Determinants of Working Capital Management
FOREX RISK MANAGEMENT STRATEGIES FOR INDIAN IT COMPANIES
ABSTRACT
Foreign exchange risk is the effect that unanticipated exchange rate changes have on the value of the firm. There are a variety of strategies which are designed to manage foreign exchange risk. Each of them, however, is constructed under specific assumptions, for a specific risk profile. It is often the case that several strategies are applicable to a given scenario. The question arises as to which strategy would be expected to yield the best results in a given scenario. This study deals with the impact of currency fluctuations on cash flows of IT service providers and explores various strategies for managing transaction exposure from this viewpoint. The risk management strategies considered for the study are: forward currency contacts, currency options, and cross-currency hedging. The study analyzes and evaluates these foreign exchange risk management strategies to find out which of the strategies is appropriate in particular situations.
KEYWORDS:
Foreign exchange risk, risk management strategies, forward currency contracts, currency options, cross-currency hedging.
INTRODUCTION
There have been several recent studies on foreign exchange risk management which have focused on managing foreign exchange risk while doing business in developing countries.
Murray (2005) studied the types of risk associated with foreign currency denominated assets and liabilities. Transaction risk is incurred whenever money is physically converted from one currency to another. Translation risk is incurred when assets or liabilities are held in a foreign currency. These two risks can be related if one takes the example of a sale of goods in a foreign currency. Holding the accounts receivable over the end of a closing period will result in translation risk and possibly an unrealized foreign exchange gain or loss.
Abor (2005) suggested that foreign exchange risk can be managed by adjusting prices to reflect changes in
ABSTRACT
Foreign exchange risk is the effect that unanticipated exchange rate changes have on the value of the firm. There are a variety of strategies which are designed to manage foreign exchange risk. Each of them, however, is constructed under specific assumptions, for a specific risk profile. It is often the case that several strategies are applicable to a given scenario. The question arises as to which strategy would be expected to yield the best results in a given scenario. This study deals with the impact of currency fluctuations on cash flows of IT service providers and explores various strategies for managing transaction exposure from this viewpoint. The risk management strategies considered for the study are: forward currency contacts, currency options, and cross-currency hedging. The study analyzes and evaluates these foreign exchange risk management strategies to find out which of the strategies is appropriate in particular situations.
KEYWORDS:
Foreign exchange risk, risk management strategies, forward currency contracts, currency options, cross-currency hedging.
INTRODUCTION
There have been several recent studies on foreign exchange risk management which have focused on managing foreign exchange risk while doing business in developing countries.
Murray (2005) studied the types of risk associated with foreign currency denominated assets and liabilities. Transaction risk is incurred whenever money is physically converted from one currency to another. Translation risk is incurred when assets or liabilities are held in a foreign currency. These two risks can be related if one takes the example of a sale of goods in a foreign currency. Holding the accounts receivable over the end of a closing period will result in translation risk and possibly an unrealized foreign exchange gain or loss.
Abor (2005) suggested that foreign exchange risk can be managed by adjusting prices to reflect changes in