Parvesh Aghi

FOREIGN EXCHANGE EXPOSURE

AND RISK MANAGEMENT

CA Parvesh Aghi
FOREIGN EXCHANGE EXPOSURE AND
RISK MANAGEMENT

The values of major

Foreign exchange (FX) currencies constantly
risk is an intrinsic part of fluctuate against each
doing international other, creating income
business. uncertainty for your
business.
FOREIGN EXCHANGE EXPOSURE AND
RISK MANAGEMENT

Many businesses like

But some businesses
to eliminate this
regard exchange rate
uncertainty by locking
movements as a profit
in future exchange
opportunity.
rates.
FOREIGN EXCHANGE EXPOSURE AND RISK
MANAGEMENT

The simplest risk But your cash flow risk can

management strategy for increase if customers with
reducing foreign exchange different native currencies
risk is to make and receive time their payments to take
payments only in your own advantage of exchange rate
currency. fluctuations.
FOREIGN EXCHANGE EXPOSURE AND RISK
MANAGEMENT

You might also lose customers So you may therefore find that
to competitors who offer more competitive pressures force
currency flexibility and your you to explore a risk
suppliers may be unwilling to management strategy that
accept payments in what is to helps manage your foreign
them a foreign currency exchange risk more efficiently.
CAGR = 4%
HEDGING CURRENCY
RISK

11
Hedging Foreign Exchange Risk

Simple FX hedging involving

currency forward contracts is
Currency forward contracts
the heart of FX risk
"lock in" the exchange rate of
management strategies for
a future payment in a foreign
many businesses and is built
currency. 
into their FX international
payments platforms.
Hedging Foreign Exchange Risk
But if the exchange rate
Payment of $10,00,000 is
Suppose you are an Indian moves to Rs 78, your
due in one year, which at an
importer of American inventory cost in INR will
INR/USD exchange rate of
Garments and have just increase by 6,00,000 lakhs ,
Rs 72 means a INR outflow
ordered next year's inventory. which could mean a hit of
of Rs 72,00,00,00
over 8% to your bottom line.

To avoid this exchange rate

risk, you could enter into a
forward contract to buy $
10,00,000 in a year's time at
today's exchange rate.
HEDGING CURRENCY RISK : is a way for a company to
minimize or eliminate foreign exchange risk. 

External
Internal
Techniques-
Techniques-within
involve dealing
the business
with a third
itself
party

14
Foreign Exchange
Market

15
Introduction

The forex market is

the market in which
participants can buy,
sell, exchange, and
speculate on
currencies.
FX Market Participants

The forex market is made
up of banks, commercial
companies, central
banks, investment
management firms, hedge
funds, and retail forex
brokers and investors. 
Foreign Exchange Market
Most countries of the world
have their own currencies: the
The trading of currencies is
Indian rupee , the U.S dollar.,
what makes up the foreign
the euro in Europe, the
exchange market.
Brazilian real, and the Chinese
yuan, just to name a few.

18
The Forex Market

The interbank market is

The forex market is made
where large banks trade The OTC market is where
up of two levels; the
currencies for purposes individuals trade through
interbank market and the
such as hedging, balance online platforms and
over-the-counter (OTC)
sheet adjustments, and on brokers. 
market.
behalf of clients.
What are Foreign Exchange
Rates?
Two kinds of exchange rate transactions make up the foreign exchange market:
Spot transaction is an
agreement between two
parties to buy one Forward transaction is
currency against selling an agreement between
another currency at an you and the bank to
agreed price for purchase one currency
settlement on the spot against selling another
date. Most spot market currency at a fixed price
transactions have a for delivery on an agreed
T+2 settlement date. date in the future

20
Foreign Exchange Market: Exchange Rates

Foreign Exchange Rates are published daily in

newspapers and internet sites such as
www.finance.yahoo.com .

Exchange rates for a currency such as rupee are

quoted in two ways ,US dollar per unit of domestic
currency or domestic currency per US dollar.

For example, on 17th November 2021 , one $ was

quoted as Rs 74.44 and 1 Rupee = $0.01343 .

21
Foreign Exchange Market: Exchange Rates

American generally would regard the exchange

rate with rupee as $0.01343 per rupee ( or $
1.371 per Rs 100) while Indians think of it as Rs
74.44 per Dollar.

Exchange Rates are quoted for the spot

transaction ( the spot exchange rate) And for
forward transaction ( the forward exchange rates
that will take place one month , three months ,
and six months in the future
22
How is Foreign Exchange Traded?
One of the most fascinating things about this market –
there is no brick and mortar marketplace for Forex
trading.

Every transaction is done electronically over-the-

counter.

Unlike the stock exchange, the Forex market remains

open round the clock with currencies traded across
every time zone, five days every week.

23
Forex markets

The foreign exchange or forex

market is the largest financial
market in the world – larger
even than the stock market,
with a daily volume of $5
trillion, vs. $85 billion for
equities worldwide.
24
 Bid, Ask and Spread

Sunday, December 12, 2021 25

Bid, Ask and Spread

A foreign exchange Bid is the price at

quotes are two-way which the dealer/bank
quotes, expressed as a is willing to buy
'bid' and ask’ rates. another currency.

The ask or offer is

the rate at which the
dealer/ bank is willing
to sell another
currency.
26
BID / ASK

ASK, SELL ,
BID, BUY –
OFFER –
dealers/bank’s
dealers/banks sell
buy price
price

27
Bid, Offer and Spread
That means that he is willing
to buy dollars at Rs 75.80/$
For example, a dealer may
(sell rupees and buy dollars),
quote Indian rupees as Rs
while he will sell dollar at Rs
75.80 - 75.90 vis-a-vis dollar.
75.90/$ (buy rupees and sell
dollars).

The offer/ask is always higher

The difference between the bid than the bid as inter-bank
and the offer is called the dealers make money by
spread. buying at the bid and selling at
the offer/ask

28
Bid / Ask & Spread
If you want to buy currency, you have to pay the
higher ask price, but if you want to sell currency,
you have to sell it at the lower bid price.

So if you were to buy currency, then immediately

sell it back to the same dealer, the dealer would
make money, and you would lose money.

Thus, the spread is the transaction cost of trading

currency.
29
Example
George is an American businessmen visiting Europe. The cost of
purchasing euros at the airport is as follows:

EUR 1 = USD 1.20 / USD 1.30 (BID / ASK)

George wants to buy EUR 10,000

The higher price (USD 1.30) is the cost to buy each euro. So he would
have to pay the dealer the ask price USD 13,000 ( 10,000 X 1.3)

30
Quiz 1
John is an American traveller visiting Europe. The cost of purchasing euros at the airport is
EUR 1 = USD 1.20 / USD 1.30 , George wants to buy EUR 15,000 , how many dollars he has to
pay to the dealer .

A. USD 13000

B. USD 19,500

C. USD 18,000

D. USD 15,000

Sunday, December 12, 2021 31

1
John is an American traveller visiting Europe. The cost of purchasing euros at the airport is
EUR 1 = USD 1.20 / USD 1.30 , George wants to buy EUR 15,000 , how many dollars he has to
pay to the dealer .

A. USD 13000

B. USD 19,500

C. USD 18,000

D. USD 15,000

© THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA Sunday, December 12, 2021 32

Quiz 2
John is an American traveller returning from Europe. The cost of euros at the airport is EUR 1
= USD 1.20 / USD 1.30 , George wants to sell EUR 3,000 , how many dollars he will get from the
dealer

A. USD 5,000

B. USD 3,600

C. USD 3,900

D. USD 3,000

© THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA Sunday, December 12, 2021 33

2
John is an American traveller returning from Europe. The cost of euros at the airport is EUR 1
= USD 1.20 / USD 1.30 , George wants to sell EUR 3,000 , how many dollars he will get from
the dealer

A. USD 5,000

B. USD 3,600

C. USD 3,900

D. USD 3,000

© THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA Sunday, December 12, 2021 34

HEDGING CURRENCY RISK : is a way for a company to
minimize or eliminate foreign exchange risk. 

External
Internal
Techniques-
Techniques-within
involve dealing
the business
with a third
itself
party

35
Internal Techniques

Leading and Lagging-Leading

means advancing a payment i.
Example: X Ltd imports X :Ltd expects $ to
e. making a payment before it
$1,00,000 goods from abroad appreciate significantly in
is due. Lagging involves
( current rate 1$ =Rs 75) next 6 months . So X plans to
postponing a payment i. e.
Payable after 6 months pay the amount upfront
delaying payment beyond its
due date.

Sunday, December 12, 2021 36

Internal Techniques

Leading and Lagging-Leading For example an Indian Firm

means advancing a payment i. e. which is due to receive
making a payment before it is payments from it's customer when this happens we say
due. Lagging involves in the UK, may press for that the Indian firm is leading
postponing a payment i. e. prompt payment from the it's receivables.
delaying payment beyond its due customer if it expects the
date. GBP rate to fall in future,

Sunday, December 12, 2021 37

Internal Techniques

Invoicing in Domestic
X Ltd invoices Rs75,000 1$ = Rs 70 after 6 months
Currency- invoicing in
for their exports (at the
domestic currency, an X receives Rs 75,000
time of export 1$ =Rs 75 )
exporter can shift Importer has to pay $
Payment receivable after 6
transaction risk to his 1071.42 as against $1000
months
customer abroad

Rs 75,000/70= $1071.42

Sunday, December 12, 2021 38

Internal Techniques

Example : X India Ltd owes

Netting-Exposure netting is a $1,00,000 to its group
method of hedging currency company X USA Ltd for the
risk by offsetting exposure in goods supplied and X USA
one currency with exposure in ltd also owes $ 80,000 for the
the same or another currency. services provided to X India
Ltd

Sunday, December 12, 2021 39

Internal Techniques

Example : X India Ltd owes

Netting-Exposure netting is a $1,00,000 to its group
method of hedging currency company X UK Ltd for the
risk by offsetting exposure in goods supplied and X UK ltd
one currency with exposure in also owes ₤ 78000 for the
the same or another currency. services provided to X India
Ltd ( 1$ = £.78)

Sunday, December 12, 2021 40

External Techniques- Derivative Instruments

FORWARD FUTURES
CONTRAC CONTRAC
T TS
OPTION SWAP
CONTRAC CONTRAC
TS TS
41
Forward Contract

A forward contract is a A forward contract can be

customized contract used for hedging or
between two parties to speculation, although its
buy or sell an asset at a non-standardized nature
specified price on a makes it particularly apt
future date. for hedging.
Forward Contract

A currency forward is a
The future date for which the
customized, written contract
currency exchange rate is
between parties that sets a
fixed is usually the date on
fixed foreign currency
which the two parties plan to
exchange rate for a transaction
conclude a buy/sell transaction
that will occur on a specified
of goods.
future date.
FORWARD CONTRACT

A currency forward is a
customized, written contract
They are most commonly
between two parties that sets Currency forward contracts
made between importers and
a fixed foreign currency are used to hedge foreign
exporters headquartered in
exchange rate for a currency exchange risk.
different countries.
transaction, set for a
specified future date.
Understanding Currency Forward
Contracts

However, parties that enter into

It protects the buyer or seller
a currency forward contract
Currency forward contracts are against unfavorable currency
forego the potential benefit of
primarily utilized to hedge exchange rate occurrences that
exchange rate changes that may
against currency exchange may arise between when a sale
occur in their favor between
rate risk. is contracted and when the sale
contracting and closing a
is actually made.
transaction.
Example of Forward Contract
A Ltd. of India has
imported some The amount is payable Spot Rate
chemical worth of in six months time.
BID $1 = 74.2150
USD 3,64,897 from The relevant spot and
one of the U.S. forward rates are: ASK $1= 74.2250
suppliers.

Six Months forward Spot rates after six

rate months Should he hedge his
forex exposure or leave
BID $1 = Rs74.324 BID $1 = Rs74.720
it unhedged ?
ASK$1= Rs 74.327 ASK$1= Rs 74.860
Solution

Six Months forward

Amount payable in rate $3,64,897 X 74.327
USD 3,64,897 after
BID $1 = Rs74.324 =Rs 2,71,21,699
six months
ASK$1= Rs 74.327
Solution

Amount payable if
Spot rates after six BID $1 = Rs74.720 not hedged
months ASK$1= Rs 74.860 $3,64,897X74.860
2,73,16,189
Solution

OPTION 1 : OPTION 2 : OPTION 1 is

HEDGED UHEDGED better so take a
Rs 2,71,21,699 Rs 2,73,16,189 forward cover
Exercise
XYZ Ltd. of India The amount is
has imported some payable in six months Spot Rate
equipment worth of time. The relevant BID £1 = 100.2150
£ 5,00,000 from one spot and forward ASK £1= 100.2250
of the UK. suppliers. rates are:

Six Months forward Spot rates after six

rate months Should he hedge his
forex exposure or
BID £1 = Rs100.324 BID £1 = Rs100.720
leave it unhedged ?
ASK£1= Rs 100.327 ASK£1= Rs 100.860
Solution

Six Months forward

Amount payable in £ rate £ 5,00,000 X 100.327
5,00,000 after six
BID £1 = Rs100.324 =5,01,63,500
months
ASK £1= Rs 100.327
Solution

Spot rates after six BID $1 = Rs100.720 ASK$1=

months Rs 100.860

Amount payable if not

hedged £5,00,000X
100.860
5,04,30,000
Outflow in rupee under both the
options

OPTION 1 : OPTION 2 : OPTION 1 is

HEDGED UHEDGED better so take a
Rs 5,01,63,500 Rs 5,04,30,000 forward cover
Currency Futures in India
In India the stock exchange provides foreign exchange risk management The contracts available
are:

Futures
Contracts in EUR-INR, GBP-INR
USD-INR,

(maximum of
and JPY-INR. 12 monthly
contracts)
Contract Size (Lot size )

1000USD 1000 EURO 1000Pounds

USDINR EURINR GBRINR

1,00,000 Yens
JPYINR

Sunday, December 12, 2021 55

Example on Hedging Using
Currency Futures for Importer
On 15th Nov 2021,
XYZ Limited wish to $ Futures is currently
book its outwards trading at 74.60 (LTP)
XYZ is an Importer.
remittance for 31st
Dec 2021 worth Expiry on 31st Dec
$100,000.

Buy Currency Futures Margin 3% = INR

No of Contracts 100 contracts at 2,23,800 (74,60,000
(100,000/$1000): 100
$1= 74.60 *3%)

Spot rate on 15th Nov 1$ =Rs 74.27

LTP : Last trading price
Month End 31st Dec : Case 1
Cash Profit =
Assume USD/INR
(75.90- Margin will get
75.90 (RBI Ref
74.60)*1,00,000 = released
Rate)
INR 1,30,000

Net outflow = Rs
Importer has to pay He is hedged and
75,90,000 -
Rs 75,90,000 on fixed his payment
1,30,000 = Rs
31st Dec at spot rate @74.60/$
74,60,000
Month End 31st Dec : Case 2
Assume USD/INR Loss: = (73.60-
Margin will get
73.60 (RBI Ref 74.60)*1,00,000 =
released
Rate) INR 1,00,000

Importer will pay Net outflow = Rs

He is hedged and
Rs 73,60,000 73,60,000
fixed his payment
on 31st Dec at spot +1,00,000 = Rs
@74.60/$
rate 74,60,000
Example on Hedging Using
Currency Futures for Exporter
On 15th Nov 2021,
XYZ Limited wish to $ Futures is currently
book its inward trading at 74.60
XYZ is an exporter.
remittance for 31st
Dec. 2021 worth Expiry on 31st Dec
$100,000.

Sell Currency Futures Margin 3% = INR

No of Contracts
100 contracts at $1= 2,23,800 (74,60,000
(100,000/$1000): 100
74.60 *3%)

Spot rate on 15th Dec , 1$ =Rs 74.27

Month End 31 Dec : Case 1 st

Cash Profit =
Assume USD/INR
(73.10- Margin will get
73.10 (RBI Ref
74.60)*1,00,000 = released
Rate)
INR 1,50,000

Exporter will get Net Receipts = Rs

He is hedged and
Rs 73,10,000 73,10,000 +
fixed his receipts
on 31st Dec at spot 1,50,000 = Rs
@74.60/$
rate 74,60,000
Month End 31st Dec: Case 2
Assume USD/INR Loss: = (74.60-
Margin will get
75.60 (RBI Ref 75.60)*1,00,000 =
released
Rate) INR 1,00,000

Exporter will get Net Receipts = Rs

He is hedged and
Rs 75,60,000 75,60,000-
fixed his receipts
on 31st Dec at spot 1,00,000 = Rs
@74.60/$
rate 74,60,000
Example on Hedging Using
Currency Options for Importer
On 15th Nov 2021, Option Strike price
XYZ Limited wish to 74.25 is available at
XYZ is an Importer. book its outwards premium of Rs 0 .25
remittance for 29th Dec
2021 worth $100,000. Expiry on 29th Dec

No of Contracts Buy Call option 100 Option Premium = INR

(100,000/$1000): 100 contracts at $1= 74.25 25,000 (1,00,000 *0.25)

Spot rate on 15th Nov 1$ =Rs 74.27

Month End 29th Dec : Case 1
Cash Profit = (75.75-
Importer has to pay
Assume USD/INR 74.25)*1,00,000 =
Rs 75,75,000 on
75.75 (RBI Ref Rate) INR 1,50,000-25000=
29th Dec at spot rate
1,25,000

Net outflow = Rs He is hedged and

75,75,000 - 1,25,000 fixed his payment
= Rs 74,50,000 @74.50-./$
Month End 29th Dec : Case 2
Assume
He will not
USD/INR 73.00 Loss = Rs 25,000
exercise his right
(RBI Ref Rate)

Importer will Net outflow = Rs

He gets the gain
pay Rs 73,00,000 73,00,000
on Rs
on 29th Dec +25,000 = Rs
appreciation
at spot rate 73,25,000
Example on Hedging Using
Currency Options for Exporter
On 15th Nov 2021,
XYZ Limited wish to Option Strike price
book its inward 74.25 is available at
XYZ is an exporter. premium of Rs 0 .25
remittance for 29th
Dec 2021 worth Expiry on 29th Dec
$100,000.

Option Premium =
No of Contracts Buy Put option 100
INR 25,000 (1,00,000
(100,000/$1000): 100 contracts at $1= 74.25
*0.25)

Spot rate on 15th Nov 1$ =Rs 74.27

Month End 29th Dec : Case 1
Gain 74.25-73.00= 1.25=
Assume USD/INR He will exercise his
1,25,000 -25000= Rs
73.00 (RBI Ref Rate) right
1,00,000

Exporter will receive Net inflow = Rs

He is hedged at Rs
Rs 73,00,000 on 73,00,000 +1,00,000
74.00
29th Dec at spot rate = Rs 74,00,000
Month End 29th Dec : Case 2
Exporter will receive
Assume USD/INR He will not exercise
Rs 75,75,000
75.75 (RBI Ref his right and losses
on 29th Dec at spot
Rate) Rs 25,000 preimum
rate

Net inflow = Rs
He gains on $
75,75,000 - 25,000 =
appreciation
Rs 75,50,000
Example of futures contract
While currency forward contracts are a type of futures contract, they differ
from standard futures contracts in that they are privately made between the
two parties involved, customized to the parties’ demands for a specific
transaction, and are not traded on any exchange.

Since currency forwards are not exchange-traded instruments, they do not

require any kind of margin deposit.
Because currency forward contracts are private agreements between the
parties involved, they can be tailored to precisely fit the parties’
respective needs regarding a monetary amount, the agreed-upon
exchange rate, and the time frame that the contract covers.

The currency exchange rate specified in a currency forward contract is

usually determined in relation to prevailing interest rates in the home
countries of the two currencies involved in a transaction.
Thank you
When Currency Forward
Contracts are Used
Currency forward contracts are typically used in situations where currency exchange
rates can affect the price of goods sold.

A common example is when an importer is buying goods from a foreign exporter, and
the two countries involved have different currencies. They may also be used when an
individual or company plans to purchase property in a foreign country or for making
maintenance payments related to such property once it has been purchased.

Currency forward contracts may also be made between an individual and a financial
institution for purposes such as paying for a future foreign vacation or funding
education to be pursued in a foreign country.
Practical Example
Currency forward contracts are most frequently used in relation to a sale of goods
between a buyer in one country and a seller in another country. The contract fixes the
amount of money that will be paid by the buyer and received by the seller. Thus, both
parties can proceed with a firm knowledge of the cost/price of the transaction.

When a transaction that may be affected by fluctuations in currency exchange rates is to

take place at a future date, fixing the exchange rate enables both parties to budget and
plan their other business actions without worrying that the future transaction will leave
them in a different financial condition than they had expected.
For example, assume that Company A in the United States wants to contract for a future
purchase of machine parts from Company B, which is located in France. Therefore,
changes in the exchange rate between the US dollar and the euro may affect the actual
price of the purchase – either up or down.

The exporter in France and the importer in the US agree upon an exchange rate of 1.30 
US dollars for 1 euro that will govern the transaction that is to take place six months
from the date the currency forward contract is made between them. At the time of the
agreement, the current exchange rate is 1.28 US dollars per 1 euro.
If, in the interim and by the time of the actual transaction date, the market exchange
rate is 1.33 US dollars per 1 euro, then the buyer will have benefited by locking in the
rate of 1.3. On the other hand, if the prevailing currency exchange rate at that time is
1.22 US dollars for 1 euro, then the seller will benefit from the currency forward contract.
However, both parties have benefited from locking down the purchase price so that the
seller knows his cost in his own currency, and the buyer knows exactly how much they
will receive in their currency.
Derivative Instruments
If you have a series of foreign currency payments to make – for example, if you are paying for
supplies through an open line of credit arrangement – you could opt for a "window forward" contract,
where exchanges may be made “on or before" a particular date. If your exposure extends over a long
period, you could consider flexible forward contracts on a historical rolling rate basis. This risk
management strategy allows you to enjoy exchange risk protection beyond the typical timespan of
simple forward contracts.
D
Forward contracts : lower foreign exchange risk and give you income certainty, but they prevent your
business profiting from favourable exchange rate movements.

You could build profit potential into your FX risk management strategy by judicious use of derivative
instruments such as options and swaps.

However, they can be expensive and difficult to unwind when no longer required.

You may find that careful management of foreign currency cash positions with the support of a good
FX service provider gives you greater flexibility and reduces your foreign exchange risk.
You can bring forward or delay payments to limit the impact of adverse exchange rate movements or
benefit from favourable ones. If you are doing business in multiple currencies, you could also time
payments and receipts to offset currency positions for currencies that tend to move together, such as
yen and yuan. Real-time rate alerts on an FX international payments platform can help you manage the
timing of payments to suit your foreign exchange rate risk appetite.