Currency Hedging

The Balance of Payments in India mainly relies on services exports, remittances and the course capital flows, both foreign direct investments (FDI) and FII. It is very essential that all market participants, such as banks and other intermediaries be provided with the wherewithal so that they can undertake a risk management in a way that is scientific. One of the ways to access domestic, foreign exchange markets is to hedge on the underlying foreign exchange exposures. In addition, the facilities that are available as the booking of forward contracts were included in the domestic forex market in order to evolve and acquire volumes and depth (Sumanth, 2012). Some of the newer hedging instruments have put in place swaps and options in the

2.There are three different types of foreign exchange risk: transaction exposure, economic exposure, and translation exposure. Transaction exposure refers to the extent to which transactions are liable to be affected by the exchange rate at a given moment. Because of the constant fluctuations of the exchange rate, the profits garnered from a given transaction can be greatly affected. Economic exposure refers to the tendency that a change in exchange rate can have on a party's cash supply and earnings. This has similar consequences to those of transaction exposure, except that it is not directly related to a specific transaction. Translation exposure relates to the impact that changes in exchange rates can have on the financial statements of a country; they differ from the other types of foreign exchange risk in that they have less relation to transactions.

When an input (machinery, components, capital, labor, etc.) is denominated in a foreign currency, the risk exists that an unfavorable exchange rate movement will increase the cost of doing business. When the products are priced and sold in a foreign currency, an adverse exchange rate movement will make the product appear more expensive to consumers, decreasing demand or forcing the company to reduce its own profit margin to maintain lower price levels. For companies with integrated international business systems, an exchange rate shock can literally force them out of business, with their operations experiencing pressures from both cost and profit centers.

Mr. Brown readily admitted that he was not at ease discussing the most recent approaches to risk reduction or hedging. He had received his MBA from Harvard in the 1960s and had spent most of his career working for a company that had little international exposure. Moreover, he was not familiar with derivatives such as currency options, which until recently were not widely traded. However, Mr. Brown had recently hired an assistant, Mr. Dan Pross, who had some knowledge of hedging and derivatives. As a student at UCLA, Mr. Pross had traded various types of derivatives for his own portfolio and was familiar with how they were traded. Although Mr. Pross did not have a finance background, he was, in Mr. Brown’s opinion, extremely intelligent and highly capable. Mr. Brown suggested that Mr. Pross make a presentation to the senior management on the use of derivatives to reduce risk.

Financial hedging is the use of hedging instruments - typically FX forwards, options and swaps - that are sold by foreign exchange brokers and banks to reduce company exposure to currency fluctuations. (Export Development Canada, 2016) Acknowledging that foreign exchange risk is a real threat to corporate cash flows, assets and expenses can be one of the biggest hurdles for most companies. However, recognizing the importance of protecting assets companies can move forward in identifying the type and magnitude of the risk to implement strategies to mitigate them. The three most common types of foreign exchange risks are:

Aspen is a software company which was established in 1982. The company mainly provides simulation solutions to process manufacturing companies. The main industry which the company focuses on is chemical processing. The entire idea began with the project of Advanced System for Process Engineering in MIT in 1976. This project was than acquired by Lawrence Evans whom founded Aspen. In a very short amount of time Aspen became a major player in the simulation part of the software industry. The company started off as a privately owned firm but in 1995 turned into a publicly traded company with a capitalization of 200 million dollars. The leading product of Aspen is Aspen Plus; we have to note that 48 % of sales were stemming from

* Currency exposure is the extent to which the future cash flows of an enterprise, arising from domestic and foreign currency denominated transactions involving assets and liabilities, and generating revenues and expenses, are susceptible to variations in foreign currency exchange rates.

downside of using only forwards is that AIFS will not be able to experience any gains if the U.S.

3. Political instability/ Terrorist attacks (1986 terrorism acts, 1991 Gulf War, 2001 September 11 attacks, 2003 war in Iraq

Then, we took into consideration only a fluctuation of the exchange rate. The scenarios that we analyzed covers different positions of the dollar against the euro: weak dollar (USD 1,48/EUR), stable dollar (USD 1,22/EUR) and strong dollar (USD 1,01/EUR). Different coverage of costs with hedging was also introduced in the analysis. The three main policies are of not hedging, 100% hedging with forward contracts and 100% hedging with options.

Exchange rate has given both positive and negative impact towards foreign direct investment (FDI). If foreign direct investment (FDI) in that country is export substituting, the increase in exchange rate volatility between headquarters and the country that allow foreign direct investment (FDI) induce a multinational to serve the host country via a local production facility rather than exports, thereby insulating against currency risk. According to Osinubi (2009), direct investment in a country with a high degree of exchange rate volatility will have more risky of profits which indicates negative impact of exchange rate towards foreign direct investment

Hedging can be defined as a risk management mechanism or strategy which is used to prevent the chances of incurring losses which arise as a result of fall in prices commodities or currencies. It is a technique which is majorly used by the investors in protecting their capital against the effects of the economic situations such as inflation whereby the investors invests in the high yield financial instruments or take a position to cushion them against such effects (Investopedia, 2012).

Currency options is a contract which shows or grants right to buy or sell currencies at a date; however, it is not an obligation to buy or sell the currencies in order to hedge against negative changing in exchange rates. When the option is bought on an exchange, it is done on the over the counter market (OTC).

A hedge is a position to minimize unwanted risk or to manage operating and transaction exposure. The goal is to compensate the loss in value of one item with the increase in value of the offsetting item. There are different reasons for hedging a position; first of all, the price increase and the fluctuation of price are volatile. Secondly, every company should have a fixed calculation basis or price basis to plan a short and long-term horizon. If not every buyer of a company does not know how to deal with the budget. Furthermore, there are a lot of different possibilities to hedge a position, but the easiest way is hedging with complete specific financial vehicles. Without hedging is business nowadays impossible

Great Eastern Toys is a company in Hong Kong that exports a huge percent of its total sales to the North American and European markets and hence is exposed to currency risk. Previously, the company was occupied with expanding their business and the company 's management had never given much attention to currency risk until their recent meeting with their banker. The banker pointed out that the depreciation of the European currencies during the previous two years had resulted in a substantial loss of income. The company 's management was indeed convinced that they should begin to devote more time and manage their currency position. In this report, we are going to explore the different options for Great Eastern Toys to hedge