Analysis of foreign exchange exposure

ZENITH

International Journal of Multidisciplinary Research

Vol.1 Issue 5, September 2011, ISSN 2231 5780

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AN ANALYSIS OF FOREIGN EXCHANGE EXPOSURE MANAGEMENT

BY MNCs IN INDIA

DR. MANISHA GOEL*; PROF. S.L. GUPTA**; MR. LALIT GOEL***

*Associate Professor, YMCA University of Science & Technology, Faridabad, Haryana, India.

**Department of Management Studies, Kurukshetra University,

Kurukshetra, Haryana, India. ***Assistant General Manager, Mahavier Die Casters Pvt Ltd.,

Faridabad.

ABSTRACT

With globalization and liberalization being adopted by almost all countries, scope as well as

sphere of international business has become much larger. The high volatility of exchange rates is

a fact of life faced by every company engaged in international business, bringing in uncertainties

in their bottom line. In recent years, variations in value of rupee have been very impulsive and

unpredictable. These fluctuations have had a profound impact on domestic and foreign sales,

profit levels and profit margins of MNCs operating in India. Many of the companies have turned

into ashes as a result of unfavorable exchange rate fluctuations. The present study portrays a

thumbnail sketch of foreign exchange exposure management as practiced by various

multinational companies in India. Due to the international dependence of its economy, India is

extremely well suited as subject for this kind of study. This article is based on a questionnaire

study undertaken in 2004-2008 using a sample of 200 Indian and foreign MNCs operating in

India. The purpose of this study is to make a comparative analysis of management of foreign

exchange exposure by banking and non banking as well as foreign and Indian MNCs operating

in India. This study deals with various other questions such as what is their attitude towards

exposure management and their policy for management of foreign exchange exposure. Whether

or not there is a separate management system for management of their foreign exchange

exposure? The results of the study evidence that majority of firms face all of three foreign

exchange exposures; transaction exposure, translation exposure and economic exposure. More

over majority of the companies under study have proper exposure management system. There is

not so significant difference between attitude of foreign and Indian MNCs towards development

of separate management system to hedge their foreign exchange exposure. Most of the

companies who are aware of foreign exchange exposure make estimation of their exposure

despite their level of exposure. There is significant effect of objective of management on

estimation of exposure. Most of the companies under the present study are managing only their

transaction exposure. Few of them are managing both transaction as well as economic exposure.

There is no significant difference between attitude of Indian and Foreign companies towards

review of their exposure and hedging policy regularly.

KEYWORDS: Exchange Rate Fluctuations, Foreign Exchange Exposure, Economic Exposure,

Exposure Management, International Business, Transaction Exposure, Translation Exposure.

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INTRODUCTION

The turmoil in the global financial markets, the volatility of the foreign exchange rates and the

intensified global competition in the product and the resource market have complicated the

decision making process and have increased the level of uncertainty regarding the outcome of

international business activities. Undoubtedly, Indian economy has proven to be resilient to

substantial exchange rate fluctuations. Arguably, this resilience has strengthened over time, as

firms have learned to adapt to exchange rate variability, including through the development of

the hedging practices of financial institutions and non-financial firms. Changes in information

technologies have also increased the speed and the accuracy of information while the surge of

financial innovations is providing the decision makers with new hedging techniques to deal with

the uncertainty regarding financial flows.

The magnitude of foreign exchange exposure has increased at a mind boggling rate in the recent

times. Foreign exchange exposure is what is at risk of exchange rate variations. It is a measure of

sensitivity of firm’s cash flows of changes in exchange rate. This exchange rate risk may be

transaction exposure, translation exposure or economic exposure. Transaction exposure is

adverse movements of the exchange rate from the time foreign currency denominated

transactions are initiated till the time of their final settlement. The exposure arises due to

conversion of transactions from one currency into another currency. While buying or selling

products in any foreign currency, there is always a time gap between the dates of entering into a

contract and its final settlement. During this time gap, the business firm is exposed to exchange

rate fluctuations. These fluctuations may be favorable as well as unfavorable. The unfavorable

fluctuations may turn a profitable deal unprofitable by the time of actual settlement of contracts;

the longer the gap between the signing of a contract and its completion, the higher the level of

exchange rate risks. Businesses that source their products from foreign countries also face the

exchange rate risk. The exchange rate movements erode gross margins if competition prevents

selling prices from rising in tandem.

Translation exposure arises from the need to "translate" foreign currency assets or liabilities into

the home currency for the purpose of finalizing the accounts for any given period. Multinational

corporations having operations in many countries have to prepare their consolidated financial

statements to have a complete knowledge of result of all their business operations. Usually,

foreign subsidiaries prepare their accounting records and financial statements in the currency of

the country where they operate. For this, it is necessary to translate foreign currency

denominated accounts of subsidiary companies into the currency of parent company. But the

currency fluctuations can create currency gains or losses from such translations. Economic

exposure reflects the extent to which the present value of future cash flows is affected by

exchange rate movements. A change in the rate affects the company's competitive position in the

market and hence indirectly the bottom-line that it affects the profitability over a longer time

span than transaction and even translation exposure. It has neither time limit nor a defined

direction of movement. It is simple to spot the influence of the expected change in exchange

rates on forecasted sales volumes.

The foreign exchange exposures emanating from unexpected corner have a definite impact on

the company. Tackling these exposures is the biggest challenge that companies face today. It

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requires a broad based proactive risk management approach at the strategic level. Unmanaged

foreign exchange exposure can cause significant fluctuations in the earnings and the market

value of the 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. It is more advisable to bear certain costs rather than giving chance to

uncertainties to cause disproportionately high costs to the firm. Foreign exchange exposure not

only affects firm’s financial position but also its competitive position in the market and value of

firm, if ignored it can paralyze the financial position of the company.

Success of a business firm largely depends on how effectively it manages foreign exchange risk.

Foreign exchange exposure management is a multi-staged process that begins with the

identification of foreign exchange exposure. Foreign exchange exposure is then monitored,

quantified and corrected on a daily or weekly basis to ensure that the risk profile of the firm

remains aligned with the objectives of foreign exchange exposure management. They must

regularly enter into hedging strategies that minimize the impact of exchange rate fluctuations on

their operating costs. Hedging refers to a strategy that strives to minimize the risk of exchange

rate fluctuations, thereby minimizing the uncertainty of future transactions denominated in a

foreign currency and providing some stability to earnings and cash flows. The task of managing

these risks has been facilitated by the increasing availability of a variety of instruments to

transfer financial price risks to other parties. This may be one of the reasons that the market for

derivative instruments has grown at a breathtaking pace in the past few decades in India. Foreign

exchange exposure management can not eliminate foreign exchange exposure completely. But

the planned course of action brings risk to manageable level.

2. LITERATURE REVIEW

Foreign exchange exposure is very crucial now a days as cross border trade is increasing day by

day at a very fast pace. But it is also regarded as very complex. One possible reason for the

absence of empirical evidence in the literature may be related to the difficulty in devising the

appropriate measures of a firm’s ability to construct its hedging strategies. There is a dearth of

good literature on this subject, especially in India. Some of the studies identified in this area are

as follow;

Bengt Pramborg, in this study, “Foreign Exchange Risk Management by Swedish and Korean

Non Financial Firms: A Comparative Survey”, 2002, makes a comparison of hedging practices

of Swedish and Korean Firms. The evidence suggests that Korean firms are more concerned

about fluctuations in their cash flows whereas Swedish firms focus on accounting numbers.

Derivatives usage is more popular for hedging among Swedish firms as compared to Korean

firms. It may be a result of relative immaturity of Korean derivative markets. In both of the

countries, majority of firms use a profit based approach to evaluate any risk management

strategy. The study depicts that the decision to hedge foreign exchange exposure is driven by the

level of exposure and size of a firm.

Bradford Cornell and Alan C. Shapiro, in their article, “Managing Foreign Exchange Risks”,

provide step by step guidance for the formulation of an effective strategy for managing currency

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risk. First step is to determine the extent of its exposure to currency risk. Second step is to

identify the objectives of its exchange risk management program. Third step is to design a set of

companywide policies to achieve its objectives. It is observed that the changes in security prices

generally reflect changes in cash flows rather than reported earnings. Currency risk affects all the

facets of a company’ operations and therefore, should not be the concern of financial managers

alone. Operating managers should develop marketing and production initiatives that help to

ensure profitability over the long run. It also pointed out the alarming need for the creation of a

committee including senior officers and top functional executives in order to adopt an integrated

approach for managing foreign currency exposure.

Chand Sooran, in his article, “What is hedging? Why do companies hedge?” presents his views

on hedging of exposures. This article will give a brief overview of the different ways in which

firms approach their financial price risk. They also introduce the rationale for using derivative

products. Companies attempt to hedge the price changes because these risks are peripheral to the

central business in which they operate. Another reason for hedging the exposure of the firm to its

financial price risk is to improve or maintain the competitiveness of the firm. In this article, he

points out that hedging objectives vary widely from firm to firm. The core problem when

deciding upon a hedging policy is to strike a balance between uncertainty and the risk of

opportunity loss.

Chris Becker and Daniel Fabbro, in their paper, “Limiting Foreign Exchange Exposure Through

Hedging: The Australian Experience, 2006-09, examine foreign exchange hedging of direct

balance sheet and transaction exposures and assesses their broader implications for the

Australian economy. This study makes use of quantitative results of Australian Bureau of

Statistics (ABS) surveys in 2001 and 2005 for comprehensive data on foreign currency

exposures and hedging practices. This paper examines the available evidence on the nature and

extent of this hedging behavior. In this paper, they show that foreign currency-denominated

assets exceed foreign currency-denominated liabilities, even before accounting for hedging,

thereby conferring a transfer of wealth from the rest of the world to Australian residents in the

event of exchange rate depreciation. Furthermore, overseas demand for Australian Dollar assets

has allowed Australian residents to further hedge their net foreign currency exposures back into

local currency terms through the use of derivatives, insulating the economy against the wide

fluctuations that can be observed in the exchange rate. They have also observed that despite wide

swings in the Australian Dollar, the economy and, specifically, the banking sector, have proved

resilient to variability in the nominal exchange rate.

DAO Van Quynh, writes an essay on “Hedging Foreign Exchange Exposures in a Multi-National

Computer Peripheral Manufacturing Business”, 2004-2005. In this essay, he has discussed

various methods and procedures that a MNC can use to hedge its cash flows and investments

against foreign exchange risk through an example of an unreal MNC – ABC Inc. As MNCs have

subsidiaries located in different countries and products sold to different countries, they bear

heavily the risk of exchange rate changes. However, like domestic firms, MNCs also expose to

other risks that are not less importance than foreign exchange one, for example, interest rate or

commodity prices exposures. These exposures can also be hedged using various kinds of

financial derivatives such as swap, forward contract and option contract.

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David A. Carter, Christos Pantzalis and Betty J. Simkins, in a study, “Asymmetric Exposure to

Foreign – Exchange Risk: Financial and Real option Hedges Implemented by U.S. Multinational

Corporations”, 2003, argue that exchange risk exposure and hedging are endogenous. The study

proves that the magnitude of foreign exchange exposure affects the hedging decisions of the firm

and in turn hedging decisions affect the firm’s exposure to fluctuations in exchange rates. It

demonstrates that operational hedges and financial hedges can effectively reduce foreign

currency exposure. The real option aspect of multi-nationality allows the firm to utilize its

network structure to increase exposure to favorable currency movements and minimize exposure

to unfavorable currency movements.

Ian H. Giddy and Gunter Dufey, in their article “The Management of Foreign Exchange risk”,

explore the impact of currency fluctuations on cash flows, on assets and liabilities and on the real

business of the firm. It is demonstrated that there are numerous realistic situations where the

economic effects of exchange rate changes differ from those predicted by the various measures

of translation exposure. It emphasizes the distinctions between the currency of location, the

currency of denomination and the currency of determination of a business. It suggests some basic

principles for managing foreign exchange risk.

Sohnke Bartram, in his paper presents the results of his comprehensive study of the foreign

exchange rate exposure of 447 German non-financial corporation during the period of 1981-95.

The empirical evidence indicates that the firms with more international sales exhibit

systematically larger and more significant foreign exchange rate exposures. In addition, firm

liquidity variables, especially cash flow/total assets, are significantly negatively related to the

exposure. Moreover, industry sectors are important determinants of the foreign exchange rate

exposure. As the choice of hedging tools is determined by the exposure profile, nonlinear foreign

exchange rate exposures suggest the use of hedging instruments with nonlinear payoff profiles

such as financial and/or real options.

3. SIGNIFICANCE OF STUDY:

It has been well documented that the vast size of daily foreign exchange trading, combined with

the global interdependencies of the foreign exchange market and payment systems involves risks

stemming from exchange rate fluctuations. Continuous fluctuations in exchange rate impose

threats for international business. As a result of change in exchange rate, importers may require

to pay extra for their imports, exporters may get lesser value for their exports, borrowers may

required to pay extra and lenders may recover also possible that a viable foreign investment

project may twin into a exchange rate fluctuations. Moreover the financial position and

profitability of a foreign subsidiary may also change. Large scale fluctuations can even bring

dramatic changes in the competitive structure of markets which may even cause some companies

to be driven out of the market. It results in too many questions; whether or not companies in

Indian, are seriously managing their foreign exchange exposure? If not, what is the reason? All

of these questions are required to be answered which initiate this research work.

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4. OBJECTIVES OF STUDY

While the risk management strategy of non-financial firms has been the subject of intense

theoretical and empirical research, very little is known about the actual hedging practices of

multinational firms. This article includes the study of existence of various types of foreign

exchange exposures in MNCs operating in India. Transaction exposure arises at the actual

conversions of unsettled contracted cash flows from one currency to another at the time of their

final settlement. Translation exposure is the result of translation of foreign currency assets or

liabilities into the home currency for the purpose of finalizing the financial statements. Economic

exposure is the adverse effect of exchange rate movements on the present value of expected

future cash flows. It also brings into light various factors affecting foreign exchange exposure

management by the companies. The present study examines the available evidence on the nature

and extent of hedging behavior of companies in India. The focal point of the study is

identification, measurement and management of foreign exchange exposure in selected corporate

sector units in India. Other objectives of the study have been to determine the factors which are

of special importance while managing foreign exchange exposure, examine the facilities

available for managing foreign exchange exposure in India, investigate and verify the techniques

used for managing foreign exchange exposure by corporate units in India.

5. HYPOTHESIS

In this research the following hypothesis have been tested;

1. 20 % of companies do not manage their exposure.

2. Management system of companies does not depend on consideration for effect of

fluctuations and objective of exposure management.

3. Only 40 % of companies managing exposure follow the policy of active management.

4. There is no significant effect of objective of management, management system and

management policy on decision of estimation of exposure.

5. There is no significant effect of origin of company on periodicity of review of their

exposure & hedging policies.

6. There is no significant effect of objective, management system and management policy

on periodicity of review of their exposure and management policies.

6. RESEARCH METHODOLOGY

Using a field study and proprietary data, it unfolds the difference between attitude of various

banking and non banking Indian and foreign MNCs engaged in international business in India

towards management of their various foreign exchange exposures. The results presented in this

study are based on a questionnaire study undertaken in 2004-2008. As such the aim is not to

create a large sample selected randomly but to create a sample of information rich cases selected

purposefully. The sample is composed of 200 companies out of fortune 500 companies which

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were ranked on the basis of their sales during the financial year from 1st Jan to 31

st December

2003, as published in Economic Times in May 2004. Out of 200 companies, 95 companies

responded back to the questionnaire.

All companies are heavily internationally oriented as significant proportion of their turnover

originates from foreign markets as per their published accounts. The selected companies cover a

broad specter of players of various sectors such as automobiles, pharmaceuticals, oil, cement,

FMCG, chemicals, steel, IT, textile, nuts, consumer durables, electricity & energy, banking,

paper & paper products and miscellaneous. Management policies for managing foreign exchange

exposure have been divided into mainly three groups; Active management, Regular management

and no management. Three point scales has been used for this purpose. Number 3 has been used

for active management, 2 for regular management and 1 for no management of foreign exchange

exposure. A scale of 1 to 5 has been used to analyze results. Significance was discussed on 5 %

level in all tests used for hypothesis testing. Z test and ANOVA have been applied to test

hypothesis and interpret the results. Graphs and tables have also been used to facilitate the

analysis of data.

7. RESULT & DISCUSSION

On the basis of the study of management of foreign exchange exposure by MNCs in India, the

followings are the findings of the study;

7.1 EXISTENCE OF VARIOUS FOREIGN EXCHANGE EXPOSURES

The speed of international business activities has magnified the impact of variable exchange

rates on every business. MNCs have to face different types of foreign exchange exposures such

as transaction exposure, economic exposure and translation exposure. The results for existence of

various exposures are depicted in table 1 and chart 1.

TABLE 1 EXISTENCE OF VARIOUS FOREIGN EXCHANGE EXPOSURES

S. No. Type of Exposure Total

1 Both Transaction & Economic Exposure 22

2 All Three Exposures 73

3 No Exposure 0

Total 95

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CHART 1 EXISTENCE OF VARIOUS FOREIGN EXCHANGE EXPOSURES

Both Transaction & Economic Exposure

23%

All Three Exposures77%

Results of the study confirm the general view that the majority of the companies (approx. 77%

companies) face all of three exposures; transaction, economic and translation exposure. Even the

companies which do not have any foreign subsidiary are also facing translation exposure because

of their foreign currency assets and liabilities. There is not even a single company under study

which has been left untouched by any of these exposures.

7.2 COMPARISON OF ATTITUDE TOWARDS MANAGEMENT OF FOREIGN

EXCHANGE EXPOSURE OF BANKING AND NON BANKING COMPANIES

Usually it is observed that companies in India do not manage their exposure. On the basis of this

general observation, null hypothesis has been formulated and tested with the help of z test. A

comparison has also been made between banking and non-banking companies. The results of

comparison are depicted in table 2 and chart 2.

NULL HYPOTHESIS: 20 % of companies do not manage their exposure.

TABLE 2 & CHART 2

ATTITUDE TOWARDS MANAGEMENT OF FOREIGN EXCHANGE EXPOSURE

Companies Facing Exposure Manage Do not Manage Total

Non Banking Companies 76 7 83

Banking Companies 12 0 12

Total 88 7 95

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Manage Exposure

93%

Do not Manage Exposure

7%

RESULT OF Z TEST

Ho: = 0. 20 Sample

p = 7 / 95

P = 0.073 Z

= - 3.094

Results of Z test show that the computed value of z lies outside the acceptance region as

compared to the critical value of z = + 1.96 at 5 % level of significance, therefore, null

hypothesis is rejected. Hence, based on this data the hypothesis that 20 % of companies do not

manage their exposure is rejected. Graph depicts that most of the companies which identify the

effect of exchange rate fluctuations (approx. 93 % companies as shown in table 2) accept the

need of management of their foreign exchange exposure. Comparative study of banking and non-

banking companies shows that all of the banking companies accept the need for managing their

foreign exchange exposure as in India; it has been made mandatory by RBI for all the banks

dealing in foreign exchange in India. Only 7 % of companies (non-banking companies) which do

not accept even the effect of foreign exchange exposure do not realize any need for managing

their exposure.

7.3 OBJECTIVES FOR FOREIGN EXCHANGE EXPOSURE MANAGEMENT

Different companies have different objectives for their foreign exchange exposure management.

The results showing various objectives of MNCs under the present study are presented in table 3.

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TABLE 3 OBJECTIVES OF EXPOSURE MANAGEMENT

Objective Responses Objective Respondents

Eliminate All Risk 31 Actively Seek Profits 3

Eliminate Risk Selectively 27 Improving Ability to Make Value

Adding Investments

3

Minimizing Net Foreign

Exchange Exposure

10 Reducing Stakeholders Perceived

Risk

4

Stabilization Purpose 5 Seek Competitive Advantages 2 Allow Profits 3

Results of the study do not comply with general view about companies in India. It shows that 35

% companies have proper management system in order to eliminate all of their exposure. 31 %

of the companies try to eliminate their risk selectively whereas 11 % of companies wish to

minimize their risk. Some of the companies follow the policy of stabilization. Only few of the

respondent companies have the other objectives in their mind.

7.4 COMPARISON OF INDIAN AND FOREIGN COMPANIES REGARDING

DEVELOPMENT OF SEPARATE EXPOSURE MANAGEMENT SYSTEM

Firm should take foreign exchange exposure management as a system which provides strategies,

techniques and an approach to recognizing and confronting any threat faced by a firm due to

exchange rate fluctuations. A proper foreign exchange exposure management policy is required

to be framed. The difference between attitude of Indian and foreign companies has been depicted

in table 4 and chart 4.

TABLE 4 & CHART 4 EXISTENCE OF SEPARATE EXPOSURE MANAGEMENT

SYSTEM

Origin of Company

Existence of Management System

Total

Yes No

Indian 56 26 82

Foreign 9 4 13

Total 65 30 95

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0%

20%

40%

60%

80%

100%

Indian

ForeignNo yes

Results of the study do not comply with general observation. It has been observed that there is no

significant difference between Indian and foreign companies regarding their attitude towards

development of management system to hedge their foreign exchange exposure.

7.5 FACTORS AFFECTING ESTABLISHMENT OF SEPARATE MANAGEMENT

SYSTEM FOR FOREIGN EXCHANGE EXPOSURE MANAGEMENT

Whether or not any company will establish a separate management system for management of its

foreign exchange exposure, it depends on many factors. But in this study two factors are

considered to be more important for this purpose. First foremost factor is the identification of

effect of exchange rate variations on the company. Those companies which do not agree that

such kind of variations in exchange rate can adversely affect their business; they will never

establish any system for its management. Another factor is the objective of exposure

management policy of the company. Any company who is willing to minimize or mitigate

exposure by applying various strategies will definitely have separate system for its management.

To study the dependence of management system of companies on these two factors, ANOVA

techniques has been applied where management system is the dependent variable and effect of

fluctuations and objective of exposure management are independent variables. The results are

depicted in table 5.

NULL HYPOTHESIS: Management system of companies does not depend on consideration

for effect of fluctuations and objective of exposure management.

Yes

32%

68%

31%

69%

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TABLE 5

FACTORS AFFECTING ESTABLISHMENT OF SEPARATE MANAGEMENT

SYSTEM FOR FOREIGN EXCHANGE EXPOSURE MANAGEMENT

Source Type III Sum of

Squares df Mean

Square F Sig.

Corrected Model 11.352(a) 2 5.676 54.782 .000

Intercept .419 1 .419 4.044 .047

Effect of Fluctuations .179 1 .179 1.729 .192

Objective of Exposure

Management 7.922 1 7.922 76.462 .000

Error 9.532 92 .104

Total 287.000 95 Corrected Total 20.884 94

a R Squared = .544 (Adjusted R Squared = .534)

The results of ANOVA show that at 5 % level of significance, objective of exposure

management affects significantly the management system of companies. It also shows that

management system of companies does not depend so much on their consideration for effect of

exchange rate fluctuations.

7.6 MANAGEMENT POLICIES OF COMPANIES

MNCs in India follow different management policies for management of their foreign exchange

exposure. There are mainly three policies; no management, regular management and active

management. It is usually stated that most of the companies ignore their foreign exchange

exposure. On the basis of general observation, hypothesis regarding the behavior of companies in

India has been formulated and tested with the help of Z Test. The results are depicted in table 6

and chart 5.

NULL HYPOTHESIS: Only 40 % of companies managing exposure follow the policy of active

management.

TABLE 6 & CHART 5

MANAGEMENT POLICIES OF COMPANIES

Management Policies of Companies Responses

Do not Manage 7

Actively Manage 55

Regularly Manage 33

Total 95

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Actively Manage

58%

Regularly Manage

35%

Do Not Manage

7%

RESULT OF Z TEST

Ho: = 0. 40

Sample p = 55 / 88 P

= 0.625 Z

= 4.31

Results of Z test show that the computed value of z is beyond the acceptance region of the

critical value of z = + 1.96 at 5 % level of significance, therefore, null hypothesis is rejected.

Hence, based on this data the hypothesis that only 40 % of companies actively manage their

exposure is not true. Graph shows that majority of companies under study are managing their

foreign exchange exposure. The results depict that 35 % of companies manage their exposure

regularly whereas 58 % companies are actively managing their exposure.

7.7 ESTIMATION OF FOREIGN EXCHANGE EXPOSURE

Foreign exchange exposure management is not possible without accurate estimation of exposure.

Estimation of foreign exchange exposure requires expertise in applying various forecasting and

statistical tools such as VaR, regression, simulation etc. Not all the companies make estimation

of their foreign exchange exposure. Usually it has also been observed that foreign companies

possess expertise to make estimations whereas Indian companies do not indulge in such tedious

activities. The results showing attitude of companies towards estimation of their foreign

exchange exposure are depicted in table 7. Whether or not any company will make estimation of

their exposure also depends on many other factors. In this study hypothesis has been formulated

to judge the effect of objective, management system and management policy on estimation of

their exposure. The hypothesis has been tested with the help of ANOVA technique where

estimation of exposure is dependent variable and effect of fluctuations and effect of objective,

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management system and management policy are independent variables. The results of the test are


TABLE 7 & CHART 6 ESTIMATION OF FOREIGN EXCHANGE EXPOSURE

0%

20%

40%

60%

80%

100%

Indian

Foreign

No yes

Results show that most of the companies who are aware of foreign exchange exposure make

estimation of their exposure. It denies the general view that Indian companies do not estimate

their exposure. Indian companies also estimate their foreign exchange exposure despite their

Origin of Company

Estimation of Exposure

Total

Yes No

Indian 76 6 82

Foreign 12 1 13

Total 88 7 95

7%

93%

8%

92%

E

S

T

I

M

A

T

I

O

N

ORIGIN

7%

93%

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level of exposure. It has also been observed that majority of companies rely on expectations of

foreign exchange market for measurement of their foreign exchange exposure. Some of the

companies also consider major indicators such as exchange controls, import restrictions, interest

rates and inflation rate while making the analysis of fluctuations in foreign exchange rate.

NULL HYPOTHESIS: There is no significant effect of objective of management, management

system and management policy on decision of estimation of exposure.

TABLE 8 EFFECT OF VARIOUS FACTORS ON DECISION OF

ESTIMATION OF FOREIGN EXCHANGE EXPOSURE


Squares

df Mean

Square

F Sig. Corrected Model 11.523(a) 3 3.841 33.904 .000 Intercept 1.584 1 1.584 13.983 .000

Management System .012 1 .012 .106 .746 Objective 4.542 1 4.542 40.089 .000 Management Policy .094 1 .094 .832 .364 Error 10.309 91 .113

Total 197.000 95 Corrected Total 21.832 94 a R Squared = .528 (Adjusted R Squared = .512)

The results of ANOVA show that at 5 % level of significance, there is significant effect of

objective of management on estimation of exposure. But the effect of management system and

management policy on estimation of exposure is not so significant.

7.8 REASONS FORCING EXPOSURE MANAGEMENT

Foreign exchange exposure, if ignored, can put survival of any company in danger any moment

which may result in huge losses of financial distress. Moreover it has always been arduous to

harmonize investment and financing activities of the company which usually pose the problem of

currency, amount or timing disparity of cash flows. Managers and shareholders of the company

have different interest. Shareholders are more interested in market value of the firm where as

mangers pay more attention towards profits. It may result in agency conflicts about the decision

of management of foreign exchange exposure. Convexity of tax functions also poses threat to

the companies. Usually it is observed that companies consider the question of hedging foreign

exchange exposure as a critical activity as they wish to evade the loss of financial distress. The

results of the study showing the reasons for which companies in India management their foreign

exchange exposure are depicted in table 9 and chart 7.

TABLE 9

REASONS FORCING EXPOSURE MANAGEMENT

Reasons Forcing Exposure Management Responses % age

Costs of Financial Distress 60 63

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Problems of Synchronizing Investments & Financing Activities 40 42

Costs of External Funding 45 47

Agency Conflicts Between Managers and Shareholders 20 21

Convexity of Tax Function 22 23

Costs of Financial

DistressProblem of

Costs of External

Funding

Agency conflicts

of tax

Synchronization

Convexity

Results of the study match with general statements. It shows that most of the companies in India

are worried about the costs of financial distress. Problems of synchronizing investments and

financing activities also force them to take care of their foreign exchange exposure. Few of the

companies consider the force of cost of external funding, agency conflicts and convexity of taxes

while considering the issue of management of their foreign exchange exposure.

7.9 MANAGEMENT OF VARIOUS EXPOSURES

Though everyone knows that unmanaged foreign exchange exposure can cause significant

fluctuations in the earnings and the market value of the firm yet it is also argued that hedging is

not so simple exercise. In fact, risk management, essentially, is a strategic function. It requires

specialized skills. It has been observed that companies have different attitude towards

management of their various foreign exchange exposures. This study makes a comparison

between attitude of banking and non-banking companies towards their various foreign exchange

exposures. The results are depicted in table 10 and chart 8.

TABLE 10 MANAGEMENT OF VARIOUS EXPOSURES

Type of Exposure Non Banking Companies Banking Companies Total

Only Transaction Exposure 48 0 48

All Three Exposures 20 11 31

Both Transaction & Economic Exposure 7 1 8

Only Economic Exposure 1 0 1

No Hedging 7 0 7

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Total 83 12 95

CHART 8 MANAGEMENT OF VARIOUS EXPOSURES

The results of the study confirm the general observation. It shows though 77% of companies

under study face all of three exposures; transaction, economic and translation exposure yet only

24 % of companies are managing all of their exposures. Most of the companies (approx. 60 %)

are managing only their transaction exposure. 8 % of companies are managing their transaction

and economic exposure. Only 7 % of companies (non-banking companies) which do not accept

even the effect of foreign exchange exposure do not manage their exposure.

7.10 FACTORS OF CONSIDERATION FOR EXPOSURE MANAGEMENT

There are many factors which should be duly taken care of while considering any decision of

foreign exchange exposure management. The results of the study show that most of the

companies are worried about few of the factors like inflow-outflow mismatches, timing

mismatches, benefits of hedge and contracted foreign currency cash flows etc. They are not so

serious about many of the other crucial factors such as degree of foreign involvement by foreign

subsidiaries, variability of expected future cash flows, location of subsidiaries, their accounting

methods, elasticity of demand of their inputs and out puts, strategies of its competitors and

flexibility of their production processes etc. which if duly taken care of, may be prove to be boon

for the company in case of adversities.

7.11 NUMBER OF TECHNIQUES USED FOR EXPOSURE MANAGEMENT

Generally it is observed that companies in India do not manage their foreign exchange exposure

as actively as they do not take it so seriously. Moreover, not many options are available to for

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hedging exposure completely. Companies use few of techniques for hedging their exposure. No.

of techniques used for exposure management has been treated as an indicator of their seriousness

towards exposure management. The results are depicted in table 11 and chart 9.

TABLE 11 & CHART 9 NUMBER OF TECHNIQUES USED FOR EXPOSURE

MANAGEMENT

7%

54%16%

5% 14%4%

Do not Hedge Use 1 Technique Use 2 Techniques Use 3 Techniques Use 4 Techniques Use 5 Techniques

RESULTS OF STATISTICAL ANALYSIS

Mean = 1.778947368

Median & Mode = 1

Standard Deviation = 0.46588033

No. of Techniques Responses

0 7

1 51

2 15

3 5

4 13

5 4

More Than 5 0

Total 95

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Skewness = 1.671980549

Statistical analysis shows that frequency of companies using only one technique is highest.

Graph depicts that 54 % of companies are using only one technique to manage their exposure. 16

% of companies use two techniques. Very few companies use more than two techniques. 5 % of

companies are using three techniques. 14 % of companies are more serious about their exposure

management and use four techniques for hedging their exposure. Whereas only 4 % of

companies apply 5 or more than 5 techniques as they make their best efforts to eliminate

exposure completely.

7.12 COMPARISON OF ATTITUDE OF INDIAN & FOREIGN COMPANIES

TOWARDS REVIEW OF EXPOSURE / HEDGING POLICIES

Success of exposure management requires not only establishment of exposure management

system or applying various hedging strategies. There should be periodic reporting and evaluation

of effectiveness of those hedging policies. System should be developed to smell out danger at the

earliest stage and quicker decision making to handle it. Having a foreign exchange exposure

management system in place will not protect a firm or enhance its performance unless it is

embedded in a risk aware corporate culture. Moreover constant eye on market fluctuations and

exposure is also essential. On one hand, some of the companies do not pay attention for review

of their exposure and hedging policies on the other hand; some of the companies have the system

of daily review. Some of the companies even follow the policy of weekly, monthly or quarterly

review system. Usually it is observed that foreign companies take exposure management very

seriously and they develop systematic periodic review system for regular evaluation of

effectiveness of their hedges whereas Indian companies are no so serious about review and

evaluation. To study the difference in attitude of Indian and foreign companies towards

periodicity of review of exposure and hedging policies, hypothesis has been formulated. The

hypothesis has been tested with the help of ANOVA where periodicity of review is the

dependent variable and origin of company (Indian or Foreign) is independent variable. The

results of comparison are depicted in table 12 and table 13.

NULL HYPOTHESIS: There is no significant effect of origin of company on periodicity of

review of their exposure & hedging policies.

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TABLE 12 COMPARISON OF ATTITUDE OF INDIAN & FOREIGN COMPANIES


Origin of

Company

Periodicity of Review No

Review Total

Daily/

weekly Monthly Quarterly Yearly

Indian 45 27 4 4 7 82

Foreign 6 3 2 1 1 13

Total 51 30 6 4 7 95

TABLE 13 COMPARISON OF ATTITUDE OF INDIAN & FOREIGN COMPANIES


Source Type III Sum

of Squares

df Mean Square F Sig.

Corrected Model .310(a) 1 .310 .875 .352

Intercept 35.527 1 35.527 100.344 .000

Origin of Company .310 1 .310 .875 .352

Error 28.678 81 .354

Total 357.000 83

Corrected Total 28.988 82

a R Squared = .011 (Adjusted R Squared = -.002)

Graph shows that there is both Indian and foreign companies have similar attitude for review of

their exposure and hedging policies. Most of the Indian as well as Foreign companies review

their exposure and hedging policy on regular basis. ANOVA table shows that at 5 % level of

significance, null hypothesis is accepted. So, there is no significant difference between Indian

and foreign companies regarding their periodicity of review of their exposure and hedging

policies.

7.13 FACTORS AFFECTING ATTITUDE OF COMPANIES TOWARDS REVIEW OF

EXPOSURE / HEDGING POLICIES

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The attitude of any company towards periodicity of review of their exposure and hedging

policies depends on many factors. In this article, to study the effect of objective, management

system and management policy on periodicity of review of their exposure and hedging policies

hypothesis has been formulated. ANOVA has been applied to test the hypothesis where

periodicity of review is dependent variable and effect of fluctuations and effect of objective,

management system and management policy are independent variables. The results of the test are


NULL HYPOTHESIS: There is no significant effect of objective, management system and

management policy on periodicity of review of their exposure and management policies.

TABLE 14 FACTORS AFFECTING ATTITUDE OF COMPANIES TOWARDS

REVIEW OF EXPOSURE / HEDGING POLICIES


Squares df Mean Square F Sig.

Corrected Model 26.665(a) 3 8.888 112.864 .000

Intercept 3.693 1 3.693 46.899 .000

Objective 10.932 1 10.932 138.813 .000

Management System .001 1 .001 .016 .899

Management Policy .145 1 .145 1.835 .179

Error 7.167 91 .079

Total 430.000 95

Corrected Total 33.832 94

a R Squared = .788 (Adjusted R Squared = .781)

Since value of p is 0.899 for management system and 0.179 for management policy which is

higher than 0.05 (5 % level), management system and management policy do not have any

significant effect on periodicity of review of their exposure and hedging policies. But objective

of exposure management have significant effect on periodicity of review.

8. CONCLUSION

Majority of the companies face all of three exposures; transaction, economic and translation

exposure. Even the companies which do not have any foreign subsidiary are also facing

translation exposure because of their foreign currency assets and liabilities. Comparative study

shows that as most of the banking companies have spread their wings in international market, no

banking company under the study has been escaped of foreign exchange exposure. Only those

non banking companies which have neither any foreign subsidiary nor any foreign currency

denominated asset or liability are not facing translation exposure. There is not even a single

company under study which has been left untouched by any of these exposures.

All of the banking companies accept the need for managing their foreign exchange exposure as

in India; it has been made mandatory by RBI for all the banks dealing in foreign exchange in

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India. Few of the non-banking companies do not accept even the effect of foreign exchange

exposure do not realize any need for managing their exposure. Majority of the companies have

proper management system in order to eliminate all of their exposure. Some of the companies try

to eliminate their risk selectively whereas some of them also try actively to seek profits or

competitive advantages. Few of them follow the policy of stabilization. Companies also consider

other objectives such as to reduce stake holder’s perceived risk, to improve their ability of

investments and to minimize their risk. Both foreign and Indian MNCs have similar attitude

towards development of separate management system to hedge their foreign exchange exposure.

The results also show that management system of companies does not depend so much on their

consideration for effect of exchange rate fluctuations.

Most of the companies who are aware of foreign exchange exposure make estimation of their

exposure. Both Indian and foreign companies estimate their foreign exchange exposure despite

their level of exposure. There is significant effect of objective of management on estimation of

exposure. But the decision of estimation of exposure is not so much affected with existence of

separate management system and management policy of the company. Most of the companies in

India are worried about the costs of financial distress. Problems of synchronizing investments

and financing activities also force them to take care of their foreign exchange exposure. Few of

the companies consider the force of cost of external funding, agency conflicts and convexity of

taxes while considering the issue of management of their foreign exchange exposure. Majority of

companies under study are actively managing their foreign exchange exposure. Though most of

the companies suffer from all of the exposures; transaction, economic and translation exposure

yet only few of them are managing all of their exposures. Most of them are managing only their

transaction exposure. Few of them are managing both transaction as well as economic exposure.

Majority of the companies are using only one technique to manage their exposure. Very few

companies are taking help of two or more than two techniques. These include those companies,

which make their best efforts to eliminate exposure completely. Both Indian and foreign

companies have similar attitude for review of their exposure and hedging policies. Most of the

Indian as well as Foreign companies review their exposure and hedging policy on regular basis.

Management system and management policy do not have any significant effect on periodicity of

review of their exposure and hedging policies. But periodicity of review is significantly affected

by objective of exposure management.

9. BIBLIOGAPHY

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