates for the shortterm borrowings.

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PROCEDURE FOR EXPORT AND THEIR PAYMENTS

PURCHASE ORDER BUYER DOCUMENTS SELLER BANK SHIPMENT BANK

PAYMENTS

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PROCEDURE FOR IMPORT AND THEIR PAYMENTS

PURCHASE ORDER SELLER BANK BUYER BANK SHIPMENT DOCUMENTS

PAYMENTS

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Currency Risk (Exposure) The currency exposure is a measure of the sensitivity of real value (adjusted for inflation) of enterprises assets and income (or liability/loss) expressed in functional currency (an enterprises operational currency) to unanticipated risk. A project has currency exposure when the currencies for its expenditures and revenues are not the same. Higher currency exposure to financial risk leads to 1. Financial distress and possible bankruptcy, as manager may compromise to quality and safety of workers. 2. The customers will start thinking of after-sales service and sale volume will decrease 3. Suppliers will tighten credit terms 4. Cost of running the enterprise will be high. 5. Conflict between stakeholders and debt holder (debt holder are given more interest, therefore, stakeholder may loose interest) 6. Tax may be more as tax on book profit will be payable and in the period of loss the compensating is not available. How to manage currency risk The devices (derivatives) available 1. Forward Market hedge: In this the Net Liability is covered by forward contract of specific period at a premium or discount 2. Roll over contracts: These are similar to Forward contracts but rolled over after specified period on premium or discount 3. Financial Swaps: It is the exchange of one set of financial obligation to another for specific period. These are mainly currency swap or interest rate swap. 4. Money Market Hedge: In this the expected position of currency is covered through borrowing or lending in money market.

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5. Currency options: Option is right (but not obligation) given by the seller (writer) to buyer (holder) to buy or sale (depend on put or call option) at predetermined price in the specific period. The writer sells the product at the price that changes on the basis of time factor and the movement (fluctuation) in the currency. These are the options where physical currency is not being transferred but only the difference is being settled.

How to manage currency risk more Efficiently Select your currency: It is desirable to hedge but all part of it, as the favorable side may generate great benefits. You may put different currencies in order of your requirement and hedge in order of preference. Suppose, an enterprise is exposed to payables in dollar and euro, one may find euro to be less strong than dollar for specific period so while hedging the currency, it may hedge euro first.
Seek more quotations: Different Banks or dealers may have different rates, so it is always better to get two or more quotations from different dealers. Even quotation from same dealer at different times also differs. Currencies are always quoted in pairs. One unit of the base currency (First currency in the pair) represents the number of units of the second currency of the pair as indicated by the exchange rate:

Example: USD/CHF @ 1.4000. This means 1 US dollar purchases 1.400 Swiss francs.
Knowing the Spread: It is the difference between the price you buy at (also known as the ask) and the price you sell at (also known as the bid). The enterprise should develop the ability to sell the buy price (ask) and the sell price (bid). The enterprise should develop the ability to sell the buy price (ask) and the sell price (bid) at all times. Spread has historically been a hidden cost. However, by using technology such as the Internet, the market has become more transparent. An enterprise can see the spread and thus can know exactly what the cost of the trade is prior to entering a position.

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 Try to minimize dependence on one currency hedge: An enterprise should try to expose to different currencies and hedge accordingly. Firms exposed to dollar in early nineties suffered a lot by using Risk Profiling, the method of worst case and Best case through scenario management on performance measure of individual currency.

Shift: Firms should shift from one instrument to another or one currency to another depending upon the changing market conditions or changing economy indicators (which are key factors of currency rates.)

Exchange rate predictions: Based on Economic forecasting models (PPP-relative purchasing power parity, balance of payment, interest rate parity), exchange rate may be predicted and acted accordingly. Rate expected=Spot rate (1+diff inflation rate)*year Suppose inflation in A currency is 6% and B currency 3% and the spot rate is 48.25 after 5 years, the predicted rate would be:48.25(1+(.06-.03))*5=55.93 Other methods like Economic indicators, oscillators, Currency and other investment ratings may also be used to predict or forecast the currency rates. Internal Derivatives currency concentration: Where a hedging affiliate (member of group having asked to use the derivates for the group having net exposure in particular currency) using the derivative for issuing affiliate (member of group, having declined to use the derivates for the group having net exposure in particular currency) to enter into a contract with unrelated party to netting off the consolidated exposure, FABS (US GAAP) have facilitated to use internal derivatives by issuing the statement 138 (amending statement 133). Ronald Fink, in CFO magazine described this as Natural Hedge, matching revenues and costs for the same currency or offsetting losses in one currency with gains in another. There are two main reasons for this shift, and probably a third. One, most multinationals have centralized their treasury operations, at least on a regional basis. With access to data from inter-company and thirdparty transactions within the various countries in which a multinational operates, risk managers can better understand how transactions in one currency offsets those in another, and thus erects natural hedges. The owner of the enterprise may also cover the exposure in currency in the firm by changing his investment portfolio.

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 Accounting of Currency derivatives: Though in India accounting of currency derivatives are not fully implemented, the Accounting Standard (AS) 11, the Effects of Changes in Foreign Exchange Rates (Revised 2003) has come with some accounting treatments. An enterprise may enter into a forward exchange contract or another financial instrument that is in substance a forward exchange contract, which is not intended for trading or speculation purposes, to establish the amount of the reporting currency required or available at the settlement date of a transaction. The premium or discount arising at the inception of such a forward exchange contract should be amortized as expense or income over the life of the contract. Exchange differences on such a contract should be recognized in the statement of profit and loss in the reporting period in which the exchange rates change. Any profit or loss

arising on cancellation or renewal of such a forward exchange contract should be recognized as income or as expense for the period. a. Any premium or discount arising at the inception of a forward exchange contract is accounted for separately from the exchange difference on the forward exchange contract b. Exchange difference on a forward exchange contract is the difference between (a) the foreign currency amount of the contract translated at the exchange rate at the reporting date, or the settlement date where the transaction is settled during the reporting period, and (b) the same foreign currency amount translated at the latter of the date of inception of the forward exchange contract and the last reporting date.
c. For enterprises entering into contract for trading or speculation purpose: A gain or

loss on a forward exchange contract to which paragraph the above not apply should be computed by multiplying the foreign currency amount of the forward exchange contract by the difference between the forward rate available at the reporting date for the remaining maturity of the contract and the contracted forward rate (or the forward rate last used to measure a gain or loss on that contract for an earlier period).
d. The gain or loss so computed should be recognized in the statement of profit and

loss for the period. e. The premium or discount on the forward exchange contract is not recognized separately.

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Accounting for currency hedge transactions in US Historically, companies have been required to disclose hedge contracts, but not record them in financial statements. However, this has changed with the adoption of the Financial Accounting Standard Board (FASB) Statement No.133 (and its associated amendment, Statement No.138). Hedge transactions fall into three categories and accounting treatment various by type: Cash flow hedges Fair value hedges Net investment in a foreign operation hedges

Cash Flow Hedge: A cash flow hedge is a hedging relationship in which the variability of the hedged items cash flow is offset by the cash flows of the hedging instrument. In addition, the hedged item is a forecasted transaction or balance sheet item with variable cash flows. 1- The remaining market value of the derivative contract is reported on the balance sheet ion Other Comprehensive Income (OCI) 2- Ineffective gain or loss is recorded in earning 3- Cash flow hedge treatment is typical for the sue of floating to fixed interest rate swaps in conjunction with variable rate loans.

Fair Value Hedge: A fair value hedge is a hedge of the exposure to a change in fair value of a recognized asset, or liability, or of an unrecognized firm commitment attributable to a particular risk. In addition: 1- The hedged item is exposed to price risk 2- For a highly effective hedge there must be offsetting fair value changes for the hedged item and the hedging instrument. 3- Changes in fair value of the hedged item and the hedging instrument are recorded in earnings. 4- Fair value hedge treatment is typical when hedging fixed rate debt with a matching fixed to float rate swap.

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Net Investment in a Foreign Operation Hedge: Relatively unchanged from FAS 52, FAS 133 calls for the changes in fair value of the hedge instrument to be consolidated with the translation adjustment in other comprehensive income with the difference between the total hedge results and the translation adjustment flowing through earnings. This statement Includes hedges of cash flow, fair value, and net investments in foreign operations Permits the limited use of non-derivative instruments Expands hedge accounting, particularly for forecasted transactions and tandem currency hedges.

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FOREIGN EXCHANGE

Foreign Exchange (FOREX) is the arena where a nation's currency is exchanged for that of another. The complexity arises from three factors:

What is the foreign exchange exposure? What will be the rate of exchange? And When does the actual exchange occur?

The foreign exchange market is the largest financial market in the world, with equivalent of over $1.5 trillion changing hands daily; more than three times the aggregate amount of the US Equity and Treasury markets combined. Unlike other financial markets, the Forex market has no physical location and no central exchange. It operates through a global network of banks, corporations and individuals trading one currency for another. The lack of a physical exchange enables the Forex market to operate on a 24-hour basis, spanning from one zone to another in all the major financial centers.

Traditionally, retail investors only means of gaining access to the foreign exchange market was through banks that transacted large amounts of currencies for commercial and investment purposes. Trading volume has increased rapidly over time, especially after exchange rates were allowed to float freely in 1971. Today, importers and exporters, international portfolio managers, multinational corporations, speculators, day traders, longterm holders and hedge funds all use the FOREX market to pay for goods and services, transact in financial assets or to reduce the risk of currency movements by hedging their exposure in other markets.

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FOREX MARKET PARTICIPANTS :

1. EXPORTERS This group consists of many of Indias largest companies. Within this group you find a diverse range of companies exporting goods and services from India to the rest of the world. India's export volumes give an excellent indication of the volumes of foreign exchange transacted by the sub sets of this group with resource sector companies taking center stage. In general exporters have a positive impact on the value of the Indian Rupee.

2. IMPORTERS This group of companies and individuals use the foreign exchange markets to purchase foreign currency to make payments for the goods and services they bring in their countries. In general they have a negative impact on the value of the Indian Rupee.

3. INDIAN FUND MANAGERS The net effect of the group depends on the investment decisions they make but in general as the industry grows they have been investing heavily offshore which generates a negative impact on the Indian Rupee. However they can hedge these investments, which often see them enter the market as buyers of, forwards contracts and options.

4. GLOBAL FUND MANAGERS This groups influence changes depending on their interest in Indian asset market. During periods when Indian stocks and bonds are attractive India gets substantial allocations of global capital, which drives up the value of the Indian Rupee. However when they wish to hedge existing investments in India this can generate selling flows.

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5. CENTRAL BANKS In India RBI generally lets the market determine the value of the Indian Rupee however there are a few exceptions to this policy. Firstly the RBI will intervene to buy or sell Indian Rupees if they believe it is substantially under or overvalued and that it is having a negative effect on the economy.

6. OTHER GOVERNMENT AGENCIES

Many government agencies have foreign exchange risk either as exporters, importers or borrowers.

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FEMA GUIDELINES

The Exchange Control Department (ECD) of the Reserve Bank administers Foreign Exchange Management Act, 1999, (FEMA) which has replaced the earlier Act, FERA, with effect from June 1, 2000. The new legislation reflects the current economic realities and is far more pragmatic in its approach. The objective of the earlier Act as contained in its preamble was conservation of foreign exchange and its utilization for economic development of the country whereas the objective of the new Act is facilitating external trade and promoting the orderly development and maintenance of foreign exchange market in India. The most significant feature of the new Act is that it provides legal basis to the current account convertibility.

For purchase of foreign exchange for most of the current account transaction, with exception of those listed in Schedule III to the Government of India Notification G.S.R. No 381(E) dated May 3, 2000; no permission from the Reserve Bank is required. Extensive powers are available to banks authorized to deal in foreign exchange, known as authorized dealers. As a result, foreign exchange can be purchased for practically all transactions, which are of current account nature. Every effort is made by the Department to deal with the applications, which are still required to be referred to the Reserve Bank, promptly and expeditiously, with a view to rendering satisfactory customer service.

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FUNCTIONS OF DEPARTMENT :

With a view to facilitating external trade and promoting orderly development of foreign exchange market in India, a new Act called the Foreign Exchange Act, 1999 (FEMA) came into force from June 1, 2000. With FEMA coming into force, the Foreign Exchange Regulation Act, 1973 stands repealed.

Under FEMA, foreign exchange transactions have been divided into two broad categories current account transactions and capital account transactions. Transactions that alter the assets and liabilities of a person resident in India or a person resident outside india have been classified as capital account transactions. All other transactions would be current account transactions.

Under FEMA only the Government of India in consultation with the Reserve Bank would be empowered to impose reasonable restrictions on current account transactions. Accordingly, Government of India has notified the Rules governing the current account transactions vide its Notification No.G.S.R381(E) dated May 3, 2000 as amended vide S.O. No.301(E) dated March 30, 2001. As per the Government of India Rules, remittances of only eight types of current account transactions are prohibited, eleven types of transactions need Government of Indias prior approval whereas seventeen transactions need prior permission from the Reserve Bank in case the amount of remittances exceeds prescribed limit for such remittances.

Reserve Bank of India has notified comprehensive simple and transparent regulations under the FEMA, 1999 governing various capital account transactions. The new regulations clearly indicate the types of permissible capital account transactions, leave very few individual transactions to be dealt in by Reserve Bank, simplify procedures, reduce the number of forms to a bare minimum and grant more powers to authorized dealers i.e. banks.

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FLOATING EXCHANGE RATES

In a floating exchange-rate environment, the exchange-rate responds to many factors including the flow of imports and exports, the flow of capital, relative inflation rates, etc. Often, limits are placed on exchange-rate fluctuations according to government policies.

One factor affecting the exchange rate between the Indian Rupee and other currencies is the merchandise trade balance. By definition, the merchandise trade balance is the net difference between the value of merchandise being exported and imported into a particular country. For example, consider the exchange rate for INR/USD. India imports products from the U.S. To pay for them, Indians need US Dollars; therefore, the Indian companies trade Indian rupees for US Dollars. On the other hand, because Americans desire Indian made goods, they purchase Indian Rupees to pay for Indian goods. The net effect is an increase in the supply of US Dollars or Indian Rupees. The Indian demand for American goods and services contributes to the demand for US Dollars while American purchases of Indian goods and services contribute to the supply of US Dollars. In this case, the net difference between Indian purchases of American goods and services, and American purchases of Indian goods and services, is the merchandise trade balance between the two countries.

The flow of funds between countries to pay for stocks and bonds purchases also contributes to the currency exchange rate between currencies. In the near term, these capital flows are greatly influenced by yield differentials. All else being equal the higher the yield on German securities compared to American securities, the more attractive German securities are relative to American securities. An increase in German yields would tend to raise the flow of U.S. dollars into German securities as well as decrease the outflow of Deutsche marks to American securities. Combined, this increased flow of funds into Germany would lower the value of the U.S. dollar and increase the value of the Deutsche mark; therefore, the Deutsche mark to U.S. dollar ("DM/USD") ratio, as it is represented in the forex market, would decrease.

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The rate of inflation is another factor influencing currency exchange rates. Consumers try to avoid the eroding effect inflation has on their purchasing power. Consequently, goods from countries with a low inflation rate become more attractive than the goods from countries with higher inflation. In turn, the currency from the lower inflation country rises in value, while the currency from the higher inflation country falls in value. Both the inflation factor and the purchasing power of the currencies directly impact currency exchange rates.

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FUNDAMENTAL VERSUS TECHNICAL ANALYSIS While technical analysis concentrates on the study of market action, fundamental analysis focuses on the economic forces, which cause prices to move higher, or lower, or stay the same. The fundamental approach examines all of the relevant factors affecting the exchange rate between two currencies to determine the intrinsic value of each currency. The intrinsic value is what the fundamentals indicate one currency is actually worth against another currency. If this intrinsic value is under the current market price, then the currency is overpriced and should be sold. If market price is below the intrinsic value, then the market is undervalued and should be bought. Both of these approaches to market forecasting attempt to solve the same problem, that is, to determine the direction prices are likely to move. They just approach the problem from different directions.

A "fundamentalist" studies the cause of market movement, while a technician studies the effect. Most market traders classify themselves as either technicians or fundamentalists. In reality, there is a lot of overlap. Most fundamentalists have a working knowledge of the basic belief of chart analysis. At the same time, most technicians have at least a passing awareness of the fundamentals. The problem is that the charts and fundamentals are often in conflict with each other. Usually at the beginning of important market moves, the fundamentals do not explain or support what the market seems to be doing. It is at these critical times in the trend that these two approaches seem to differ the most. Usually they come back into sync at some point, but often too late for the trader to act. One explanation for these seeming discrepancies is that market price tends to lead the known fundamentals. Stated another way, market price acts as a leading indicator of the fundamentals or the conventional wisdom of the moment. While the known fundamentals have already been discounted and are already "in the market," prices are now reacting to the unknown fundamentals. Some of the most dramatic market movements in history have begun with little or no perceived change in the fundamentals. By the time those changes became known, the new trend was well underway

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EXCHANGE RATE MOVEMENT CREATES RISK

While all these examples illustrate how currency exchange rates can float in the foreign exchange market, free-floating currency exchange rates create risk. For example, when an Indian wine merchant contract to buy 1,000 cases of French wine, the merchant may agree to pay in French Euros, say 600 Euros per case, when the vintage is ready for shipment in two years. However, over the next two years, the value of the INR could drop from Rs.55 to Rs.60, raising the price of each case from Rs.33000 to Rs.36000. Thus, pricing the wine in Euros exposes the Indian wine merchant to a currency exchange-rate risk.

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EXPOSURE

IDENTIFYING EXPOSURE The first step in management of corporate foreign exchange risk is to acknowledge that such risk does exist and that managing it is in the interest of the firm and its shareholders. The next step, however, is much more difficult: the identification of the nature and magnitude of foreign exchange exposure. In other words, identifying what is at risk, and in what way.

The task of gauging the impact of exchange rate changes on an enterprise begins with measuring its exposure, that is, the amount, or value, at risk. This issue has been clouded by the fact that financial results for an enterprise tend to be compiled by methods based on the principles of accrual accounting.

Unfortunately, this approach yields data that frequently differ from those relevant for business decision-making, namely future cash flows and their associated risk profiles. As a result, considerable efforts are expended -- both by decision makers as well as students of exchange risk -- to reconcile the differences between the point-in-time effects of exchange rate changes on an enterprise in terms of accounting data, referred to as accounting or translation exposure, and the ongoing cash flow effects which are referred to as economic exposure. Both concepts have their grounding in the fundamental concept of transactions exposure.

EXPOSURE IN A SIMPLE TRANSACTION OR TRANSACTION EXPOSUREThe typical illustration of transaction exposure involves an export or import contractgiving rise to a foreign currency receivable or payable. On the surface, when the exchange rate changes, the value of this export or import transaction will be affected in terms of the domestic currency. However, when analyzed carefully, it becomes apparent that the exchange risk results from a financial investment (the foreign currency receivable) or a foreign currency liability (the loan from a supplier) that is purely incidental to the underlying exports or imports transaction; it could have arisen in and of itself through independent foreign borrowing and lending. Thus, what is involved here is simply foreign currency assets and liabilities, whose value is contractually fixed in nominal terms.

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E.g. suppose today we have finalized a contract for the export of any commodity worth say euros 1, 00,000 and the exchange rate today is Rs. 55 per Euro. But by the time say after two months when the export is effected and we get the payment of euros 100000 the exchange rate is Rs.50 per euro. So two months earlier when we finalized the contract it was worth Rs.55, 00,000 lacs but today when we get the payment after two months (because it takes suppose two months for the shipment of the material from our godown and after that realization of the payment with the help of bill of lading and letter of credit) we are getting Rs.50,00,000 lacs. A net loss of Rs.5,00,000 lacs due to just the fluctuations in the exchange rate. So this is a transaction exposure, which arises due to foreign currency denominated receipts or payments in an international business transaction. So the profitability of the export transaction can be completely wiped out by the movement in the exchange rate.

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ACCOUNTING EXPOSURE OR TRANSLATION EXPOSURE :

The concept of accounting exposure arises from the need to translate accounts that are denominated in foreign currencies into the home currency for the purpose of finalizing the accounts for any given period. Most commonly the problem arises when an enterprise has foreign affiliates keeping books in the respective local currency. For purposes of consolidation these accounts must somehow be translated into the reporting currency of the parent company. In doing this, a decision must be made as to the exchange rate that is to be used for the translation of the various accounts.

E.g. suppose a company has taken loan in USD 1 million to purchase imported capital goods. Now the exchange rate is Rs45 for one dollar. So the cost of this asset for the company is Rs.450 lacs and the accounting entry would be like

Fixed Assets A/c dr. To bank (dollars loan)

Rs. 450 lacs Rs. 450 lacs

And if we assume that on the date of closing of the accounts there is no change in the exchange rate, the company will provide depreciation on the asset valued at Rs. 450 lacs and will show the asset in the b/s after reducing the depreciation that has been charged from the original cost of that asset i.e. 450 lacs.

But if we take another case that at the time of closing of the accounts the exchange rate has moved to Rs. 50 per dollar then now we will have to translate the dollars loan at Rs. 50 per dollar involving "translation loss" of Rs. 50 lacs. So due to this translation exposure the cost of the asset as well as company's liability has increased by 50 lacs. So now the book value of the asset has become Rs. 500 lacs and consequently higher depreciation will have to be provided which will reduce the net profit of the company.

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To a certain extent this difficulty is revealed by the struggle of the accounting profession to agree on appropriate translation rules and the treatment of the resulting gains and losses. A comparative historical analysis of translation rules may best illustrate the issues at hand. Over time, U.S. companies have followed essentially four types of translation methods. These four methods differ with respect to the presumed impact of exchange rate changes on the value of individual categories of assets and liabilities. Accordingly, each method can be identified by the way in which it separates assets and liabilities into those that are "exposed" and are, therefore, translated at the current rate, i.e., the rate prevailing on the date of the balance sheet, and those whose value is deemed to remain unchanged, and which are, therefore, translated at the historical rate.

The current / non-current method of translation divides assets and liabilities into current and non-current categories, using maturity as the distinguishing criterion; only the former are presumed to change in value when the local currency appreciates or depreciates vis-vis the home currency. Supporting this method is the economic rationale that foreign exchange rates are essentially fixed but subject to occasional adjustments that tend to correct themselves in time. This assumption reflected reality to some extent, particularly with respect to industrialized countries during the period of the Breton Woods system. However, with subsequent changes in the international financial environment, this translation method has become outmoded; only in a few countries is it still being used.

Under the monetary / non-monetary method all items explicitly defined in terms of monetary units are translated at the current exchange rate, regardless of their maturity. Non-monetary items in the balance sheet, such as tangible assets, are translated at the historical exchange rate. The underlying assumption here is that the local currency value of such assets increases (decreases) immediately after a devaluation (revaluation) to a degree that compensates fully for the exchange rate change. This is equivalent of what is known in economics as the Law of One Price, with instantaneous adjustment.

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A similar but more sophisticated translation approach supports the so-called temporal method. Here, the exchange rate used to translate balance sheet items depends on the valuation method used for a particular item in the balance sheet. Thus, if an item is carried on the balance sheet of the affiliate at its current value, it is to be translated using the current exchange rate. Alternatively, items carried at historical cost are to be translated at the historical exchange rate. As a result, this method synchronizes the time dimension of valuation with the method of translation. As long as foreign affiliates compile balance sheets under traditional historical cost principles, the temporal method gives essentially the same results as the monetary/non-monetary method. However, when "current value accounting" is used, that is, when accounts are adjusted for inflation, then the temporal method calls for the use of the current exchange rate throughout the balance sheet.

In contrast, U.S. companies whose foreign affiliates produced internationally traded goods (minerals or oil, for example) felt very comfortable valuing their assets on a dollar basis. Indeed, this later category of companies was the ones that did not like the transition to the current rate method at all. Here, all assets and liabilities are translated at the exchange rate prevailing on the reporting date. They found the underlying assumption that the value of all assets (denominated in the local currency of the given foreign affiliate) would change in direct proportion to the exchange rate change did not reflect the economic realities of their business.

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ECONOMIC EXPOSURE :

Both transaction and translation exposures are accounting concepts, and affect the bottomline directly. In contrast an economic exposure is more a managerial than an accounting concept. A company could have an economic exposure to say, the yen: rupee rate even if the company does not have any transaction or translation exposure in the Japanese currency, this would be the case, for example, if the company's competitors are using Japanese imports. If the yen weakens, the company looses its competitiveness (and, of course, vice versa).

With progressively liberalized trade policy, Indian companies selling in the domestic market in competition with imports are facing economic exposure to exchange rates. E.g. a company exporting from India to the U.S. its major competitors are from Thailand. Clearly the company has an economic exposure to the dollar: Baht (the Thailand's currency) exchange rate, as a depreciation of the Baht in dollar terms would help improve the competitiveness of Thailand's exporters, worsening the Indian company's export prospects. In a more general sense, all businesses have economic exposures to exchange rates.

In general, economic exposure to an exchange rate is the risk that a change in the rate affects the company's competitive position in the market and hence, indirectly its bottomline. Broadly speaking, economic exposures affect the profitability over a longer time span than transaction exposures.

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MANAGING ECONOMIC EXPOSURE :

Under Indian exchange control, while transaction and translation exposures can be hedged, economic exposures cannot. On the other hand, transaction or translation exposures can be used to hedge economic exposures.

Consider a company whose domestic selling prices are governed by the landed cost of competing imports. This is the case today in India for most producers of commodity- type output: copper, aluminum, petrochemicals etc. Clearly, such business has an economic exposure to the INR: USD exchange rate. In cash flow terms they are long dollars. For such businesses, dollar loans (i.e. a short position in the dollar) would act as a hedge in the broader sense of the price change in the hedge compensating for the cash flow impact of the economic exposure:

If INR: USD is stable, (ignoring the independent impact of commodity price changes), the domestic prices cannot be increased, but the debt servicing costs come down. If INR falls against the dollar, the debt servicing costs would go up but so would the rupee prices in the domestic market.

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TOOLS AND TECHNIQUES FOR THE MANAGEMENT OF FOREIGN EXCHANGE RISK

Hedging is about doing things that reduce your exposure to bad events. Indias transition in to a market economy has been accompanied by a new regime of market volatility. Individuals and firms are exposed to volatility in interest rates, currencies and commodity prices, which is quite unlike that seen in previous decades.

Suppose a person exports garments and is hence exposed to the fluctuations of the dollarrupee. There are exactly two strategies that he can adopt: speculation or hedging.

Here we consider the relative merits of several different tools for hedging exchange risk including forwards, futures, debt, swaps and options. We will use the following criteria for contrasting the tools.

First, there are different tools that serve effectively the same purpose. Most currency management instruments enable the firm to take a long or a short position to hedge an opposite short or long position. Thus one can hedge a DM payment using a forward exchange contract, or debt in DM, or futures or perhaps a currency swap. In equilibrium the cost of all will be the same, according to the fundamental relationships of the international money market. They differ in details like default risk or transactions costs, or if there is some fundamental market imperfection. Indeed in an efficient market one would expect the anticipated cost of hedging to be zero. This follows from the unbiased forward rate theory.

Second, tools differ in that they hedge different risks. In particular, symmetric hedging tools like futures cannot easily hedge contingent cash flows: options may be better suited to the latter.

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TOOLS AND TECHNIQUES :

1- Internal Techniques

2- External Techniques

1- INTERNAL HEDGING TECHNIQUES

INVOICING

A firm may be able to shift the entire exchange risk to the other party by invoicing its exports in its home currency and insisting that its imports to be invoiced in its home currency. In its presence of well functioning forward markets this will not yield any added benefit compared to forward hedge. At times, it may diminish the firms competitive advantage if it refuses to invoice its cross-border sales in buyers currency.

NETTING & OFFSETTING

A firm with receivables and payables in diverse currencies can net out its exposure in each currency by matching receivables with payables. Netting also assumes importance in the context of cash management in a MNC with a number of subsidiaries and extensive intracompany transactions. Sometimes the receivables and payables may be in different currencies. Then offsetting can be used which is similar to netting if the currencies are closely correlated.

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LEADING & LAGGING

In this one can shift the timing of exposure by leading and lagging payables and receivables. The general rule is lead, i.e. advance payables and lag, and i.e. postpone receivables in strong currencies and vice versa. Shifting the exposure in time must be combined with a borrowing/lending transaction or a forward transaction to complete the hedge.

RISK SHARING

Another non-market based hedging technique is to work out a currency risk sharing agreement between two parties-for instance the exporter and the importer. It can be implemented by embedding a bundle of forward and option contracts in the underlying trade transaction.

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2- EXTERNAL HEDGING TECHNIQUE

FOREIGN EXCHANGE FORWARDS

Foreign exchange is, of course, the exchange of one currency for another. Trading or "dealing" in each pair of currencies consists of two parts, the spot market, where payment (delivery) is made right away (in practice this means usually the second business day), and the forward market. The rate in the forward market is a price for foreign currency set at the time the transaction is agreed to but with the actual exchange, or delivery, taking place at a specified time in the future. While the amount of the transaction, the value date, the payments procedure, and the exchange rate are all determined in advance, no exchange of money takes place until the actual settlement date. This commitment to exchange currencies at a previously agreed exchange rate is usually referred to as a forward contract.

Forward contracts are the most common means of hedging transactions in foreign currencies. The trouble with forward contracts, however, is that they require future performance, and sometimes one party is unable to perform on the contract. When that happens, the hedge disappears, sometimes at great cost to the hedger. This default risk also means that many companies do not have access to the forward market in sufficient quantity to fully hedge their exchange exposure. For such situations, futures may be more suitable.

CURRENCY FUTURES

Outside of the inter-bank forward market, the best-developed market for hedging exchange rate risk is the currency futures market. In principle, currency futures are similar to foreign exchange forwards in that they are contracts for delivery of a certain amount of a foreign currency at some future date and at a known price. In practice, they differ from forward contracts in important ways.

One difference between forwards and futures is standardization. Forwards are for any amount, as long as it's big enough to be worth the dealer's time, while futures are for standard amounts, each contract being far smaller that the average forward transaction. Futures are also standardized in terms of delivery date. The normal currency futures delivery dates are March, June, September and December, while forwards are private agreements that can specify any delivery date that the parties choose. Both of these features allow the futures contract to be tradable.

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Another difference is that forwards are traded by phone and telex and are completely independent of location or time. Futures, on the other hand, are traded in organized exchanges such the LIFFE in London, SIMEX in Singapore and the IMM in Chicago.

But the most important feature of the futures contract is not its standardization or trading organization but in the time pattern of the cash flows between parties to the transaction. In a forward contract, whether it involves full delivery of the two currencies or just compensation of the net value, the transfer of funds takes place once: at maturity. With futures, cash changes hands every day during the life of the contract, or at least every day that has seen a change in the price of the contract. This daily cash compensation feature largely eliminates default risk. Thus forwards and futures serve similar purposes, and tend to have identical rates, but differ in their applicability. Most big companies use forwards, futures tend to be used whenever credit risk may be a problem.

CURRENCY OPTIONS

Many companies, banks and governments have extensive experience in the use of forward exchange contracts. With a forward contract one can lock in an exchange rate for the future. There are a number of circumstances, however, where it may be desirable to have more flexibility than a forward provides. For example a computer manufacturer in California may have sales priced in U.S. dollars as well as in German marks in Europe. Depending on the relative strength of the two currencies, revenues may be realized in either German marks or dollars. In such a situation the use of forward or futures would be inappropriate: there's no point in hedging something you might not have. What is called for is a foreign exchange option: the right, but not the obligation, to exchange currency at a predetermined rate.

A foreign exchange option is a contract for future delivery of a currency in exchange for another, where the holder of the option has the right to buy (or sell) the currency at an agreed price, the strike or exercise price, but is not required to do so. The right to buy is a call; the right to sell, a put. For such a right he pays a price called the option premium. The option seller receives the premium and is obliged to make (or take) delivery at the agreedupon price if the buyer exercises his option. American options permit the holder to exercise at any time before the expiration date; European options, only on the expiration date.

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E.g. a company had just agreed to purchase $ I5 million worth of any commodity from his supplier from U.S.A. Payment of $ 5 million was to be made in 245 days' time. The dollar had recently appreciated and the company wanted to avoid any further rise in the cost of imports. He viewed the dollar as being extremely instable in the current environment of economic tensions. Having decided to hedge the payment, he had obtained dollar/rupees quotes of Rs.45 spot, Rs.47 for 245 days forward delivery. His view, however, was that the dollar was bound to rise in the next few months, so he was strongly considering purchasing a call option instead of buying the forward. At a strike price of Rs. 47, the best quote he had been able to obtain was from the Bank of India, who would charge a premium of 0.85% of the principal. Company decided to buy the call option. In effect, it reasoned, I'm paying for downside protection while not limiting the possible savings I could reap if the dollar does recover to a more realistic level. In a highly volatile market where crazy currency values can be reached, options make more sense than taking your chances in the market, and you're not locked into a rock-bottom forward rate. This simple example illustrates the lopsided character of options.

Futures and forwards are contracts in which two parties oblige themselves to exchange something in the future. They are thus useful to hedge or convert known currency or interest rate exposures. An option, in contrast, gives one party the right but not the obligation to buy or sell an asset under specified conditions while the other party assumes an obligation to sell or buy that asset if that option is exercised. There may be the two possible outcomes of an option such as that bought by the company.

One the dollar may appreciate and it would be in the favor of the company to exercise the option and limiting the cost of its imports. And the second may be that the dollar may depreciate and it would be in the favor of the company not to exercise the option and buy the dollars from the spot market.

Indeed the price of an option is directly influenced by the outlook for a currency's volatility: the more volatile, the higher the price." A currency call or put option's value is affected by both direction and volatility changes, and the price of such an option will be higher, the more the market's expectations (as reflected in the forward rate) favor exercise and the greater the anticipated volatility.

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Unmanaged exchange rate risk can cause significant fluctuations in the earnings and the market value of an international firm. A very large exchange rate movement may cause special problems for a particular company, perhaps because it brings a competitive threat from a different country. At some level, the currency change may threaten the firm's viability, bringing the costs of bankruptcy to bear. To avert this, it may be worth buying some low-cost options that would pay off only under unusual circumstances, ones that would particularly hurt the firm. Out-of-the-money options may be a useful and costeffective way to hedge against currency risks that have very low probabilities but which, if they occur, have disproportionately high costs to the company.

Credit Swaps

Swaps are like packages of forward contracts. Currency swaps can be used to avoid the credit risk associated with a parallel loan. In broad terms, a currency swap is an agreement by two companies to exchange specified amounts of currency now and to reverse the exchange at some point in the future. The lack of credit risk arises from the nature of a currency swap. Default on a currency swap means that the currencies are not exchanged in the future, while default on a parallel loan means that the loan is not repaid. Unlike a parallel loan, default on a currency swap entails no loss of investment or earnings. The only risk in a currency swap is that the companies must exchange the foreign currency in the foreign exchange market at the new exchange rate.Frequently, multinational banks act as brokers to match partners in parallel loans and currency swaps. However, finding companies whose needs mutually offset one another is difficult, imperfect and only partially reduces currency exposure risk. If a company cannot find a match, a credit swap may be used. Credit swaps involve a deposit in one currency and a loan in another. The deposit is returned after the loan is repaid. For example, a U.S. business could deposit dollars in the San Francisco branch of an Asian bank, which would, in turn, lend the depositor yen for an investment in Japan. After the Asian bank loan is repaid in yen, the dollar deposit would be returned.

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 Foreign Debt Foreign debt can be used to hedge foreign exchange exposure by taking advantage of the International Fischer Effect relationship. This is demonstrated with the example of an exporter who has to receive a fixed amount of dollars in a few months from present. The exporter stands to lose if the domestic currency appreciates against that currency in the meanwhile so, to hedge this, he could take a loan in the foreign currency for the same time period and convert the same into domestic currency at the current exchange rate. The theory assures that the gain realized by investing the proceeds from the loan would match the interest rate payment (in the foreign currency) for the loan.

Cross Hedging

Thus far, a market for forward rates, futures contracts, credit or options in the foreign currency being hedged has been presumed to exist. But this may not be true in all cases, especially for small developing countries. In such cases, cross hedging may be the only hedging alternative available. Cross hedging is a form of a hedge developed in a currency whose value is highly correlated with the value of the currency in which the receivable or payable is denominated. In some cases, it is relatively easy to find hghly correlated currencies, because many smaller countries try to peg the exchange rate between their currency and some major currency such as the dollar, the franc or euro. However, these currencies may not be perfectly correlated because efforts to peg values frequently fail.As an example, a company has a payable or a receivable denom- inated in the currency for a small nation for which there are no developed currency or credit markets. The company would explore the possibility that the currency is pegged to the value of a major currency. If not, the company would look at past changes in the value of the currency to see if they are correlated with changes in the value of any major currency. The company would then undertake a forward market, futures market, money market, or options market hedge in the major currency that is most closely related to the small nations currency.Cross-hedging success depends upon the extent to which the major currency changes in value along with the minor currency. Although cross hedging is certainly imperfect, it may be the only means available for reducing transaction exposure.

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HEDGING RISKS IN MMTC LTD

There are various risk management policies adopted by MMTC Ltd. to cover its Foreign Exchange Risk.

VARIOUS TECHNIQUES OF FOREIGN EXCHANGE RISK MANAGEMENT As we have discussed earlier there are some hedging techniques, which can be used to manage the risk, related to this aspect like:

Foreign Exchange Forwards Foreign Exchange Futures Options Swaps etc.

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TECHNIQUES ADOPTED IN MMTC Ltd.

But I found that in MMTC Ltd they use only forwards to hedge their currency risks because there is a strong and very liquid market for these contracts. There are no upfront fees like in options and are easily available in the market. There is a very active market in India for these forward contracts. Another thing is that there are banks who are the counter party in these transactions so we have already a guarantee and any other risks like credit risk etc. are not there. The company doesnt go for other hedging techniques available because of the following reasons:

a) Futures and Options are very newly introduced techniques and started just last

year in Indian Market. b) There is a upfront fees in options which we have to pay whether we exercise the Option or not. c) No liquid market is there i.e. these futures and options are not easily available in India because always there are two parties buyer and seller in a transaction. So suppose if a bank writes a option and if the counter party exercise it, it mean it is in favor to that party then this party will gain but the other party will loose like in this case the other party is bank so bank wont take any risk and it again sees to buy the same option with other banks so that it can shift the risk and if the other party exercises the option the bank will also exercise the option which it has bought from the other bank. So if this bank doesnt find another bank for the same option then why it will write the option. So in India no liquid market is there for these futures and options.

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DECISIONS TAKEN RELATED TO FORWARD COVER IN MMTC LTD

In MMTC the Decisions related to the forward cover is taken by a committee comprising of Concerned Product Division In charge The concerned associate finance head G.M. (Banking/ Treasury) G.M. (Internal Audit) C.G.M. (Business Development Group)

In case of absence of any committee member, the next senior most available official from the respective division to be considered as a member of that committee. All the decisions related to the forward cover of any contract would be taken by that committee and the decision taken by that committee would be considered as the final decision.

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ANALYSIS

After the study done by me of foreign exchange risk management in MMTC Ltd., what I analyzed are the following points: Currency of transaction is mainly US dollar and all the exports and imports transactions are settled through US dollars. Euro still doesnt count much in these transaction even though it is strengthening against the US dollars. Rupee transactions are mainly for the domestic transactions and for a little part of export transactions. The period of hedging is normally three months. Generally, the time period of hedging depends upon the expected time in which the transaction is supposed to be settled. As the company is a commodity trader the business cycle is not lengthy and therefore, a short period of hedging is sufficient. Therefore, the hedging period is short, i.e., three months. Hedging is mainly undertaken to curb currency risks and not speculation. The company doesnt deal in hedging for speculation as it is not permitted by RBI guidelines.The company mainly hedges by undertaking forward covers. Other techniques of hedging are almost ignored. The company has centralized operations to look after such currency risks of all the divisions.

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RECOMMENDATIONS During the course of my studies of Foreign Exchange Risk Management at MMTC Ltd., I found that the following things need to be worked out at MMTC Ltd. as a part of risk management policy: In addition to forward cover of its foreign exchange risk, MMTC Ltd. should go for currency futures and options also because in options we have to pay just a upfront fees but after that we have right not obligation whether to exercise our option or not. If its in favor of us then we will exercise the option otherwise not. MMTC Ltd. should arrange special training session for its employees, dealing with the risk involved in international trading operations of MMTC Ltd. and the various hedging instruments other than forward contract as I felt during my initial investigations that MMTC is dealing only with forwards and most of the employees are unaware about the other hedging instruments available in the market like futures and options etc. Currency risks and their hedging, is not given much of importance in MMTC. The company has centralized system of hedging with no independent operation for the various divisions. As the company is a commodity trader and deals in trading material internationally it should have different treasury divisions for each area of activity especially precious metals and minerals. The reason for lack of usage of hedging concept are as below: (a) Lack of understanding of the term hedging within the different departments. The people working in the departments do not have much exposure to these terms and therefore they do not understand the concept of risks and their exposure related to international business transactions. Therefore the employees concerned must be updated with this concept and also educate them about the latest changes in risk related to international business transactions from time to time. (b) Hedging is also used by the company at times when the movement in different currencies is favorable to the company e.g. many at times when hedging is done the prices of the currencies may change favorably, and the company earns less than what it would have earned if there was no hedging. Therefore most of the time the company does not use hedging to curb its risk.

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CONCLUSIONS Although seeing the past performances of MMTC Ltd, one can very well make out that it has performed well in managing and controlling of its foreign currency risks. The past performances show that its exports are increasing since the year 1997, which is clearly suggestive of the fact that its foreign exchange earnings are increasing day by day. Where in the year 1997 the exports of MMTC Ltd. stood at Rs.11367 million, in the year 2002 it stood at Rs.17287 million. Similar trends can be seen in MMTCs imports, which have been increasing since the year 1998. In the year 1998 its imports stood at Rs.31318 million, it stands at Rs.54805 million in the year 2002. This is a healthy sign for business fairing well even there is an economic slow down in the world of business across the globe. Besides, it has been making use of hedging tools such as forward contracts for all its exports businesses to cover any sort of foreign currency fluctuations that may result in any kind of loss for the organization. The efficient use of these hedging tools have borne fruits for the organization which can be seen in the overall profitability for the last two years, viz., Rs.123 million and Rs.185 million for the financial years 2000-2002. Again the company has paid hefty Special Interim Dividends to the tune of 121% of paid up equity share capital during the financial year 2001-2002. So it will not be wrong if it is said that the company i.e. MMTC Ltd. is in sound health and doing a good business as a whole considering the fact that the world economy is facing the negative impacts of economic downturn. A trading company like MMTC Ltd. having a wide range of product portfolio both in exports and imports and having global business operations, such a company being able to do a good business in foreign trade is more than appreciated.

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BIBLIOGRAPHY

Books

Annual Report of MMTC Ltd. Foreign Exchange Manual International Finance By A.V Rajwade Risk Management Journal of the Institute of Chartered Accountant of India www.mmtclimited.org www.rbi.org www.google.com www.mcx.com www.nmce.com

Websites

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ABBREVATIONS

MMTC USD L/C FOREX MT MNC INR DM ECD FEMA FERA OCI RBI FAS MW PPP

MINERAL AND METAL TRADING CORPORATION US DOLLARS LETTER OF CREDIT FOREIGN EXCHANGE METERIC TONE MULTI NATIONAL COMPANIES INDIAN RUPEE DEUTSCHE MARK EXCHANGE CONTROL DEPARTMENT FOREIGN EXCHANGE MANAGEMENT ACT FOREIGN EXCHANGE REGULATION ACT OTHER COMPREHENSIVE INCOME RESERVE BANK OF INDIA FINANCIAL ACCOUNTING STANDARD MEGAWATT CAPACITY PURCHASING POWER PARITY

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