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Ifm Assignment

In: Business and Management

Submitted By sanjayguptas
Words 1704
Pages 7
Student Name: Sanjay Kumar Gupta
SMS Id: 110604
Center: Grand Mall – Gurgaon
Assignment: International Financial Management
Batch: PGCBM-21
Title: MNC Response to Currency Crisis
Professor Name: Dr. HK Pradhan

MNC Response to Currency Crisis

Introduction
A currency crisis means a decline in the value of country currency, the decline in value of currency have impact on the economy of country negatively. Decline in value of currency means same currency will not buy anther currency as it was buying earlier. Currency crisis happens because of investor expectation/act and the result of those acts. Currency crisis generally happens due to sudden devaluation of the currency.
Following are the reason which makes a currency crisis: 1. Current account deficit. 2. Currency value increased rapidly. 3. Uncertainty over government actions and policies. 4. Sudden outflow of capital by speculators. 5. If investors' confidence in the stability of an economy is eroded, then they will try to get their money out of the country. This is referred to as capital flight. Once investors have sold their domestic-currency denominated investments, they convert those investments into foreign currency. This causes the exchange rate to get even have further impacted, resulting in a run on the currency. 6. Currency outflow will be there till the time reserves are getting finished. Speculators foresee this potential opportunity for a capital gain and compete against each other for advance repatriation, In doing so, they bring forward the date when reserves are exhausted. 7. Before reserves are depleted naturally, an attack can occur as speculators rush to purchase US Dollar, with depleting central bank’s remaining stock of reserves. 8. If central bank borrows the foreign currency to defend its currency it only postpone the crisis.

Currency crisis in India
Below table shows the rupee situation from 2000 onwards against dollar. INR remain almost stable or strong from year 2000 to April 2011. It got start depreciating from September 2011 and deprecated up to Rs. 57.15 till June.
It recently start appreciating due to some changes in government policies regarding FDI and price hike is diesel, as price hike in diesel will help government to cut down the fiscal deficit. Year/Month | INR/USD | 2000 | 45 | 2006 | 48.336 | 2007 (Oct) | 38.48 | 2008 (June) | 42.51 | 2008 (October) | 48.88 | 2009 (October) | 46.37 | 2010 (January 22) | 46.21 | 2011 (April) | 44.17 | 2011 (September 21) | 48.24 | 2011 (November 17) | 50.97 | 2011 (November 24) | 52.11 | 2011 (December 15) | 53.65 | 2011 (December 14) | 53.7147 | 2012 (May 21) | 55.03 | 2012 (May 22) | 55.395 | 2012 (June 22) | 57.15 |

Currency crisis and hedging
Change in Rupee value against vehicle currency has significant impact on the corporate india. They need to rethink on their strategies regarding foreign exchange and hedging.
Currency crisis which has started in Sep 2011 and currently going has impact on exporters, importers, financial companies, companies which are looking for or have taken loan from foreign banks/investors.
Companies have to hedge foreign exchange exposure which they have as the impact of this can be felt on the income statement and the balance sheet. Companies which are exposed in foreign exchange transaction would face the risk due to fluctuations in currency rates on their income statement.
Hedging strategy depends upon the Size of the firm as per the various surveys large firms do the perfect hedging they do OTC forward contracting, futures, Swaps, options. Small firms generally do not do hedging they generally take the strategy.
Firms can limit their risk by hedging, by doing this currency risk will be less likely to occur and they can avoid financial crisis.
Small firms do following as their hedging strategy:
Small firms generally use internal tactics like leading and lagging. This can ensure that companies utilize the exchange rate movements to ensure that company always pays less and earn more profit. That is, when a company can lead payments (pay them in advance) when company expect the home currency to depreciate with respect to the foreign currency. Similarly netting the payments and receipts that are in the same foreign currency will also help reduce the exposure
In other words small firms generally tracks the market for rate movements and accordingly take the decision and they don’t go for the techniques like Forward contracts, Futures, options and Swaps.

Any company with operations in foreign currency can benefit from Currency Hedging: * By purchasing machinery or equipment abroad (importers) * By selling goods and services abroad (exporters) * By making overseas investments * By taking loan/debt in foreign currency
Below I am describing in short the different types of hedging techniques learn during class:
Forward Transactions
Hedging currency risks with forward transaction is a relatively easy to implement hedging strategy. In this, the currency payment is locked in at a particular exchange rate for a pre-specified date in the future, irrespective of what the actual market exchange rate at that time is. This helps both, the creditor and the lender do not have to worry about fluctuations in the income and expenditure respectively.

Currency Futures
Currency futures are the same as forward contracts and are just for locking in an exchange rate for a pre-set date of the transaction in the future. The advantage that currency futures have over currency forwards is that as these are exchange traded, counter-party risk is eliminated. It also helps that currency futures are more transparent in their pricing and are more easily available to all market participants.

Currency Swaps
These exchange rate transactions are real-time transactions where one thing is just exchanged for another. These swaps can also be used for hedging interest rate risks where two parties can exchange their fixed and floating interest rate obligations with each other.

Currency Options
Currency options are financial instruments that give the owner the right but not the obligation to buy or sell a specific foreign currency at a predetermined exchange rate. While a call option gives the holder the right to buy the currency at an agreed price, a put option gives him the right to sell it at an agreed price, irrespective of an unfavorable market price for the same.
By selling goods and services abroad (exporters)
When a currency depreciates, It gives benefit to exports because export companies will have more local currency in exchange of foreign currency. Few companies have got benefited by the sudden drop in to the rupee value as many companies has hedge against the currency and they have fixed it with dollar from Rs. 46 to 47. Sudden changes in the rupee position of the rupee do not really matter much.

Exporters these days resort to hedging against such risks (of volatility), Besides, the buyers overseas also renegotiate and push rates down.

The depreciating rupee will be positive for the Indian IT sector that generate more than 80-90 per cent of their $70 billion revenue from the overseas markets and this kind of appreciation in foreign currency will enhance their actual realization of revenue in dollar terms. Every one per cent change in rupee-dollar has an impact on the net profit of Indian IT companies, like TCS, Infosys, HCL to mention a few.
However companies are aware that in this situation the gain is short term in long term scenarios buyers seeks price adjustment. This will be more clear with below statements.
There can be a significant time gap in the middle of changes in the spot rate and the hedged rate. When the exchange rate is appreciating, this gap “buys time” for exporters, giving them the opportunity to implement productivity improvements, price adjustment or to change exporting strategies. On the other hand, when the exchange rate is falling, hedging delays the benefit of higher export returns, which may be much needed.
Hedging can have some impact on export earnings even over the medium term (2 to 3 years), providing some offset – albeit a limited offset – to the impact of exchange rate movements on earnings.
The hedged exchange rate is smoother than the spot rate in the short term; this reduces the variability in export earnings that arise from sudden exchange rate movements.
Overall the benefits from hedging for a firm are largely in terms of smoothing income, rather than producing net increases in income.
By purchasing machinery or equipment abroad (importers)
Importers also hedge themself for any increase exchange rupee dollar exchange rate. They want to keep them self-secure for the any deprecation in rupee value against dollar.
For example importer might use the forward contracting strategy to hedge himself or they just analyze the market and pay in advance if they accept that exchange rates are going to increase in future or later when they accept exchange rates are going to decrease in future.

By taking loan/debt in foreign currency
Big Indian companies and corporates has taken loan from foreign banks or investors for their needs as the interest rates of foreign investors or bankers is lower than the money available from Indian financial institutions.
Second reason for obtaining the finance from the foreign banks is the easy availability of money and requirement of foreign currency for the buying of foreign companies.
When the companies have took heavy loans earlier for their purchase of foreign companies at that time rupee was very strong from 39 to 45.
Now Dollar value has increased and this has impacted companies very badly there loan amount suddenly has increased and there takeover now looking very costly, Some Indian companies has got impacted very badly due to this.
Currently Indian companies who have taken loans from foreign banks are facing difficult times and they are using strategy of re-financing their loans. Companies has taken the loan for 3 to 5 years of term during 2007-2008 for their takeovers, and not exchange rate is moving around Rs. 55/$ and that is causing serious issue for the companies.

References: http://www.rbnz.govt.nz/research/bulletin/2002_2006/2004dec67_4briggs.pdf http://www.buzzle.com/articles/currency-hedging-for-importers.html http://www.buzzle.com/articles/hedging-currency-risk.html http://www.buzzle.com/articles/foreign-currency-hedging.html
http://www.straightforex.com/currency-hedging-for-companies/…...

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