Corporate Hedging Strategies: Evaluating the case for India
Kanika Ghocha, Vaatsal Tandon, Amritha Krishnan, SPJIMR
KEYWORDS Hedging, Derivatives, Risk Management, Swaps
ABSTRACT
This paper evaluates the various corporate hedging strategies applied in India; considering the current state of development of capital markets, regulations and legislations. Also, not every company strategizes on minimizing its foreign exchange exposure risk; hence, the need for currency risk management is highlighted.
Various companies in various sectors have been studied on parameters like – industry, foreign exchange exposure, foreign exchange strategies; to undertake the qualitative research, which reflects that as derivative instruments, futures, forwards and options are preferred in the short-run, while different kinds of swaps and options are used in the long term. Data of listed companies has been researched upon using various statistical methods; to understand what kind of companies really go for corporate hedging, whereas there are some which believe in the traditional methods. The available literature helps in broadening our views on framework for risk management & its regulation per se.
It concludes by pressing for the need of stronger corporate hedging strategies in India and the need for reforming and developing our capital markets; also the fact that SEBI and RBI- the regulators have a major role to play. The recommendations outline the findings, and the behavioural aspect of corporate firms in India.
RESEARCH PAPER
1.0 FOREIGN EXCHANGE RISK MANAGEMENT: PROCESS & NECESSITY The global market for derivatives has grown substantially in the recent years. The Foreign Exchange and Derivatives Market Activity survey conducted by Bank for International Settlements( BIS) points to this increased activity( Exhibits 1 & 2).
Firms dealing in multiple currencies face the risk of volatility in the exchange rate market which can adversely affect their business; this is referred to as exposure to foreign exchange risk. The process of identifying the risks faced by a firm and implementation of a process of protection from these risks by financial or operating hedging is called foreign exchange risk management.
1.1 EVOLUTION OF THE FOREIGN EXCHANGE DERIVATIVES MARKET IN INDIA In India, the economic liberalization in the early nineties provided the economic rationale for the introduction of FX derivatives. In the pre-liberalisation era, marked by State dominated, tightly regulated foreign exchange regime, the only risk management tool available for corporate enterprises was, ' lobbying for government intervention '. With the advent of LERMS( Liberalised Exchange Rate Mechanism System) in India, the unified exchange rate phase has witnessed improvement in informational and operational efficiency of the foreign exchange market, though at a halting pace.
The spurts in foreign investments in India have led to substantial increase in the quantum of inflows and outflows in different currencies, with varying maturities. Corporate enterprises have had to face the challenges of the shift from low risk to high risk operations involving foreign exchange. Earlier, the Indian companies had been entering into forward contracts with banks, which were the Authorised Dealers( AD) in foreign exchange, but many firms preferred to keep their risk exposures unhedged as they found the forward contracts to be very costly. In the current formative phase of the development of the foreign exchange market, it will be worthwhile to take stock of the initiatives taken by corporate enterprises in identifying and managing risk.
1.2 INSTRUMENTS FOR FOREIGN EXCHANGE HEDGING
Forwards: A forward is a made-to-measure agreement between two parties to buy / sell a specified amount of a currency at a specified rate on a particular date in the future. Futures: A futures contract is similar to the forward contract but is more liquid because it is traded in an organized exchange i. e. the futures market. Options: A currency Option is a contract giving the right, not the obligation, to buy or sell a specific quantity of one foreign currency in exchange for another at a fixed price; called the Exercise Price or Strike Price. Swaps: A swap is a
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