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Foreign Exchange Risk Management In India

The free essay below has been submitted to us by a student. The essay is the student's work and is not an example of our expert essay writers' work. READ MORE Get an Instant Quote A vast variety of literature is available on the utility of efficient management of foreign exchange risk in a company as well as importance of various tools that can be used for the reduction ofexposure caused due to dealings in multiple currencies. In one such study, Allayanis and Ofek (2001) performed an analysis on a sample of S&P 500 non-financial companies and calculated the companies exchange-rate exposure. They also tried isolating the impact of use of foreigncurrency derivatives (widely used for purpose of foreign exchange risk management) on a firms foreignexchange exposures. The results of their study found a significant association between theabsolute value of the exposures and the (absolute value) of the percentage use offoreign currency derivatives and prove that the use of derivatives in fact reduceexposure. Despite this, there are various reasons why many organizations do not employ foreign exchange risk management techniques to overcome the losses that can be caused due to the fluctuating exchange rates. Dufey and Giddy (2003) state several reasons why many organizations do not employ foreign exchange risk management techniques, such as lack of awareness about the importance of foreign exchange risk management, belief that the company does not need hedging, and the belief that company will be rewarded only when it takes risk and hence, no requirement for risk management. However, these arguments are flawed and it is a well-established fact that any organization dealing in foreign currency transactions is exposed to foreign exchange risk. The degree of foreign exchange risk exposure plays an important role in an organizations foreign exchange risk management strategies. For an organization it is first essential to identify and analyze the type and degree of exposure, as this will give the company a clear understanding of the consequences of foreign exchange risk management (Papaioannou, 2006). The following are the three types of exposures that affect the company when multiple currencies are involved in their business transactions (Rich, 2010): Translation Exposure: When company converts revenue earned in foreign currency to home currency, then the exposure is called as translation exposure Transaction Exposure: When prices received or paid for goods are influenced by currency, then such exposures are termed as transaction exposure. Economic Exposure: Where input costs, balance sheet values, companys competitive advantage, COG (cost of goods) sold are affected, we call them as economic exposure.

1.2 Framework for Foreign Exchange Risk Management Framework for Foreign Exchange Risk Management
Figure 1: Source: Kshitij Consultancy Services, 2010 The first step is complete when an organization accepts the need for foreign exchange risk management due to its exposure. The next step involves allocation of resources for managing such exposure. A generic framework is

presented in the above figure 1 can assist organizations in effective allocation of resources for risk management. Forecasts: Once the organization initiates the risk management process, the first step for the company is to develop an appropriate forecast with respect to expected market trends and expected currency movements in the future i.e. what is the expected direction/trend for the foreign exchange rates (Jacque, 1981). The forecast period depends on organization and varies with their choices. However, average forecast period is usually 6 months. Since the forecasts form foundation of risk management process, it is very necessary to ensure that forecasts are as accurate and valid as possible. The margin of error should also be estimated so that the organization can prepare itself for unexpected movements or error in judgement. Risk Estimation: Once the forecast for currency movements is completed, the next step is to measure the actual profit or loss that will be incurred corresponding to forecasted currency rate movements (Kshitij Consultancy Services, 2010). This is usually performed using a technique called Value at Risk and is accompanied with the probability of such risks (Xu and Wirjanto, 2010). While calculating such profit or loss, various risks such as those caused due to market specific issues, systemic risk (due to inadequacies such as reporting gaps and implementation gaps in the firms exposure management system) should also be included in the analysis. Benchmarking: Now the organization will have estimates for expected exposure as well as the corresponding risk. Depending on the organizations volume and size, it has to determine the limits for handling foreign exchange exposure. The company also has to decide the manner in which it wants to manage its exposures (Godwin and Goldberg, 2006): Cost centre approach is a defensive approach whereby the organizations objective is to ensure minimizing adverse effect on companys cash flows to the decided limit.(Sivakumar and Sarkar, 2008) Profit centre approach is an aggressive approach where the organizations objective is to generate profits on its exposure through company transactions. (Sivakumar and Sarkar, 2008) Hedging: Based on the above steps of forecasts, risk estimation and benchmarking, the organization has to now determine an appropriate hedging strategy. Depending on specific requirement, the organization can select from a variety of financial instruments available such as, futures, forwards, options and swaps and issue of foreign debt (Sivakumar and Sarkar, 2008). Stop Loss: The organization can select an instrument based on its forecasts and estimates. However, the firm has to consider the situation where movements may not be according to their estimates and may cause losses instead of risk management. For such scenario, the organization needs to ensure stop loss arrangements to cover for errors in estimates/forecasts. The organization also needs to monitor actual movements with respect to their estimates such that losses can be contained when risk reaches certain critical level (Lien, 2006) Reporting and Review: Risk management policies of any organization are usually reviewed periodically due to uncertainty and chances of forecast errors. Moreover, the effectiveness of current risk management strategy needs to be assessed such that rectifying measures can be taken in appropriate time frame. For this purpose, periodic reports may be generated which include profit/loss status on open contracts after marking to market, the actual exchange/interest rate achieved on each exposure, and profitability vis--vis the benchmark and the expected changes in overall exposure due to forecasted exchange/ interest rate movements. Such review reportshelp in analyzing the validity of benchmarks, effectiveness of strategies and accuracy of forecasts as also the requirement for any changes.

1.3 Foreign Exchange Risk in Indian Context

The Indian economy became deregulated in 1990s and started taking huge steps towards liberalization. The currency exchange rates in the country first became market determined in 1993. The rupee became fully convertible in 1994. In the recent years, Indian IT/software companies have successfully led the ITeS success story and have fuelled Indias economic growth to a large extent. Indian software companies are the largest in undertaking software outsourcing (contracting to third-party), with majority of clients from USA and European countries. The table 1 below shows the list of top software companies in India (taken for our research), whose major revenues comes from US, UK and Europe. The shocking fact here is that almost 70-80% of their revenues were dealt with foreign currencies. Almost all of the billings are through foreign currency.

Indian Software companies revenues Geographic Segment TCS Infosys Wipro HCL

% of Revenues % of Revenues % of Revenues % of Revenues

2009-10 2008-09 2009-10 2008-09 2009-10 2008-09 2009 North America 52.8

51.38 74.4 72.3 44 45 54.4 UK 16.18 18.99 8.5 11.8 21 22 29.2 Europe 10.49 10.53 6.7 6.9 Australia

5.8 4.4

India 8.65 7.85

4.6 4.6 23 21 16.4 Rest of the world 11.88 11.25 12 12 Table 1: Source: TCS, 2010a; Infosys, 2010a; Wipro, 2010a; HCL, 2009a. As per NASSCOM report, wealth of software and service segments is estimated to cross the $1.2 trillion mark by 2012 (Nasscom, 2009). The figure 2 below shows that the software exports to other countries are on incremental trend since FY2000. Thanks to the Indian outsourcing and IT/software companies, India has come to be known as the preferred outsourcing destination.

Industry performance
Figure 2: Source: Nasscom, 2009 However, on the flipside, given the recent India success story and increasing amounts of foreign exchange reserves in the country, the Indian rupee is also facing high volatility. The volatile rupee aggravates the problem for such IT companies as majority of the revenues of such companies are from foreign countries rather than from India. It has been estimated that 1% of movement in Foreign exchange will have 0.7% adverse/favourable impact on operations margin %. 10% of foreign exchange movement in 2007 shaved off 7% margins in the business. Suresh Senapathy (2009), Wipros Chief operating officer says that 25% foreign exchange movement (USD against INR) in 2008 (Rs. 40 to Rs.50) had added 15-16% margins back. In 2009, 6% movement in downward trend (Rs.50-> Rs.47) took 4% of margin. The recent appreciation of rupee witnessed many of such similar companies reporting huge losses due to the foreign exchange exposure and inadequate risk coverage by the companies. Volatility in the foreign exchange rates continues to impact company results - but it can be managed properly through effective foreign exchange risk management practices.Hence, foreign exchange risk management gains special importance in case of such companies. In keeping with the requirement, foreign exchange risk management has gained a lot of momentum in India in the last two decades. Even the ban on futures trade was lifted in early 2000s in order to facilitate wider usage of such instruments. The companies in India were allowed to deal in options in 2007.

A joint survey conducted by NASSCOM and Mecklai Financial, on risk management practices among 41 of the information technologies (IT) firms found that more than 50% of the respondents believed that foreign exchange risk had the top or second priority in the list of considerable risks for their respective companies (Nasscom, 2007). An overwhelming four-fifth of the respondents revealed that the board members in their companies asked for foreign exchange forecasts at least once a year. In contrast to the above encouraging results, the same survey also revealed a surprising lack of sophistication among respondent IT companies, in regard to their risk exposure. The survey results revealed that 13% of companies interviewed allowed their risk exposures to be realized at the spot, whereas 16% of them stated that they didnt even know the margin they were charged by the bankers (Nasscom, 2007). A reason for usage of limited hedging instruments can also be the fact that very limited research and literature is available on the rationale behind choice of hedging instruments. There are various options and techniques like Hedging, currency options, currency swaps, currency futures and forward currency transactions should be utilised depending on the situation to minimise the foreign exchange risk (Sivakumar and Sarkar, 2008). But because the concept is relatively new and different authors and experts on the subject vary widely in their opinions on choice of instruments, the confusion regarding appropriate choice of instrument prevails. This was reflected in results of the above mentioned survey where two-third of the companies were relatively conservative and using just forward contracts with very small percentage using options and ameagre percentage of companies using options and swaps. Another surprising finding was that more than half of them do not "see" their non-dollar risk as existing in two parts - example, a Euro receivable is really the combination of euro/US dollar and US dollar/Indian rupee. This was also true for more than half the companies who had more than 25% of their exposures in non-dollar currencies, the survey said. Clearly, Indian software companies need to focus more on better risk management strategies. The survey also concluded results by highlighting urgent need for much sounder foreign exchange risk management practices among the Indian IT companies.

1.4 Objective of the Research Study

The objective of the project is to devise best foreign exchange risk management strategies that are appropriate for varied situations in software industries and to stress the importance of foreign exchange risk management. This research study aims at discussing various foreign exchange risk management practices followed by Indian software companies, their changed strategies to accommodate the highly volatile currency markets and changed regulations, etc. In order to gain valuable insight into the topic and understand the latest changes, developments and trends in the field, Chapter 2 of the study discusses the vast literature available on the foreign exchange risk management techniques. It will cover the latest developments of risk minimizing strategies that are opted by software companies in India. The current scenario of risk minimizing techniques, effectiveness of such techniques, and effects of current models will also be reviewed.

Chapter 3 of the study discusses the research methodology utilized for the research. The chapter also includes a justification of approach and methods used including the problems faced in the research process. Chapter 4 of the study presents the research analysis and results obtained from primary sources and secondary sources. The six companies covered for primary data collection include Infosys technologies, Tata Consultancy Services, HCL Technologies, Wipro Technologies and 2 relatively smaller companies. The smaller companies were not interested in disclosing their names in this project report. As requested by the company, the name of the company and other sensitive data (as described by them) is not disclosed in this report. The sample companies represent a healthy mix of top 4 and 2 smaller Indian software companies. All the top 4 companies taken for this research has more than 90% of their revenues coming from outside India. Therefore companies taken for this research has huge impact on their operating margins due to foreign exchange volatility. The two smaller companies were taken for this research in order to make this research a fruitful one, so that recommendation provided would suit wider range of companies. Based on data analysis, Chapter 5 discusses the recommendation on best practices for an effective foreign exchange risk management and conclusion.

Chapter 2 Literature Review

Apart from the primary research conducted, the works of various other researchers, authors and experts will be used for the research. Secondary research is always conducted prior to the primary research as it gives valuable insight into the topic and helps to understand the latest changes, developments and trends in the field. There is a vast amount of literature available on foreign exchange risk management techniques. Any firm that deals in multiple currencies is exposed to the risk of any unexpected changes in the exchange rates and therefore they should invest in identifying these risks and come up with implementation strategies to protect themselves (Jacque, 1997). There are companies that implement foreign exchange risk management strategies but not aware of the best suited techniques for their firms and there are other companies, which argue that there is no need for investing in devising strategies specifically for managing foreign exchange risk and they have their own reasons for not implementing risk management techniques (Jacque, 1997). Here, this chapter is divided into three sections. First section deals with the issues around why companies are not concentrating on foreign exchange risk management and later part of the section throws light on their necessities. The second section based on secondary research will explain the various foreign exchange risk management techniques that an organization can use. That is, based on the information collected from the secondary research various techniques will be explained in detail. This will give an insight into the existing literature and help in understanding the concepts and the purpose behind using these techniques. In the third section, two research papers that are primarily used for this research are summarized and further to that other research works in similar lines are discussed. It will focus on the methodologies, population, sample, results and conclusions of the sources.

2.1Need for Foreign Exchange Risk Management

Foreign exchange risk management has gained a lot of momentum in the last two decades but not all organizations employ foreign exchange risk management techniques. There are various reasons why many organizations do not employ foreign exchange risk management techniques to overcome the losses that can be caused due to the fluctuating exchange rates. Dufey and Giddy (2003) state several reasons why many organizations do not employ foreign exchange risk management techniques. The first reason that they put forward is that managers do not understand the importance of foreign exchange risk management and they believe that many risk management techniques (which will be discussed later) are speculative. Some are of the view that such financial manipulations do not come under the organizations core competency or expertise and hence there is no need for indulging in such an activity. One of the other reasons highlighted is that foreign exchange exposure is complex and measuring it accurately is not possible. People also argue that all the businesses are carried on in home currency (Dollars, rupees, yen, etc) and hence the organization does not have any exchange risks. Most of the managers are of the view that that an organization is already hedged and hence there would be no reason for the organizations to practice foreign exchange risk management. The final argument is that doing business itself is a risk and the organization gets rewarded for taking risks. And hence there is no reason for organizations to practice foreign exchange risk management (Dufey & Giddy, 2003). There are flaws in all of the above arguments and the need for organizations to practice foreign exchange risk management is well established by various researchers and authors. But before going on to the argument of whether to practice foreign exchange risk management; it is essential to look at the literature on foreign exchange risk exposure. Foreign exchange risk exposure plays an important role in an organizations foreign exchange risk management strategies. Based on the degree of exposure, the need for an organization to practice foreign exchange risk management is determined. In simple words, the change in parent country currency value of liabilities and assets to the exposure rate change can be defined as the rate of exposure. Foreign exchange exposure can be both negative and positive. A negative exposure will result in losses and a positive exposure will result in profits (Gandhi, 2006). For an organization it is first essential to identify and analyze the type and degree of exposure, as this will give the company a clear understanding of the consequences of foreign exchange risk management. Now returning back to the need or necessity for indulging in foreign exchange risk management, Dufey and Giddy (2003) argue that an organization by not indulging in foreign exchange risk management exposes itself to substantial speculative risks. Even when an organizations business is done in home currency, it will not make it completely independent of the risks of changes in exchange rates. For, example when an invoice is drawn in Indian rupees, the prices will change when there is a drop in dollars. Hence, there is a need to change the pricing strategy depending on the changes in the exchange rate if not local competitors will seize the advantage. And also the argument that all the transactions are hedged is an incomplete strategy. This is because of the fact that the bulk of an organizations value comes from transactions those are not yet completed is ignored. Another important reason is that the volatility witnessed in foreign exchange markets is very high. This adds to the need for organizations to employ foreign exchange risk management (Bradstreet, 2007). Research by Export Development Canada (2009) has indicated that companies that have a formal foreign exchange risk management approach are more successful in risk management. 85% of the respondents of the study said that the main objective to practice foreign exchange risk

management was to protect profit margins and the 55% said that one of the key objectives was to increase the predictability of margins. This means that foreign exchange risk management would benefit the stakeholders of an organization. Also the 67% of the respondents were of the view that currency volatility would significantly impact their business. Research conducted by Smart FX has found out that the change in exchange rates has made negative impact on the profits of 42 percent of small and medium sized enterprises. The CEO of Global Reach Partners, Stewart Blake, observes that half of small firms in UK are being negatively affected by fluctuations in the exchange rates (Masters, 2010). Based on the research he states that - the need for foreign exchange risk management to become central to everyday risk management has never been greater (NewswireToday, 2010). V Balakrishnan, Chief Financial Officer of Infosys (India) states that 1% fluctuation in the rupee-dollar rates would impact operational margins to about 40-basis point (Tejaswi, 2010). Hence it is very important for an organization to practice foreign exchange risk management techniques.

2.2 Foreign Exchange Risk Management Techniques

There are various tools that an organization can use to reduce foreign exchange risk. But before going into the details of the various foreign exchange risk management techniques, it is important to understand the concept of hedging. The approach of using financial instruments to neutralize the risk, which is a result of changes in exchange rates and cash flows is known as Hedging. Hedging is an important tool for managers in foreign exchange risk management (Cusatis & Thomas, 2005). Hence, hedging is a measure used to reduce or eliminate foreign exchange exposure (Coyle, 2000). Hedging practices could lead to any one of the below outcomes Completely avoid foreign exchange exposure Partially avoid foreign exchange exposure Elimination of foreign exchange exposure by advance fixing of an effective exchange rate where transaction of multiple currencies is involved (Coyle, 2000). There is a vast amount of literature available on the various techniques of risk management. Debasish (2008) list the following techniques (Figure 3 below) of risk management/Hedging that can be used by organizations:

Hedging Techniques
Figure 3: Source: Adapted from Debasish, 2008

Forward Contracts:
Forward contracts are the most commonly used foreign exchange risk management technique by non-bank corporations. Forward contracts involve an agreement between two parties to buy/sell an amount of currency at a fixed price on a specified date in the future (Sivakumar & Sarkar, 2008). This will help to eliminate the foreign exchange exposure as the rate of exchange is already fixed for the future transaction. Hence, changes that take place between the contract date and the actual transaction date does not make any impact. The foreign exchange rates are locked for the future transaction and the future settlement date can be an exact date or any time between two agreed dates (Coyle, 2000). Ex: If an Indian company X wants to buy goods from a US company in Dollars after six months. Then X can get into an agreement (forward contract) to pay Rupees and buy dollars and the exchange rate can be fixed and locked in. As the contract is to be executed in the future it will not be affected by the then INR-USD exchange rate. One of the main advantages of forward contracts is that it can be tailor made to the specific needs of an organization. A company getting into a forward contract can only expect to upside benefit if there is any favorable movement in the foreign exchange rates but the contract does not provide any downside protection (Gandhi, 2006).

Currency Futures
Currency futures contract is an agreement between a buyer and seller and is similar to currency forward contracts. In a futures contract two parties get into an agreement to buy or sell a currency for a fixed amount at a specified time in the future, and it is traded on futures exchange (Debasish, 2008). Unlike forward contracts, futures contracts are more liquid as they are traded in an organized exchange. Futures make it possible to hedge currency depreciations by selling futures. Hedging of currency appreciations is possible by buying futures (Sivakumar & Sarkar, 2008). The incoming and outgoing cash flows of different currencies with respect to each other can be fixed by selling and purchasing currency futures (Gandhi, 2006). There are four important features of currency futures: they are standardized contracts, trading happens in 1 physical location or virtual location, Exchanges clearing houses are responsible for the settlement of contracts and contracts are revealed according to the market value (Clark &Ghosh, 2004). The example for currency forwards can be used here to. The only change here is that the company X has to purchase standardized dollar futures from US Dollar futures exchange. But the limit with the futures is that an organization cannot buy the futures for the exact amount required but has to buy standard denominations of currency (Sivakumar & Sarkar, 2008).

Currency Options
Currency options is an agreement which gives the owner of the agreement the right to buy or sell a specified amount of currency for a specified price over a given time period. Currency options give the owner of the agreement the right but it is not an obligation (Madura, 2009). The owner of the agreement can choose to sell or buy the currency or decide otherwise based on the exchange rates. The fixed price at which the owner can sell or buy the currency is called as strike price or the exercise price. It is possible to take advantage of the potential gains through currency options. Through currency options downside risks can be limited (Clark & Ghosh, 2004). The advantages of currency options can be best understood with an example. If an Indian company has to buy goods from the US in USD after six months, the company can buy a currency option. There are two possible scenarios here. First, if the dollar depreciates and the exchange rates turn out to be favorable, then the company can buy the currency at spot rate, as they are cheaper. On the other hand, if the dollar appreciates, than the spot rate will be higher than the strike price and hence the company can choose to use its right and purchase the currency at the strike price. Hence, in both cases the company will be paying the lowest price to purchase the dollar (Sivakumar & Sarkar, 2008).

Currency Swaps
A currency swap involves an agreement between two parties to exchange a principal amount of currency for the same principal amount of another currency (Chance & Brooks, 2010). The exchange of the currencies happens at the beginning of the deal. Each party would pay the interest for the exchanged currency at regular interval of time during the term of the loan. At maturity or at the termination of the loan period each party would re-exchange the principal amount in two currencies (Kevin, 2009). Coyle (2000) argues that a currency swap is an agreement made to buy/sell an exact amount of currency in exchange for the same amount of another currency at the spot exchange rates or an agreement is made to re-exchange the same amount of currency at pre-decided date at the same exchange rates or an agreement to exchange the interest costs for the duration of the swap. Hence each party would receive the same amount of currency that they had initially exchanged irrespective of the fluctuations in the exchange rates.

Foreign Debt
Foreign debts are an effective way to hedge the foreign exchange exposure (Chance & Brooks, 2010). This is supported by the International Fischer Effect relationship. To understand how foreign debts work, lets consider the example that a company is expected to receive a fixed amount of Euros at a specified time in the future. There is a possibility that the company can experience losses of the domestic currency appreciates against the Euros during the meantime. So in order to avoid this, company can take a loan in Euros for the same time period and convert the foreign currency into domestic currency at the spot exchange rate. But the company will have to pay interests for the loan, which the company must bare. This is where the International Fischer Effect plays a role. According to the theory profits gained by investing the proceeds will be equal to interest paid (foreign currency) for the loan (Sivakumar & Sarkar, 2008). Hence the company will not hedge the risk due to the foreign exchange exposure as it completely eliminates it.

Leading and Lagging

Leading and lagging are foreign exchange risk management techniques, which involve adjusting the timing of the payment or receivables (Madura, 2009). Leading is used when an unfavorable movement in foreign exchange rates is expected. In such a scenario, the payment or the receivables of a foreign currency can be postponed in order to avoid the exposure to unfavorable movement in the exchange rates. Lagging is used when there is a favorable movement in the exchange rates expected. In this case the payable or receivable of the foreign currency is postponed in order to benefit from the favorable movements in exchange rates (Kevin, 2009).

Cross Hedging
Cross Hedging can be used when hedging of a particular foreign currency is not possible. Hedging of the foreign currency may not be possible when hedging facilities do not exist or it may not be a frequently traded currency (Madura, 2009). In such a scenario cross hedging can be employed. In cross hedging another foreign currency, which is correlated to the currency that can be hedged is selected and hedging is done in this currency. Even though hedging is done in a different currency, the effects would remain the same and hence cross hedging is an important technique that can be used by companies (Kevin, 2009).

Currency Diversification
The fluctuations in exchange rates are dependent on various factors. These factors are can be both specific to the respective country and global factors. There can be a pattern seen in changes in the exchange rates of different countries. The pattern is seen in both volatility and direction. A company that deals with the currencies of one or two foreign currencies will experience fluctuating cash flow values, which are in tune with the volatility of the exchange rates of the currency. But a company, which deals with numerous foreign currencies, would see exchange rate movements of different countries offsetting one another. Hence, currency diversification would be an important tool in foreign exchange risk management (Kevin, 2009).

2.3Relevant Researches to Current Study

The current research is heavily dependent on two recently conducted researches. Oneby Debasish (2008) and the other one by Sivakumar and Sarkar (2008). Both researchers concentrate on the foreign exchange risk management in India. Debasish in his 2008 paper Foreign Exchange Risk Management Practices A Study in Indian Scenario conducts an industry wide cross-sectional research on the recent techniques used by non-banking Indian based firms for foreign exchange

risk management. The sampling of the study involved 501 non-banking Indian companies. The study identifies that the prime reason for hedging is the volatility reduction in cash flows. The paper identifies and discusses the various foreign exchange risk management techniques in detail. The study finds out that forward contracts are the most commonly used techniques by Indian firms and it is then followed by swaps and cross-currency options. He has also mentioned that the currency risk management in India is growing at very slow pace and there should be urgency shown in using better-suited hedging instruments appropriate for the firms while considering the impact of the foreign exchange. On the other hand Sivakumar and Sarkar (2008) in their paper Corporate Hedging for Foreign Exchange Risk in India evaluate the various alternatives available for Indian companies to hedge the foreign exchange risks. The paper studies various companies from various sectors and concludes that currency forwards and currency options are the most highly preferred hedging techniques used by Indian companies for short term hedging while swaps are preferred for long term hedging. They also discuss the various factors that influence the decision of the companies to hedge. Their research concluded that software companies in India have short term planning horizons when compared with high capital-intensive organizations. Figure 4 below shows that the top two Indian software companies namely TCS and Infosys, prefers to hedge using Options than forwards whereas capital intensive firms like Reliance industries, Maruti Udyog, Mahindra & Mahindra, Ranbaxy uses forward contracts and currency swaps, which shows their long term planning horizons as they involve longer gestation periods and heavy initial capitals. In general Indian firms choose short-term measures for hedging. The paper concludes that there is a need for rupee futures.

Hedging Instruments used by various companies

Figure 4 Source: Sivakumar and Sarkar, 2008 Another important work that the current research is based on is Khoury and Chans (1988) Hedging foreign exchange risk: Selecting the optimal tool. The paper concentrates on the various factors that have to be considered in choosing a specific hedging tool. It discusses the nature and characteristics of various currently available hedging tools. The study is based on the questionnaire survey of finance officers to understand their preferences of the hedging tools. There are no past researches that have concentrated primarily on software companies in India but there is a vast amount of research concentrating on Indian companies as a whole. Alok (2007) in his research proves that the Indian firms are becoming highly sensitive (both short term and long term) to changes in the exchange rates. In his study he concentrates hedging of foreign currency impacts the stock returns of a company and in the outcome proves that there is a need for Indian firms to practice foreign exchange risk management. Chakrabarti (2006) through his study proves that the foreign exchange market in India has grown manifold in the past decade (swaps and forwards have tripled). Various other researchers in their studies have proved that many Indian companies are now actively involving in foreign exchange risk management (Sivakumar & Sarkar, 2008; foreign exchange-hedging.org, 2010). Currency swaps, forwards and options (call, put, cross currency, etc) are the various hedging tools that Indian companies are using to hedge the foreign exchange risk (Sivakumar & Sarkar, 2008; Bradstreet, 2007; Ross et al., 2009). Forward contracts are the most used Hedging tool by Indian companies. The top two Indian Software companies, Tata Consultancy Services and Infosys, use forward contracts and option contracts as hedging tools (Sivakumar & Sarkar, 2008; Ross et al., 2009). It is evident from studies that most Indian firms think short term while hedging foreign risks and hence use forwards and options rather than foreign debts. Even though there is a vast amount of literature available on foreign exchange risk management, there are no researches that have concentrated particularly on software companies in India. The current research will completely focus on the software companies in India, questionnaires were prepared to in order to assist the research in best effective manner. Also the available research analysis mentioned above dates back to 2007 and 2008, there have been many changes since then. All such issues were kept in mind while doing this research so as to make this research highly fruitful. The above-mentioned papers concentrate on Indian firms in general and discuss the scenario in India. The available literature and primary research findings of this research will be fused

to come up with effective foreign exchange risk management tools that best suit the Indian software companies.

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