1.

INTRODUCTION

1.1 EXECUTIVE SUMMARY

The purpose of FX (Foreign Exchange) market is to facilitate trade and investment. The need for a foreign exchange market arises because of the presence of multifarious international currencies such as US Dollar, Pound Sterling, etc., and the need for trading in such currencies. Any individual who had a diversified portfolio or firms operating in foreign countries and trading in foreign currencies are supposed to encounter foreign exchange risk.

Although the foreign exchange risk is volatile and the future risk cannot be predicted but still it can be managed. This project is aimed to expose the various types of risk involved in foreign exchange and study some of the foreign exchange risk management tools with regarding to firms, institutions and individuals. These tools help in measuring and minimizing the foreign exchange risk. They are Money Market Hedging, Currency Risk Sharing, Insurance, Derivatives, Forward Contract, Future Contract, Swaps, Options, and Forward Rate Agreement etc.

Each of the tools is elaborated briefly with suitable examples in relation to the risk encountered by individuals and firms in this project. Finally, a risk is not risk if it is anticipated.

1.2 INTRODUCTION TO THE TOPIC

What Is Exchange Risk?

Exchange risk is simple in concept: a potential gain or loss that occurs as a result of an exchange rate change. For example, if an individual owns a share in Toyota, the Japanese company, he or she will lose if the value of the yen drops.

Yet from this simple question several more arise. First, whose gain or loss? Clearly not just those of a subsidiary, for they may be offset by positions taken elsewhere in the firm. And not just gains or losses on current transactions, for the firm's value consists of anticipated future cash flows as well as currently contracted ones. What counts, modern finance tells us, is shareholder value; yet the impact of any given currency change on shareholder value is difficult to assess, so proxies have to be used. The academic evidence linking exchange rate changes to stock prices is weak.

Moreover the shareholder who has a diversified portfolio may find that the negative effect of exchange rate changes on one firm is balanced by gains in other firms; in other words, that exchange risk is diversifiable. If it is, than perhaps it's a non-risk.

Finally, risk is not risk if it is anticipated. In most currencies there are futures or forward exchange contracts whose prices give firms an indication of where the market expects currencies to go. And these contracts offer the

ability to lock in the anticipated change. So perhaps a better concept of exchange risk is unanticipated exchange rate changes.

These and other issues justify a closer look at this area of international financial management.

Should Firms Manage Foreign Exchange Risk? Many firms refrain from active management of their foreign exchange exposure, even though they understand that exchange rate fluctuations can affect their earnings and value. They make this decision for a number of reasons.

First, management does not understand it. They consider any use of risk management tools, such as forwards, futures and options, as speculative. Or they argue that such financial manipulations lie outside the firm's field of expertise. Perhaps they are right to fear abuses of hedging techniques, but refusing to use forwards and other instruments may expose the firm to substantial speculative risks.

Second, they claim that exposure cannot be measured. They are right -currency exposure is complex and can seldom be evaluated with precision. But as in many business situations, imprecision should not be taken as an excuse for indecision.

Third, they say that the firm is hedged. All transactions such as imports or exports are covered, and foreign subsidiaries finance in local currencies. This ignores the fact that the bulk of firms value comes from transactions not yet completed, so the transactions hedging is a very incomplete strategy.

Fourth, they say that the firm does not have any exchange risk because it does all its business in rupees (or dollar, or whatever the home currency is). But a moment's thought will make it evident that even if you invoice German customers in rupees, when the mark drops your prices will have to adjust or you'll be undercut by local competitors. So revenues are influenced by currency changes.

Finally, they emphasize that the balance sheet is hedged on an accounting basis--especially when the "functional currency" is held to be the dollar. The misleading signals that balance sheet exposure measure can give are documented in later sections. One counter-argument is that transaction costs are typically greater for individual investors than firms. Yet there are deeper reasons why foreign exchange risk should be managed at the firm level. Operating managers can make such estimates with much more precision than shareholders who typically lack the detailed knowledge of competition, markets, and the relevant technologies. Furthermore, in all but the most perfect financial markets, the firm has considerable advantages over investors in obtaining relatively inexpensive debt at home and abroad, taking maximum advantage of interest subsidies and minimizing the effect of taxes and political risk.

Another line of reasoning suggests that foreign exchange risk management does not matter because of certain equilibrium conditions in international markets for both financial and real assets. These conditions include the relationship between prices of goods in different markets, better known as Purchasing Power Parity (PPP), and between interest rates and exchange rates, usually referred to as the International Fisher Effect (IFE).

However, deviations from PPP and IFE can persist for considerable periods of time, especially at the level of the individual firm. The resulting variability of net cash flow is of significance as it can subject the firm to the costs of financial distress, or even default. Modern research in finance supports the reasoning that earnings fluctuations that threaten the firm's continued viability absorb management and creditors' time, entail out-of-pocket costs such as legal fees, and create a variety of operating and investment problems, including underinvestment in R&D. The same argument supports the importance of corporate exchange risk management against the claim that in equity markets it is only systematic risk that matters. To the extent that foreign exchange risk represents unsystematic risk, it can, of course, be diversified away provided again, those investors have the same quality of information about the firm as management a condition not likely to prevail in practice. This reasoning is supported by the likely effect that exchange risk has on taxes paid by the firm. It is generally agreed that leverage shields the firm from taxes, because interest is tax deductible whereas dividends are not. But the extent to which a firm can increase leverage is limited by the risk and costs of bankruptcy. A riskier firm, perhaps one that does not hedge exchange

risk, cannot borrow as much. It follows that anything that reduces the probability of bankruptcy allows the firm to take on greater leverage, and so pay less taxes for a given operating cash flow. If foreign exchange hedging reduces taxes, shareholders benefit from hedging.

However, there is one task that the firm cannot perform for shareholders: to the extent that individuals face unique exchange risk as a result of their different expenditure patterns, they must themselves devise appropriate hedging strategies. Corporate management of foreign exchange risk in the traditional sense is only able to protect expected nominal returns in the reference currency.

Unmanaged exchange rate risk can cause significant fluctuations in the earnings and the market value of an international 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. To avert this, it may be worth buying some financial instruments which may be a useful and cost-effective way to hedge against currency risks that have very high probabilities which, have disproportionately high costs to the company.

1.3 INDUSTRY OVERVIEW

Brokerage firms in India

Business entities that deal with stock trading are known as brokerage firms. The Indian broking industry is one of the oldest trading industries that have been around even before the establishment of BSE in 1875. Despite passing through number of changes in the post liberalization period, the industry has found its way onwards sustainable growth. With an increasing capital market and growing number of investors, India has a number of brokerage firms. In Indian retail brokerage industry, the brokerage firms primarily work as agents for buying & selling of securities like shares, stocks & other financial instruments and earn commission for each of the transactions. Indian retail brokerage market is growing through a wonderful phase with high growth rate. The total trading volume of Indian brokerage companies is expected to reach US$ 6535.7 billion by the year 2015. The 189 equity broking firms included in the study have a total of 144,346 trading terminals, 21,013 branches/ offices, and 77,125 employees across the country. Furthermore, almost 70% of the 189 companies profiled in the publication reported a total sub-broker base of 37,213.

The top 10 brokerage firms in India are:

Sharekhan Terminals- 1644 Sub Brokers- NA No. of Employees- 3879

No. of Branches- 294

India Infoline Terminals- 173 Sub Brokers- 173 No. of Employees- NA No. of Branches- 605

Kotak Securities Ltd Terminals- 4320 Sub Brokers- 910 No. of Employees- 4008 No. of Branches- 350

Motilal Oswal Securities Terminals- 7923 Sub Brokers- 890 No. of Employees- 2193 No. of Branches- 63

Angel Broking Terminals- 5715 Sub Brokers- NA No. of Employees- 284 No. of Branches- NA

India Bulls Terminals- 2876 Sub Brokers- NA No. of Employees- 5873 No. of Branches- 522

KarvyStock Broking Ltd Terminals- 1700 Sub Brokers- 19000 No. of Employees- 3910 No. of Branches- 581

Geojit Financial Services Terminals- 627 Sub Brokers- 247 No. of Employees- 343 No. of Branches- 314

Anand Rathi Securities Ltd Terminals- 1527 Sub Brokers- 320 No. of Employees- 4566 No. of Branches- 220

Reliance Money Terminals- 2428 Sub Brokers- 1494 No. of Employees- 2037 No. of Branches- 14

De mat Com pany A/c Ope ning Cha rge 750/ 5000 /Mar gin Mon ey

Brok erag e Intr aday Deli very (%) 0.050.50 250/10 times 2100 AM C Exp osur e (for intra ) Bran ches

IIFL Kota k Secur ities ICIC I Direc t Motil al Oswa l Relig are Angel Broki ng Geoji t

750/ -

5000 /-

0.060.59

360/-

4 times

890

500/ -

0.07 975/50.50 450/-

5 times

2124

415/ -

Not restri cted

0.030.30

300/-

4 times

430

299/ -

5000 /-

0.02 50.25 0.030.30 0.030.30 Nil

20 times

1837

731/ 650/ -

5000 /-

300/-

4 times 20 times

120

Nil

Nil

500

India Bulls Relia nce Mone y Share khan HDF C

900/ -

Nil

0.030.30

Nil

20 times

718

750/ -

Not restri cted 5000 /5000 /-

0.050.25

50/-

5 times

1000 0

750/ 799/ -

0.030.30 0.050.50

500/-

4 times 5 times

250

500/-

650

Global Brokerage firms 1. J.P. Morgan 2. Goldman Sachs 3. Smith Barney Citigroup 4. Lehman Brothers 5. Prudential Equity Group 6. Merrill Lynch 7. Bank of America Securities 8. UBS 9. BB&T Capital Markets 10.Piper Jaffray

Financial Markets The financial markets have been classified as 1. Cash market 2. Derivatives market 3. Debt market

4. Commodities market Cash market, also known as spot market, is the most sought after amongst investors.

Stock Exchanges NSE

The National Stock Exchange (NSE) is India's leading stock exchange covering various cities and towns across the country. NSE was set up by leading institutions to provide a modern, fully automated screen-based trading system with national reach. The Exchange has brought about unparalleled transparency, speed & efficiency, safety and market integrity. It has set up facilities that serve as a model for the securities industry in termsof systems, practices and procedures.

NSE has played a catalytic role in reforming the Indian securities market in terms of microstructure, market practices and trading volumes. The market today uses state-of-art information technology to provide an efficient and transparent trading, clearing and settlement mechanism, and has witnessed several innovations in products & services viz. demutualization of stock exchange governance, screen based trading, compression of settlement cycles, dematerialization and electronic transfer of securities, securities lending and borrowing, professionalization of trading members, fine-tuned risk

management systems, emergence of clearing corporations to assume counterparty risks, market of debt and derivative instruments and intensive use of information technology. BSE Bombay Stock Exchange is the oldest stock exchange in Asia What is now popularly known as the BSE was established as "The Native Share & Stock Brokers' Association" in 1875. Over the past 135 years, BSE has facilitated the growth of the Indian corporate sector by providing it with an efficient capital raising platform.

Today, BSE is the world's number 1 exchange in the world in terms of the number of listed companies (over 4900). It is the world's 5th most active in terms of number of transactions handled through its electronic trading system. And it is in the top ten of global exchanges in terms of the market capitalization of its listed companies (as of December 31, 2009). The companies listed on BSE command a total market capitalization of USD Trillion 1.28 as of Feb, 2010.

BSE is the first exchange in India and the second in the world to obtain an ISO 9001:2000certifications. It is also the first Exchange in the country and second in the world to receive Information Security Management System Standard BS 7799-2-2002 certification for its BSE On-Line trading System (BOLT). Presently, we are ISO 27001:2005 certified, which is a ISO version of BS 7799 for Information Security.

The BSE Index, SENSEX, is India's first and most popular Stock Market

benchmark index. Exchange traded funds (ETF) on SENSEX, are listed on BSE and in Hong Kong. Futures and options on the index are also traded at BSE.

Regional stock exchanges in India

There are 23 stock exchanges in India. Among them two are national level stock exchanges namely Bombay Stock Exchange (BSE) and National Stock Exchange of India (NSE). The rest 21 are Regional Stock Exchanges (RSE). AhmedabadStock Exchange BangaloreStock Exchange BhubaneshwarStock Exchange CalcuttaStock Exchange CochinStock Exchange CoimbatoreStock Exchange DelhiStock Exchange GuwahatiStock Exchange HyderabadStock Exchange JaipurStock Exchange LudhianaStock Exchange Madhya PradeshStock Exchange MadrasStock Exchange MagadhStock Exchange

 MangaloreStock Exchange Meerut Stock Exchange OTC Exchange Of India Pune Stock Exchange Saurashtra KutchStock Exchange UttarPradeshStock Exchange VadodaraStock Exchange

Regulatory body for Indian Securities market (SEBI)

In 1988 the Securities and Exchange Board of India (SEBI) was established by the Government of India through an executive resolution, and was subsequently upgraded as a fully autonomous body (a statutory Board) in the year 1992 with the passing of the Securities and Exchange Board of India Act (SEBI Act) on 30th January 1992.

The basic objectives of the Board were identified as:

To protect the interests of investors in securities; To promote the development of Securities Market; To regulate the securities market and For matters connected therewith or incidental thereto.

Some insights of this industry

1. Around 17% equity broking companies have 80% of broking terminals Equity broking terminals consisting of NEAT, BOLT and CTCL licenses are the key in determining the size of an equity broking company. According to our study, 17% of the 189 profiled companies have 80% of the total trading terminals provided by such companies. 2. New kids on the block A majority of the 189 broking firms featured in this publication (approximately 85%) entered the business in the decade following 1990s. The financial sector reforms, which commenced in that decade, opened up opportunities in the securities markets, especially for new entrants.

3. Employee break-up

4.

More

than

50%

of

companies

are

engaged

in

three

market

segment

5. Western region has highest number of companies

6. NSE has a share of 66% among total shares traded

7. NSDL witnesses surge in dematerialized shares

8. Volatility in stock markets

In FY10, the global stock markets displayed lesser volatility compared with FY09. Month-wise, average daily volatility in the Indian benchmark indices was the highest in May 2009. The lowest volatility in the benchmark indices

was noticed during Mar 2010. The annualised volatility of BSE Sensex decreased from 43.6% in FY09 to 29.2% in FY10. A similar trend was also observed for the S&P CNX Nifty, which recorded annualised volatility of 29.4% in FY10, compared with 41.5% the previous year.
9. Overall profit of broking companies soar; small companies see a turnaround

Net profit of broking companies

2.2COMPANY OVERVIEW (INDIA INFOLINE)

The IIFL (India Infoline) group, comprising the holding company, India Infoline Ltd (NSE: INDIAINFO, BSE: 532636) and its subsidiaries, is one of the leading players in the Indian financial services space. IIFL offers advice and execution platform for the entire range of financial services covering products ranging from Equities and derivatives, Commodities, Wealth management, Asset management, Insurance, Fixed deposits, Loans, Investment Banking, Gold bonds and other small savings instruments. IIFL recently received an in-principle approval for Securities Trading and Clearing

memberships from Singapore Exchange (SGX) paving the way for IIFL to become the first Indian brokerage to get a membership of the SGX. IIFL also received membership of the Colombo Stock Exchange becoming the first foreign broker to enter Sri Lanka. IIFL owns and manages the website, www.indiainfoline.com, which is one of Indias leading online destinations for personal finance, stock markets, economy and business. IIFL has been awarded the Best Broker, India by FinanceAsia and the Most improved brokerage, India in the AsiaMoney polls. India Infoline was also adjudged as Fastest Growing Equity Broking House - Large firms by Dun & Bradstreet. A forerunner in the field of equity research, IIFLs research is acknowledged by none other than Forbes as Best of the Web and a must read for investors in Asia. Our research is available not just over the Internet but also on international wire services like Bloomberg, Thomson First Call and Internet Securities where it is amongst one of the most read Indian brokers.

A network of over 2,500 business locations spread over more than 500 cities and towns across India facilitates the smooth acquisition and servicing of a large customer base. All our offices are connected with the corporate office in Mumbai with cutting edge networking technology. The group caters to a customer base of about a million customers, over a variety of mediums viz. online, over the phone and at our branches.

History & Milestones 2011 Launched IIFL Mutual Fund. 2010 Received in-principle approval for membership of the Singapore Stock Exchange. Received membership of the Colombo Stock Exchange

2009 Acquired registration for Housing Finance SEBI in-principle approval for Mutual Fund Obtained Venture Capital license

2008 Launched IIFL Wealth Transitioned to insurance broking model

2007

Commenced institutional equities business under IIFL Formed Singapore subsidiary, IIFL (Asia) Pvt. Ltd

2006 Acquired membership of DGCX Commenced the lending business

2005 Maiden IPO and listed on NSE, BSE

2004 Acquired commodities broking license Launched Portfolio Management Service

2003 Launched proprietary trading platform Trader Terminal for retail customers

2000 Launched online trading through www.5paisa.com Started distribution of life insurance and mutual fund

1999 Launched www.indiainfoline.com

1997 Launched research products of leading Indian companies, key sectors and the economy Client included leading FIIs, banks and companies

1995 Commenced operations as an Equity Research firm

IIFL (India Infoline Ltd) - Corporate Structure

Board of directors Mr. Nirmal Jain is the founder and Chairman of India Infoline Ltd. He is a PGDM (Post Graduate Diploma in Management) from IIM (Indian Institute of Management) Ahmedabad, a Chartered Accountant and a rank-holder Cost Accountant. His professional track record is equally outstanding. He started his career in 1989 with Hindustan Lever Limited, the Indian arm of Unilever.

During his stint with Hindustan Lever, he handled a variety of responsibilities, including export and trading in agro-commodities. He contributed immensely towards the rapid and profitable growth of Hindustan Levers commodity export business, which was then the nations as well as the Companys top priority.

He founded Probity Research and Services Pvt. Ltd. (later re-christened India Infoline) in 1995 perhaps95; perhaps the first independent equity research Company in India. His work set new standards for equity research in India. Mr. Jain was one of the first entrepreneurs in India to seize the internet opportunity:witht with the launch of www.indiainfoline.com in 1999. Under his leadership, India Infoline not only steered through the dotcom bust and one of the worst stock market downtrends but also grew from strength to strength.

Mr. R.Venkataraman, Managing Director ,India Infoline Ltd

Mr. R. Venkataraman, Co-Promoter and Managing Director of India Infoline Ltd, is a B.Tech (electronics and electrical communications engineering, IIT Kharagpur) and an MBA (IIM Bangalore). He joined the India Infoline Board in July 1999. He previously held senior managerial positions in ICICI Limited, including ICICI Securities Limited, their investment banking joint venture with J P Morgan of US, BZW and Taib Capital Corporation Limited. He was also the Assistant Vice President with G E Capital Services India Limited in their private equity division, possessing a varied experience of more than 19 years in the financial services sector.

Vision:

To be the most respected company in the financial services space.

Mission: To educate, empower, enrich and enhance customer investment skills set through research, knowledge and delightful service.

Values: Team Work Mutual Respect Execution Transformation Transparency Accountability

SWOT ANALYSIS

The Company is uniquely positioned as a supplier of High Chrome Mill Internals on a global scale, on account of the following competitive strengths: Focus on the combination of Metallurgy, Design and Applications. Comprehensive solutions based approach, as distinct from supply of commodity products.

 Focus on technology research and development. Worldwide presence in more than 60 countries, being directly in front of the customers through a network of overseas marketing Subsidiaries in the

Middle East, Europe and USA and warehouse facilities. Low cost of production. A management team comprising of Technocrats, Professionals and Consultants having rich experience in High Chrome Mill Internals industry.

WEAKNESS/THREATS Inability to scale up the capacities rapidly owing to extremely high importance of absolutely zero failure rate of the products expected by the customers, requiring close monitoring of the quality. Issues related to logistics, particularly with the increasing volumes of the products. Current global slowdown in the cement Industry-particularly in the EU

and USA-which may Company.

impact the short term performance of the

The focus on the Global Mining Industry may lead to pressure on the margins in the short term due to the typical entry related competitive factors. Lack of a banking arm to complete the bank broker-depository chain.

OPPORTUNITIES AND STRATEGIES To maintain and further strengthen our capabilities of Research & Development activity. To consider tapping the significant opportunity offered by China as a Market for the mill internals consumed by the Cement and Utility Industry. To focus more on strategic relationship/ commercial partnerships with international groups.

CHAPTER 3 RESEARCH DESIGN

RESEARCH DESIGN INTRODUCTION Foreign exchange risk is the exposure of a companys financial strength to the potential impact of movements in foreign exchange rates. The risk is that adverse fluctuations in exchange rates may result in a reduction in measures of financial strength. It is acknowledged that specific foreign exchange risk practices may differ among banks depending upon factors such as the institutions size, and the nature and complexity of its activities. However, a comprehensive foreign exchange risk programme should deal with, at a minimum, good management information systems, contingency planning and other managerial and analytical techniques.

TITLE OF THE STUDY

A STUDY ON FOREIGN EXCHANGE RISK MANAGEMENT

STATEMENT OF THE PROBLEM The main role of the exchange rate is to allow international regulations related to international trade: an exporter wants to be paid in foreign currency, because they need currency to pay its employees or its suppliers, while the importer does not have a priori that its own currency to pay. Every time there is an international commercial transaction, there will be a foreign exchange transaction.

The exchange rate fluctuations will affect the prices of export goods. For example, if a product sold in France and the USA is 100 , with an exchange rate of $ 1.25 per euro, therefore it will cost $ 125 (100 x 1.25) to U.S. consumers . A decline in the exchange rate at $ 1.10 per euro will drop the export price at 110 (100 x 1.10), while a rise in the exchange rate will rise. Conversely, a well made in the USA, sold in France and worth $ 100, cost 80 (100 / 1.25) to French consumers in the first case and 90.10 (100 / 1.10) in the second case. Thus, any decline in the exchange rate of the national currency promotes exports and imports disadvantage, and vice versa for an increase in the exchange rate. So there is a possibility for a country to improve its balance of trade (and hence growth) if it gets a drop in the value of its currency. Countries that consistently under-estimate their currencies to facilitate their exports are accused of making monetary protectionism.

To prevent this form of protectionism that countries may agree on a system of fixed exchange rates - such as the Bretton Woods (1944-1971) or the European Monetary

System (1979-1992). But some economists point out that a flexible exchange system allows you to balance trade. The reasoning is based on the functioning of the foreign exchange market. If a country has a deficit in its current payments, this means that the country lacks foreign currency to pay for purchases with the rest of the world, and must be requested in the foreign exchange market which lowers the value of its currency in relation to other currencies. Accordingly, the exchange rate of the national currency down, which encourages exports and restricts imports, which, ultimately, the foreign trade balance. The mechanism is reversed in case of current account surplus.

PURPOSE OF THE STUDY The purpose of FX market is to facilitate trade and investment. The need for a foreign exchange market arises because of the presence of multifarious international currencies such as US Dollar, Pound Sterling, etc., and the need for trading in such currencies. Foreign exchange, or forex, is critical to transact international business. Foreign exchange refers to the process of trading domestic for foreign currency at fluctuating exchange rates. Foreign exchange markets have been established to facilitate this process. Private citizens, traders, and government officials all monitor the foreign exchange market carefully to gauge the implications of particular currency values upon the world economy. You should identify foreign exchange risks, before making financial decisions.
3.1 OBJECTIVES OF THE STUDY

This project attempt to study the complexities of the foreign exchange market. The purpose of this study is to get a better idea and comprehensive details of foreign

exchange risk management.

SUB OBJECTIVES

To know about the various concept and technicalities in foreign exchange. To study the various types of risks related to foreign exchange when a firm, institution, individual is exposed to deal with foreign currencies. To get the knowledge about the traditional risk management tools such as Money Market Hedging, Currency Risk Sharing, Insurance, Derivatives, Forward Contract, Future Contract, Swaps, Options, Forward Rate Agreement etc.

These and other issues justify a closer look at the area of Foreign Exchange Risk Management.
LIMITATION OF THE STUDY

Time constraint Resource constraint. Bias on the part of interviewer

SOURCE OF DATA The sources of data may be classified into primary sources and secondary source. a) Primary Data: The primary data was collected through interviews of professionals and observations. b) Secondary Data: The secondary data was collected from books, newspapers, other publications and internet and browses taken from the company. DATA ANALYSIS The data analysis was done on the basis of the information available from various sources and brainstorming.