PART A

EXECUTIVE SUMMARY

INDUSTRY PROFILE:

There are many markets: marketplaces for stocks, futures, choices and foreign currencies.
These are most likely one of the most accessible markets for everyday traders like you and I. Folks simply
comprehend the basics of buying and selling shares. I began investing shares first after which it I moved on
to buying and selling foreign currencies.

The industry is available 24 several hours a morning which enables you to style your trading
several hours all-around your daily commitments. It's very volatile, that is excellent for those people
individuals who are looking for day-trading chances.

The forex industry is the industry in which values are purchased and sold against 1 one more.
Individuals may loosely refer to this industry under various labels, such as foreign exchange marketplace,
forex industry, fx industry or even the foreign currency market.

The forex industry is the largest marketplace inside the planet, with daily trading volumes in
excess of $1.five trillion US money. All transactions involving international industry and investment ought
to go by means of this marketplace because these transactions involve the exchange of values.

It can be the most ideal marketplace that exists simply because it has a large quantity of buyers
and sellers all promoting similar items. There is a free flow of details and you can find tiny barriers to
participate.

The currency trade marketplace is definitely an over-the-counter (OTC) marketplace which

indicates that there just isn't 1 specific location where buyers and sellers can actually meet to trade foreign
currencies. Instead, transactions are carried out by phone, fax, e-mail or with the web sites of brokers who
specialize in foreign currency buying and selling.

COMPANY PROFILE:

Nth Sense Business Consultants presents as imminent consultants in the area

of currency risk and interest rate risk management, forex Directional positioning and
International Trade finance.

We offered tailored products and customized services in forex risk management. We

apply high end techniques like simulation process to gauge the accuracy level and rely on
us proven technical expertise.

The Firm is managed by Management graduates with specialization in Finance and

treasury, Financial Risk Management and Ex Bankers and consultants.

NEED FOR THE STUDY:

 The Indian Forex industry provides comprehensive services and hedging tools to
individuals, corporates and small business, because of to know how hedging strategies
against forex Exchange Risk of SME (Small and Medium enterprise) using various hedging
tools in this company.
In this project the report is mainly focused on the various hedging tools like derivatives
(Future, option and forward) are followed by company while hedging the Risk exposed by
the SME.
The basic study is to build the strategies for the importers and exporter to hedge
against the risk of forex rate fluctuation.

OBJECTIVES OF THE STUDY:

1. To evaluate the firms hedging strategies for managing foreign exchange

risk using currency option in different scenario, and the scenario are :
a. Bullish market condition.
b. Bearish market condition.
c. Volatile market condition.
2. To understand the volatility of the exchange rates in different market
conditions.
3. To analyze and evaluate suitable hedging strategy for SMEs.
4. To minimize firms exposure in terms of exchange rate fluctuation by
hedging using derivative instrument on a currency exchange.
5. To obtain, analyze and interpret the survey done for the SMEs for
managing forex risk.

SCOPE OF THE STUDY:

The study is limited to only Nth Sense Business Pvt Ltd.
METHODOLOGY:

Data Collection Method:

The information will be collected from following source.

Primary data: The primary data will be collected through personnel interaction.

Secondary data: The secondary data will be collected through the clients information
available in the company.
 INTRODUCTION TO THE STUDY
The Indian economic is growing. There are various factors contributing for the
development of economy. In this including maintenance of financial aspects of the will be
there. Every company must prepare records of financial accounts in the organization and also
use method of auditing system. All company will appoint auditors of the company to audit
the financial statements of the particular company. In this company also auditor will be there.
Change in the IT & faster growth has changed the insurance operations to a great extent.
Insurance operations have led to a great development of economy & meeting customer’s and
also company needs. Among various sectors that insurance is involved, accounts and audit is
one area that has changed gradually in meeting dynamic needs of organization or a company.

TITLE OF THE STUDY:

The title of the study is to be undertaken on an “Accounts and Audit” at Tata aig
life insurance pvt ltd Hubli.

BACKGROUND OF PROJECT TOPIC:

I have undertaken my study in area of financial management in order to get the basic
understanding of insurance company operations specially insurance sector. As account and
audit activity has been changing & very competitive in nature in meeting needs of company
or organization. Tata aig has been focus on accounts and audit. The idea of undertaking this
project is to understand the present expectation from life insurance. To know how the
management principles are laid down by eminent authors have actually been applied.
 INDUSTRIAL PROFILE
Globalization and integration of financial markets, coupled with Loss increase
of cross border flow of capital have transformed the dynamics of Ind ian financ ial
markets. This has increased the need dynamic currency risk management. In
today‟s globalized and integrated business environment, many entities irrespective of
its business are impacted by currency risk either directly or indirectly. The steady rise
in India‟s foreign trade along with liberalization in foreign exchange regime has led
to large inflow of foreign currency into the system in the form of FDI and FII‟s
investments. INR has seen huge fluctuations of around 10% in its price against USD in a
span of less than one year.

In order to provide a liquid, transparent and vibrant market for foreign exchange rate
risk management, Securities & Exchange Board of India (SEBI) and Reserve Bank of
India (RBI) have allowed trading in currency futures for the first time in India based
on the USD-INR exchange rate. This provided Indian corporate another tool for
hedging their exchange risk effectively and flexibility at transparent rates on an
electronic trading platform. The primary purpose of exchange traded currency future
derivatives is to provide a mechanism for price risk management and consequently
provide price curve of expected future prices to enable the industry to protect its foreign
currency exposure. The need for such instrument increases with increase of foreign
exchange volatility.

After its inception, currency future is coming up with good signs. It is still in its nascent
stage, still provid ing a better option for investment in comparison to other future and
options including gold. Gold are perceived as inflation hedges. India is one of the
largest importer of Gold. If India wants to use Gold, they have to buy it. And they have
to pay for it with the currency of the country that produces it. In this India have to sell
rupee and then buy dollar (as examp le) to pay for the Gold. From this dollar gets double
boost. A huge amount of dollar are bought in the market for this particular transaction.

Although U.S is facing economic crisis, still dollar is looking strong against rupee
(graph 1). In expectation of improvement in future, investors are inclining toward
currency futures. It has been observed that inter -nationally, many investors use
futures rather than the cash market to manage the duration of their portfolio or
asset allocation because of low upfront payments and quick transactions.

As per the latest Reserve Bank of India (RBI) data, non-resident Indians (NRIs) sent
$28 b illion in remittances in 2007-08. Strengthening of Indian rupee against other
currencies runs the risk of reducing the real value of the money sent back home by
NRIs and people of Indian origin abroad whether they are from the West Asia, far
east countries, the US,UK or Canada. Here the currency futures really help investors.
As they can enter into future contract of currency future derivatives. They can
contract on future rate of currency. Since futures derivative are linked to the
underlying cash market, its availab ility improves trad ing volume in the cash market.
To facilitate liquid ity in the futures contracts, the exchange specifies certain standard
features of the contract.

Since the commencement of trad ing of currency futures in all the three exchanges, the
value of the trade has gone up steadily from Rs. 17,429 crores in October 2008 to Rs.
45,803 crores in December 2008.This trend is continuously increas ing with increasing
number of contracts (graph

2). Since futures derivative are linked to the underlying cash market, its availability
improves trading vo lume in the cash market. Gold are perceived as inflation
hedges. If India wants to use Gold, they have to buy it. And they have to pay for it with
the currency of the country that produces it. In this India have to sell rupee and then
buy dollar (as examp le) to pay for the Gold. From this dollar gets double boost. A huge
amount of dollar are bought in the market for this particular transaction. Here the
currency futures really help investors. They can enter into future contract of currency.
They can contract on future rate of currency.

The National Stock Exchange (NSE) will become the first exchange in the country to
th
introduce currency derivatives on 29 August 2008. Currency futures trading
currently is being offered by MCX-SX, NSE and BSE. S ince the commencement of
trading of currency futures in all the three exchanges, the value of the trade has gone up
steadily from Rs. 17,429 crores in October 2008 to Rs. 45,803 crores in December 2008.
Without financ ial futures, investors would have only one trad ing location to alter
portfolio when they get new information that is expected to influence the value of
assets- the cash market. Future provide another market that investors can use to alter
their risk exposure to an asset when new information is
acquired.United Stock Exchange has received in-principal approval from the
market regulator for commencing contracts in currency derivatives. The United
Stock Exchange of India (USE), promoted by state-run MMTC and brokerage firm
Jaypee Capital, will start trading in currency derivatives from July this year. “USE will
launch currency futures in July 2009.

Ratio nale B e hind Launc hing E TCF :

The introduction of exchange-traded c u r r e n c y futures (ETCF) on the National

Stock Exchange (NSE) from August 29 is a reflection of two important points.

First, it is evidence of the seriousness of efforts demonstrated by players across the

board to sustain investors' interest in the markets.

The currency futures segment is meant to provide non-institutional market

participants a means to hedge their currency exposures in a transparent and price
efficient manner, the size of future contract is not unduly large. In currency future, the
 price d discovery are such that the individual and SME‟s are able to trade on same
price as are available to large customers. While in OTC market, if price discovery
is done for a large size lot, the individual and SME‟s may not be able to capture the
fineness of that rate for their small size lots. This is the one of demerit of the OTC
markets. Currency future is a very good alternative to the present over- the-counter
hedging mechanism, which requires a lot of documentation and sanctions.

Second, an investor can take advantage of currency futures as an asset class.

Thirdly, by virtue of scale of partic ipation and its cost structures, the transaction cost
in futures is usually much lesser than that of OTC alternative.

Fourthly, compared to OTC, futures offer more price transparency,

fully eliminating the counterparty risks and reach out to a larger section of population.

After its inception, currency future is coming up with good signs. It is still in its nascent
stage, still provid ing a better option for investment in comparison to other future and
options includ ing gold. Although U.S is facing economic crisis, still dollar is
looking strong against rupee. In expectation of improvement in future,
investors are inc lining toward currency futures. It has been observed that inter-
nationally, many investors use futures rather than the cash market to manage the duration
of their portfolio or asset allocation because of low upfront payments and quick
transactions.
OR IG IN OF F OREX MARK E T
The foreign exchange market is where currency trad ing takes place. It is where
banks and other official institution fac ilitate the buying and selling of foreign
currencies. The foreign exchange market that we see today started evo lving during the
1970s when world over countries gradually switched to floating exchange rate from fixed
exchange rate. The purpose of foreign exchange market is to facilitate trade and
investment. It is the largest and most liquid financ ial market in the world.

The origin of the forex market development in Ind ia could be traced back to 1978
when banks were permitted to undertake intra-day trades. However, the market
witnessed major activity only in the 1990‟s with the floating of the currency in
March 1993, following the recommendations of the Report of the High Level
Committee on Balance of Payments. Exchange traded foreign exchange future
contracts were introduced in 1972 at the Chicago Mercantile Exchange and are
actively traded relative to most other future contracts. The global turnover is
around USD 4000 b illion per day. It is 24hrs market. The main currenc ies traded in forex
market are USD, EUR, JPY.

The foreign exchange market is unique because of:

1. Its trading volumes

2. The extreme liquidity of the market
3. Its geographical dispersion
4. Its long trading hours
5. Use of leverage

In terms of convertibility, there are mainly three kind of currencies. The first is fully
convertible in that it can be freely converted into other currencies, the second kind is
only partially convertible for non-residents, while the third kind is not convertible
at all. The last holds true for currencies of a large number of developing
countries. All the developed countries already have fully convertible capital
a c c o u n t s . Most
e m e r g i n g c o u n t r i e s do no t permit foreign exchange derivative products on
their exchange in view of prevalent control on the capital accounts. However, a few
select emerging countries like India, Korea, South Africa, have successfully
experimented with the currency future exchanges, despite having control on the capital
account.

OVERVIEW OF THE FOREIGN EXCHANGE MARKET IN INDIA :

The foreign exchange market has acquired a distinct vibrancy as evident from the range
of products, participation, liquidity and turnover. According to the Bank for
International Settlements (2007), India’s share in global transactions has increased
sharply in the past three years from about 0.3% to the current 0.7%.
Currently, India is a USD 34 billion OTC market, where all the major currencies like
USD, EURO, YEN, Pound, Swiss Franc etc. are traded. It has been a long felt need
to have a transparent currency derivatives platform in the country. With increasing
globalization and robust performance of the economy, businesses in India have been
rapidly integrating with the world, especially in the past few years, forcing them to
face the additional risk of exchange rate fluctuations besides other risks.

The Indian foreign exchange market has grown significantly in the several years. The
daily average turnover has gone up from about USD 5 b illion per day in 1998 to more
than USD 50 billion per day in 2008.The spot foreign exchange market remains the
most important segment but the derivative segment has also grown. In the derivative
market foreign exchange swaps account for the largest share of the total turnover of
derivative in India followed by forward and options.

Cash settled exchange traded currency futures have made foreign currency a
separate asset class that can be traded without any underlying need or exposure and on a
leveraged basis on the recognized stock exchanges with the credit risks being assumed
by the central counterparty.

During the early 1990s, India embarked on a series of structural reforms in the
foreign exchange market. The exchange rate regime, that was earlier pegged, was
partially floated in March 1992 and fully floated in March 1993. Although liberalization
helped the Indian forex market in various ways, it led to extensive fluctuations of
exchange rate. This issue has attracted a great deal of concern from policymakers and
investors. While some flexibility in foreign exchange markets and exchange rate
determination is desirable, excessive volatility can have an adverse impact on price
discovery, export performance, sustainability of current account balance, and balance
sheets.

In the context of upgrading Indian foreign exchange market to international standards, a

well developed foreign exchange derivative market (both OTC as well as Exchange-
traded) is imperative. With a view to enable entities to manage volatility in the
currency market, RBI on April 20, 2007 issued comprehensive guidelines on the
usage of foreign currency forwards, swaps and options in the OTC market. At the
same time, RBI also set up an Internal Working Group to explore the advantages of
introducing currency futures.

The Report of the Internal Working Group of RBI submitted in April 2008,
recommended the introduction of Exchange Traded Currency Futures.
Subsequently, RBI and SEBI jo intly constituted a Standing Technical Committee to
analyze the Currency Forward and Future market around the world and lay down the
guidelines to introduce Exchange Traded Currency Futures in the Indian market. The
Committee submitted its report on May 29, 2008. Further RBI and SEBI also issued
circulars in this regard on August 06, 2008.Later on, trading in exchange traded currency
futures commenced on August 29, 2008 on the National Stock Exchange.

The need for widening hedging options arose as the OTC markets were largely
opaque and accessible only to a few players. However, currency derivatives differ from
OTC as they help improve the efficiency of price discovery, attracting heterogeneous
partic ipants. So, the success of a futures platform is determined by the liquid ity it
can achieve that will make the process of price discovery more efficient.

The foreign exchange markets of a country provide the mechanism of exchanging

different currencies with one and another, and thus, facilitating transfer of
purchasing power from one country to another. With the multip le growths of
international trade and finance all over the world, trading in foreign currencies has
grown tremendously over the past several decades. Since the exchange rates are
continuously changing, so the firms are expo sed to the risk of exchange rate
movements. As a result, the assets or liability or cash flows of a firm which are
denominated in foreign currencies undergo a change in value over a period of time due
to variation in exchange rates. This variability i n the value of assets or liabilities
or cash flows is referred to exchange rate risk. Since the fixed exchange rate system has
been fallen in the early 1970s, specifically in developed countries, the currency risk has
become substantial for
many business firms. As a result, these firms are increas ingly turning to various
risk
hedging products like foreign currency futures, foreign currency forwards, foreign
currency
options, and foreign currency swaps.

F ore ig n e xc ha nge rate :

It is defined as the conversion rate of one currencies into another. This rate
depends on the local demand for foreign currencies and their local supply,
country‟s trade balance, strength of its economy, and other such factors. Exchange rates
are constantly changing, which means that th e value of one currency in terms of the
other is constantly in flux. Changes in the rates are expressed as
strengthening or weakening of one currency over the second currency. Changes are also
expressed as appreciation or depreciation of one currency in terms of the second
currency. Whenever the base currency buys more of the term currency, the base currency
has strengthened/appreciated and the term currency has weakened.

B ase Curre nc y/ Te rms C urre nc y:

In foreign exchange markets, the base currency is the first currency in a currency pair.
The second currency is called as the terms currency. Exchange rates are quoted in
per unit of the base currency. That is the expression Dollar-Rupee, tells you that the
Do llar is being quoted in terms of the Rupee. T he Dollar is the base currency and the
Rupee is the terms currency.
P a rtic ipants :

No person other than a person resident in India‟s as defined in section 2(v) of the
Foreign Exchange Management, 1999(Act 42 of 1999) shall partic ipate in the
currency future market. Only a res ident of India can participate in the trad ing and no
other agency, inc luding banks, can participate in the futures market without getting
the approval of its concerned regulators. Foreign institutional investors and NRIs (Non
Resident Indians) are presently exc luded from the market.

The membership of the currency future market of a recognized stock exchange shall
separate from the membership of the equity derivative segment or the cash segment.
Membership for both trading and clearing, in the currency futures market shall be subject
t the guidelines issued by the SEBI.

Bank authorized by the Reserve Bank of India under section 10 of the Foreign
Exchange Management Act, 1999 as „AD Catego ry–I bank‟ are permitted to
become trading and clearing member of the currency future market o f the
recognized stock exchange, on their account and on the behalf of their clients,
subject to fulfilling the required formalities. A bank can become a trading or a
clearing member of such an exchange provided it has capital and reserves worth
Rs.500 crore,10 percent capital adequacy ratio, 3 percent or less net non-
performing assets and has a three-year profit record.

There are three types of participants on the currency futures market: floor trader, floor
broker (also called pit broker), broker- trader. Floor trader operate for their own
account. They are speculators whose time horizon is short term. Floor broker
representing the broker‟s firm, operate on behalf of their clients and, therefore, are
remunerated through commission. The third category, called broker trader, operates
either on the behalf of clients or for their own accounts.
PLAYERS IN THE CURRENCY FUTURE MARKETS :

The following three broad categories of participants –

Hedgers,
Speculators,
Arbitrageurs

Hedgers face risk associated with the price of an asset and they use futures or
options markets to reduce or eliminate this risk. Speculators wish to bet on future
movements in the price of an asset. Arbitrageurs are in business to take advantage of a
discrepancy between prices in two different markets. If, for example, they see the
futures price of an asset getting out of line with the cash price, they will take offsetting
positions in the two markets to lock in a profit.

The participants in this segment shall prima -fac ie include all the entities who
directly
or indirectly have exposure to the foreign exchange movements. Any importer or
exporter of goods and services has exposure to foreign currency risk. These entities
shall
find this product useful for hedging their risks. The entities shall include corporates
importing machinery / raw materials or paying for services to an offshore entity, and
corporate exporting their products and services abroad. Therefore all entities having
trade or capital related flows denominated in foreign currency will have an interest in us
ing this product.

The share holders and creditors of the c ompanies also may be indirectly exposed
to the currency risk and hence may find the product useful. Any entity using such
goods and services whose price is exposed to foreign exchange movements may also
find this useful. For example, entities who procure, say oil or metals like say zinc,
copper, etc. locally, are not importers. International price movement expose these users
to foreign currency risks. Hence entities who are directly importers or exporters or
entities having an indirect or derived exposure are potential users of exchange traded
futures.

HEDGING :

Currency futures are widely used as hedging tools by financial institutions, b anks,
exporters, importers etc. There is a strong need to hedge currency risk and this need
has grown manifold with fast growth in cross-border trade and investments flows. The
currency risk arising from exchange rate fluctuations that is faced by exporters and
importers needs to be properly managed. For example, an exporting firm is expecting
 to
receive dollar inf lows. If the rupee appreciates against the dollar, then there will be a
negative impact on the profitability of these companies. If a company has un-hedged
exposures in foreign currency on account of borrowings, and the rupee depreciates
against the borrowed currency, there could be a loss requiring d isclosure. Though this
is
not a direct business loss, it adds to the liab ility and as such impacts the balance
sheet. It
is possible that subsequently the rupee might appreciate or regain the lost ground;
but,
what is relevant is the rate as on the day of the c losure of the books. The defic it on the
date
is considered a notional loss as the liability has not crystallized and there is no outflow
of
rupees.

Says Nth sense Financial Services‟ managing director, “Exchange traded currency
futures are likely to attract retail interest, so far as inflation -related speculation
(rupee movement) could be hedged here. For instance, a mid -level go ld importer,
currently unab le to hedge dollar exposures, can come on to these markets and take a
directional call on the rupee.” Exporters who receive continuous cash inflows can
hedge their positions through selling currency futures at the most suited exchange
rate.

Before the introduction of currency futures market, expo rters had to take hedge
positions in OTC markets where delivery of the underlying is a must. Contract
cancellation is possible but it would be very expensive. In the futures market,
positions
are settled in cash but the client-wise exposure is limited to 6 million dollars or 5%
of
the total open interest, whichever is higher. The position limits are not high enough for
exporting houses to take b ig positions. However, the interest of small exporters has
been protected after the introduction of the currency futures market.

A key d ifference between investing in domestic and foreign asset is that the latter
exposes
the investor to a currency risk. The reasoning was that if the exchange rate remains
constant from time of purchase of the foreign asset to its sale, then the currency risk
has had zero
impact. On the other hand, if the domestic has weakened (strengthened) against the
foreign currency, the exposure would result in a gain (loss).

Exchange rates are quite volatile and unpredictab le, it is possible that antic ipated
profit in foreign investment may be eliminated, rather even may incur loss. Thus, in
order to hedge this foreign currency risk, the traders‟ oftenly use the currency futures.
For examp le, a long hedge (i.e.., buying currency futures contrac ts) will protect
against a rise in a foreign currency value whereas a short hedge (i.e., selling
currency futures contracts) will protect against a decline in a foreign currency‟s value. It
is noted that corporate profits are exposed to exchange rate risk in many situation. For
example, if a trader is exporting or importing any particular product from other countries
then he is
exposed to foreign exchange risk. Similarly, if the firm is borrowing or lending or
investing for short or long period from foreign countries, in all these situations, the
firm‟s profit will
be affected by change in foreign exchange rates. In all these situations, the firm can
take long or short position in futures currency market as per requirement. In a long
hedge,
one takes a long futures position to offset an existing short position in the cash market.
In
a short hedge, one takes a short futures position to offset an existing long position in the
cash market. The general rule for determining whether a long or short futures position
will
hedge a potential foreign exchange loss is:

Loss from appreciating in Indian rupee= Short hedge

Loss form depreciating in Indian rupee= Long hedge

Princ iple of covering on future market is rather simple. A long position is covered by
a short position on Future market and vice versa. In order to have a perfect cover, it
is necessary that the value of a position in Future changes by the same amount as the
Spot position, but in opposite direction. On future market, enterprise which want to
cover themselves against rate risk, compensate for the losses that they are likely to
incur on Spot market. For this they need to take reverse position on Future market as
against their position on Spot market. The contracts may be kept up to the maturity
date or they may be settled before that date, depending upon the choice of the
operator or hedger.

The price d ifference between Spot and future is called Basis, and th e risk aris ing out
of the difference is defined as Bas is Risk. The situation in which the difference between
spot and future price reduces (either negative or positive) is defined as “Narrowing of
the Bas is”. Two situations generally happen;

First; When future prices are higher than spot price, then

Narrowing of Basis Widening of Basis

Benefits Short Hedgers Benefits Long Hedgers

Second; When future prices are lower (discount) to spot price, then
 Narrowing of Basis Widening of Basis

Benefits Long Hedgers Benefit Short Hedgers

If a small importer wants to hedge through currency futures, he can do so by

buying futures. After purchasing the currency futures if the rupee c loses at a
depreciated price, then the importer gains in currency futures, and later, he has to
convert the rupee into dollar at a higher price. Imagine that an importer with an
obligation to pay US$10,000 after three months, bought currency futures which is
maturing after three months at Rs.44. A few weeks later, currency depreciates to Rs.46.
Here, the importer gains Rs.2/- per dollar (Rs.2 *10000). Later, he converts his import
obligation at Rs.46. The importer‟s net obligation is therefore only Rs.44.

NRIs who regularly send dollars to their families can also advise their family
members to create hedge positions in the currency futures market. When the
exchange rates are comfortable, the family members can take short positions on various
maturities. Later, if the rupee appreciates, then the family member can make profits.
On the other hand, if the rupee depreciates, the family member incurs a loss, but he can
later convert the currency at a higher exchange rate thereby getting a fixed amount
throughout the year.

Choice of underlying currency;

The first important dec ision in this respect is deciding the currency in which
futures contracts are to be initiated.

Choice of the maturity of the contract;

The second important decis ion in hedging through currency futures is selecting the
currency which matures nearest to the need of that currency.

Choice of the number of contracts (hedging ratio)

Another important decision in this respect is to decide hedging ratio. The value of
the futures position should be taken to match as closely as possible the value of the cash
market position. In the futures markets due to their standardization, exact
match will generally not be possible but hedge ratio should be as close to unity as
possible, which can be defined as follows:

HR= VF / Vc

Where, VF is the value of the futures position and Vc is the value of the cash
position. Suppose value of contract dated 28th May 2009 is 49.8850. And spot
value is 49.8500. HR=49.8850/49.8500=1.001.

Currency exposure could happen to anybody and hedging against future risks could work
to one's advantage. The latest decision of the government would enab le multip le
hedging opportunities for ind ividuals. A person could hedge on a currency for future
medical treatment of a kin abroad or reduce one's risk while receiving the periodical
remittances from abroad or even for the ind ividual who paid in foreign currency
for his kin's education abroad.

SPECULATION:

Generally two strategies is followed by the investors which are as follows :

Speculation: Bullish, buy futures

Take the case of a speculator who has a view on the direction of the market. He
would like to trade based on this view. He expects that the USD-INR rate presently at
Rs.42, is to go up in the next two -three months. How can he trade based on this belief.
In case he can buy dollars and ho ld it by investing the necessary capital, he can earn
profit if say the Rupee depreciates to Rs.42.50. Assuming he buys USD 10000, it
would require an investment of Rs.4,20,000. If the exchange rate moves as he expected
in the next three months, then he shall make a profit.

Speculation: Bearish, sell futures

Futures can be used by a speculator who believes that an underlying is over-valued and
is likely to see a fall in price. All he needs to do is sell the futures.

ARBITRAGE :

Arbitrage is the strategy of taking advantage of d ifference in price of the same or

similar product between two or more markets. That is, arbitrage is striking a
combination of matching deals that capitalize upon the imbalance, the profit being the
difference between the market prices. If the same or similar product is traded in say two
different markets, any entity which has access to both the markets will be able to
identify price differentials, if any. If in one of the markets the product is trading at
higher price, then the entity shall buy the product in the cheaper market and sell in the
costlier market and thus benefit from the price d ifferential without any additional risk.

One of the methods of arbitrage with regard to USD-INR could be a trad ing
strategy between forwards and futures market. As we d iscussed earlier, the futures price
and forward prices are arrived at using the princip le of cost of carry. Such of those
entities who can trade both forwards and futures shall be ab le to identify any mispricing
between forwards and futures. If one of them is priced higher, the same shall be sold
while simultaneous ly buying the other which is priced lower. If the tenor of both the
contracts is same, since both forwards and futures shall be settled at the same RBI
reference rate, the transaction shall result in a risk less profit.
 COMPANY PROFILE

INTRODUCTION

Nth Sense Business Consultants presents as imminent consultants in the area of currency
risk and interest rate risk management, forex Directional positioning and International
Trade finance.

We offered tailored products and customized services in forex risk

management. We apply high end techniques like simulation process to gauge the accuracy
level and rely on us proven technical expertise.

The Firm is managed by Management graduates with specialization in

Finance and treasury, Financial Risk Management and Ex Bankers and consultants.

Services Provided:

Nth Sense Business Consultants offers the following products/services in the area of forex
and interest rate risk management. The level of services will be designed to match the
exposure, risk appetite, and business model of the clientele. The scope of the produce and
services are elucidated below.

1. Currency Risk Management.

2. Currency Trading.
3. Conception of Risk Management.
4. Composing of Forex policy.
5. Currency Futures.
6. Commodity Futures.
7. Forex Information Services.
8. International Trade Services.
9. Structured Finance.
10. Treasury Outsourcing.

Currency Risk & Opportunity Management

We act as an extended arm of treasury to the corporate. We exploit every opportunity that
the Forex Market offers. The corporate who can adapt to the changing scenario and
manage the risk in a professional manner will be successful in mitigating the business risk.
The threats and risk can be transformed into rewards.

Nth Sense Business Consultants aims to bridge the gap between market opportunities and
its exploitation by providing rich knowledge base with timely alerts.

By providing the necessary market strategies, Nth Sense Business Consultants optimizes
the return from the market for its valued partners.Every advice or suggestions we give
you, is aimed at minimizing your payables and maximizing your receivables.

Forex Directional Positioning

The global foreign exchange market is the largest financial market in the world with more
than USD 3.21 Trillion turnover day. It is open 24 hours day. It is an over the Counter
market, highly volatile and operates purely on Supply and Demand. These characteristics
make the Currency Market, the highly liquid market where manipulation is impossible.

Technical Analysis serves as a barometer to this market. The forward market having
validity 12 months allows one to hold positions till such time. Short trading positions
provide an opportunity to get benefited from a falling market also. This makes the Forex
Market a winning trader’s market.

The Corporate Treasury is a source of profit generation. This trend line is catching up with
most of the corporates. The highly volatile currency can be a bottleneck in achieving the
business targets. The budgeting and profit margins may go awry unless it is combated with
alternative skill set. The currency market offers a huge potential to generate revenue from it.

Corporates, based on their risk appetite, can take Directional positions in currencies backed
by their Import and Export exposures. Nth Sense Business Consultants has a proven
expertise in this area. We can confidently say that we have mastered this. Nth Sense
Business Consultants with a talented pool of Analysts and Financial professionals has now
ventured into advisory on Forex Positional Trading.
Our clients have reaped rich returns from our trading calls, given after in-depth analysis of
both Fundamental and Technical factors.

Trade Finance

Supplier’s Credit

Supplier's Credit is a term used to refer to financing of an import by an international bank

at LIBOR related rates. Simply put, instead of importing on "sight basis" which entails
opening a sight L/C, the importer opens a usance L/C on an international bank (financing
bank) where the L/C is restricted for negotiation, discounts the drafts drawn under the L/C
so that the beneficiary (Supplier) gets paid at sight and the opener (importer) has to pay,
invoice amount and interest, to the financing bank after 180-days. The interest element is
determined on the basis of the Libor for the concerned currency. For Example the 6-month
Libor for the USD is currently 3.11% p.a. The spread over Libor at which the financing is
done ranges from 0.5 % to 0.75% depending upon, the size of the transaction, the usance
period, the country of import etc. Thus, by using supplier's credit an importer is in a
position to finance his imports at international interest rates which are significantly lower
than those charged by banks (usually around prime rate plus spread or the CC rate).

Role of Nth Sense Business Consultants

• Arrange cost effective and aggressive rates for financing.

• Scrutinize the L/C being issued to the financing bank.
• Follow up and Co-ordinate assisting the process of payment to the
supplier.

Buyer’s Credit

This mode of financing is used to extend the due dates of sight payments of L/C’s or
documents. This type of financing is routed through the ECB route where the L/c opening
bank or the document routing bank acknowledges the transaction arranged by its customer
and gives an undertaking via a SWIFT message to pay the offshore financing bank the
principal and the Libor related interest amount on the promised future date.

The major benefits of implementing this structure are as follows.

1. The Supplier can negotiate with his own banker

2. Applicant gets the money on a simple undertaking from his banker
3. The control of the transaction lies in the hand of the importer.
4. This transaction can be implemented to make payment to any supplier in the globe
irrespective of his location.
5. The above route can also be adopted in case of Non-L/c or CAD documents.
Role of Nth Sense Business Consultants

•Arrange cost effective and aggressive rates for financing.

• Follow up and Co-ordinate assisting the process of payment to the bank.

Corporate Training
As part of our forex training program, we educate our customers a step-by-step approach
to understand the intricate forex market. We believe that this is the most essential part of
services because it enables the client to understand the market and there by acquire basic
skills and a specific system to follow, which in turn builds discipline.

Who can benefit from our free training?

Our corporate training sessions are designed to give new and experienced forex
professionals alike all the necessary tools to equip with latest risk mitigation techniques,
hedging tools, regulatory issues and cost saving dexterity.

What does the complete forex training program consist of?

• Basic Module in Forex

• Advanced Module in Forex
• Advanced Training in Hedging Techniques
• Forex Directional Positioning and Currency Futures
• International Trade Finance

Currency Futures

Currency future Contract is a standardized, exchange-traded Derivative contract, to buy or

sell a currency at a certain date in the future, at a specified exchange rate. At present this is
open to resident Indians only. CFs has been introduced for hedging or otherwise.
Therefore CFs can be traded without any requirement of underlying exposure in forex.

The broad features of the currency futures are summarized as below.

• One CF contract is 1000 $

• 12 contracts will be available for trading at any point of time. On the first
day of trading, contracts for 12 months will be available for trading.
• Price of the contract will be denominated in INR e.g. CURFUT USD/INR
• CF will be available for trading from 9 AM to 5 PM on all working days
from Monday to Friday.
• A client can trade up to 6% of the open interest in the market or $ 5 million
whichever is higher. Open interest in the market is published by the exchange in
a real time basis.

Role of Nth Sense Business Consultants

• To give active trading calls based on fundamentals and technical charts

• To monitor and generate MTM at timely intervals
• Advice on exit opportunities with strict stop loss and take profit strategy
All in all, Nth Sense Business Consultants widespread wisdom, efforts and professional
liaison are aimed at one objective. The objective is also our corporate theme which is,
“Translate Risk into Reward”.

At Nth Sense Business Consultants , we assist you to translate the uncertainty in to profits.
Because, today the key to stay ahead is to effectively manage risk. Volatility is here to
stay and the only way to encounter is to manage it.

To conclude, Nth Sense Business Consultants offers specialized service to corporates

involved in Forex transactions with the aim to exploit the potential offered by the market
with a vigilant stance to avert the possible threats.

Commodity Hedging
In our Endeavor to provide gamut of services under one roof, we offer commodity
services which comprises advisory, hedging and on line trading. We are associated with
one of the leading players in commodity ventures, M/s PJ Commodity Ventures. We
provide end to end solution in all the services related to commodities. Few of the popular
services are web based commodity trading, corporate training, Advisory services backed
by extensive research and portfolio management, risk management etc.

PRODUCT/SERVICES PROFILE
DER IVA TIVES

Derivatives are very important financial instruments for risk management as they allow
risks to be separated and more precisely controlled. Derivatives are used to shift
elements of risk and therefore can act as a form of insurance. There are three basic ways
in which trad ing can take place:

1. Over The Counter (OTC);

2. On an exchange floor using open outcry; and

3. Using an electronic, automated matching system

Derivative is a product whose value is derived from the value of one or more basic
variab les, called bases (underlying asset, index, or reference rate), in a contractual
manner. The underlying asset can be equity, foreign exchange, commodity or any other
asset. In the Indian context the Securities Contracts (Regulation) Act, 1956 (SC(R)A)
defines "derivative" to inc lude-

1. A security derived from a debt instrument, share, loan whether secured or

unsecured, risk instrument or contract for differences or any other form of security.

2. A contract which derives its value from the prices, or index of prices, of
underlying securities.

Derivatives are securities under the SC(R)A and hence the trading of derivatives is
governed
by the regulatory framework under the SC(R)A. The term derivative has also been
defined in
section 45U(a) of the RBI act as follows:

“An instrument, to be settled at a future date, whose value is derived from change in
interest rate, foreign exchange rate, cred it rating or credit index, price of
securities
(also called “underlying”), or a combination of more than one of them and inc ludes
interest rate swaps, forward rate agreements, foreign currency swaps, foreign currency-
rupee swaps, foreign currency options, foreign currency-rupee options or such other
instruments as may be specified by the Bank from time to time”.

There are two basic types of assets for which futures contracts exist. These are
Comm
odity futures contracts and Financial futures contracts. Although both contracts
are
similar in principle, the methods of quoting prices, delivery and settlement terms vary
according to the contract being traded. Commodity futures comprise grains, oil seeds,
energy, metals, coffee, sugar, cocoa, etc. Financ ial futures comprise Interest rates,
Bond prices, Currency exchange rates, stock indices. Financ ial Derivatives
were
introduced in India, mainly as a risk management tool for both institutional and
retail
investors. Derivative products initially emerged as hedging devices against fluctuations
in
commodity prices, and commodity-linked derivatives.

DERIVATIVE PRODUCTS

Derivative contracts have several variants. The most common variants are forwards,
futures, options and swaps.

Forwards: A forward contract is a customized contract between two entities, where

settlement takes place on a specific date in the future at today's pre-agreed price. The
basic objective of a forward market in any underlying asset is to fix a price for a
contract to be carried through on the future agreed date and is intended to free both the
purchaser and the seller from any risk of loss which might incur due to fluctuations in
the price of underlying asset.

Futures: A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price. Futures contracts are special types of
forward contracts in the sense that they are standardized exchange traded contracts. A
currency futures contract provides a simultan eous right and obligation to buy and sell a
particular currency at a specified future date, a specified price and a standard quantity.

Options: Options are of two types - calls and puts. Calls give the buyer the right but
not the obligation to buy a given quantity of the underlying asset, at a given price on
or before a given future date. Puts give the buyer the right, but not the obligation to sell a
given quantity of the underlying asset at a given price on or before a given date.
Warrants: Options generally have lives of upto one year, the majority of options traded
on options exchanges having a maximum maturity of nine months. Longer- dated
options are called warrants and are generally traded over-the-counter.

LEAPS: The acronym LEAPS means Long-Term Equity Antic ipation Securities.
These are options having a maturity of upto three years.

Baskets: Basket options are options on portfolios of underlying assets. The underlying
asset is usually a moving average of a basket of assets. Equity index options are a form
of basket options.

Swaps: Swaps are private agreements between two parties to exchange cash flows in
the future according to a prearranged formula. They can be regarded as portfolios
of forward contracts. The two commonly used swaps are:
·
Interest rate sw aps: These entail swapping only the interest related cash flows
between the parties in the same currency.

· Currency swaps: These entail swapping both princ ipal and interest between the
parties, with the cash flows in one direction being in a d ifferent currency than those in
the opposite direction. There are a various types of currency swaps like as fixed - to-
fixed currency swap, floating to floating swap, fixed to floating currency swap.

FACTORS DRIVING THE GROWTH OF DERIVATIVES :

The derivatives market has seen a phenomenal growth. A large variety of

derivative contracts have been launched at exchanges across the world. Some of the
factors driving the growth of financ ial derivatives are:

1. Increased volatility in asset prices in financial markets,

2. Increased integration of national financ ial markets with the international

markets,

3. Marked improvement in communication facilities and sharp decline in their

costs,

4. Development of more sophisticated risk management tools, pro vid ing economic
agents a wider choice of risk management strategies, and

5. Innovations in the derivatives markets, which optimally combine the risks and returns
over a large number of financ ial assets leading to higher returns, reduced risk as well
as transactions costs as compared to individual financ ial assets.

Option Contracts:
 Option can be defined as a derivative contract which gives the
holder a right, but no obligation, to buy or sell a specified quantity of the underlying
asset on a future date at the predetermined price.

Evolution of Option:
The idea of an option existed in ancient Greece and Rome. Romans
wrote options in the cargoes that were transported by their ships.

During 1773 options were declared as illegal till 1869 and again banned
them. In USA until 1973 options on equity stock on the Over The Counter.

Types of Option
Broadly, Options can be classified into two namely call option and put
option.

Call Option
A call option gives the right, but no obligation to the contract buyer to
purchase a specified quantity of the underlying asset subject to the contract terms
such as strike price, exercise data etc.
On the other side, the seller of a call option is bound to honor the
rights of the buyer as per the contract terms.

Covered Call: If a call is written on a asset on the backing of long position (Buying)
of the same asset in the cash market, it is known as a covered call. Since the call
seller has bought the required quantity of the asset in the cash market, losses du e to a
price increase of the asset could be eliminated.

Naked call: A naked call is one where the seller of the call option does not have
position in the underlying asset.

Put Option
Put option refers to a type of option contract which gives its buyer a
right, but no obligation, to sell a specified quantity of the underlying asset on a future
date at the agreed price(strike price).
On the other side, the seller of the contract is obligated to buy the asset
from the contract buyer as per the agreed terms.
As stated earlier, the buyer enjoys unlimited profit and limited loss in the
case of put option too while the seller has unlimited loss and limited profit.

Intrinsic Value: The difference between strike price of a contract and spot value of
the underlying asset at any point of the time is the intrinsic value. Based on this, option
contracts are said to be in the money and out of money.
In the money: A contract is the money when the contract is in favors of the buyer, that
is a profit could be made by training or exercising his rights.
In fact, it depends on the difference between the strike price and the exercise value and
hence will differ in the case of call option and put option.
A call option is in the money when the settlement value of the asset is
higher than the strike price.
A put option will be in the money when the settlement value is lower
than the strike price.

At the money: An option contract is said to be in the money when there is no cash
flow from exercising the contract. Such a situation arises when the strike price is equal
to the exercise price and the case is the same in both call option and put option.

Out of Money: An option contract is out of money when the contract is not in favour
of the buyer, that is, a profit could not be generated by exercising the right or by
trading.
A call option is out of money at times when the strike price is lower than
the spot value or settlement price of the asset.

INTRODUCTION TO CURRENCY FUTURES :

Currency derivatives can be described as contracts between the sellers and buyers,
whose values are to be derived from the underlying assets, the currency amounts. These
are basically risk management tools in forex and money markets . They are used for
hedging risks and act as insurance against unforeseen and unpredictable currency and
interest rate movements. It is not completely risk free. Market r isks can't be avoided,
but have to be managed. The currency derivative serve the purpose of financ ial risk
management.

A futures contract is a standardized contract, traded on an exchange, to buy or sell a

certain underlying asset or an instrument at a certain date in the future, at a
specified price. When the underlying is an exchange rate, the contract is termed a
“currency futures contract. The origin of futures can be traced back to 1851 when the
Chicago Board of Trade (CBOT) introduced standardized forward contracts The
Chicago Mercantile Exchange (CME) first conceived the idea of a currency futures
exchange and it launched the same in 1972. The Chicago Mercantile Exchange, or CME,
provides the most popular currency futures.

The undertaker in a futures market can have two positions in the contract :

i. Long position when the buyer of a future contract agrees to purchase the
underlying asset.
ii. Short position when the seller agrees to sell the asset.
The holder of a contract could exit from his commitment prior to the settlement date
by either selling a long position or buying back a short position (offset or reverse
trade). Currency futures can be cash settled or settled by delivering the respective
obligation of seller and buyer. All settlements however, unlike in the case of OTC
markets, go through the exchange. The future date is called the delivery date or
final settlement date. The pre-set price is termed as future price, while the price of
the underlying ass et on the delivery date is termed as the settlement price. The
future price normally converges towards the spot price on the settlement date.

The sta nda rdize d ite ms in a f ut ure s c o nt rac t a re :

The standardized items of a future contract can be discussed as :

Quantity of the underlying

Quality of the underlying
The date and the month of delivery
The units of price quotation and minimum price change
Location of settlement

RBI has currently permitted futures only on the USD-INR rates. The contract
specification of the futures shall be as under:

Underlying
Initially, currency futures contracts on US Dollar – Indian Rupee (USD-INR)
would be permitted.

Trading Hours
The trading on currency futures would be availab le from 9 a.m. to 5 p.m. from Monday
to Friday.

Size of the contract

The minimum contract size of the currency futures contract at the time of
introduction would be USD 1000.

Quotation
The currency futures contract would be quoted in Rupee terms. However, the
outstanding positions would be in dollar terms.

Tenor of the contract

The currency futures contract shall have a maximum maturity of 12 months.
Available contracts
All monthly maturities from 1 to 12 months would be made availab le.

Settlem ent mechanism

The currency futures contract shall be settled in cash in Ind ian Rupee.

Settlem ent price

The settlement price would be the Reserve Bank of India Reference Rate on the last
trad ing day.

Final settlem ent day

The final settlement would be the last working day (subject to holiday calendars) of
the month. In keep ing with the modalities of the OTC markets, the value date / final
settlement date for the each contract will be the last working day of each month
and the reference rate fixed by RBI two days prior to the final settlement date will
be used for final settlement (graph 3). The last trad ing day of the contract will
therefore be 2 days prior to the final settlement date. On the last trad ing day, since
the settlement price gets fixed around 12:00 noon, the near month contract shall
cease trading at that time (exceptions: sun outage days, etc.) and the new far month
contract shall be introduced.

The contract specification in a tabular form is as under:

Underlying Rate of exchange between one USD and

INR
Trading Hours 9:00 a.m to 5:00 p.m
(Monday to Friday)
Contract Size USD 1000
Tick Size 0.25 paise or 0.0025
Trading Period Maximum exp iration period of 12 months
Contract Months 12 near calendar months
Final Settlement date/Value date Last working day of the month(subject to
holiday calendars)
 Last Trading Day Two working days prior to Final
Settlement Date
Settlement Cash Settled
Final Settlement Price The reference rate fixed by RBI two
working days prior to the final settlement
date will be used for final settlement.

Adva ntage s o f Curre nc y F ut ure :

The advantage of exchange traded forex futures trad ing India:

EASY ACCESSIBILITY: Small investors would get an easy access to currency

futures trading on the popular exchanges.

EASY AFFORDABILITY: Margins are very low and the contract size is very small.
As per the specification of NSE USD-INR currency future contract, the lot size is
1000$. Margin is 1.75%. It is easy and affordable for any retail investor to take a call
on Ind ian Rupee by taking position in currency futures.

LOW TRANSACTION COSTS: When you trade in currency futures in India, you
have to pay a small amount of brokerage fees and statutory duties and taxes. In overseas
forex trading you have to pay commissions to the banks or foreign exchange
agents in the form of spread. Spread is the difference in the buy/sell price over the
reference rate, which can be very high.

TRANSPERANCY: It is possible for you to verify trade details if you have a

doubt that the broker has tried to cheat you.

EFFICIENT PRICE DISCOVERY: Internationally it has been established that

currency future is a better and efficient mechanism for price discovery. With its
state of the art automated electronic trad ing system where the orders are executed on
the basis of price-time priority, it is well poised to offer effic ient price
discovery.

COUNTER-PARTY DEFAULT RISKS: All the trades done on the recognized

exchanges are guaranteed by the c learing corporations and hence it eliminates the
risks associated with counter party default. NSCCL (National Securities Clearing
Corporation Limited) carries out all the novation, c learing and settlement process of
currency futures trading.

STANDARDIZED CONTRACTS: Exchange Traded currency

futures are standarizsed in respect of lot size (1000$) and
maturity (12 monthly contracts). Retail investors with their limited resources would
find it tremendously benefic ial to take positions in standardised USD INR futures
contracts.

Dist inc tio n be twee n F ut ure s a nd F orwa rd Co nt rac t :

Futures contracts Forwards contracts

1. Are traded on an exchange 1. Are not traded on an exchange

2. Use a Clearing House which 2. Are private and are negotiated between the
provides protection for both parties parties with no exchange guarantees
3. Require a margin to be paid 3. Involve no margin payments

4. Are used for hedging and 4. Are used for hedging and physical
speculating delivery
5. Are dependent on the negotiated
5. Are standardised and published contract conditions

6. Are transparent - futures contracts are 6. Are not transparent as they are all
reported by the exchange. private deals

F uture Te rm inology:

SPOT PRICE :

The price at which an asset trades in the spot market. The transaction in which
securities and foreign exchange get traded for immed iate delivery. Since the
exchange of securities and cash is virtually immediate, the term, cash market, has also
been used to refer to spot dealing. In the case of USDINR, spot value is T + 2.

FUTURE PRICE :
The price at which the future contract traded in the future market.

CONTRACT CYCLE :

The period over which a contract trades. The currency future contracts in Indian market
have one month, two month, three month up to twelve month exp iry cycles. In
NSE/BSE will have 12 contracts outstanding at any given point in time.

VALUE DATE / FINAL SETTELMENT DATE :

The last business day of the month will be termed the value date /final settlement date
of each contract. The last business day would be taken to the same as that for inter
bank settlements in Mumbai. The rules for inter bank settlements, inc lud ing those
for „known holidays‟ and would be those as laid down by Foreign Exchange Dealers
Association of India (FEDAI).

EXPIRY DATE :

It is the date specified in the futures contract. This is the last day on which the contract
will be traded, at the end of which it will cease to exist. The last trad ing day will be
two business days prior to the value date / final settlement date.

CONTRACT SIZE :

The amount of asset that has to be delivered under one contract. Also called as lot
size. In case of USDINR it is USD 1000.

BASIS :
In the context of financ ial futures, basis can be defined as the futures price minus
the spot price. There will be a different basis for each delivery month for each
contract. In a normal market, basis will be positive. This reflects that futures prices
normally exceed spot prices.

COST OF CARRY :
The relationship between futures prices and spot prices can be summarized in
terms of what is known as the cost of carry. This measures the storage cost plus the

interest that is paid to finance or „carry‟ the asset till delivery less the income
earned on the asset. For equity derivatives carry cost is the rate of interest.

INITIAL MARGIN :

When the position is opened, the member has to deposit the margin with the
clearing house as per the rate fixed by the exchange which may vary asset to asset. Or
in another words, the amount that must be deposited in the margin account at the
time a future contract is first entered into is known as initial margin.
MARKING TO MARKET:

At the end of trading session, all the outstanding contracts are reprised at the settlement
price of that session. It means that all the futures contracts are daily settled, and profit
and loss is determined on each transaction. This procedure, called marking to
market, requires that funds charge every day. The funds are added or subtracted
from a mandatory margin (initial margin) that traders are required to maintain the
balance in the account. Due to this adjustment, futures contract is also called as
daily reconnected forwards.

MAINTENANCE MARGIN:
Member’s account are debited or credited on a daily basis. In turn customers‟
account
are also required to be maintained at a certain level, usually about 75 percent of
the
initial margin, is called the maintenance margin. This is somewhat lower than the
initial
margin. This is set to ensure that the balance in the margin account never becomes
negative.
If the balance in the margin account falls below the maintenance margin, the
investor
receives a margin call and is expected to top up the margin account to the initial
margin
level before trading commences on the next day.

Mckensy’s 7s frame work:

The McKinsey 7S Model

The above figure illustrates the multiplicity interconnectedness of elements that define
an organization's ability to change. The theory helped to change manager's thinking
about how companies could be improved. It says that it is not just a matter of devising
a new strategy and following it through. Nor is it a matter of setting up new systems
and letting them generate improvements.
The 7S model is an anthropological way to understand culture. The model shows that
corporate success requires the development of both the hard Ss (strategy, structure,
and systems) and the soft Ss (style of leadership, skills, stakeholder values, and shared
values). The 7Ss serve as the following to help leaders:

1. STRUCTURE
It is the skeleton of the whole company edifice. It prescribes the formal relationship
among various positions and activities. It includes about reporting relationship, how
the company member is to communicate with other members, what roles to perform
and what rule and procedure exist to guide the various activities performed by
company members, are all parts of the company structure.

2. STRATEGY
 The strategy refers to short term or long – term policies. It means the set of actions
that you start with and must maintain. The direction and scope of the Company over
the long term.
The strict implementation of the WMC policies is the strategy of the company
which has managed to get the Company its global recognition.
The Company has a few long plans.

3. SYSTEM
System refers to all the rules, regulation and procedure, both formal that compliment
the company structure. In includes production planning and control system, capital
budgeting system, training and development system.

4. SHARED VALUE
This may be considered to “company purpose”. According to the Shared value refers
to “…a set of values and aspiration, of them unwritten that goes beyond the
convectional formal statement of corporate objectives. Super ordinate goals are the
fundamental ideas around which a business is build. They are its main values. They
are the board notions of future directions that the top management team infuse
throughout the company they are way in which the team wants express its self to live
its own mark.

5. STAFF
Staffing is the process of acquiring human resources for the company and ensuring
that they have the potential to contribute the achievement of the company’s goals. It is
selecting people for specific company position and developing in them the ability and
skill that they would need to be effective in this and subsequent assignments, the
staffing function applies to the whole company.

6. STYLE
Style is one of the seven levels, which top management can use to bring about
company change. Companies differ from each other in their style of working. The
style of company becomes evident through the pattern of action taken by member of
the top management scheme over a period of time.
7. SKILLS:
The skills refer to the Dominant or capabilities that exist in an individual. The term
skills include those characteristics, which most people use to describe the Company.
Companies have strengths in number of areas. These are developed over a period of
time. The company 5-S System, which was first originated in China, Quality
assurance, KAIZEN etc are some of the disciplinary skills of the company.

PART B
INTRODUCTION
Risk can be broadly classified into two groups business and financial. Business risk is
associated with the operating environment such as technological changes, marketing, etc.
Financial risk includes foreign exchange rates, interest rate, and commodity prices.

Foreign exchange risk arises as a result of uncertainty about the future spot exchange
rate. It is a result of uncertainty about the future spot exchange rate (due to the variability
of exchange rates), the domestic value of assets, liabilities, operating incomes, profit, rates
of return, and expected cash flows that are stated in foreign currency are uncertain.

The importance of foreign exchange management is broadly defined under the following
heads in the research report as:

• Value of the firm

• Reduction in Taxes
• Expected Cost of Financial Distress
• Investment Decisions
• Financing Decision

The report also explains the various hedging strategies employed by firms to manage their
foreign exchange risks. The uses of the following derivative instruments are explained:

• Forwards
• Futures
• Options
• Swaps
• Foreign Debt

The report explains the hedging strategies that a firm should employ for managing foreign
exchange risk using Currency Options. The report explains the scenarios and their
respective hedging strategies. The scenarios are:

• Bullish Conditions
• Bearish Conditions
• Volatile Conditions

Different periods are taken for analysis where historically the currency has shown the
above conditions and the analysis is done on the basis of the results.

Foreign E xchange-Rate Risk

Exchange rate volatility is one of the most difficult and unrelenting problems
in the era of globalization. Firms with foreign transactions and obligations may face
substantial losses due to adverse movements in exchange rates. Firms are exposed to the
adverse movement of exchange rates because of three broad reasons.
First, all foreign financial transactions involving cash payments must often be
denominated in the creditor’s domestic currency. As the exchange rates fluctuate between
the time of contract and the date of payment, there is the possibility of losses because the
amount of money that has to be available for conversion from the debtor’s to creditor’s
currency at the payment date is larger than it was expected on the contract.
Second, the exposure arises because of the size of the foreign transactions.
Finally, the length between the date of contract and the date of payment is also the
reason for firms’ exposure to foreign exchange rate risk.

The Dimensions of Foreign Exchange Exposures

Beside the financial impacts of cash losses and increased debt obligations, the adverse
effects of foreign exchange have several dimensions for firms with foreign operations.
For the purpose of financial reporting, the foreign operational units must often translate
items in the financial statement at the common exchange rate that may differ from the rate
at which the transaction items prevail. As a result, the parent company will experience
exchange gains or losses which, in turn, influences the firm’s performance from the
perspectives of investors, banks, analysts, and other external users who rely merely on
consolidated financial statements. The adverse effect of exchange rate movements for firms
with foreign operations has yet another dimension. A depreciation of domestic exchange
rate of the overseas operational units may not only change the value of assets and
liabilities that are translated in the currency of the parent company but also increase
the competitiveness of ex portable products of the operational units. Thus, the reported
decrease in the assets and liabilities at the parent company do not reflect the true value
of the revenue and expense streams of the operational units since any advantage from a
depreciation may offset the lower value of assets and liabilities from translation. Hence, an
appropriate measure of the adverse effect of exchange rate movements is the expected
cash flows of the operational units. Although the first and the second dimensions of the
adverse consequences of exchange rate movements appear contradictory, it may actually
have the same effects on the parent company and the overseas operational units. For
example, the decreased value of retained earnings when it is translated at the currency of
the parent company may also be experienced by the foreign operating firms. This is
because the real economic environment of the operating firms remains unknown
Regardless of whether the domestic economic environment where the operational units
conducting business improve or deteriorate the obvious effects of exchange rate
movements on cash flows of both overseas operating firms and parent company is
inevitable. The variability of input costs and a decrease in the products’ competitive
position may contribute to an increase in variability of the firm’s expected cash flows.
The persistent variability of cash flows can cause further severe direct and indirect
problems including, liquidity, bankruptcy and financial, spoiling investment decisions and
the firm’s ability to raise capital, and the perception of stakeholders, regulators, and society
in general of inadequate corporate governance.

Meaning of Risk

Risk means condition or choices that have certain consequences of loss or danger. In
probability and statistics, financial management, and investment management, risk is used to
describe the likelihood of variability in outcomes around expected value, which is often
measured by the extent of the dispersion around the mean or average value of the underlying
variables. Thus, the term risk, which is used here, refers to the situations where outcomes are
uncertain that may lead to the losses.

Foreign Exchange Risk: One Type of Business Risk

Risk can be broadly classified into two groups business and financial. Business risk is
associated with the operating environment such as technological changes, marketing, etc.
Financial risk includes foreign exchange rates, interest rate, and commodity prices.
A more comprehensive classification has been presented by Harrington and Niehaus.
In this classification, the business risk is divided into three types, price, credit, and pure.
Price risk refers to uncertainty of cash flows owing to changes in output and input prices.
Credit risk occurs mostly in financial institutions because loans are the primary products.
Since there is a probability of default by the borrower, firms engaging in this business face
credit risk. Non-financial firms are also vulnerable to this risk due to credit selling. The
difference between financial and non-financial firms is the
magnitude of the risk. Finally, pure risk refers to risk arising from three sources. The first
source is risk of reduction in value of business assets on account of physical damage, theft
and expropriation. The second source is risk resulting from legal liability from harm
to customers, suppliers, shareholders, and other parties. Finally, there is risk that may
 force a firm to pay benefits to injured workers which it is not covered by the workers'
compensation. Foreign exchange rate risk is only one source of price risk. This arises from
fluctuations of input prices as a result of exchange rate movements. This type of risk
occurs due to firms' activity to obtain inputs from foreign countries. The reasons for
obtaining inputs from foreign markets are often dictated b y several considerations,
including price, quality, and availability. Under similar considerations, firms expand their
operation by selling products in foreign countries. Since the sales price is affected by
exchange rate changes, firms are exposed to foreign exchange rate risk.

Foreign Exchange Rate Risk and Exposure

The word risk is often used interchangeably with exposure. Although these words have
a close relationship, the meaning is different. The risk is usually concerned with the
probability of an unexpected outcome, while exposure is concerned with the magnitude of
the possibility of loss.
The definition of foreign exchange risk differs to foreign exchange exposure. Foreign
exchange risk can be defined as "related to the variability of domestic-currency values of
Assets, liabilities, or operating incomes due to unanticipated changes in exchange rates,
whereas foreign exchange exposure is “what is at risk".
Foreign exchange risk arises as a result of uncertainty about the future spot exchange
rate. It is a result of uncertainty about the future spot exchange rate (due to the variability
of exchange rates), the domestic value of assets, liabilities, operating incomes, profit, rates
of return, and expected cash flows that are stated in foreign currency are uncertain.
Exposure can exist on assets, liabilities, and operating incomes. Exposure exists on
foreign assets when the real domestic currency value of foreign assets rises and when
the foreign currency appreciates, and vice versa. This relationship can be simplified
with the following regression equation:
(A/L) = ß S (2.1)
Where, A and L are changes in the real domestic currency value of foreign assets or
liabilities, S is changes in exchange rates, and ß is the slope of the equation as well as a
measure of exposure. The larger the value of ß the more sensitive the value of the assets
towards exchange rate changes, an therefore, the larger the exposure.

Foreign Exchange Risk Management Framework

Once a firm recognizes its exposure, it then has to deploy resources in managing it. A
heuristic for firms to manage this risk effectively is presented below which can be
 modified to suit firm-specific needs i.e. some or all the following tools could be used.

1. Forecasts: After determining its exposure, the first step for a firm is to
develop a forecast on the market trends and what the main direction/trend is
going to be on the foreign exchange rates. The period for forecasts is typically
6 months. It is important to base the forecasts on valid assumptions. Along
with identifying trends, a probability should be estimated for the forecast
coming true as well as how much the change would be.

2. Risk Estimation: Based on the forecast, a measure of the Value at Risk (the
actual profit or loss for a move in rates according to the forecast) and the
probability of this risk should be ascertained. The risk that a transaction would
fail due to market-specific problems4 should be taken into account. Finally, the
Systems Risk that can arise due to inadequacies such as reporting gaps and
implementation gaps in the firms’ exposure management system should be
estimated.

3. Benchmarking: Given the exposures and the risk estimates, the firm has to
set its limits for handling foreign exchange exposure. The firm also has to
decide whether to manage its exposures on a cost centre or profit centre basis.
A cost centre approach is a defensive one and the main aim is ensure that cash
flows of a firm are not adversely affected beyond a point. A profit centre
approach on the other hand is a more aggressive approach where the firm
decides to generate a net profit on its exposure over time.

4. Hedging: Based on the limits a firm set for itself to manage exposure, the
firms then decides an appropriate hedging strategy. There are various financial
instruments available for the firm to choose from: futures, forwards, options
and swaps and issue of foreign debt. Hedging strategies and instruments are
explored in a section.

a. Stop Loss: The firms risk management decisions are based on forecasts which
are but estimates of reasonably unpredictable trends. It is imperative to have stop loss
arrangements in order to rescue the firm if the forecasts turn out wrong. For this, there
should be certain monitoring systems in place to detect critical levels in the foreign
exchange rates for appropriate measure to be taken.

b. Reporting and Review: Risk management policies are typically subjected to

review based on periodic reporting. The reports mainly include profit/ loss status on
open contracts after marking to market, the actual exchange/ interest rate achieved on each
exposure, and profitability vis-à-vis the benchmark and the expected changes in overall
exposure due to forecasted exchange/ interest rate movements. The review analyses
whether the benchmarks set are valid and effective in controlling the exposures, what
the market trends are and finally whether the overall strategy is working or needs change.

Forecasts

Risk Estimation
 Benchmarking

Hedging

Stop Loss

Reporting and review

Figure 1: Framework for Risk Management

Hedging Strategies/ Instruments

A derivative is a financial contract whose value is derived from the value of some
other financial asset, such as a stock price, a commodity price, an exchange rate, an
interest rate, or even an index of prices. The main role of derivatives is that they
reallocate risk among financial market participants, help to make financial markets
more complete. This section outlines the hedging strategies using derivatives with
foreign exchange being the only risk assumed.

Forwards: A forward is a made-to-measure agreement between two parties to

buy/sell a specified amount of a currency at a specified rate on a particular
date in the future. The depreciation of the receivable currency is hedged
against by selling a currency forward. If the risk is that of a currency
appreciation (if the firm has to buy that currency in future say for import), it
can hedge by buying the currency forward. E.g if RIL wants to buy crude oil
in US dollars six months hence, it can enter into a forward contract to pay INR
and buy USD and lock in a fixed exchange rate for INR-USD to be paid after
6 months regardless of the actual INR-Dollar rate at the time. In this example
the downside is an appreciation of Dollar which is protected by a fixed
forward contract. The main advantage of a forward is that it can be tailored to
the specific needs of the firm and an exact hedge can be obtained. On the
downside, these contracts are not marketable, they can’t be sold to another
party when they are no longer required and are binding.

Futures: A futures contract is similar to the forward contract but is more

liquid because it is traded in an organized exchange i.e. the futures market.
Depreciation of a currency can be hedged by selling futures and appreciation
can be hedged by buying futures. Advantages of futures are that there is a
central market for futures which eliminates the problem of double
coincidence. Futures require a small initial outlay (a proportion of the value of
the future) with which significant amounts of money can be gained or lost
with the actual forwards price fluctuations. This provides a sort of leverage.
The previous example for a forward contract for RIL applies here also just that
RIL will have to go to a USD futures exchange to purchase standardised dollar
futures equal to the amount to be hedged as the risk is that of appreciation of
the dollar. As mentioned earlier, the tailorability of the futures contract is
limited i.e. only standard denominations of money can be bought instead of
the exact amounts that are bought in forward contracts.

Options: A currency Option is a contract giving the right, not the obligation,
to buy or sell a specific quantity of one foreign currency in exchange for
another at a fixed price; called the Exercise Price or Strike Price. The fixed
nature of the exercise price reduces the uncertainty of exchange rate changes
and limits the losses of open currency positions. Options are particularly
suited as a hedging tool for contingent cash flows, as is the case in bidding
processes. Call Options are used if the risk is an upward trend in price (of the
currency), while Put Options are used if the risk is a downward trend. Again
taking the example of RIL which needs to purchase crude oil in USD in 6
months, if RIL buys a Call option (as the risk is an upward trend in dollar
rate), i.e. the right to buy a specified amount of dollars at a fixed rate on a
specified date, there are two scenarios. If the exchange rate movement is
favourable i.e the dollar depreciates, then RIL can buy them at the spot rate as
they have become cheaper. In the other case, if the dollar appreciates
compared to today’s spot rate, RIL can exercise the option to purchase it at the
agreed strike price. In either case RIL benefits by paying the lower price to
purchase the dollar

Swaps: A swap is a foreign currency contract whereby the buyer and seller
exchange equal initial principal amounts of two different currencies at the spot
rate. The buyer and seller exchange fixed or floating rate interest payments in
their respective swapped currencies over the term of the contract. At maturity,
the principal amount is effectively re-swapped at a predetermined exchange
rate so that the parties end up with their original currencies. The advantages of
swaps are that firms with limited appetite for exchange rate risk may move to a
partially or completely hedged position through the mechanism of foreign
currency swaps, while leaving the underlying borrowing intact. Apart from
covering the exchange rate risk, swaps also allow firms to hedge the floating
interest rate risk. Consider an export oriented company that has entered into a
swap for a notional principal of USD 1 mn at an exchange rate of 42/dollar.
The company pays US 6months LIBOR to the bank and receives 11.00% p.a.
every 6 months on 1st January & 1st July, till 5 years. Such a company would
have earnings in Dollars and can use the same to pay interest for this kind of
borrowing (in dollars rather than in Rupee) thus hedging its exposures.

Foreign Debt: Foreign debt can be used to hedge foreign exchange exposure
by taking advantage of the International Fischer Effect relationship. This is
demonstrated with the example of an exporter who has to receive a fixed
amount of dollars in a few months from present. The exporter stands to lose if
the domestic currency appreciates against that currency in the meanwhile so,
to hedge this, he could take a loan in the foreign currency for the same time
period and convert the same into domestic currency at the current exchange
rate. The theory assures that the gain realised by investing the proceeds from
the loan would match the interest rate payment (in the foreign currency) for
the loan.
Determinants of Hedging Decisions

The management of foreign exchange risk, as has been established so far, is a fairly
complicated process. A firm, exposed to foreign exchange risk, needs to formulate a
strategy to manage it, choosing from multiple alternatives. This section explores what
factors firms take into consideration when formulating these strategies.

Production and Trade vs. Hedging Decisions

An important issue for multinational firms is the allocation of capital among different
countries production and sales and at the same time hedging their exposure to the
varying exchange rates. Research in this area suggests that the elements of exchange
rate uncertainty and the attitude toward risk are irrelevant to the multinational firm's
sales and production decisions (Broll,1993). Only the revenue function and cost of
production are to be assessed, and, the production and trade decisions in multiple
countries are independent of the hedging decision.

The implication of this independence is that the presence of markets for hedging
instruments greatly reduces the complexity involved in a firm’s decision making as it
can separate production and sales functions from the finance function. The firm
avoids the need to form expectations about future exchange rates and formulation of
risk preferences which entails high information costs.

Cost of Hedgin g

Hedging can be done through the derivatives market or through money markets
(foreign debt). In either case the cost of hedging should be the difference between
value received from a hedged position and the value received if the firm did not
hedge. In the presence of efficient markets, the cost of hedging in the forward market
is the difference between the future spot rate and current forward rate plus any
transactions cost associated with the forward contract. Similarly, the expected costs of
hedging in the money market are the transactions cost plus the difference between the
interest rate differential and the expected value of the difference between the current
and future spot rates. In efficient markets, both types of hedging should produce
similar results at the same costs, because interest rates and forward and spot exchange
rates are determined simultaneously.

Factors affecting the decision to hedge foreign currency risk

Research in the area of determinants of hedging separates the decision of a firm to
hedge from that of how much to hedge. There is conclusive evidence to suggest that
firms with larger size, R&D expenditure and exposure to exchange rates through
foreign sales and foreign trade are more likely to use derivatives. (Allayanis and Ofek,
2001) First, the following section describes the factors that affect the decision to
hedge and then the factors affecting the degree of hedging are considered.

Firm size: Firm size acts as a proxy for the cost of hedging or economies of
scale. Risk management involves fixed costs of setting up of computer
systems and training/hiring of personnel in foreign exchange management.
Moreover, large firms might be considered as more creditworthy
counterparties for forward or swap transactions, thus further reducing their
cost of hedging. The book value of assets is used as a measure of firm size.
 Leverage: According to the risk management literature, firms with high
leverage have greater incentive to engage in hedging because doing so reduces
the probability, and thus the expected cost of financial distress. Highly levered
firms avoid foreign debt as a means to hedge and use derivatives.

Liquidity and profitability: Firms with highly liquid assets or high

profitability have less incentive to engage in hedging because they are exposed
to a lower probability of financial distress. Liquidity is measured by the quick
ratio, i.e. quick assets divided by current liabilities). Profitability is measured
as EBIT divided by book assets.

Sales growth: Sales growth is a factor determining decision to hedge as

opportunities are more likely to be affected by the underinvestment problem.
For these firms, hedging will reduce the probability of having to rely on
external financing, which is costly for information asymmetry reasons, and
thus enable them to enjoy uninterrupted high growth.

A. STATEMENT OF PROBLEM:

Derivative use for hedging is only to increase due to the increased global
linkages and volatile exchange rates. Firms need to look at instituting a sound risk
management
system and also need to formulate their hedging strategy that suits their specific firm
characteristics and exposures.

The Statement of Problems are listed as follows:

 1. Selecting the suitable option hedging strategies for managing foreign
exchange Risk
a. Currency option strategies for importers transaction in Bullish Market
conditions
b. Currency option strategies for exporters transaction in Bearish Market
conditions
c. Currency option strategies for importers transaction in volatile Market
conditions.

2. Design of Survey.
a. The survey is based on a questionnaire which was sent by mail to 30-50 SMEs
and the content of the questionnaire aimed to get the answer to the following areas of
questions that are directly related to the hedging strategies for managing foreign
exchange Risk.

The Above made survey gives the overall view of the SMEs hedging
patterns
for managing the foreign exchange risk, so the study of

“Pattern of hedging process across SMEs for managing forex risk in

India”

B. Objectives:

6. To evaluate the firms hedging strategies for managing foreign exchange

risk using currency option in different scenario, and the scenario are :
a. Bullish market condition.
b. Bearish market condition.
c. Volatile market condition.
7. To understand the volatility of the exchange rates in different market
conditions.
8. To analyze and evaluate suitable hedging strategy for SMEs.
9. To minimize firms exposure in terms of exchange rate fluctuation by
hedging using derivative instrument on a currency exchange.
10. To obtain, analyze and interpret the survey done for the SMEs for
managing forex risk.

C. Scope of Study:

In India, SME sector plays a pivotal role in the overall industry

economy of the country. It is estimated that in terms of values, the sector
accounts for about 39% of the manufacturing output and around 33% of
the total export of the country.
Further in recent years the SME sector has consistently registered
higher growth rate compared to overall industrial sector.

The Scope of the above study are discussed below:

1. A detailed study of currency forwards, currency options, swaps, Futures.

 2. To see various hedging strategies to manage foreign exchange
risk/exposure of the SMEs.

D. Methodology:

The first step in the project is to go through the various research papers available on the
different currency hedging strategies available for companies. Since the project is
about managing the currency risk effectively, the next step was identifying the data
which would be required for proceeding with the project. The data that is needed for the
project is primarily the currency rates between Rupee and Dollar.

The next step was data collection. The project involves the study of hedging strategies
in the following three scenarios regarding the Rupee v/s Dollar exchange rate:

• Bearish Market Conditions

• Bullish Market Conditions
• Volatile Market Conditions

The daily exchange rates for INR/USD were then collected from the RBI website. Using
the daily exchange rates the periods were identified where the exchange rate experienced
the above three conditions.
Based on the aforesaid market conditions, the suitable hedging strategies were applied. The
option premium was calculated u s i n g th e Black-Scholes M o d e l. The data ordering
involved various assumptions because of unavailability of certain data. For example, the
Strike Prices in certain cases were taken to be the mean of the spot prices for the given
period. For strategies that involved hedging with more than one Option like Strangle or
Butterfly Spread, the Strike prices were assumed as mentioned in the data ordering part of
the project.

By applying the mentioned strategies in the above market conditions, the Net Cash flow
for the importer and the exporter were calculated. The results thus prove the suitability of
the hedging strategies applied.

E. Limitation of the Study :

1. As research required detail information of portfolios of clients, which is

very confidential for the clients, a huge difficulty was faced in getting the data.
 2. Also the data used in research may suffer from incorrectness.

3. As the company guide was very busy his exhausting work schedule,
very less guidance was available.

ANALYSIS AND INTREPRETATION

SELECTING SUITABLE OP TION HEDGING STRATEGI ES FOR

MANAGING FO REIGN EXC HANGE RISK

Currency option strategies for Import transactions in Bullish Market conditions

The foreign exchange market is said to be Bullish if the foreign currency concerned is
appreciating against the domestic currency. For example if the Dollar is appreciating against
the Rupee, then the market is said to be bullish.
In such bullish conditions, the importers who have imported goods on credit will have to
pay more than what they would have during the beginning of the period. To hedge against
any such risk arising due to the movement in the exchange rates, the following hedging
strategies using currency options are
available for importers.

Period choosen for study:

The period chosen for the study in which the currency market was bullish or when
Dollar appreciated against the Rupee is

Long Call
Call buying is a strategy used if the investor thinks that the underlying asset will
advance in price. It is important, given the risk,that the hedgers have a clear idea
about where the exchange rate is going and when. For the most part, there are two
 types of Call buyers:
• The bullish speculators wanting to take advantage of the leverage options can offer,
and.
• The investor buying a Call as a substitute for buying the stock.

Risk/Reward Characteristics

Break-even Point: At expiration, the break-even point (B.E.) is equal to the strike price of
the Call option plus the Call option's premium. Before expiration, the break-even point is
lower.

Profit: Profits are unlimited as long as the underlying stock continues in advance.

Loss: Losses are limited to the premium paid for the option. At expiration, for every point
XYZ is above the strike price, the Call option increases an additional point in value.

Time Decay: A call option's premium consists of both intrinsic value (if any) plus time
value. As time passes, the time value portion of the Call erodes (i.e., decays). At expiration,
the Call's value will equal its intrinsic value.

Changes in implied Volatility: Changes in the option's implied volatility has an effect on
the "time value" portion of an option's premium. Thus, a change in the option's implied
volatility has the same effect as changing (+/-) the number of days remaining until the
option's expiration.
 Short Put
•The investor writing Put options should believe that the underlying asset is not going
down. The maximum profit is limited to the Put premium received and is achieved when
the price of the underlying is at or above the option's strike price at expiration. The maximum
loss is unlimited.
• Like uncovered Call writing uncovered Put writing has limited rewards (the premium
received) and potentially substantial risk.

Risk/Reward Characteristics

Break-even Point: At expiration, the break-even point (B.E.) is equal to the strike price of
the Put option minus the Put option's premium. Before expiration, the break-even point is
higher.

Profit: Profits are limited no matter how large the advance in exchange rate.

Loss: Losses are unlimited.

Time Decay: Positive. A Put option's premium consists of both intrinsic value (if any) plus
time value. As time passes, the time value portion of the Put erodes (i.e., decays). At
expiration, the Put's value will equal its intrinsic value.

Changes in implied Volatility: Changes in the option's implied volatility has an effect on
the "time value" portion of an option's premium. Thus, a change in the option's implied
volatility has the same effect as changing (+/-) the number of days remaining until the
option's expiration.

Currency Option Strategies for Export Transactions in Bearish Market

Conditions

The foreign exchange market is said to be bearish when the foreign currency is
expected to depreciate with respect to the domestic currency. Thus, if the Rupee is
expected to appreciate and the Dollar is expected to depreciate, then Bearish conditions
prevail.
In such a case, the importers are at a gain as they have to pay to the importer less than
what they would have when the transaction took place. On the other hand, the exporters
are at a loss as they have to pay more to their creditor.
Thus, in such a situation there arises a need for the exporter to hedge their foreign
exchange risks. The Option hedging strategies available to the exporter in such bearish
market are discussed below:

Period chosen for study

The period chosen during which the currency market experienced bearish conditions is
from 1st

March, 2007 to 31st May, 2007. During this two month period, the Dollar depreciated by
7.7% from
44.287 to 40.87. The mean of the INR/USD spot rates during this period is 42.38 and
standard deviation of the spot rates during the period is 1.39.

Purchase Put Option

Put buying is a strategy used if the investor thinks that underlying asset will decline. The
 “Speculative” Put buyer looks for leverage, emphasizing the number of options he
or she can purchase. The "Hedger" Put buyer looks to protect a long position in the
stock for a period of time covered by the option.

Risk/Reward Characteristics

Break-even Point: At expiration, the break-even point is equal to the strike price of the Put
option minus the Put option's premium. Before expiration, the break-even point is higher.

Profit: Profits are unlimited as long as the underlying stock continues to decline.

Loss: Losses are limited to the premium paid for the option.

Time Decay: Negative. A Put option's premium consists of both intrinsic value (if any)
plus time value. As time passes, the time value portion of the Put erodes (i.e., decays). At
expiration, the Put's value will equal its intrinsic value.

Changes in implied Volatility: Changes in the option's implied volatility has an effect on
the "time value" portion of an option's premium. Thus, a change in the option's implied
volatility has the same effect as changing the number of days remaining until the option's
expiration.

Sell Call Option

The investor writing Call options should firmly believe that the underlying asset is not going
up. This is because the strategy's break-even point at expiration is a certain distance above
the then current stock price. Thus, depending on the option's strike price, writing Call
options can be a viewed as a neutral to bearish strategy. Writing uncovered ("naked")
 Call options is a strategy with very high risk for a small potential return.

Risk/Reward Characteristics

Break-even Point: At expiration, the break-even point (B.E.) is equal to the strike price of
the Call option plus the Call option's premium. Before expiration, the break-even point is
Profit: Profits are limited no matter how large the decline in XYZ.

Loss: Losses are unlimited!!

Time Decay: A Call option's premium consists of both intrinsic value (if any) plus time
value. As time passes, the time value portion of the Call erodes (i.e., decays). At expiration,
the Call's value will equal its intrinsic value.
Changes in implied Volatility: Changes in the option's implied volatility has an effect on
the "time value" portion of an option's premium.

Currency Option strategies for Import transactions in Volatile Market

conditions

It becomes extremely difficult for an importer/exporter when there is volatility in the

currency movements. In such a scenario, hedging the foreign exchange risk becomes even
more significant as currency is expected to deviate more from its mean. Volatile
exchange rates make international trade and investment decisions more difficult because
volatility increases exchange rate risk. Exchange rate risk refers to the potential to lose
money because of a change in the exchange rate.
Period chosen for study:

The period chosen for study is from 1st March, 2007 to 23rd December, 2008
The following are the hedging strategies available for importer in volatile market conditions:

Long Straddle

The long straddle is simply the simultaneous purchase of a long call and a long put on
the same underlying security with both options having the same expiration and same
strike price.

Increasing volatility and large price swings in the underlying security. The hedgers
potentially profit from
a big move, either up or down, in the underlying price during the life of the options.

Purchasing only long calls or only long puts is primarily a directional strategy. The long
straddle however, consisting of both long calls and long p uts is not a directional strategy, rather
it is one where the hedger feels large price swings are forthcoming but is unsure of the
direction. This strategy may prove beneficial when the investor feels large price movement,
either up or down, is imminent but is uncertain of the direction.

Benefit

A long straddle benefits when the price of the underlying moves above or below the break
even points. If a large price movement occurs outside of this range, significant profits can
be realized. If an increase in the implied volatility of the options outpaces time value erosion,
likewise the position could realize a profit.

Risk vs. Reward

Maximum Profit: Theoretically unlimited to the upside; limited profits on the down side
as the stock can only decline to zero.

Maximum Loss: Limited and predetermined, but potentially significant, equal to the sum
of the two premiums paid (call premium plus put premium). Maximum loss occurs should
the underlying price equal the strike price of the options at expiration.

Upside Profit at Expiration: (Stock Price at expiration – total premium paid) –

strike price. Assuming Stock Price above BEP at expiration.

Downside Profit at Expiration: Strike price - (Stock price at expiration + total

premium paid). Assuming stock price is below BEP at expiration.

The maximum profit on the upside is theoretically unlimited as there is no theoretical limit
on how high a stock price can rise. The maximum downside profit is limited by the stock's
potential decrease to no less than zero. Though the potential loss is predetermined and
limited in dollar amount, it can be as much as 100% of the premiums initially paid for the
straddle. Whatever your motivation for
purchasing the straddle is, weigh the potential reward against the potential loss of the
entire premium paid.
 Break-Even-Point (BEP) BEP: Two break-even prices:

• Call Strike + Premium Paid

• Put Strike – Premium Paid

Volatility

• If Volatility Increases: Positive Effect

• If Volatility Decreases: Negative Effect

Passage of Time: Negative Effect

Long Strangle

The long strangle is simply the simultaneous purchase of a long call and a long put on
the same underlying security with both options having the same expiration but where the
put strike price is lower than the call strike price. Because the position includes both a
long call and a long put, the investor using a long strangle should have a complete
understanding of the risks and rewards associated with both long calls and long puts.
Since the strangle involves two trades, a commission charge is likely for the
purchase (and any subsequent sale) of each position; one commission for the call and one
commission for the put and commission charges may significantly impact the breakeven
and the potential profit/loss of the strategy.
The long strangle is similar to the long straddle. However, while the straddle uses the same
strike price for the call and the put, the strangle uses different strikes. In the case of the
strangle, the put strike is below the call strike. As a result, whereas the straddle expires
worthless only if the stock price equals the strike price, the long strangle expires worthless
if the underlying price is at or between the strike prices at expiration. The strangle will
generally provide more leverage when compared to a straddle as it is normally less expensive
to purchase a strangle than a straddle.

Increasing volatility and extremely large price swings in the underlying security. The hedgers
potentially profit from a large move, either up or down, in the underlying price during the
life of the options.
Purchasing only long calls or only long puts is primarily a directional strategy. The long
strangle however, consisting of both long calls and long puts is a not a directional strategy,
rather one where the investor feels extremely large price swings are forthcoming but is
unsure of the direction. This strategy may prove beneficial when the investor feels large
price movement, either up or down, is about to happen but uncertain of the direction.

Break-Even-Point (BEP) BEP: Two break-even prices:

• Call Strike + Premium Paid

• Put Strike – Premium Paid

Volatility

• If Volatility Increases: Positive Effect

• If Volatility Decreases: Negative Effect

Passage of Time: Negative Effect

SHORT BUTTERFLY SPREAD

Long two ATM put options, short one ITM put option and short one OTM put option.
Risk / Reward

Maximum Loss: Limited to the net difference between the ATM strike less the ITM strike
less the premium received for the position.

Maximum Gain: Limited to the net premium received for the option spread.

Characteristics

When to use: When you are bullish or bearish on market direction and bullish on
volatility. Short put butterflies have the same characteristics as the Short Call Butterfly - the
only difference is that we use put options instead of call options. Short butterflies are an
excellent strategy if you expect the market to move, however, you are unsure about what
direction the market will move. For example, say there is an announcement due regarding
earnings or a Government figure to be released. You might be nervous about market
activity and expecting a large move in either direction. In these types of situations you might
want to consider implementing a short butterfly strategy - even though your profits are
limited they are inexpensive to establish therefore giving you a higher return on
investment.

SHORT CONDOR OPTIONS

A Condor strategy is similar to a butterfly spread involving 4 options of the same

type, with the only difference that instead of three, four strike prices are involved. Just
like a short butterfly, Short Condors are used when an investor believes that the underlying
market will break out of a trading range but are not sure in what direction.
Risk/Reward Characteristics

Profit Potential of Short Condor Spread

Short Condor Spreads achieve their maximum profit potential at expiration if the price of the
underlying asset is within the 2 middle strike prices.
Max loss: Limited. The maximum loss of a short condor occurs at the center of the option
spread. If you’ve broken the Condor down as 2 call (put) spreads, take the one that has the
maximum distance between the strike prices, add the net premium received for the spread
and that is the max loss.

Max gain: Limited. The maximum profit of a short condor occurs on the wings, when the
underlying asset is trading past the upper or lower strike prices.

It is the maximum of the difference between the lower strike call spread less the higher call
spread plus the total premium received for the condor.

Risk / Reward of Short Condor Spread

• Upside Maximum Profit: Limited

• Maximum Loss: Limited.
Break Even Points of Short Condor Spread:
A Short Condor Spread is profitable if the underlying asset expires outside of the price
range bounded by the upper and lower breakeven points.

• Lower Breakeven Point: Credit + Lower Strike Price

• Upper Breakeven Point: Higher Strike Price – Credit.
Findings and Observations
Case 1:
Mr. Bhandari bought 675 shares of Tisco few days just before the budget @ Rs.350/- per
share, as general expectation from the budget was that it will be an infrastructure of
development focused budget. He was also bullish on Tisco.
 However Mr. Bhandari wanted to hedge against any downward movement of
Tisco in the market.
Solution:
There are following alternatives for Mr. Bhandari to hedge his position.
1. Long put strategy.
2. Protection put strategy.
3. Bear put spread strategy.
Since Mr. Bhandari has to protect his shares of Tisco so in this case, to hedge against any
downward movement of Tisco, Mr. Bhandari will opt Protective Put Strategy, should buy 1
lot of put option for Rs.350/- Strike price @Rs.10/- premium at same time.
Now the total cost of Bhandari is:
1. Bought Tisco @ Rs.350/- Share = 2,36,250
2. Cost of 1 lot of Tisco put option @ Rs. 10/- = 6.750
_____________
2,43,000
Analysis
S.no Stock Price Stock Value Put value Cost of Return
Premium
1 320 2,16,000 20,250 6,750 (6.750)
2 330 2,22,750 13,500 6,750 (6.750)
3 340 2,29,500 6,750 6,750 (6.750)
4 350 2,36,250 0 6,750 (6.750)
5 360 2,43,000 0 6,750 Nil
6 370 2,49,750 0 6,750 6.750
7 380 2,56,500 0 6,750 13,500
8 390 2,63,250 0 6,750 20,250
9 400 2,70,000 0 6,750 27,000

Interpretation
1. The Stock value is arrived at (Stock Price * 675 Shares).
2. If the Stock price is below Rs.350 in spot market, the put otion will be executed, thus
put value is arrived at as
(Strike price – Stock price) * 675.
3. If the stock price goes below Rs.360/-, loss is limit to extend of its premium amount
(Rs.10/-) or Rs.6, 750.
4. If the Stock price goes up from Rs.360/-, it can fetch unlimited profits as stock price
keeps going up.
 Findings of CASE 1:

1. As the stock price go down value of put option increases.

2. Break Even Point (B.E.P) for Mr. Bhandari in Rs.360/- share or Rs.2,43,000/-
3. Loss in limit to the extent of its premium.
4. As the stock price goes up value of Put option loses its significance.
5. If the put option is not executed till its expiration period it will automatically
repudiated.

CASE 2:
Mr. Bhalgat, was mildly bullish on bank of India, he clearly got 1900 shares of Bank of India
@ Rs.110/- share few days back. Though Mr. Bhalgat bullish on Bank of India, wanted to
hedge against any downside movement of Bank of India due to budget related volatility.
Solution:
That time Bank of India was trading around Rs.120-Rs.130 range.
These are following alternatives for Mr. Bhalgat to hedge his position
1. Long put Strategy.
2. Protection Put Strategy.
3. Bear call Spread Strategy.
Since Mr. Bhalgat is mildly bullish on Bank of India, he will opt for Bull call Spread
strategy, following things might be suggested.
a. Buy a July call option of Bank of India for 1 lot of Strike price Rs.120/- shares, at a
premium of Rs. 12/- share.
b. Buy a July call option of Bank of India for 1 lot of strike price of Rs.120/- shares, at a
premium of Rs.2/- share.
Costs:
Buying 1lot of call option of BOI (1900 * 12) = 22,800/-
Selling 1lot of call option of BOI (1900 * 2) = 3,800/-
______________
19,000/-

Analysis:
S.no Stock Stock Bought Sold call Cost of Return
price value call value value Premium
1 90 1,71,000 0 0 19,000 (19,000)
2 100 1,90,000 0 0 19,000 (19,000)
 3 110 2,09,000 0 0 19,000 (19,000)
4 120 2,28,000 0 0 19,000 Nil
5 130 2,47,000 19,000 0 19,000 19,000
6 140 2,66,000 38,000 0 19,000 38,000
7 150 2,85,000 57,000 19,000 19,000 38,000
8 160 3,04,000 76,000 38,000 19,000 38,000

Interpretation:
1. Stock price is arrived at as (Stock price * 1900).
2. At any price above Rs.120/- shares bought call value is arrived at as
{(stock price – 120) * 1900}.
3. At any price above Rs.140/- share, sold call value is arrived at as
{(Stock price – 140) * 1900}.
4. Return is maximum loss Rs.19, 000 and maximum profit Rs.38,000.

Findings of CASE 2:

1. As the value of the stock price goes up from the strike price the bought call value and
sold call value increase.
2. Rs.120/- share or Rs.2, 28,000/- is the Break Even Point (B.E.P) for Mr. Bhalgat.
3. Mr. Bhalgat made limit his profit and loss by buying and selling 1 lot of call option
simultaneously.
4. As the Stock price goes down from its strike price the value of call option losses its
significance.

CASE 3:
Mr. Sonagra is a regular mid long term investor, In the beginning of the month of the july, he
had not enough money in hand to invest in share, he was suppose to get money in the end of
the month.
However he was bearish on Titan, he wanted to buy Titan, but not after few days as it
could lead to loss of Thousands.
Solution:
Since Mr. Sonagra has not sufficient amount to invest in shares, he will adopt only long call
strategy to hedge his position.
In such circumstances, Mr. Sonagra will buy only buy only 1 lot (100 shares) of call option at
a premium of Rs.10/- per share the strike price of which is Rs.510/-.

Cost of 1 lot of Titan in call option will be

800 * 10 = Rs.8,000/-

ANALYSIS:
Sr. No Stock Price Stock value Cost of Value of Call
Premium option
1 480 3,84,000 8000 0
2 490 3,93,000 8000 0
3 500 4,00,000 8000 0
4 510 4,08,000 8000 0
5 520 4,16,000 8000 10
6 530 4,24,000 8000 20
7 540 4,32,000 8000 30
8 550 4,40,000 8000

Interpretation:
1. Though Mr. Sonagra bought a call option of strike price of Rs.150/-, he expects stock
price will go up.
2. No matter how much stock price will go up stock price goes up more, he can fetch
more profit, because he can purchase at a fix stock price of Rs.510/-.
3. If the stock price goes down, call option will not be executed, because purchasing a
lot in Rs.510/-. Downward movement does not sound reasonable.
4. In downward movement his loss will be limit to extend of premium amount
(Rs.8000/-).
5. While in upward movement his profit will be unlimited as the price goes up
deducting (premium + stock price).

Findings of CASE 3:
1. Mr. Sonagra should be quite sure that the value of the stock price will increase in
coming future.
2. He will fetch profit when market will be at bullish by purchasing the shares @
Rs.510/- shares and selling it in more that Rs.520/- in spot market.
3. Mr. Sonagra has been given rights but not obligation to buy shares @ Rs.510/- in lieu
of Rs.10/- per share as premium whatever market condition may be.
4. The value of call option become insignificant if stock price goes below from Rs.510/-

CASE 4:
Mr. Pandit was holding 550 shares of Reliance Energy ltd (REL), which he had purchased
Rs.1620/-, due to market sentiments and his personnel study, he was bearish on REL, in
the fearing of losing, he wanted to hedge against downfall in the price of REL (lot size=
 550).

Solution:
There are following alternatives for Mr. Pandit to hedge his position
1. Long put Strategy.
2. Protection put Strategy.
3. Bear put Spread Strategy.

Since Mr. Pandit has to protect his 550 share of REL. In such circumstances Mr.
Pandit will prefer to buy a 1 lot of put option at a premium of lets assume Rs.10/- per share,
strike price of which Rs.620/-.

Now the total cost of Mr. Pandit will be:

1. Buying of 550 shares of REL @ Rs.620/- (550*620) = 3,41,000/-
2. Buying of 1 lot of put option @ Rs.10/- share (10*550 ) = 5,500/-
________
3, 46,500/-

ANALYSIS:
Sr.no Stock Price Stock value Bought Cost Return
Put Value of Premium
1 590 3,24,500 16,500 5,500 (5,500)
2 600 3,30,000 11,000 5,500 (5,500)
3 610 3,35,000 5,500 5,500 (5,500)
4 620 3,41,000 0 5,500 (5,500)
5 630 3,46,000 0 5,500 Nil
6 640 3,52,000 0 5,500 5,500
7 650 3,57,500 0 5,500 11,000
8 660 3,63,000 0 5,500 16,500
9 670 3,68,500 0 5,500 22,000

Interpretation:
1. Stock value is arrived at as (Stock price * 550 shares).
2. If the stock price goes below from Rs.620/- put option is executed. The put value is
arrived at as
 (Strike price – stock price) * 550.
3. If the stock price below from Rs.630/-(cost price) the loss is limit to the extent of its
premium means Rs.5,500/-
4. If the stock price goes up from Rs.630/- of can fetch unlimited profit an stick price
keeps going up and put option will not be executed.

CASE 4:

1. As the stock price decrease the value of bought put option increase.
2. Rs.630/- share or Rs.3, 46,500/- is the Break-even point for Mr. Pandit.
3. As the stock price goes up from its strike price put option become insignificant.
4. Here loss is limit to the extent of its premium amount.
5. If the put option is not executed till its expiration period it is automatically repudiated.

Suggestions and conclusion

Suggestions:

CASE 1:

1. Mr. Bhandari should be very conscious about premium rate and expiration period
before option put option.
2. If the stock price strats to decline he should not execute his put option immediately
because in any low cases he will lose Rs.6,750/- while he may fetch profit in going up of
stock price after downward movement.

CASE 2:

1. Mr. Bhalgat should adopt this Strategy only in that case, when he is quite sure that
profit is not possible after a certain extent.

CASE 3:

1. Mr. Sonagra should buy September call option instead of july call option, because
during this gap stock price must go up.
2. When stock price reaches up to its highest level he should execute his call option.

CASE 4:

1. Mr. Pandit should be very conscious about premium rate and expiration period of
option.
2. If the stock price starts to decline, he should not execute his put option immediately,
Because in any low case he will lose Rs.5, 500/- while he may fetch profit in going up
of stock price after downward movement.

Conclusion:

1. Derivative is the best tool for hedging the position or risk.

2. Hedging is basically done in option market.
3. Purchase of a call option always hopes that the stock price will go up.
4. Purchase of put option always hopes that the stock price will go down.
5. Strike price and expiration period plays important role in hedging.
6. Fund managers use basically use index option to hedge their position.
7. Individuals use generally stock option to hedge risks.
8. Individuals use option in speculative manner.
9. There is a wide scope of Derivative market.

Bibliography

News Papers

 Business Line
 Business standard
 Economic times
 Times of India

Web sites
 www.nthsense.in
 www.moneycontrol.com
 www.google.com
 www.rbi.in

Text Book
 Option, futures and forward by J.C Hull.
 Financial services advertisements.