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The Exchange Rate Exposure of Indian Companies

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 IJER © Serials Publications
13(4), 2016: 1885-1894
ISSN: 0972-9380

THE EXCHANGE RATE EXPOSURE OF INDIAN

COMPANIES

Abstract: In this global era foreign exchange exposure is a matter of concern for majority of
the firms involved in international trade. By doing proper risk measurement and management
the companies will not only be able to minimise their risk but also it enabled the companies
to obtain benefit from the profitable opportunities available in the market. The present paper
discusses about the attitude, knowledge and general view of the financial experts working
in various Indian companies regarding the three types of foreign exchange exposures. It is
also analysed whether there is any difference in using hedging instruments to manage the
currency risk/exposure by banking and non- banking enterprises.The present study is based
on 50Indian corporateenterprisesselected from the list of Fortune India 500 companies in
2015 on the basis of their revenue. Data analysis has been done by using Descriptive analysis
and ANOVA.Thestudy concludes that derivative products are used for risk management
and major motive of the hedging instrument is to reduce volatility of the cash flows.
Key Words: Foreign Exchange Risk; Transaction Exposure; Translation Exposure;
Operating Exposure; Hedging.
JEL Classification: G15, G31, F62

1. INTRODUCTION
It is well known that international trade is possible only because globalization policy
came into existence in 1991. Afterglobalization and liberalization policy the concept
of foreign exchange exposure aroused because now maximum companies want to do
trade at international level so they need international customers and they have to deal
in foreign currency. But because of the changes in the demand and supply of the
various currencies, fluctuations occur in exchange rates which lead to exchange rate
risk for the exporters and importers. These exchange rate changes can be positive or
negative for the concerned companies which can affect the financial performance of a
company upto very large extent so the concept of this foreign exchange risk

* Assistant Professor, School of Business, Lovely Professional University, Jalandhar-Delhi G. T. Road

(NH-1), Phagwara, Punjab (India)-144411, E-mail: reeta.clonia@gmail.com, reeta.19811@lpu.co.in
** Research Scholar, Lovely Professional University, Jalandhar-Delhi G. T. Road (NH-1), Phagwara,
Punjab (India)-144411, E-mail: kayapuri2@gmail.com
1886 Reeta and Kaya Puri

management came into existence. To survive in this competitive era it is compulsory

for all the organisations to measure their foreign exchange exposure and then do proper
management of unfavourable exposures to avoid losses.The firms having business
transactions in various currencies of various countries are very prone to get their cash
flows affected due to exchange rate fluctuations. The literature available on foreign
exchange risk has grownrapidly more exactly after the financial crises occurred in
1990s. These crises have made itclear that exchange rates may have significant real
economy effects.So many researches have been conducted by different researchers to
conclude the reasons as well as importance to manage foreign exchange risk. (Christie
and Marshall, 2003) risk management now a days has become the most important
function of management because of the huge volatility in the currency market.
The main types of foreign exchange exposure are:
Transaction Exposure: Transaction exposure arises due to exchange rate changes
between the transaction date and the subsequent settlement date, i.e. it is the gain or
loss arising on conversion.This type of risk is primarily associated with imports and
exports. If a company exports goods on credit basis then it has a figure for debtors in
its accounts. The amount it will finally receive depends on the foreign exchange
movement from the transaction date to the settlement date.As transaction risk has a
potential impact on the cash flows of a company so maximum companies always do
efforts to minimise its negative impact by using optimal hedging instruments.
Transaction Exposure = Rupee worth of accounts receivable (payable) when actual
settlement is made minus rupee worth of account receivable
(payable) when the trade transaction is initiated.
Operating Exposure – also called economic exposure, measures the change in the
present value of the firm resulting from any change in expected future operating cash
flows caused by an unexpected change in exchange rates.
Translation Exposure – also called accounting exposure, is the changes in owner’s
equity because of the need to “translate” financial statements of foreign subsidiaries
into a single reporting currency for consolidated financial statements.
Accounting Exposure = Exposed Assets- Exposed Liabilities

2. LITERATURE REVIEW
Batten, Metlor and Wan (1993) analyzed exchange rate activities used in Australian
companies. The researchers found that, out of the 72 selected firms covered in the
study, 70% of the companies are bearing exchange rate exposures due to exchange
rate fluctuations. Jesswein et al., (1995) did their research on U.S. based firms and
categorised the risk management instruments in three generations which include
forward contract as first generation hedging instrument, Future contracts, options
and swap instruments are known as second generation hedging tools and foreign
exchange agreements, compounded options, range and synthetic products lie in the
The Exchange Rate Exposure of Indian Companies 1887

category of third generation hedging instruments. They also concluded in their study
that maximum time only first and second generation products are used to hedge the
risk and the use of third generation instrument is very less. Phillips (1995)analused
the usage of derivative instruments in all types of businesses and found that the
entire organisation required proper risk management committees and should focus
on the appropriate use of risk management tools and techniques. Hentschel and
Kothari (2000) identified those firms which are using derivative products. They did
comparison the risk exposure of derivative user firms with non-derivative user firms.
They found very less difference in equity return volatility between derivative users
andnon-derivative user firms. Sathya Swaroop Debashish (2008) concentrated on
recent currency exposure management practices and hedging tools used by the
selected indian companies. The research aimed to know the risk management
techniques used by the companies to manage their risk/exposure.The study focused
whether the concerned persons are aware about the risk management practices/
techniques or not. Söhnke M. Bartram, Günter Dufey, and Michael R. Frenkel,
(2009) exploredall the three types of currency exposures. The researchers said that
in the presence of deviations from parity conditions such as purchasing power parity
and the international Fisher effect, non-financial corporations are confronted by risks
stemming from the impact of unexpected exchange rate changes on the value of the
firm. Nevertheless, professional firm-wide risk management does not yet seem to
be in place at all non-financial institutions. Consequently, the need for implementing
or improving risk management systems appears especially strong for firms outside
the financial sector.

3. OBJECTIVES OF THE STUDY

1. To ascertain the level of importance assigned to foreign exchange risk as
compared to other risks faced by the Indian Companies
2. To ascertain the foreign exchange exposure hedging instruments used in the
selected Indian firms.
3. To know the attitudes, perceptions andconcerns of the selected Indian firms
towards Foreign exchange risk.
4. To understand the level of awareness regardingderivative instruments among the
firms.

4. METHODOLOGY OF THE STUDY

An exploratory survey, by way of extensive literature review of books, journals and
other published data related to the focus of the study, as also concerned websites, was
carried out to gather background information about the general nature of the research
problem. This study is undertaken primarily to describe the foreign exchange risk
management practices in the Indian corporate sector. An attempt is also made to
examine the various exchange rate risk measurement techniques in banking and non-
1888 Reeta and Kaya Puri

banking units in India. In sync with the above mentioned objectives, the study intends
to test the following null hypotheses:
1. There is no significant variance in the level of importance assigned to various
types of risks.
2. There is no significant difference in various risk management practices used
by banking and non-banking companies.
This research is descriptive cum exploratory. To obtain the above said objectives
of this paper, researchers used judgement sampling technique and the sample size
consists 50 Indian companies having ranking in Fortune India 500 list, presented by
The Economic Times in 2015 which comprise 12 banks and 38 non-banking Indian
companies. Primary data for the current research has been collected by using
questionnaire method. Secondary date has been collected from the Capitaline-plus
data base, journals, websites and from the annual reports available of the companies.
Capitaline database is also used to find out the data of foreign currency inflows and
outflows. The respondents to the questionnaire are financial executives of the selected
companies with the responsibility of foreign exchange risk management.The responses
are obtained on 5-point Likert’s scale ranging from 1 to 5. Here, 1 means unimportant,
2 means less important, 3 means neutral, 4 means important and 5 means the maximum
importance given to a parameter. To do analysis, Descriptive statistics is done and
test ANOVA is also applied where ever needed by using MS-Excel and SPSS.

5. SURVEY RESPONSES AND ANALYSIS

As the first objective of this research is to find out the importance level assigned to
exchange rate risk so the first question asked to the financial experts of the companies
was aimed to indicate the importance level assigned to the various types of financial
risks. Answers had been collected on the basis of 5-point Likert’sscale where 1 indicates
no importance and 5 indicate the highest importance. The results of the survey as
presented in tables 5.1 shows that 58 percent respondents consider exchange rate risk
as the most important risk and 20 percent respondent consider it important. 38 percent
respondents are considering interest rate risk as highly important and 54 percent
consider it important for the Indian firms. Credit risk and commodity risk are

Table 5.1
Importance Assigned to various Types of Risks by Respondents
(Figures in Percentage)

  Importance Assigned to Various Types of Risk

Types of Risk Not Important Less Important Neutral Important Highly Important
Exchange Rate Risk 4 8 10 20 58
Interest Rate Risk 0 2 6 54 38
Equity Risk 16 21 50 10 3
Commodity Price Risk 12 6 32 32 18
Credit Risk 12 6 38 26 18
The Exchange Rate Exposure of Indian Companies 1889

considered important by 18 percent respondents separately. Equity risk is ticked as

highly important only by 3 percent respondents.
In order to make the analysis more precise, the descriptive statistics of the rank
assigned are computed and the same are disclosed in table 5.2. It is obvious from the
said table that interest rate risk obtains the highest mean score (4.28) and thus it is
considered as the most important risk by the sample companies. Mean score obtained
by exchange rate risk equals 4.18, so this is also considered as the second most important
risk. Equity risk and credit risk obtain the third and fourth level of importance
respectively.

Table 5.2
Descriptive Statistics about the Importance Assigned to various Types of Risk

Types of Risk N Mean Std. Deviation

Exchange Rate Risk 50 4.18 1.22
Interest Rate Risk 50 4.28 0.67
Equity Risk 38 2.58 1.08
Commodity Risk 34 3.35 1.28
Credit Risk 34 3.32 1.2

To check the significance level for the 1st null hypothesis i.e. “there is no significant
variance among the level of importance assigned to the various types of risk by the
various companies” ANOVA is used where various types of risk are considered as
independent variables and level of importance assigned to these risk by the respondents
is being considered as dependent variable. The results of ANOVA test are revealed in
table 5.3 which shows that at 5% level of significance, the variance in importance assigned
to various types of risk by the various companies is found significant at 0.000 level.
Table 5.3
ANOVA
Results regarding Importance Assigned to Various Types of Risk

    Sum of Squares Df Mean Square F Sig.

Importance level Between Groups 84.032 4 21.008 17.599 0
  Within Groups 239.929 201 1.194    
  Total 323.961 205

In maximum studies it is discussed that the Indian companies are bearing the
effect of exchange rate fluctuations. In order to study the awareness of these companies
regarding foreign exchange exposure, a question was raised from the respondents,
Do fluctuations in exchange rates have any effect on the company? The results of the
survey as indicated in Table 5.4 shows that out of 50 companies, 46 companies
(approximately 92%) accept that they are affected by the fluctuations in exchange
rate. It means that most of the respondents are aware regarding the effect of exchange
rate fluctuations on their company.
1890 Reeta and Kaya Puri

Table 5.4
Whether Fluctuations of Exchange Rate affect the Company

Companies Yes No Total

No. No. No.
(% age) (% age) (% age)
Banking 12 (100) 0 12 (100)
Non-Banking 34 (89) 4 (11) 38 (100)
Total 46 (92) 4 (8) 50 (100)

The analysis has also been done across banks and the companies not related to
banking sector which indicates that all the banks consider the effect of fluctuations in
exchange rates. These fluctuations not only affect the revenues of the firm but also
affect its assets and liabilities, its value in domestic and international market which
would definitely affect its overall value. In case of non-banking companies 89 percent
companies accept that exchange rate fluctuations affect the cash flows of the companies
only 11percent respondents said that the company’s financial positions are not affected
by exchange rate changes. In the next question the respondents were asked to tick the
area of effect of exchange rate fluctuations on their companies.Survey results are presented
in Table 5.5 which shows that 61percent of the respondents said that exchange rate
fluctuations have a valuable impact on the market value of the firm. 13 percent of the
respondents are also conscious about the effect of exchange rate fluctuations on the
competitive value of their firm in the domestic market and according to 11%
respondents these fluctuations also affect the firm’s competitive value in the
international market. Present value of expected cash flows and the liabilities of the
company have lower effect of exchange rate fluctuations.

Table 5.5
Effect of Exchange Rate Fluctuations

S. No. Area of Effect of Exchange Rate Fluctuations Responses (% age)

1 Competitive Value of a Firm in the Domestic Market 13
2 Competitive Value of a Firm in the International Market 11
3 Present Value of Expected cash flows 2
4 Market Value of a Firm 61
5 Assets of the Company 11
6 Liabilities of the Company 2

The speed of international business activities has magnified the impact of variable
exchange rates on every business. Companies face different types of foreign exchange
exposures such as transaction exposure, economic exposure and translation exposure.
To know the type of foreign exchange exposure which the Indian companies face, the
respondents were asked to tick the type of exposure which the Indian companies are facing.
Results obtained for this question as presented in table 5.6 shows that maximum Indian
firm (80%) have all of the three types of foreign exchange exposures.
The Exchange Rate Exposure of Indian Companies 1891

Table 5.6
Level of Foreign Exchange Exposure

S. No. Types of Exposures Non-Banking Banking Total No.

Companies Companies (% age)
No. (% age) No. (% age)
1 Both Transaction & Economic Exposures 10 (20) 0 (0) 10 (20)
2 All Three Exposures 28 (56) 12 (24) 40 (80)
3 No Exposure 0 0 0 (0)
  Total 38 (76) 12 (24) 50 (100)

A comparison has also been made on the basis of banking and non- banking
companies. The result shows that in today’s era maximum Indian banks have set up
their branches in abroad also, thus not even a single bank is there which is not suffering
currency exposure.In case of the companies other than the banks (20 percent), only
those companies are not facing currency exposures which have their all transactions
denominated in domestic currency only. To know the behavior of the Indian firms
regarding the risk management, respondents were asked to tick the type of foreign
exchange exposure, which you manage. Responses of the study are highlighted in table
5.7 which revealed that 80 percent of the Indian firmshave all the three types of
exposuresbut regarding the management of exposure only 40 percent firms are doing
proper risk management activity to managing these three types of exposures. It has
been investigated that transaction exposure is managed by the most of the companies
(approx. 34%). 22 percent companies are doing efforts to manage both transaction
and translation exposure. only 4 percent Indian firms are managing their economic
exposure.

Table 5.7
Foreign Exchange Exposure Managed by the Companies

S. No. Kind of Currency Exposure Non-Bank Banks No. Total No.

Companies (% age) (% age)
No. (% age)
1 Only Transaction Exposure 17 (34) 0 17 (34)
2 Only Economic Exposure 2 (4) 0 2 (4)
3 Both Transaction and translation Exposure 11 (22) 0 11 (22)
4 All Three Exposures 8 (16) 12 (24) 20 (40)
  Total 38 (76) 12 (24) 50 (100)

Now after exploring all the three types of exposures, the researchers want to find
out the various important hedging techniques and practices used by the selected
companies to manage their foreign exchange exposure. The results of the respondents
are depicted in Table 5.8 validate that companies are actively using various hedging
strategies for the management of all three types of foreign exchange exposure. Forward
contracts are most popular among companies as long term as well as short term hedging
instrument. 96 percent companies hedge their foreign exchange exposure by using
1892 Reeta and Kaya Puri

forward contracts. Future contracts are also used by 96 percent of the respondent
companies. Currency options are also being used very frequently by 86 percent of the
companies. Though there is no restriction on the tenure and size of the swap yet due
to complexity, use of swap is not so admired as the use of forward contracts. 88 percent
companies minimize their risk by swap transactions.

Table 5.8
Hedging Techniques to Manage Transaction Exposure

S. No. Techniques Non-Banking Banking Total (% age) Out

Companies Companies of Total 50
Companies
1 Forward 37 11 48 96
2 Currency Future 36 12 48 96
3 Currency Swap 35 9 44 88
4 Currency Option 33 10 43 86
5 Matching 22 10 32 64
6 Multilateral Netting 22 8 30 60
7 Leads & Lags 12 4 16 32
8 Invoicing & Currency Clauses 23 6 29 58
9 Money Market Hedging 24 8 32 64
10 Currency Diversification 15 5 20 40
11 Risk Sharing 8 2 10 20
Note: The percentages are derived from total sample i.e. 50.

Second hypothesis framed for the present research i.e. “There is no significant
difference in the various hedging techniques used by the Banking and Non-Banking companies”
is analysed with the help of ANOVA technique where various hedging techniques are
considered as independent variable and the importance assigned to these techniques
by various companies is considered as dependent variable. The results of ANOVA are
revealed in Table 5.9 which shows that at 5 percent level of significance, the variance
in importance assigned to various risk management techniques is significant at 0.000
levels. Therefore the null hypothesis is rejected and alternative hypothesis that there
is significant variance in importance assigned to various hedging techniques by the
companies is accepted. It means that different companies use and assign different
level of importance to various hedging techniques for their risk management. It is
also suggested that the firms should usemore than one technique to hedge foreign
exchange exposure effectively.

Table 5.9
ANOVA
Importance Assigned to Various Hedging Techniques of Foreign Exchange Risk

  Sum of Squares Df Mean Square F Sig.

Between Groups 242.724 10 24.272 13.494 0
Within Groups 642.165 357 1.799    
Total 884.889 367      
The Exchange Rate Exposure of Indian Companies 1893

6. CONCLUSION
It is the Globalisation policy which has given a tremendous growth to the quantum of
cross border transactions denominated in various currencies and due to the fluctuations
in the currencies it is very risky for the companies to perform their operations in
foreignexchange transactions. This paper made an attempt to study the general
framework of foreign exchange exposure management strategies in the selected Indian
firms. Regarding the extent of risk, the results reveal that exchange rate risk (with the
mean score - 4.18) is being considered as very important risk by banking and non-
banking units of India. Regarding the impact of exchange rate fluctuations, it is found
that 92 percent of the companies are aware regarding the effect of exchange rate
fluctuations and they consider the impact of these fluctuations on the assets and
liabilities of their company. Maximum selected firms (80%) havewhollythree types of
foreign exchange exposures. Although 80 percent of the selected firmsare affected by
the currency exposures but only 40 percent of the firms are doing efforts to manage all
these three exposures. The firms which are not using derivatives as a risk management
tool in their company have confused perception about the usage of derivative
instruments, they consider it highly cost product and they also have some technical
and administrative constraint in using of derivative instruments as hedging tools. It
has been also investigated that maximum firms have their concern for the management
of their transaction exposure. 22 percent firms are targeting to manage both
i.e.transaction and translation exposure and merely 4 percent firms are managing their
economic exposure.Simple Forward contract is preferred as an important hedging
instrument by the maximum enterprises. As per the respondent’s view 96 percent
Indian firmsuse forward contracts to manage their currency exposure. Swaps and
Cross Currency Options are used 86 percent companies. Though there is no restriction
on the tenure and size of the swap yet due to complexity, use of swap is not so admired.
88 percent companies minimize their risk with the help of swap.

RESEARCH IMPLICATION/ VALUE OF THE STUDY

The present research work is an effort done by the researchers to analyse the viewpoint
of financial experts on international transactions denominated in international currencies.
With the help of this paper tools and techniques available to hedge the currency risk are
examined. The financial experts and CFOs of various companies will be benefited by
this study in identifying and addressing foreign exchange exposurefor their companies
and can establishing support and control mechanism to overcome the impact of all types
of risk. The study shall beneficial to the top management to set the courses for risk
management team in terms of its policies and objectives. The study will also be of immense
use for the other stakeholders in the companies such as shareholders, employees and
credit suppliers. The findings shall also be relevance to the investment community for
their investment portfolio, besides the corporate sector in general. The study is also
expected to be of immense interest and use for students, academicians and researchers,
as it would open new vistas of further research.
 1894 Reeta and Kaya Puri

7. LIMITATIONS AND FUTURE AREAS OF RESEARCH

A survey with questionnaire is always subject to respondents’ biasness. The
respondents answer can vary based on their own experience. In the present study the
results are based on the opinions of only 50 respondents. As there are more than 4500
listed companies in India, it seems inappropriate to generalize the results based on a
sample of 50 companies only. Hence the future researchers must learn from this
limitation and should make efforts for large size samples.
The present study discussed about foreign exchange exposure which is only one
part of financial risk.The study has excluded some important aspects such as
measurement and management of interest rate risk, credit risk and equity risk.
Therefore, it is suggested that the researchers in future must consider these aspects
too.
The participants in the survey were seen reluctant to respond because of some
security reasons. The participants were also not willing to give the true estimation of
their future cash inflows and outflows.

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