Question

3. Discuss how firms manage transaction and operating exposure in practice: the various financial hedges and strategic responses.

Answer 1

operational exposure affects companies present, as well as future cash flow, thus affecting the company's value and can generate a firm non-competitive. In other words, operational exposure affects companies' daily lives
operations such as where to sell, where to produce and acquire, etc. Compared to the transaction
exposure management, operational exposure management is more difficult. Operative
Exposure management involves managing marketing, production and
outsourcing so that a company can change these activities to take advantage of
favorable exchange rate movement and, more importantly, reduces the negative effects
impact of adverse exchange rate movements.

Operational exposure management requires joint effort in an operation such as
well at a strategic level.

Matching Currency Cashflows:

the Indian exporter may correspond to its assets and liabilities. This strategy creates a natural hedge for the company. The Indian
The exporter can perform the following activities:
• You can borrow / issue debt securities in currencies denominated in US dollars and yen,
that your export receivable is used to pay interest and principal. In doing so, the
The Indian exporter is protecting itself from the fluctuation of the INR / Euro.
• Indian exporter can pay to his Sri Lankan subsidiary and Bangladeshi dye
supplier in dollars or yen. In doing so, the Indian company is combining its assets
with liabilities. However, exchange rate risk now shifts to Sri Lanka
Bangladesh subsidiary and dye supplier.

Many companies are adopting this option to manage the operational exposure that has been
previously it is not feasible. With the globalization of the international capital market, many
companies are going beyond their home territories to obtain financing in
currency. Likewise, investors are also interested in investing in foreign companies in order to
reap the benefit of diversification.

Risk Sharing Agreement:

Risk sharing is a contractual agreement between the
exporter and importer to “share” or “divide” the exchange risk between them. At a risk
sharing agreement, buyers and sales work together so that benefits / loss
foreign currency rate is shared by both parties.

It works like this. The Indian exporter and Wal-Mart agree that:

1.If INRUSD rate varies within INR 43.50/USD to INR45/USD ( i.e, >= INR 43.50/USD to < INR45/USD), then Wal-Mart pays USD20 per unit of bed linen.

2. If INR depreciates and remains within the range INR45/USD to INR46.75/USD ( i.e, > =INR45/USD to < INR46.75/USD) , then the Indian exporter receives USD 19 per bed linen.

3. If INR appreciates and remains within a range of INR42/USD to INR43.50 ( i.e, > =INR42/USD to < INR43.50/USD), then Wal-Mart pays USD 22 per bed linen.

When INR appreciates beyond a certain point, exporting to Wal-Mart at a price of $ 20
it becomes a deficit provision for the Indian exporter. Therefore, Walmart compensates for
paying a higher price. Likewise, when the INR depreciates, the Indian exporter is making
extra profit. By agreeing to accept less for the bedding unit, the Indian exporter is passing
some benefits for Walmart.

Different range of INR / USD can be negotiated between two parties so that both parties
are also benefited by the exchange rate movement. This interval is also not sacrosanct
for all time to come. Both parties also agree on the length of the period during which the
a risk sharing agreement is applicable. In other words, the risk sharing agreement
built-in flexibility so that neither party has an undue advantage. The Indian exporter can
enter into a similar agreement with its Japanese counterpart, depending on the INR / JPY
movement.

Back-to-Back or Parallel Loans:

In consecutive or parallel loans, two companies in
different countries borrow compensation values ​​from each other in each other's currency.
For example, an Indian company imports high quality perfumes and cosmetic products from
USA and sells in India. Operates a subsidiary in the USA to purchase cosmetic products
and export it to India. We will name this company as an Indian importer. The Indian
the importer's main expenses are in US dollars, while earnings are in Indian rupees.
The Indian exporter (exporting to Wal-mart and earnings in USD) lends us
$ 15000 for the Indian importer's subsidiary. The Indian importer provides an equivalent
loan amount in INR to the Indian exporter.
On the day this loan was granted, the cash rate is INR42 / USD. Indian exporter
grants a loan of $ 15,000 to the branch. Indian importer grants loan from INR
630,000 for Indian exporter.
It is clearly evident that the two companies managed to obtain their forex requirements without
going to the forex market. However, consecutive loans have inherent disadvantages. A party
wanting to mitigate foreign exchange risk must discover a counterpart willing to
position.

Reinvoicing centers:

Re-invoicing requires the presence of an intermediary between the buyer
and seller. The seller, instead of providing goods or services to the buyer directly first
sells to the middleman. The intermediary pays the seller in his local currency,
minimizing the impact of currency risk.
The intermediary, in turn, sells these products to the buyer and collects foreign currency. O
the seller sends the goods directly to the buyer, but proof of payment is channeled through
re-billing center.

The reinvestment center handles each buyer and seller in the local currency. The paper
of the reinvestment center increases substantially for an MNC, whose income and expenses
they are paid and received in many currencies. The reinvention center is the center
financial subsidiary of the multinational. As the different units of the MNCs receive their income in
their local currency, they don't need to spend money on staff to manage
currency risk. The center for network reinvestment of all currencies and only protects
amount that cannot be offset. In addition, the re-billing center gets a better forex quote because
puts larger transactions for hedge. Basically, the reinvention center benefits from
Scale economy.