ZENITH

International Journal of Multidisciplinary Research Vol.1 Issue 5, September 2011, ISSN 2231 5780

AN ANALYSIS OF FOREIGN EXCHANGE EXPOSURE MANAGEMENT BY MNCs IN INDIA

ABSTRACT With globalization and liberalization being adopted by almost all countries, scope as well as sphere of international business has become much larger. The high volatility of exchange rates is a fact of life faced by every company engaged in international business, bringing in uncertainties in their bottom line. In recent years, variations in value of rupee have been very impulsive and unpredictable. These fluctuations have had a profound impact on domestic and foreign sales, profit levels and profit margins of MNCs operating in India. Many of the companies have turned into ashes as a result of unfavorable exchange rate fluctuations. The present study portrays a thumbnail sketch of foreign exchange exposure management as practiced by various multinational companies in India. Due to the international dependence of its economy, India is extremely well suited as subject for this kind of study. This article is based on a questionnaire study undertaken in 2004-2008 using a sample of 200 Indian and foreign MNCs operating in India. The purpose of this study is to make a comparative analysis of management of foreign exchange exposure by banking and non banking as well as foreign and Indian MNCs operating in India. This study deals with various other questions such as what is their attitude towards exposure management and their policy for management of foreign exchange exposure. Whether or not there is a separate management system for management of their foreign exchange exposure? The results of the study evidence that majority of firms face all of three foreign exchange exposures; transaction exposure, translation exposure and economic exposure. More over majority of the companies under study have proper exposure management system. There is not so significant difference between attitude of foreign and Indian MNCs towards development of separate management system to hedge their foreign exchange exposure. Most of the companies who are aware of foreign exchange exposure make estimation of their exposure despite their level of exposure. There is significant effect of objective of management on estimation of exposure. Most of the companies under the present study are managing only their transaction exposure. Few of them are managing both transaction as well as economic exposure. There is no significant difference between attitude of Indian and Foreign companies towards review of their exposure and hedging policy regularly. KEYWORDS: Exchange Rate Fluctuations, Foreign Exchange Exposure, Economic Exposure, Exposure Management, International Business, Transaction Exposure, Translation Exposure.

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INTRODUCTION The turmoil in the global financial markets, the volatility of the foreign exchange rates and the intensified global competition in the product and the resource market have complicated the decision making process and have increased the level of uncertainty regarding the outcome of international business activities. Undoubtedly, Indian economy has proven to be resilient to substantial exchange rate fluctuations. Arguably, this resilience has strengthened over time, as firms have learned to adapt to exchange rate variability, including through the development of the hedging practices of financial institutions and non-financial firms. Changes in information technologies have also increased the speed and the accuracy of information while the surge of financial innovations is providing the decision makers with new hedging techniques to deal with the uncertainty regarding financial flows. The magnitude of foreign exchange exposure has increased at a mind boggling rate in the recent times. Foreign exchange exposure is what is at risk of exchange rate variations. It is a measure of sensitivity of firms cash flows of changes in exchange rate. This exchange rate risk may be transaction exposure, translation exposure or economic exposure. Transaction exposure is adverse movements of the exchange rate from the time foreign currency denominated transactions are initiated till the time of their final settlement. The exposure arises due to conversion of transactions from one currency into another currency. While buying or selling products in any foreign currency, there is always a time gap between the dates of entering into a contract and its final settlement. During this time gap, the business firm is exposed to exchange rate fluctuations. These fluctuations may be favorable as well as unfavorable. The unfavorable fluctuations may turn a profitable deal unprofitable by the time of actual settlement of contracts; the longer the gap between the signing of a contract and its completion, the higher the level of exchange rate risks. Businesses that source their products from foreign countries also face the exchange rate risk. The exchange rate movements erode gross margins if competition prevents selling prices from rising in tandem. Translation exposure arises from the need to "translate" foreign currency assets or liabilities into the home currency for the purpose of finalizing the accounts for any given period. Multinational corporations having operations in many countries have to prepare their consolidated financial statements to have a complete knowledge of result of all their business operations. Usually, foreign subsidiaries prepare their accounting records and financial statements in the currency of the country where they operate. For this, it is necessary to translate foreign currency denominated accounts of subsidiary companies into the currency of parent company. But the currency fluctuations can create currency gains or losses from such translations. Economic exposure reflects the extent to which the present value of future cash flows is affected by exchange rate movements. A change in the rate affects the company's competitive position in the market and hence indirectly the bottom-line that it affects the profitability over a longer time span than transaction and even translation exposure. It has neither time limit nor a defined direction of movement. It is simple to spot the influence of the expected change in exchange rates on forecasted sales volumes. The foreign exchange exposures emanating from unexpected corner have a definite impact on the company. Tackling these exposures is the biggest challenge that companies face today. It
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International Journal of Multidisciplinary Research Vol.1 Issue 5, September 2011, ISSN 2231 5780

requires a broad based proactive risk management approach at the strategic level. Unmanaged foreign exchange exposure can cause significant fluctuations in the earnings and the market value of the 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 firms viabilit y, bringing the costs of bankruptcy to bear. It is more advisable to bear certain costs rather than giving chance to uncertainties to cause disproportionately high costs to the firm. Foreign exchange exposure not only affects firms financial position but also its competitive position in the market and value of firm, if ignored it can paralyze the financial position of the company. Success of a business firm largely depends on how effectively it manages foreign exchange risk. Foreign exchange exposure management is a multi-staged process that begins with the identification of foreign exchange exposure. Foreign exchange exposure is then monitored, quantified and corrected on a daily or weekly basis to ensure that the risk profile of the firm remains aligned with the objectives of foreign exchange exposure management. They must regularly enter into hedging strategies that minimize the impact of exchange rate fluctuations on their operating costs. Hedging refers to a strategy that strives to minimize the risk of exchange rate fluctuations, thereby minimizing the uncertainty of future transactions denominated in a foreign currency and providing some stability to earnings and cash flows. The task of managing these risks has been facilitated by the increasing availability of a variety of instruments to transfer financial price risks to other parties. This may be one of the reasons that the market for derivative instruments has grown at a breathtaking pace in the past few decades in India. Foreign exchange exposure management can not eliminate foreign exchange exposure completely. But the planned course of action brings risk to manageable level. 2. LITERATURE REVIEW Foreign exchange exposure is very crucial now a days as cross border trade is increasing day by day at a very fast pace. But it is also regarded as very complex. One possible reason for the absence of empirical evidence in the literature may be related to the difficulty in devising the appropriate measures of a firms ability to construct its hedging strate gies. There is a dearth of good literature on this subject, especially in India. Some of the studies identified in this area are as follow; Bengt Pramborg, in this study, Foreign Exchange Risk Management by Swedish and Korean Non Financial Firms: A Comparative Survey, 2002, makes a comparison of hedging practices of Swedish and Korean Firms. The evidence suggests that Korean firms are more concerned about fluctuations in their cash flows whereas Swedish firms focus on accounting numbers. Derivatives usage is more popular for hedging among Swedish firms as compared to Korean firms. It may be a result of relative immaturity of Korean derivative markets. In both of the countries, majority of firms use a profit based approach to evaluate any risk management strategy. The study depicts that the decision to hedge foreign exchange exposure is driven by the level of exposure and size of a firm. Bradford Cornell and Alan C. Shapiro, in their article, Managing Foreign Exchange Risks, provide step by step guidance for the formulation of an effective strategy for managing currency

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risk. First step is to determine the extent of its exposure to currency risk. Second step is to identify the objectives of its exchange risk management program. Third step is to design a set of companywide policies to achieve its objectives. It is observed that the changes in security prices generally reflect changes in cash flows rather than reported earnings. Currency risk affects all the facets of a company operations and therefore, sho uld not be the concern of financial managers alone. Operating managers should develop marketing and production initiatives that help to ensure profitability over the long run. It also pointed out the alarming need for the creation of a committee including senior officers and top functional executives in order to adopt an integrated approach for managing foreign currency exposure. Chand Sooran, in his article, What is hedging? Why do companies hedge? presents his views on hedging of exposures. This article will give a brief overview of the different ways in which firms approach their financial price risk. They also introduce the rationale for using derivative products. Companies attempt to hedge the price changes because these risks are peripheral to the central business in which they operate. Another reason for hedging the exposure of the firm to its financial price risk is to improve or maintain the competitiveness of the firm. In this article, he points out that hedging objectives vary widely from firm to firm. The core problem when deciding upon a hedging policy is to strike a balance between uncertainty and the risk of opportunity loss. Chris Becker and Daniel Fabbro, in their paper, Limiting Foreign Exchange Exposure Through Hedging: The Australian Experience, 2006-09, examine foreign exchange hedging of direct balance sheet and transaction exposures and assesses their broader implications for the Australian economy. This study makes use of quantitative results of Australian Bureau of Statistics (ABS) surveys in 2001 and 2005 for comprehensive data on foreign currency exposures and hedging practices. This paper examines the available evidence on the nature and extent of this hedging behavior. In this paper, they show that foreign currency-denominated assets exceed foreign currency-denominated liabilities, even before accounting for hedging, thereby conferring a transfer of wealth from the rest of the world to Australian residents in the event of exchange rate depreciation. Furthermore, overseas demand for Australian Dollar assets has allowed Australian residents to further hedge their net foreign currency exposures back into local currency terms through the use of derivatives, insulating the economy against the wide fluctuations that can be observed in the exchange rate. They have also observed that despite wide swings in the Australian Dollar, the economy and, specifically, the banking sector, have proved resilient to variability in the nominal exchange rate. DAO Van Quynh, writes an essay on Hedging Fo reign Exchange Exposures in a Multi-National Computer Peripheral Manufacturing Business, 2004-2005. In this essay, he has discussed various methods and procedures that a MNC can use to hedge its cash flows and investments against foreign exchange risk through an example of an unreal MNC ABC Inc. As MNCs have subsidiaries located in different countries and products sold to different countries, they bear heavily the risk of exchange rate changes. However, like domestic firms, MNCs also expose to other risks that are not less importance than foreign exchange one, for example, interest rate or commodity prices exposures. These exposures can also be hedged using various kinds of financial derivatives such as swap, forward contract and option contract.
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David A. Carter, Christos Pantzalis and Betty J. Simkins, in a study, Asymmetric Exposure to Foreign Exchange Risk: Financial and Real option Hedges Implemented by U.S. Multinational Corporations, 2003, argue that exchange risk exposure and hedging are endogenous. The study proves that the magnitude of foreign exchange exposure affects the hedging decisions of the firm and in turn hedging decisions affect the firms exposure to fluctuations in exchange rates. It demonstrates that operational hedges and financial hedges can effectively reduce foreign currency exposure. The real option aspect of multi-nationality allows the firm to utilize its network structure to increase exposure to favorable currency movements and minimize exposure to unfavorable currency movements. Ian H. Giddy and Gunter Dufey, in their article The Management of Foreign Exchange risk, explore the impact of currency fluctuations on cash flows, on assets and liabilities and on the real business of the firm. It is demonstrated that there are numerous realistic situations where the economic effects of exchange rate changes differ from those predicted by the various measures of translation exposure. It emphasizes the distinctions between the currency of location, the currency of denomination and the currency of determination of a business. It suggests some basic principles for managing foreign exchange risk. Sohnke Bartram, in his paper presents the results of his comprehensive study of the foreign exchange rate exposure of 447 German non-financial corporation during the period of 1981-95. The empirical evidence indicates that the firms with more international sales exhibit systematically larger and more significant foreign exchange rate exposures. In addition, firm liquidity variables, especially cash flow/total assets, are significantly negatively related to the exposure. Moreover, industry sectors are important determinants of the foreign exchange rate exposure. As the choice of hedging tools is determined by the exposure profile, nonlinear foreign exchange rate exposures suggest the use of hedging instruments with nonlinear payoff profiles such as financial and/or real options. 3. SIGNIFICANCE OF STUDY: It has been well documented that the vast size of daily foreign exchange trading, combined with the global interdependencies of the foreign exchange market and payment systems involves risks stemming from exchange rate fluctuations. Continuous fluctuations in exchange rate impose threats for international business. As a result of change in exchange rate, importers may require to pay extra for their imports, exporters may get lesser value for their exports, borrowers may required to pay extra and lenders may recover also possible that a viable foreign investment project may twin into a exchange rate fluctuations. Moreover the financial position and profitability of a foreign subsidiary may also change. Large scale fluctuations can even bring dramatic changes in the competitive structure of markets which may even cause some companies to be driven out of the market. It results in too many questions; whether or not companies in Indian, are seriously managing their foreign exchange exposure? If not, what is the reason? All of these questions are required to be answered which initiate this research work.

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4. OBJECTIVES OF STUDY While the risk management strategy of non-financial firms has been the subject of intense theoretical and empirical research, very little is known about the actual hedging practices of multinational firms. This article includes the study of existence of various types of foreign exchange exposures in MNCs operating in India. Transaction exposure arises at the actual conversions of unsettled contracted cash flows from one currency to another at the time of their final settlement. Translation exposure is the result of translation of foreign currency assets or liabilities into the home currency for the purpose of finalizing the financial statements. Economic exposure is the adverse effect of exchange rate movements on the present value of expected future cash flows. It also brings into light various factors affecting foreign exchange exposure management by the companies. The present study examines the available evidence on the nature and extent of hedging behavior of companies in India. The focal point of the study is identification, measurement and management of foreign exchange exposure in selected corporate sector units in India. Other objectives of the study have been to determine the factors which are of special importance while managing foreign exchange exposure, examine the facilities available for managing foreign exchange exposure in India, investigate and verify the techniques used for managing foreign exchange exposure by corporate units in India. 5. HYPOTHESIS In this research the following hypothesis have been tested; 1. 20 % of companies do not manage their exposure. 2. Management system of companies does not depend on consideration for effect of fluctuations and objective of exposure management. 3. Only 40 % of companies managing exposure follow the policy of active management. 4. There is no significant effect of objective of management, management system and management policy on decision of estimation of exposure. 5. There is no significant effect of origin of company on periodicity of review of their exposure & hedging policies. 6. There is no significant effect of objective, management system and management policy on periodicity of review of their exposure and management policies. 6. RESEARCH METHODOLOGY Using a field study and proprietary data, it unfolds the difference between attitude of various banking and non banking Indian and foreign MNCs engaged in international business in India towards management of their various foreign exchange exposures. The results presented in this study are based on a questionnaire study undertaken in 2004-2008. As such the aim is not to create a large sample selected randomly but to create a sample of information rich cases selected purposefully. The sample is composed of 200 companies out of fortune 500 companies which
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were ranked on the basis of their sales during the financial year from 1 st Jan to 31st December 2003, as published in Economic Times in May 2004. Out of 200 companies, 95 companies responded back to the questionnaire. All companies are heavily internationally oriented as significant proportion of their turnover originates from foreign markets as per their published accounts. The selected companies cover a broad specter of players of various sectors such as automobiles, pharmaceuticals, oil, cement, FMCG, chemicals, steel, IT, textile, nuts, consumer durables, electricity & energy, banking, paper & paper products and miscellaneous. Management policies for managing foreign exchange exposure have been divided into mainly three groups; Active management, Regular management and no management. Three point scales has been used for this purpose. Number 3 has been used for active management, 2 for regular management and 1 for no management of foreign exchange exposure. A scale of 1 to 5 has been used to analyze results. Significance was discussed on 5 % level in all tests used for hypothesis testing. Z test and ANOVA have been applied to test hypothesis and interpret the results. Graphs and tables have also been used to facilitate the analysis of data. 7. RESULT & DISCUSSION On the basis of the study of management of foreign exchange exposure by MNCs in India, the followings are the findings of the study; 7.1 EXISTENCE OF VARIOUS FOREIGN EXCHANGE EXPOSURES The speed of international business activities has magnified the impact of variable exchange rates on every business. MNCs have to face different types of foreign exchange exposures such as transaction exposure, economic exposure and translation exposure. The results for existence of various exposures are depicted in table 1 and chart 1. TABLE 1 EXISTENCE OF VARIOUS FOREIGN EXCHANGE EXPOSURES S. No. 1 2 3 Type of Exposure Both Transaction & Economic Exposure All Three Exposures No Exposure Total Total 22 73 0 95
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International Journal of Multidisciplinary Research Vol.1 Issue 5, September 2011, ISSN 2231 5780

CHART 1 EXISTENCE OF VARIOUS FOREIGN EXCHANGE EXPOSURES

Both Transaction & Economic Exposure 23%

All Three Exposures 77%

Results of the study confirm the general view that the majority of the companies (approx. 77% companies) face all of three exposures; transaction, economic and translation exposure. Even the companies which do not have any foreign subsidiary are also facing translation exposure because of their foreign currency assets and liabilities. There is not even a single company under study which has been left untouched by any of these exposures. 7.2 COMPARISON OF ATTITUDE TOWARDS MANAGEMENT OF FOREIGN EXCHANGE EXPOSURE OF BANKING AND NON BANKING COMPANIES Usually it is observed that companies in India do not manage their exposure. On the basis of this general observation, null hypothesis has been formulated and tested with the help of z test. A comparison has also been made between banking and non-banking companies. The results of comparison are depicted in table 2 and chart 2. NULL HYPOTHESIS: 20 % of companies do not manage their exposure. TABLE 2 & CHART 2 ATTITUDE TOWARDS MANAGEMENT OF FOREIGN EXCHANGE EXPOSURE
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Companies Facing Exposure Manage Non Banking Companies Banking Companies Total 76 12 88

Do not Manage 7 0 7

Total 83 12 95

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Do not Manage Exposure 7%

Manage Exposure 93%

RESULT OF Z TEST Ho: = 0. 20 p = 7 / 95 P = 0.073 = - 3.094 Sample Z

7.3 OBJECTIVES FOR FOREIGN EXCHANGE EXPOSURE MANAGEMENT Different companies have different objectives for their foreign exchange exposure management. The results showing various objectives of MNCs under the present study are presented in table 3.

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Results of Z test show that the computed value of z lies outside the acceptance region as compared to the critical value of z = + 1.96 at 5 % level of significance, therefore, null hypothesis is rejected. Hence, based on this data the hypothesis that 20 % of companies do not manage their exposure is rejected. Graph depicts that most of the companies which identify the effect of exchange rate fluctuations (approx. 93 % companies as shown in table 2) accept the need of management of their foreign exchange exposure. Comparative study of banking and nonbanking companies shows that all of the banking companies accept the need for managing their foreign exchange exposure as in India; it has been made mandatory by RBI for all the banks dealing in foreign exchange in India. Only 7 % of companies (non-banking companies) which do not accept even the effect of foreign exchange exposure do not realize any need for managing their exposure.

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TABLE 3 OBJECTIVES OF EXPOSURE MANAGEMENT Objective Eliminate All Risk Eliminate Risk Selectively Minimizing Net Foreign Exchange Exposure Stabilization Purpose Allow Profits Responses 31 27 10 5 3 Objective Actively Seek Profits Improving Ability to Make Value Adding Investments Reducing Stakeholders Perceived Risk Seek Competitive Advantages Respondents 3 3 4 2

Results of the study do not comply with general view about companies in India. It shows that 35 % companies have proper management system in order to eliminate all of their exposure. 31 % of the companies try to eliminate their risk selectively whereas 11 % of companies wish to minimize their risk. Some of the companies follow the policy of stabilization. Only few of the respondent companies have the other objectives in their mind. 7.4 COMPARISON OF INDIAN AND FOREIGN COMPANIES REGARDING DEVELOPMENT OF SEPARATE EXPOSURE MANAGEMENT SYSTEM Firm should take foreign exchange exposure management as a system which provides strategies, techniques and an approach to recognizing and confronting any threat faced by a firm due to exchange rate fluctuations. A proper foreign exchange exposure management policy is required to be framed. The difference between attitude of Indian and foreign companies has been depicted in table 4 and chart 4. TABLE 4 & CHART 4 EXISTENCE OF SEPARATE EXPOSURE MANAGEMENT SYSTEM Existence of Management System Origin of Company Yes Indian Foreign Total 56 9 65 No 26 4 30 82 13 95
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Total

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32%
100%
80%

31%

68%

60%
40% 20% 0%

69%

Yes
Indian

No

yes

Foreign

Results of the study do not comply with general observation. It has been observed that there is no significant difference between Indian and foreign companies regarding their attitude towards development of management system to hedge their foreign exchange exposure. 7.5 FACTORS AFFECTING ESTABLISHMENT OF SEPARATE MANAGEMENT SYSTEM FOR FOREIGN EXCHANGE EXPOSURE MANAGEMENT Whether or not any company will establish a separate management system for management of its foreign exchange exposure, it depends on many factors. But in this study two factors are considered to be more important for this purpose. First foremost factor is the identification of effect of exchange rate variations on the company. Those companies which do not agree that such kind of variations in exchange rate can adversely affect their business; they will never establish any system for its management. Another factor is the objective of exposure management policy of the company. Any company who is willing to minimize or mitigate exposure by applying various strategies will definitely have separate system for its management. To study the dependence of management system of companies on these two factors, ANOVA techniques has been applied where management system is the dependent variable and effect of fluctuations and objective of exposure management are independent variables. The results are depicted in table 5. NULL HYPOTHESIS: Management system of companies does not depend on consideration for effect of fluctuations and objective of exposure management.

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International Journal of Multidisciplinary Research Vol.1 Issue 5, September 2011, ISSN 2231 5780

TABLE 5 FACTORS AFFECTING ESTABLISHMENT OF SEPARATE MANAGEMENT SYSTEM FOR FOREIGN EXCHANGE EXPOSURE MANAGEMENT Source Corrected Model Intercept Effect of Fluctuations Type III Sum of Squares 11.352(a) .419 .179 df Mean Square 2 5.676 1 .419 1 .179 1 92 95 94 7.922 .104 F Sig.

54.782 .000 4.044 .047 1.729 .192 76.462 .000

Objective of Exposure 7.922 Management Error 9.532 Total 287.000 Corrected Total 20.884 a R Squared = .544 (Adjusted R Squared = .534)

The results of ANOVA show that at 5 % level of significance, objective of exposure management affects significantly the management system of companies. It also shows that management system of companies does not depend so much on their consideration for effect of exchange rate fluctuations. 7.6 MANAGEMENT POLICIES OF COMPANIES MNCs in India follow different management policies for management of their foreign exchange exposure. There are mainly three policies; no management, regular management and active management. It is usually stated that most of the companies ignore their foreign exchange exposure. On the basis of general observation, hypothesis regarding the behavior of companies in India has been formulated and tested with the help of Z Test. The results are depicted in table 6 and chart 5. NULL HYPOTHESIS: Only 40 % of companies managing exposure follow the policy of active management. TABLE 6 & CHART 5 MANAGEMENT POLICIES OF COMPANIES Management Policies of Companies Do not Manage Actively Manage Regularly Manage Total Responses 7 55 33 95
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Do Not Manage 7%

Regularly Manage 35% Actively Manage 58%

RESULT OF Z TEST Ho: = 0. 40 Sample p = 55 / 88 = 0.625 = 4.31 P Z

Results of Z test show that the computed value of z is beyond the acceptance region of the critical value of z = + 1.96 at 5 % level of significance, therefore, null hypothesis is rejected. Hence, based on this data the hypothesis that only 40 % of companies actively manage their exposure is not true. Graph shows that majority of companies under study are managing their foreign exchange exposure. The results depict that 35 % of companies manage their exposure regularly whereas 58 % companies are actively managing their exposure. 7.7 ESTIMATION OF FOREIGN EXCHANGE EXPOSURE Foreign exchange exposure management is not possible without accurate estimation of exposure. Estimation of foreign exchange exposure requires expertise in applying various forecasting and statistical tools such as VaR, regression, simulation etc. Not all the companies make estimation of their foreign exchange exposure. Usually it has also been observed that foreign companies possess expertise to make estimations whereas Indian companies do not indulge in such tedious activities. The results showing attitude of companies towards estimation of their foreign exchange exposure are depicted in table 7. Whether or not any company will make estimation of their exposure also depends on many other factors. In this study hypothesis has been formulated to judge the effect of objective, management system and management policy on estimation of their exposure. The hypothesis has been tested with the help of ANOVA technique where estimation of exposure is dependent variable and effect of fluctuations and effect of objective,

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management system and management policy are independent variables. The results of the test are depicted in table 8. TABLE 7 & CHART 6 ESTIMATION OF FOREIGN EXCHANGE EXPOSURE

Estimation of Exposure Origin of Company Yes Indian Foreign 76 12 No 6 1 82 13 Total

Total

88

95

7% 7%
E S T I M A T I O N
100% 80% 60% 40% 20% 0%

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Indian

No
Foreign

yes

ORIGIN

92%

Results show that most of the companies who are aware of foreign exchange exposure make estimation of their exposure. It denies the general view that Indian companies do not estimate their exposure. Indian companies also estimate their foreign exchange exposure despite their

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level of exposure. It has also been observed that majority of companies rely on expectations of foreign exchange market for measurement of their foreign exchange exposure. Some of the companies also consider major indicators such as exchange controls, import restrictions, interest rates and inflation rate while making the analysis of fluctuations in foreign exchange rate. NULL HYPOTHESIS: There is no significant effect of objective of management, management system and management policy on decision of estimation of exposure. TABLE 8 EFFECT OF VARIOUS FACTORS ON DECISION OF ESTIMATION OF FOREIGN EXCHANGE EXPOSURE Source Type III Sum of Corrected Model 11.523(a) Squares Intercept 1.584 Management System .012 Objective 4.542 Management Policy .094 Error 10.309 Total 197.000 Corrected Total 21.832 a R Squared = .528 (Adjusted R Squared = .512) df 3 1 1 1 1 91 95 94 Mean 3.841 Square 1.584 .012 4.542 .094 .113 F 33.904 13.983 .106 40.089 .832 Sig. .000 .000 .746 .000 .364

The results of ANOVA show that at 5 % level of significance, there is significant effect of objective of management on estimation of exposure. But the effect of management system and management policy on estimation of exposure is not so significant. 7.8 REASONS FORCING EXPOSURE MANAGEMENT Foreign exchange exposure, if ignored, can put survival of any company in danger any moment which may result in huge losses of financial distress. Moreover it has always been arduous to harmonize investment and financing activities of the company which usually pose the problem of currency, amount or timing disparity of cash flows. Managers and shareholders of the company have different interest. Shareholders are more interested in market value of the firm where as mangers pay more attention towards profits. It may result in agency conflicts about the decision of management of foreign exchange exposure. Convexity of tax functions also poses threat to the companies. Usually it is observed that companies consider the question of hedging foreign exchange exposure as a critical activity as they wish to evade the loss of financial distress. The results of the study showing the reasons for which companies in India management their foreign exchange exposure are depicted in table 9 and chart 7. TABLE 9 REASONS FORCING EXPOSURE MANAGEMENT Reasons Forcing Exposure Management Costs of Financial Distress Responses 60 % age 63
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Problems of Synchronizing Investments & Financing Activities Costs of External Funding Agency Conflicts Between Managers and Shareholders Convexity of Tax Function

40 45 20 22

42

47 21 23

Costs of External Funding

Convexity Agency conflicts of tax Costs of Financial Distress

Problem of Synchronization

Results of the study match with general statements. It shows that most of the companies in India are worried about the costs of financial distress. Problems of synchronizing investments and financing activities also force them to take care of their foreign exchange exposure. Few of the companies consider the force of cost of external funding, agency conflicts and convexity of taxes while considering the issue of management of their foreign exchange exposure. 7.9 MANAGEMENT OF VARIOUS EXPOSURES Though everyone knows that unmanaged foreign exchange exposure can cause significant fluctuations in the earnings and the market value of the firm yet it is also argued that hedging is not so simple exercise. In fact, risk management, essentially, is a strategic function. It requires specialized skills. It has been observed that companies have different attitude towards management of their various foreign exchange exposures. This study makes a comparison between attitude of banking and non-banking companies towards their various foreign exchange exposures. The results are depicted in table 10 and chart 8.
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TABLE 10 MANAGEMENT OF VARIOUS EXPOSURES Type of Exposure Only Transaction Exposure All Three Exposures Both Transaction & Economic Exposure Only Economic Exposure No Hedging Non Banking Companies Banking Companies Total 48 20 7 1 7 0 11 1 0 0 48 31 8 1 7

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Total

83

12

95

CHART 8 MANAGEMENT OF VARIOUS EXPOSURES

The results of the study confirm the general observation. It shows though 77% of companies under study face all of three exposures; transaction, economic and translation exposure yet only 24 % of companies are managing all of their exposures. Most of the companies (approx. 60 %) are managing only their transaction exposure. 8 % of companies are managing their transaction and economic exposure. Only 7 % of companies (non-banking companies) which do not accept even the effect of foreign exchange exposure do not manage their exposure. 7.10 FACTORS OF CONSIDERATION FOR EXPOSURE MANAGEMENT There are many factors which should be duly taken care of while considering any decision of foreign exchange exposure management. The results of the study show that most of the companies are worried about few of the factors like inflow-outflow mismatches, timing mismatches, benefits of hedge and contracted foreign currency cash flows etc. They are not so serious about many of the other crucial factors such as degree of foreign involvement by foreign subsidiaries, variability of expected future cash flows, location of subsidiaries, their accounting methods, elasticity of demand of their inputs and out puts, strategies of its competitors and flexibility of their production processes etc. which if duly taken care of, may be prove to be boon for the company in case of adversities. 7.11 NUMBER OF TECHNIQUES USED FOR EXPOSURE MANAGEMENT Generally it is observed that companies in India do not manage their foreign exchange exposure as actively as they do not take it so seriously. Moreover, not many options are available to for

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hedging exposure completely. Companies use few of techniques for hedging their exposure. No. of techniques used for exposure management has been treated as an indicator of their seriousness towards exposure management. The results are depicted in table 11 and chart 9. TABLE 11 & CHART 9 NUMBER OF TECHNIQUES USED FOR EXPOSURE MANAGEMENT

No. of Techniques 0 1 2 3 4 5 More Than 5 Total

Responses 7 51 15 5 13 4 0 95

5% 16% 54%

4%7% 14%

Do not Hedge

Use 1 Technique

Use 2 Techniques

Use 3 Techniques

Use 4 Techniques

Use 5 Techniques

RESULTS OF STATISTICAL ANALYSIS Mean Median & Mode = 1.778947368 =1

Standard Deviation = 0.46588033

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Skewness

= 1.671980549

Statistical analysis shows that frequency of companies using only one technique is highest. Graph depicts that 54 % of companies are using only one technique to manage their exposure. 16 % of companies use two techniques. Very few companies use more than two techniques. 5 % of companies are using three techniques. 14 % of companies are more serious about their exposure management and use four techniques for hedging their exposure. Whereas only 4 % of companies apply 5 or more than 5 techniques as they make their best efforts to eliminate exposure completely. 7.12 COMPARISON OF ATTITUDE OF INDIAN & FOREIGN COMPANIES TOWARDS REVIEW OF EXPOSURE / HEDGING POLICIES Success of exposure management requires not only establishment of exposure management system or applying various hedging strategies. There should be periodic reporting and evaluation of effectiveness of those hedging policies. System should be developed to smell out danger at the earliest stage and quicker decision making to handle it. Having a foreign exchange exposure management system in place will not protect a firm or enhance its performance unless it is embedded in a risk aware corporate culture. Moreover constant eye on market fluctuations and exposure is also essential. On one hand, some of the companies do not pay attention for review of their exposure and hedging policies on the other hand; some of the companies have the system of daily review. Some of the companies even follow the policy of weekly, monthly or quarterly review system. Usually it is observed that foreign companies take exposure management very seriously and they develop systematic periodic review system for regular evaluation of effectiveness of their hedges whereas Indian companies are no so serious about review and evaluation. To study the difference in attitude of Indian and foreign companies towards periodicity of review of exposure and hedging policies, hypothesis has been formulated. The hypothesis has been tested with the help of ANOVA where periodicity of review is the dependent variable and origin of company (Indian or Foreign) is independent variable. The results of comparison are depicted in table 12 and table 13. NULL HYPOTHESIS: There is no significant effect of origin of company on periodicity of review of their exposure & hedging policies.

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TABLE 12 COMPARISON OF ATTITUDE OF INDIAN & FOREIGN COMPANIES TOWARDS REVIEW OF EXPOSURE / HEDGING POLICIES Periodicity of Review Origin of Company Daily/ weekly 45 No Review Monthly Quarterly Yearly Total

Indian

27

82

Foreign

13

Total

51

30

95

TABLE 13 COMPARISON OF ATTITUDE OF INDIAN & FOREIGN COMPANIES TOWARDS REVIEW OF EXPOSURE / HEDGING POLICIES Source Type III Sum df of Squares Corrected Model .310(a) 1 Intercept 35.527 1 Origin of Company .310 1 Error 28.678 81 Total 357.000 83 Corrected Total 28.988 82 a R Squared = .011 (Adjusted R Squared = -.002) Mean Square .310 35.527 .310 .354 F .875 100.344 .875 Sig. .352 .000 .352

Graph shows that there is both Indian and foreign companies have similar attitude for review of their exposure and hedging policies. Most of the Indian as well as Foreign companies review their exposure and hedging policy on regular basis. ANOVA table shows that at 5 % level of significance, null hypothesis is accepted. So, there is no significant difference between Indian and foreign companies regarding their periodicity of review of their exposure and hedging policies. 7.13 FACTORS AFFECTING ATTITUDE OF COMPANIES TOWARDS REVIEW OF EXPOSURE / HEDGING POLICIES

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The attitude of any company towards periodicity of review of their exposure and hedging policies depends on many factors. In this article, to study the effect of objective, management system and management policy on periodicity of review of their exposure and hedging policies hypothesis has been formulated. ANOVA has been applied to test the hypothesis where periodicity of review is dependent variable and effect of fluctuations and effect of objective, management system and management policy are independent variables. The results of the test are depicted in table 14. NULL HYPOTHESIS: There is no significant effect of objective, management system and management policy on periodicity of review of their exposure and management policies. TABLE 14 FACTORS AFFECTING ATTITUDE OF COMPANIES TOWARDS REVIEW OF EXPOSURE / HEDGING POLICIES Source Type III Sum of Squares df 3 1 1 1 1 91 95 94 Mean Square 8.888 3.693 10.932 .001 .145 .079 F 112.864 46.899 138.813 .016 1.835 Sig. .000 .000 .000 .899 .179

Corrected Model 26.665(a) Intercept 3.693 Objective 10.932 Management System .001 Management Policy .145 Error 7.167 Total 430.000 Corrected Total 33.832 a R Squared = .788 (Adjusted R Squared = .781)

Since value of p is 0.899 for management system and 0.179 for management policy which is higher than 0.05 (5 % level), management system and management policy do not have any significant effect on periodicity of review of their exposure and hedging policies. But objective of exposure management have significant effect on periodicity of review. 8. CONCLUSION
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Majority of the companies face all of three exposures; transaction, economic and translation exposure. Even the companies which do not have any foreign subsidiary are also facing translation exposure because of their foreign currency assets and liabilities. Comparative study shows that as most of the banking companies have spread their wings in international market, no banking company under the study has been escaped of foreign exchange exposure. Only those non banking companies which have neither any foreign subsidiary nor any foreign currency denominated asset or liability are not facing translation exposure. There is not even a single company under study which has been left untouched by any of these exposures. All of the banking companies accept the need for managing their foreign exchange exposure as in India; it has been made mandatory by RBI for all the banks dealing in foreign exchange in

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India. Few of the non-banking companies do not accept even the effect of foreign exchange exposure do not realize any need for managing their exposure. Majority of the companies have proper management system in order to eliminate all of their exposure. Some of the companies try to eliminate their risk selectively whereas some of them also try actively to seek profits or competitive advantages. Few of them follow the policy of stabilization. Companies also consider other objectives such as to reduce stake holders perceived risk, to improve their ability of investments and to minimize their risk. Both foreign and Indian MNCs have similar attitude towards development of separate management system to hedge their foreign exchange exposure. The results also show that management system of companies does not depend so much on their consideration for effect of exchange rate fluctuations. Most of the companies who are aware of foreign exchange exposure make estimation of their exposure. Both Indian and foreign companies estimate their foreign exchange exposure despite their level of exposure. There is significant effect of objective of management on estimation of exposure. But the decision of estimation of exposure is not so much affected with existence of separate management system and management policy of the company. Most of the companies in India are worried about the costs of financial distress. Problems of synchronizing investments and financing activities also force them to take care of their foreign exchange exposure. Few of the companies consider the force of cost of external funding, agency conflicts and convexity of taxes while considering the issue of management of their foreign exchange exposure. Majority of companies under study are actively managing their foreign exchange exposure. Though most of the companies suffer from all of the exposures; transaction, economic and translation exposure yet only few of them are managing all of their exposures. Most of them are managing only their transaction exposure. Few of them are managing both transaction as well as economic exposure. Majority of the companies are using only one technique to manage their exposure. Very few companies are taking help of two or more than two techniques. These include those companies, which make their best efforts to eliminate exposure completely. Both Indian and foreign companies have similar attitude for review of their exposure and hedging policies. Most of the Indian as well as Foreign companies review their exposure and hedging policy on regular basis. Management system and management policy do not have any significant effect on periodicity of review of their exposure and hedging policies. But periodicity of review is significantly affected by objective of exposure management. 9. BIBLIOGAPHY Aabo, Tom (2001), E-Commerce and Exchange Rate Exposure Management: A tilt towards Real Hedging, Journal of E-Business, Vol. 1, Issue-1 June 2001. Aliber, Robert Z., 1978, Exchange Risk and Corporate International Finance, Hasted Press, New York. Allayannis, George and E. Ofek, 1997, Exchange rate Exposure, Hedging, and the Use of Foreign Currency Derivatives, Working Paper, University of Virginia.
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Davis, Henry A., and Frederick C. Militello, Jr., 1995, Foreign Exchange Risk Management: A Survey of Corporate Practices, (Financial Executives Research Foundation, Morristown, New Jersey, USA) 44 He, Jia and Lilian K. Ng, 1998, The Foreign Exchange Exposure of Japanese Multinational Corporations, the Journal of Finance 53 (2), 733 -753. Hiten Jhaveri, Strategies for Managing Risks, Chartered Financial Analyst, Dec. 2002. Jorion, Philippe, 1990, The Exchange Rate Exposure of U.S. Multinationals, Journal of Business 63 (3), 331-45. Laurent L. Jacque, Management of Foreign Exchange Risk: A Review Article, Jour nal of International Business Studies, Spring/Summer 1981. Pringle, John J., 1991, Managing Foreign Exchange Exposure, Journal of Applied Corporate Finance 73-82. Schrand, Catherine, and Haluk Unal, 1998, Hedging and Coordinated Risk Management: Evidence from Thrift Conversions, Journal of Finance, Vol. 53, No. 3, 979-1013. Shapiro, Alan C., and Sheridan Titman, 1986, An Integrated Approach to Corporate Risk Management, in Joel Stern and Donald Chew, Eds.: The Revolution in Corporate Finance (Basil Blackwell, Ltd. Oxford, England and Basil Blackwell, Inc., Cambridge, Mass.). Shapiro, Alan C., 1996, Multinational Financial Management, 5 th edition, Prentice Hall Inc., Upper Saddle River, New Jersey. T. Ramanan, Risk Management, Chartered Financial A nalyst, Feb. 2003.

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