Page 102 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

Unit 6: Economic Fundamentals and Foreign Exchange Risk Exposure

2. On a daily basis, there are huge volumes settled between two counterparties. In the Notes
developed markets, this settlement is done on a net basis unlike India. This firstly leads to
additional counterparty limits for the banks and also leads to problems in settlement.
Also, there are a number of regulations which act as impediments to the growth of options and
derivatives: USD/INR options are prohibited in India as per RBI Regulations. The market in
India does not allow a customer to be a net receiver of premium on options. Thus a customer
cannot write an option in isolation or do any option structure where he is a net receiver of
premium. No swap structure involving upfront payment of rupees in any form which is
tantamount to prepayment of external commercial borrowings can be undertaken. Derivative
transactions which involve swap transactions can be undertaken by banks purely as intermediaries
by fully matching the requirements of corporate counterparties. Finding fully matched corporate
is not always possible and this has acted as a hindrance to the growth of the derivatives market.
In case the foreign exchange market has to be accessed to cover currency risk, the access is
restricted to amount specified by the Reserve Bank. Any further access can be made to the extent
swaps undertaken by accessing the market are matched by opposite corporate interest.

Task Do firms have clearly outlined guidelines on exposure management?

Self Assessment

Fill in the blanks:
13. Forward contracts are one of the most common means of …………………… transactions
in foreign currencies.
14. An …………………… contract is one where the customer has the right but not the obligation
to contract on maturity date.
15. A currency …………………… is defined as an agreement where two parties exchange a
series of cash flows in one currency for a series of cash flows in another currency, at agreed
intervals over an agreed period.

Case Study How BMW Dealt with Exchange Rate Risk

MW Group, owner of the BMW, Mini and Rolls-Royce brands, has been based in
Munich since its founding in 1916. But by 2011, only 17 per cent of the cars it sold
Bwere bought in Germany. In recent years, China has become BMW's fastest-growing
market, accounting for 14 per cent of BMW's global sales volume in 2011. India, Russia and
Eastern Europe have also become key markets.
The Challenge

Despite rising sales revenues, BMW was conscious that its profits were often severely
eroded by changes in exchange rates. The company's own calculations in its annual reports
suggest that the negative effect of exchange rates totalled 2.4bn between 2005 and 2009.

BMW did not want to pass on its exchange rate costs to consumers through price increases.
Its rival Porsche had done this at the end of the 1980s in the US and sales had plunged.

Contd...

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