Types of Exposures

Risks in Forex Operations &

Management
Hedging Strategies
Hedging Products

Types of Exposures

Balance sheet Segment

Type of Exposures

1. Revenue Exposures

Imports, Exports

2. Other Exposures
(Non-revenue Inflow /
Outflow)

Royalty, FDI, Misc. payments /

receipts, capital goods

3. Other Exposures
(Assets & Liabilities)

Loans, Deposits

4. Interest Rate Exposures

Loans, Deposits

Risks in Forex Operations &

Management of Risk

High volatility is the distinctive feature of foreign

exchange market.
Only a small percentage of foreign exchange
transactions are for commercial import/export
purposes while the major chunk is traded for
speculative gains.
Globalization of Indian economy is increasingly
exposing the Indian corporate to greater forex risks.
The uncertainty of the moves and lack of clear trend
rules the market.

Depending on nature of exposure two types of risks

may be associated with the forex exposure:
1. Risk of Exchange Rate
2. Risk of Intt. Rate Index (LIBOR) Movement

Foreign Currency exposure in USD, EURO, JPY etc. Loans linked

to 6M USD LIBOR, 6M EURIBOR, 6M JPYLIBOR etc.

Exposure risk on two parameters:

1. Currency Risk:

EURO and / or JPY appreciation against USD (with / without

USD appreciation against INR)

USD appreciation against INR

2. Interest Rate Risk:
6M JPYLIOBOR and / or 6M USD LIBOR and / or 6M EURIBOR
moving upwards over the tenor of the loan

Company placed an order for purchase of some

machinery:
Time of placing order Time of payment
Cost : USD 10.00 mio To Pay : USD 10.00 mio
USD/INR : 61.80
USD/INR : ????
What would be the conversion rate at the time of
payment?

One of the fundamental requirement for any business is

MONEY and Corporate may not like to lose MONEY on
account of fluctuations in Currency Market.
With increased volatility, management of the financial
risks is necessary to gain competitive advantage.
More and more corporate are moving towards raising
foreign currency loans to reduce their interest cost and
they may not like to lose it on account of fluctuations in
currency market as well as interest rate.

Hedging Strategies

Hedging may be termed as a Risk Management

Strategy used in limiting or offsetting probability of
loss from adverse fluctuations in the prices of
commodities, currencies, or securities. In effect,
hedging is a transfer of risk; of course for a price.

Unique to the company depending upon exposure and

Risk Management Policy.
May be of three types:
1. Complete Hedging
2. Part Hedging
3. Do Nothing (No Hedging)
No best practice and a dynamic process, needs
flexibility depending upon varying company exposure
and varying market conditions.

Is this a risk?
Borrowing Rupees with a fixed rate of interest for 5
years
Borrowing Dollars with a floating rate of interest for 5
years
Borrowing JPY with a floating rate of interest for 5
years
Depositing money for 6 months at a fixed rate with a
bank
Concept: Can changes in market prices affect the value
of the contract?

Why Have a Policy?

Formalises a thought process that may otherwise be
people dependent.
Helps the Board of Directors articulate their
strategic view in terms of risk management.
Facilitates approval from Regulators wheresoever
necessary

Concept:

Formalises a process.

What is Risk?

The likelihood that your company will face a loss

owing to market movements.
Measurement of Risk
Factor Sensitivity
Calculation of the change in the market value of a
portfolio of contracts for a given scenario, e.g. interest
rates moving up 1 bp, FX rates moving up 1%, etc.

Financial instruments whose value is derived from

some other asset.
Typically returns are based on movement in the value
of that asset.

DERIVATIVES

EXCHANGE TRADED
EX. EQUITY & FX
FUTURES
EQUITY & FX OPTIONS

OVER THE COUNTER(OTC)

EX. FORWARDS
OPTIONS
CURRENCY SWAPS
INTEREST RATE SWAPS

Hedging Options for

ECB of JPY 9.12
billion

Amount of ECB
Costing
Repayment
Instalment Start Date
Instalment End Date

: JPY 9.12 billion

: 6M JPY LIBOR + 57 bps
: 10 half-yearly instalment
: 18.04.2014
: 18.10.2018

Risks
1. Exchange risk on Principal repayment
2. Exchange risk on Interest payment
3. Interest risk due to movement in JPY LIBOR

SWAP is a contractual agreement to exchange specified

cash flows at future dates
Contracts constructed as multiple forward contracts
Advantages:
Hedging of risk beyond 3 years
Long term forwards are not available beyond 3 years
One rate for entire period of exposure or variable
rates for various maturities
Cost payable could be amortized over the life of
swap
Disadvantages:
Exit cost inflexible and less transparent.

Swaps may be broadly categorised into:IRS Interest Rate Swap

POS Principal Only Swap
CIRS Currency and Interest Rate Swap
COS Coupon Only Swap

An agreement between two parties (known as

counterparties) where one stream of future interest
payments is exchanged for another based on a specified
principal amount.
For example, NHPC has to repay loans linked to 6M
JPY LIBOR to the lender. To hedge the exposure on
account of movement in 6M JPY LIBOR, NHPC may
enter into a swap where NHPC will receive applicable
6M JPY LIBOR on its hedged loan and pay the fixed
swap rate over the period of hedging.

PAYS SWAP RATE

(x%)

NHPC

SBI
PAYS LIBOR 6M

PAYS
LIBOR
6M

LENDER

Effectively , NHPC pays fixed

interest rate of x% on the loan
linked to 6M LIBOR. So,
irrespective of where the LIBOR
is fixed on the respective LIBOR
setting dates, the company pays a
fixed interest rate for the tenor of
loan.

 Advantage

The risk of LIBOR moving upwards is completely

hedged.
Risks

NHPC will not be able to take advantage of lower

LIBOR if it moves below the present rates.
NHPC is open to USDJPY & USDINR exchange
rate.

A POS involves two parties that exchange principal

(notional or actual) with one another in order to gain
exposure to a desired currency. Periodic cash flows are
exchanged in the appropriate currency as per the
repayment schedule.
For example, NHPC has to repay loans in JPY to the
lender as per the repayment schedule. To hedge the
exposure on account of movement in JPY/INR, NHPC
may enter into a swap where NHPC will receive JPY
and pay INR at the swap rate.

On repayment dates, INR at fixed rate

and x% fixed on o/s INR amount

NHPC

SBI
JPY (As per repayment schedule)

JPY (as
per
repayment
schedule)

LENDER

Effectively , NHPC hedges itself

against the fluctuations in JPY/INR
for JPY loan. So, irrespective of
where the JPY/INR trades on
repayment dates, the company pays
a fixed amount of INR at todays
spot ref and pays x% on o/s INR
amount instead of JPY.

 Advantage

The risk of JPY/INR moving upwards is completely

hedged.
Risks
NHPC will not be able to take advantage of lower
rates if JPY/INR moves lower than the present
rates.
NHPC is open to LIBOR rate moving upwards.
NHPC is open to JPY/INR movements on interest
portion.

CIRS involves two parties that exchange principal

(notional or actual) as also interest rate with one another
in order to gain exposure to a desired currency & interest
rate.
For example, NHPC has to repay a JPY loan linked to 6M
JPY LIBOR to the lender as per the repayment schedule.
To hedge the exposure on account of movement in
JPY/INR as also LIBOR, NHPC may enter into a swap
where NHPC will receive JPY at 6M JPY LIBOR and
pay INR at fixed interest rate as per the schedule.

INR at fixed interest rate of X% (as

per repayment schedule)

NHPC
USD AT 6M JPY LIBOR (as per
repayment schedule)

JPY at 6M
JPY LIBOR
(as per
repayment
schedule)

LENDER

SBI

Effectively , NHPC hedges itself

against
the
fluctuations
in
JPY/INR and 6M JPY LIBOR.
So, irrespective of where the
JPY/INR trades on repayment
dates or where 6M JPY LIBOR is
fixed on resetting dates, the
company pays a fixed amount of
INR at a fixed interest rate.

 Advantage

The risk of JPY/INR & 6M JPY LIBOR

moving upwards is completely hedged.
Risks

NHPC will not be able to take advantage of

lower rates in JPY/INR &/or 6M JPY
LIBOR rate moves lower than the present
rates.

Coupon Only Swap involves two parties that

exchange interest payments from one currency to
another currency.
For example, NHPC has to repay JPY loan at
LIBOR 6M. If NHPC exchanges the interest
payments from JPY LIBOR 6M to INR Fixed, the
liability on account of interest payments shift to
INR.

NHPC

Intt. payments in INR at x% at spot

(as per repayment schedule)

JPY LIBOR
6M (as per
repayment
schedule)

LENDER

JPY LIBOR 6M (as per repayment

schedule)

SBI

Effectively , NHPC converts its

interest liability from JPY
LIBOR to INR FIXED.
Principal payments, however,
are open to market fluctuations.

Advantage
The risk of 6M JPY LIBOR moving upwards is and
JPY/INR appreciation (on interest amount) is completely
hedged.

Disadvantages
JPY/INR exposure on principal amount has not been
hedged.
NHPC will not be able to take advantage of lower rates if
6M JPY LIBOR rate moves lower than the present rates.
NHPC will not be able take advantage of INR appreciation
against JPY on the intt. portion as rate it is already fixed.

Type of
Structure

Exchange Risk
on Principal

Exchange Risk
on Interest

Interest Rate
Risk

CIRS

Yes

Yes

Yes

POS

Yes

No

No

IRS

No

No

Yes

COS

No

Yes

Yes

Type of Structure

NHPC Receives

NHPC Pays

CIRS

6M JPY LIBOR + 0.57%

8.7975%

POS

7.7975%

IRS

6M JPY LIBOR + 0.57%

0.9125%

COS

6M JPY LIBOR + 0.57%

1.0775%

Other Hedging Products

Forward Contract
Options
Combinations

Contract to buy or sell a specified amount of

currency at a specified price on a specified
future date.

No exchange of money at the time of contract; settlement on

end date;
An obligation to buy/sell on settlement date at the contracted
rate;

Cancellation, partial or early delivery allowed as per relevant

guidelines;
Transparent Pricing;
Used to hedge as also to Trade/ Speculate i.e. profit from
currency movements as per relevant guidelines.

 At the time of booking a forward contract the customer can

choose for:
1. A fixed delivery date;
2. A period called option period (up to 1 calendar month)
within which the customer can deliver his part of the
contract on any date.
In both the cases, however, the forward rate is fixed.
However, in the latter case, as the customer is buying the
option to take delivery anytime during the contracted
month, the forward rate will be worse than that of a fixed
date delivery.

ILLUSTRATION

66
FORWARD
IMPORT
CONTRACT
FORWARD
USD/INR

65

PROFIT

64
FORWARD
CONTRACT

63
62

61
60

LOSS

Advantages of Forward Contract

Simple
Easy to use
Liquid
Transparent

Disadvantages of Forward Contract..

No chance
volatility.

of

participating

in

market

The upside and downside (opportunity profit /

loss) theoretically unlimited.
INR based forwards demand and supply
dependent.

An option is a financial contract in which

the buyer of the option has the right but
not the obligation, to buy or sell an asset,
at a pre- specified price, on or up to a
specified date.

Buying Call option: Gives right to buy

Buying Put option: Gives right to sell
Strike Price: Rate at which option is to be exercised
Premium: Amount paid for buying the option
At the money: Strike price is equal to price of asset
In the money: Call option where asset price is higher than
strike price or put option where asset price is lower than strike
price.
Out of money: A call option where asset price is lower than
strike or put option where asset price is higher than strike.
The maximum loss to a holder of an option is the premium
paid which is to be paid upfront.

The current rate

The strike rate
The time to expiration
The volatility of underlying
The Interest rates

Premium of
Higher strike price
Higher volatility
Longer option
time period

Call
Lower
Higher
Higher

Put
Higher
Higher
Higher

Buy Call
Buy the right to Purchase
Option to Buy
Profit potential unlimited
Loss limited to Premium
Must Pay a Premium

Sell Call
Sell the right to purchase
Obligation to Deliver
Profit potential limited to Premium
Loss unlimited
Receives a Premium

Buy Put
Buy the Right to Sell
Option to Sell
Profit potential unlimited
Loss limited to Premium
Must Pay Premium

Sell Put
Sell a right to Sell
Obligation to Purchase
Profit potential limited to Premium
Loss unlimited
Receives a Premium

Derivative Products : Options

nn

Confidence
View

High
Buyer of USD

Low
Seller of USD

Buyer of USD

Seller of USD

INR Firming

Keep exposure open

Book Forward

Buy a Call

Buy a Put

INR Weakening

Book Forward

Keep exposure open

Buy a Call

Buy a Put

Plane Vanilla Call Option

NHPC buys USD Call INR Put for USD 1mio @ 62.00
Benefit

for Customer : NHPC is fully protected

against depreciation of INR beyond 62.00, at the same
time they can take benefit of appreciation of INR below
62.00.
Offers full hedge against currency movement.
Cost to Customer : Upfront premium paid by
customer to buy the option.

Range Forward
NHPC Buy USD Call INR Put for USD 1 mio @ 70.00
NHPC Sell USD Put INR Call for USD 1 mio @ 61.00
Analysis:
By the structure NHPC has ensured that for it the rate will
not be worse than 70.00 or better than 61.00 and in between
NHPC is open to the market.
By entering the structure NHPC will be able to reduce the
premium cost vis-a-vis the premium on Plain Call Option.

Call Spread
NHPC Buy USD Call INR Put for USD 1.00 mio @ 65.00
NHPC Sell USD Call INR Put for USD 1.00 mio @ 75.00
Analysis:

Offers partial hedge and full opportunity.

On INR depreciation NHPC has limited his gain to
maximum of difference between the chosen levels,
however, below 65.00 NHPC is open to market for
unlimited gain as no option will be exercised.

Seagull
NHPC Buy USD Call INR Put for USD 1.00 mio @ 65.00
NHPC Sell USD Call INR Put for USD 1.00 mio @ 75.00
NHPC Sell USD Put INR Call for USD 1.00 mio @ 61.00

Analysis:

NHPC has limited its gain on INR depreciation to the

difference between levels of two Calls and for INR
appreciation has limited its gain to the level of sold Put. In
other words its rate cant be better than sold Put level (61.00).

Plain Vanilla Option

(+)offers protection
(+) opportunity of participation in INR Appreciation
(-) Initial Cash Outflow
Call Spread
(+) protection up to certain level
(+) opportunity of participation in INR Appreciation
(-) Initial Cash Outflow
Seagull
(+) protection up to certain level
(-) No opportunity to participate in INR appreciation

Customer Should Have:

1. Board Approval
2. Risk Policy & Procedures
3. Exposures: Size And Tenor
4. Understanding Of Risks
5. No Net receipt of Premium
6. ISDA Documentation
7. For ECB: Loan Regn. No.

Thank You