International Financial Management

Risk Management
&
Derivatives
Dr. Kulbir Singh
ACF (Term III) 2016-17
IMT - N
Which Types of Firms Interact in Forex Mkt/International Finance
Products Receive FC($) which is sold in exchange for LC (RS.)
EXPORT
Services
Firms engaged in

Raw Materials
IMPORT Buy FC($) for the purchase/exchange of LC (RS.)
Components

Raise Finance Loans/Interest Received/Dividend Sell FC ($)

INFLOW OF FC ($) Rec. /Principal Amt. Recevd. for LC
Abroad (Rs.)
Firms engaged in

Investments
Loans Given/Interest Buy FC ($)
OUTFLOW OF FC ($) Payment/Dividend Paid/Principal Xge for LC
Abroad
Amt. Payment (Rs.)

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 2

Which Types of Firms Interact in Forex Mkt/International Finance
CIF
COF
Impacted by Exchange Rates between various
Investments countries where their operations/assets are
(Capital located
MNC Budgeting)

Impacts on P/L acct. & B/S of Parent Co. due

to Translation Exposure
WC Finance

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-N) 3

Foreign Exchange Market
There is no central market
Business is conducted electronically (Telephones & Computers)
Over-the-Counter (OTC) Market
Operates all the time 24x7 Internationally
Communication Medium of Trading is SWIFT (Society for Worldwide
Inter-bank Financial Transactions)
Belgian-based Non-Profit organization connecting major banks and centers
with one another
ISO (International Standards Organization) has developed a unique
Three-Lettered Code for each of worlds currencies
Eg.: Rupees INR US Dollar USD Euro EUR

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Foreign Exchange Market
Total World Forex Market is the largest of all markets on Earth
Largest centers of Forex dealings is located in LONDON, followed by
NEW YORK, TOKYO, SINGAPORE, SWITZERLAND, and HONK KONG.

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Forex Market: Participants

DEALERS

MERCHANTS
Participants
(Individuals/Firm)

BANKS

Interbank Transactions Merchant Transactions

90-95% 2%

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Risk Management & Corporates
Objective of Managers??
Maximization of SHs Wealth
Types of Risks faced by Businesses
Known, Unknown, & Unknowable
Loss due to Fires, Floods, Earthquakes, etc. solution???
Risks incidental to the business
Price Risk
Exchange Rate Risk &
Interest Rate Risk
Isnt business risk diversifiable.. Why managers spend time & money on
it!!
Alters firms CF in a way which is beneficial to SHs even after meeting costs of
hedging
Firm can achieve at much lower cost than SHs

ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-

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 Britannia Industries Ltd.
2016 2015 2014
% of % of % of
Expenditure
% of % of Total % of
Items Total Total
Sales Sales Expend Sales
Expend. Expend.
.
Flour 27% 13% 27% 13% 29% 14%
Fats and Oils 14% 6% 15% 7% 15% 8%
Sugar 12% 6% 13% 6% 14% 7%
Lamination
9% 4% 2% 1% 9% 5%
Roll
Others 39% 18% 43% 21% 32% 16%
source: Annual Report 2016-15 & 2015-14
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Derivative Market
What is Derivative?
What is Derivative Markets
types?
Over-the-Counter (OTC) vs. Exchanges
Derivative Products
Forwards
Futures
Options, &
Swaps

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Derivative Market .
Participants in Derivatives Market?
Hedgers
Speculators
Arbitrageurs

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Derivative Market
Functions of Derivatives Market
Price Discovery
Futures Market
Proxy for price of underlying asset
Widely accepted by traders facing risk of uncertain future
Forward contracts & Swaps also help in price discovery
Option not price discoverer but inferences price volatility
Facilitate Risk Transfer
Hedgers vs. Speculators
Improve Market Efficiency for the underlying assets
Relatively low transaction costs
Leveraging
ACF (Term III) Jan-Mar 2017 Dr. Kulbir Singh (IMT-
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Derivative Market
Criticisms of Derivative Markets
Complex instruments in wrong hands of unsophisticated
investors thanks to brokers!
Complex instruments lack of knowledge & understanding
Legalized Gambling?

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Forward & Futures Contracts
A forward contract is an agreement between two parties to trade a
specific asset at a future date with the terms and price agreed on
today.
Forward contracts are provided by financial institutions and dealers;
are less standardized and more tailor-made; are usually held to
maturity; often do not require initial or maintenance margins.
A futures contract, is a marketable forward contract, with
marketability provided through futures exchanges that list hundreds
of standardized contracts, establish trading rules, and provide for
clearinghouses to guarantee and intermediate contracts.

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Forward vs. Futures Contracts
COMPARISON FORWARD FUTURES

Trade on organized exchanges No Yes

Use standardized contract terms No Yes

Use associate clearinghouses to guarantee contract fulfillment No Yes

Require margin payments and daily settlements No Yes

Close easily No Yes

Regulated by identifiable agencies No Yes

Any quantity Yes No

Any product Yes No
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FUTURE POSITIONS
A speculator or hedger can take one of two positions on a futures (or forward
contract) contract:
a long position (or futures purchase) or
a short position (futures sale).
In a long Futures position, one agrees to buy the contracts underlying asset at a
specified price, with the payment and delivery to occur on the expiration date
(also referred to as the delivery date);
in a short position, one agrees to sell an asset at a specific price, with delivery
and payment occurring at expiration.

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