Executive Summary

This project gives an in-depth analysis and understanding of Foreign Exchange Markets
in India. It helps to understand the History and the evolution of the foreign market in
India.

It gives an overview of the conditions existing in the current global economy. It gives an
overview of the Foreign exchange market.

It talks about the foreign exchange management act applicable and also gives details
about the participants in the forex markets.

It also talks about what are the sources of demand and supply of foreign exchange in the
market all over the world.

The report also talks about the Foreign Exchange trading platform and how the efficiency
and the transparency is maintained.

The report focuses on corporate hedging for foreign exchange risk in India. The report
contains details about some companies Foreign Exposure and how they have maintained
it.

It also talks about the determinants to be taken care of while taking corporate hedging
decisions. It gives insights about the Regulatory guidelines for the use of Foreign
Exchange derivatives, Development of Derivatives markets in India and also the Hedging
instruments for Indian firms.

The report gives an in-depth analysis of the currency risk management by talking about
what currency risk is, the types of currency risk – Transaction risk ,Translation risk and
Economic risk. It also contains details about the companies in the index sensex and nifty
showing their transaction is foreign currency like the imports, exports, Loans, Interest
payments and the other expenses. It then shows the sensitivity analysis of how the
currency rates impact the gains/ profits of the company.
 CHAPTER 1.

INTRODUCTION TO FOREIGN EXCHANGE MARKET

1.1 INTRODUCTION:
Globally, operations in the foreign exchange market started in a major way after the
breakdown of the Bretton Woods system in 1971, which also marked the beginning of
floating exchange rate regimes in several countries. Over the years, the foreign exchange
market has emerged as the largest market in the world. The decade of the 1990s
witnessed a perceptible policy shift in many emerging markets towards reorientation of
their financial markets in terms of new products and instruments, development of
institutional and market infrastructure and realignment of regulatory structure consistent
with the liberalized operational framework. The changing contours were mirrored in a
rapid expansion of foreign exchange market in terms of participants, transaction volumes,
decline in transaction costs and more efficient mechanisms of risk transfer.

The origin of the foreign exchange market in India could be traced to the year 1978 when
banks in India were permitted to undertake intra-day trade in foreign exchange. However,
it was in the 1990s that the Indian foreign exchange market witnessed far reaching
changes along with the shifts in the currency regime in India. The exchange rate of the
rupee, that was pegged earlier was floated partially in March 1992 and fully in March
1993 following the recommendations of the Report of the High Level Committee on
Balance of Payments (Chairman: Dr.C. Rangarajan). The unification of the exchange rate
was instrumental in developing a market-determined exchange rate of the rupee and an
important step in the progress towards current account convertibility, which was achieved
in August 1994. 6.3 A further impetus to the development of the foreign exchange market
in India was provided with the setting up of an Expert Group on Foreign Exchange
Markets in India (Chairman: Shri O.P. Sodhani), which submitted its report in June 1995.
The Group made several recommendations for deepening and widening of the Indian
foreign exchange market. Consequently, beginning from January 1996, wide-ranging
reforms have been undertaken in the Indian foreign exchange market. After almost a
decade, an Internal Technical Group on the Foreign Exchange Market (2005) was
constituted to undertake a comprehensive review of the measures initiated by the Reserve
Bank and identify areas for further liberalization or relaxation of restrictions in a
medium-term framework.

The momentous developments over the past few years are reflected in the enhanced risk-
bearing capacity of banks along with rising foreign exchange trading volumes and finer
margins. The foreign exchange market has acquired depth (Reddy, 2005). The conditions
in the foreign exchange market have also generally remained orderly (Reddy, 2006c).
While it is not possible for any country to remain completely unaffected by developments
in international markets, India was able to keep the spillover effect of the Asian crisis to a
minimum through constant monitoring and timely action, including recourse to strong
monetary measures, when necessary, to prevent emergence of self fulfilling speculative
activities

In today’s world no economy is self sufficient, so there is need for exchange of goods and
services amongst the different countries. So in this global village, unlike in the primitive
age the exchange of goods and services is no longer carried out on barter basis. Every
sovereign country in the world has a currency that is legal tender in its territory and this
currency does not act as money outside its boundaries. So whenever a country buys or
sells goods and services from or to another country, the residents of two countries have to
exchange currencies. So we can imagine that if all countries have the same currency then
there is no need for foreign exchange.

1.2 NEED FOR FOREIGN EXCHANGE MARKET:

Let us consider a case where Indian company exports cotton fabrics to USA and invoices
the goods in US dollar. The American importer will pay the amount in US dollar, as the
same is his home currency. However the Indian exporter requires rupees means his home
currency for procuring raw materials and for payment to the labor charges etc. Thus he
would need exchanging US dollar for rupee. If the Indian exporters invoice their goods in
rupees, then importer in USA will get his dollar converted in rupee and pay the exporter.
From the above example we can infer that in case goods are bought or sold outside the
country, exchange of currency is necessary. Sometimes it also happens that the
transactions between two countries will be settled in the currency of third country. In that
case both the countries that are transacting will require converting their respective
currencies in the currency of third country. For that also the foreign exchange is required.

1.3 ABOUT FOREIGN EXCHANGE MARKET:

Particularly for foreign exchange market there is no market place called the foreign
exchange market. It is mechanism through which one country’s currency can be
exchange i.e. bought or sold for the currency of another country. The foreign exchange
market does not have any geographic location. Foreign exchange market is described as
an OTC (over the counter) market as there is no physical place where the participant
meets to execute the deals, as we see in the case of stock exchange. The largest foreign
exchange market is in London, followed by the New York, Tokyo, Zurich and Frankfurt.
The markets are situated throughout the different time zone of the globe in such a way
that one market is closing the other is beginning its operation. Therefore it is stated that
foreign exchange market is functioning throughout 24 hours a day. In most market US
dollar is the vehicle currency, viz., the currency sued to dominate international
transaction. In India, foreign exchange has been given a statutory definition. Section 2 (b)
of foreign exchange regulation ACT, 1973 states: Foreign exchange means foreign
currency and includes:
All deposits, credits and balance payable in any foreign currency and any draft, traveler’s
cheques, letter of credit and bills of exchange. Expressed or drawn in India currency but
payable in any foreign currency.

Any instrument payable, at the option of drawee or holder thereof or any other party
thereto, either in Indian currency or in foreign currency or partly in one and partly in the
other. In order to provide facilities to members of the public and foreigners visiting
India, for exchange of foreign currency into Indian currency and vice-versa RBI has
granted to various firms and individuals, license to undertake money-changing business
at seas/airport and tourism place of tourist interest in India. Besides certain authorized
dealers in foreign exchange (banks) have also been permitted to open exchange bureaus.
Following are the major bifurcations:

1. Full fledge moneychangers – they are the firms and individuals who have been
authorized to take both, purchase and sale transaction with the public.
2. Restricted moneychanger – they are shops, emporia and hotels etc. that have
been authorized only to purchase foreign currency towards cost of goods supplied
or services rendered by them or for conversion into rupees.
3. Authorized dealers – they are one who can undertake all types of foreign
exchange transaction. Banks are only the authorized dealers. The only exceptions
are Thomas cook, western union, UAE exchange which though, and not a bank is
an AD. Even among the banks RBI has categorized them as follows:

Branch A – They are the branches that have Nostro and Vostro account.

Branch B – The branch that can deal in all other transaction but do not maintain Nostro
and Vostro a/c’s fall under this category. For Indian we can conclude that foreign
exchange refers to foreign money, which includes notes, cheques, bills of exchange, bank
balance and deposits in foreign currencies.

 Foreign Exchange Market: An Assessment

The continuous improvement in market infrastructure has had its impact in terms of
enhanced depth, liquidity and efficiency of the foreign exchange market. The turnover in
the Indian foreign exchange market has grown significantly in both the spot and
derivatives segments in the recent past. Along with the increase in onshore turnover,
activity in the offshore market has also assumed importance. With the gradual opening up
of the capital account, the process of price discovery in the Indian foreign exchange
market has improved as reflected in the bid-ask spread and forward premia behaviour.

 Foreign Exchange Market Turnover

As per the Triennial Central Bank Survey by the Bank for International Settlements (BIS)
on“Foreign Exchange and Derivatives Market Activity”, global foreign exchange market
activity rose markedly between 2001 and 2004 (Table 6.4). The strong growth in turnover
may be attributed to two related factors. First, the presence of clear trends and higher
volatility in foreign exchange markets between 2001 and 2004 led to trading momentum,
where investors took large positions in currencies that followed persistent appreciating
trends. Second, positive interest rate differentials encouraged the so-called “carry
trading”, i.e., investments in high interest rate currencies financed by positions in low
interest rate currencies. The growth in outright forwards between 2001 and 2004 reflects
heightened interest in hedging. Within the EM countries, traditional foreign exchange
trading in Asian currencies generally recorded much faster growth than the global total
between 2001 and 2004. Growth rates in turnover for Chinese renminbi, Indian rupee,
Indonesian rupiah, Korean won and new Taiwanese dollar exceeded 100 per cent
between April 2001 and April 2004 (Table 6.5). Despite significant growth in the foreign
exchange market turnover, the share of most of the EMEs in total global turnover,
however, continued to remain low.
The Indian foreign exchange market has grown manifold over the last several years. The
daily average turnover impressed a substantial pick up from about US $ 5 billion during
1997-98 to US $ 18 billion during 2005-06. The turnover has risen considerably to US $
23 billion during 2006-07 (up to February 2007) with the daily turnover crossing US $ 35
billion on certain days during October and November 2006. The inter-bank to merchant
turnover ratio has halved from 5.2 during 1997-98 to 2.6 during 2005-06, reflecting the
growing participation in the merchant segment of the foreign exchange market (Table 6.6
and Chart VI.2). Mumbai alone accounts for almost 80 per cent of the foreign exchange
turnover.

6.60 Turnover in the foreign exchange market was 6.6 times of the size of India’s balance
of payments during 2005-06 as compared with 5.4 times in 2000-01 (Table 6.7). With the
deepening of the foreign exchange market and increased turnover, income of commercial
banks through treasury operations has increased considerably. Profit from foreign
exchange transactions accounted for more than 20 per cent of total profits of the
scheduled commercial banks during 2004-05 and 2005-06

1.4 HISTORY:

Early Stages: 1947-1977

The evolution of India’s foreign exchange market may be viewed in line with the shifts in
India’s exchange rate policies over the last few decades from a par value system to a
basket-peg and further to a managed float exchange rate system. During the period from
1947 to 1971, India followed the par value system of exchange rate. Initially the rupee’s
external par value was fixed at 4.15 grains of fine gold. The Reserve Bank maintained the
par value of the rupee within the permitted margin of ±1 per cent using pound sterling as
the intervention currency. Since the sterling-dollar exchange rate was kept stable by the
US monetary authority, the exchange rates of rupee in terms of gold as well as the dollar
and other currencies were indirectly kept stable. The devaluation of rupee in September
1949 and June 1966 in terms of gold resulted in the reduction of the par value of rupee in
terms of gold to 2.88 and 1.83 grains of fine gold, respectively. The exchange rate of the
rupee remained unchanged between 1966 and 1971 (Chart VI.1).

Given the fixed exchange regime during this period, the foreign exchange market for all
practical purposes was defunct. Banks were required to undertake only cover operations
and maintain a ‘square’ or ‘near square’ position at all times. The objective of exchange
controls was primarily to regulate the demand for foreign exchange for various purposes,
within the limit set by the available supply. The Foreign Exchange Regulation Act
initially enacted in 1947 was placed on a permanent basisin 1957. In terms of the
provisions of the Act, the Reserve Bank, and in certain cases, the Central Government
controlled and regulated the dealings in foreign exchange payments outside India, export
and import of currency notes and bullion, transfers of securities between residents and
non-residents, acquisition of foreign securities, etc3 .

With the breakdown of the Bretton Woods System in 1971 and the floatation of major
currencies, the conduct of exchange rate policy posed a serious challenge to all central
banks world wide as currency fluctuations opened up tremendous opportunities for
market players to trade in currencies in a borderless market. In December 1971, the rupee
was linked with pound sterling. Since sterling was fixed in terms of US dollar under the
Smithsonian Agreement of 1971, the rupee also remained stable against dollar. In order
to overcome the weaknesses associated with a single currency peg and to ensure stability
of the exchange rate, the rupee, with effect from September 1975, was pegged to a basket
of currencies. The currency selection and weights assigned were left to the discretion of
the Reserve Bank. The currencies included in the basket as well as their relative weights
were kept confidential in order to discourage speculation. It was around this time that
banks in India became interested in trading in foreign exchange

Formative Period: 1978-1992

The impetus to trading in the foreign exchange market in India came in 1978 when banks
in India were allowed by the Reserve Bank to undertake intra-day trading in foreign
exchange and were required to comply with the stipulation of maintaining ‘square’ or
‘near square’ position only at the close of business hours each day. The extent of
position which could be left uncovered overnight (the open position) as well as the limits
up to which dealers could trade during the day were to be decided by the management of
banks. The exchange rate of the rupee during this period was officially determined by the
Reserve Bank in terms of a weighted basket of currencies of India’s major trading
partners and the exchange rate regime was characterised by daily announcement by the
Reserve Bank of its buying and selling rates to the Authorised Dealers (ADs) for
undertaking merchant transactions. The spread between the buying and the selling rates
was 0.5 per cent and the market began to trade actively within this range. ADs were also
permitted to trade in cross currencies (one convertible foreign currency versus another).
However, no ‘position’ in this regard could originate in overseas markets.

As opportunities to make profits began to emerge, major banks in India started quoting
two way prices against the rupee as well as in cross currencies and, gradually, trading
volumes began to increase. This led to the adoption of widely different practices (some of
them being irregular) and the need was felt for a comprehensive set of guidelines for
operation of banks engaged in foreign exchange business. Accordingly, the ‘Guidelines
for Internal Control over Foreign Exchange Business’, were framed for adoption by the
banks in 1981. The foreign exchange market in India till the early 1990s, however,
remained highly regulated with restrictions on external transactions, barriers to entry, low
liquidity and high transaction costs. The exchange rate during this period was managed
mainly for facilitating India’s imports. The strict control on foreign exchange transactions
through the Foreign Exchange Regulations Act (FERA) had resulted in one of the largest
and most efficient parallel markets for foreign exchange in the world, i.e., the hawala
(unofficial) market.

By the late 1980s and the early 1990s, it was recognized that both macroeconomic policy
and structural factors had contributed to balance of payments difficulties. Devaluations
by India’s competitors had aggravated the situation. Although exports had recorded a
higher growth during the second half of the 1980s (from about 4.3 per cent of GDP in
1987-88 to about 5.8 per cent of GDP in 1990-91), trade imbalances persisted at around 3
percent of GDP. This combined with a precipitous fall in invisible receipts in the form of
private remittances, travel and tourism earnings in the year 1990-91 led to further
widening of current account deficit. The weaknesses in the external sector were
accentuated by the Gulf crisis of 1990-91. As a result, the current account deficit widened
to 3.2 per cent of GDP in 1990-91 and the capital flows also dried up necessitating the
adoption of exceptional corrective steps. It was against this backdrop that India embarked
on stabilisation and structural reforms in the early 1990s.

Post-Reform Period: 1992 onwards

This phase was marked by wide ranging reform measures aimed at widening and
deepening the foreign exchange market and liberalisation of exchange control regimes. A
credible macroeconomic, structural and stabilization programme encompassing trade,
industry, foreign investment, exchange rate, public finance and the financial sector was
put in place creating an environment conducive for the expansion of trade and
investment. It was recognised that trade policies, exchange rate policies and industrial
policies should form part of an integrated policy framework to improve the overall
productivity, competitiveness and efficiency of the economic system, in general, and the
external sector, in particular. As a stabilsation measure, a two step downward exchange
rate adjustment by 9 per cent and 11 per cent between July 1 and 3, 1991 was resorted to
counter the massive drawdown in the foreign exchange reserves, to instill confidence
among investors and to improve domestic competitiveness. A two-step adjustment of
exchange rate in July 1991 effectively brought to close the regime of a pegged exchange
rate. After the Gulf crisis in 1990-91, the broad framework for reforms in the external
sector was laid out in the Report of the High Level Committee on Balance of Payments
(Chairman: Dr. C. Rangarajan). Following the recommendations of the Committee to
move towards the market-determined exchange rate, the Liberalised Exchange Rate
Management System (LERMS) was put in place in March 1992 initially involving a dual
exchange rate system. Under the LERMS, all foreign exchange receipts on current
account transactions (exports, remittances, etc.) were required to be surrendered to the
Authorised Dealers (ADs) in full. The rate of exchange for conversion of 60 per cent of
the proceeds of these transactions was the market rate quoted by the ADs, while the
remaining 40 percent of the proceeds were converted at the Reserve Bank’s official rate.
The ADs, in turn, were required to surrender these 40 per cent of their purchase of
foreign currencies to the Reserve Bank. They were free to retain the balance 60 per cent
of foreign exchange for selling in the free market for permissible transactions. The
LERMS was essentially a transitional mechanism and a downward adjustment in the
official exchange rate took place in early December 1992 and ultimate convergence of
the dual rates was made effective from March 1, 1993, leading to the introduction of a
market-determined exchange rate regime.

The dual exchange rate system was replaced by a unified exchange rate system in March
1993, whereby all foreign exchange receipts could be converted at market determined
exchange rates. On unification of the exchange rates, the nominal exchange rate of the
rupee against both the US dollar as also against a basket of currencies got adjusted lower,
which almost nullified the impact of the previous inflation differential. The restrictions
on a number of other current account transactions were relaxed. The unification of the
exchange rate of the Indian rupee was an important step towards current account
convertibility, which was finally achieved in August 1994, when India accepted
obligations under Article VIII of the Articles of Agreement of the IMF.

With the rupee becoming fully convertible on all current account transactions, the risk-
bearing capacity of banks increased and foreign exchange trading volumes started rising.
This was supplemented by wide-ranging reforms undertaken by the Reserve Bank in
conjunction with the Government to remove market distortions and deepen the foreign
exchange market. The process has been marked by ‘gradualism’ with measures being
undertaken after extensive consultations with experts and market participants. The reform
phase began with the Sodhani Committee (1994) which in its report submitted in 1995
made several recommendations to relax the regulations with a view to vitalising the
foreign exchange market.

In addition, several initiatives aimed at dismantling controls and providing an enabling

environment to all entities engaged in foreign exchange transactions have been
undertaken since the mid-1990s. The focus has been on developing the institutional
framework and increasing the instruments for effective functioning, enhancing
transparency and liberalising the conduct of foreign exchange business so as to move
away from micro management of foreign exchange transactions to macro management of
foreign exchange flows (Box VI.3).

An Internal Technical Group on the Foreign Exchange Markets (2005) set up by the
Reserve Bank made various recommendations for further liberalisation of the extant
regulations. Some of the recommendations such as freedom to cancel and rebook forward
contracts of any tenor, delegation of powers to ADs for grant of permission to corporates
to hedge their exposure to commodity price risk in the international commodity
exchanges/markets and extension of the trading hours of the inter-bank foreign exchange
market have since been implemented.

Along with these specific measures aimed at developing the foreign exchange market,
measures towards liberalising the capital account were also implemented during the last
decade, guided to a large extent since 1997 by the Report of the Committee on Capital
Account Convertibility (Chairman: Shri S.S. Tarapore). Various reform measures since
the early 1990s have had a profound effect on the market structure, depth, liquidity and
efficiency of the Indian foreign exchange market.

1.5 Basic Concepts in Forex Trading:

 Bid and Ask Rate:

The bid/ask spread is the difference between the price at which a bank or market
maker will sell ("ask", or "offer") and the price at which a market taker will buy ("bid")
from a wholesale or retail customer. The customer will buy from the market-maker at the
higher "ask" price, and will sell at the lower "bid" price, thus giving up the "spread" as
the cost of completing the trade.

 Margin Trading:
Foreign exchange is normally traded on margin. A relatively small deposit can control
much larger positions in the market. For trading the main currencies, Saxo Bank requires
a 1% margin deposit. This means that in order to trade one million dollars, you need to
place just USD 10,000 by way of security.

In other words, you will have obtained a gearing of up to 100 times. This means that a
change of, say 2%, in the underlying value of your trade will result in a 200% profit or
loss on your deposit.

 Stop-loss discipline:

There are significant opportunities and risks in foreign exchange markets. Aggressive
traders might experience profit/loss swings of 20-30% daily. This calls for strict stop-loss
policies in positions that are moving against you.

Fortunately, there are no daily limits on foreign exchange trading and no restrictions on
trading hours other than the weekend. This means that there will nearly always be an
opportunity to react to moves in the main currency markets and a low risk of getting
caught without the opportunity of getting out. Of course, the market can move very fast
and a stop-loss order is by no means a guarantee of getting out at the desired level. For
speculative trading, it is recommended to place protective stop-loss orders.

 Spot and forward trading:

When you trade foreign exchange you are normally quoted a spot price. This means that
if you take no further steps, your trade will be settled after two business days. This
ensures that your trades are undertaken subject to supervision by regulatory authorities
for your own protection and security. If you are a commercial customer, you may need to
convert the currencies for international payments. If you are an investor, you will
normally want to swap your trade forward to a later date. This can be undertaken on a
daily basis or for a longer period at a time. Often investors will swap their trades forward
anywhere from a week or two up to several months depending on the time frame of the
investment.

Although a forward trade is for a future date, the position can be closed out at any time -
the closing part of the position is then swapped forward to the same future value date.

Currency Traded Across Globe & India

The FOUR major currency pairs

 EUR/USD
 USD/JPY
 USD/CHF
 GBP/USD

Currency Crosses

 EUR/CHF
 EUR/JPY
 GBP/JPY
 EUR/GBP

Currencies traded in India:

 USD/INR
  EUR/INR

 GBP/INR

 JPY/INR

Currency Exchanges in India:

1. MCX Stock Exchange (MCX – SX)

2. National Stock Exchange (NSE)
3. United Stock Exchange (USE)

The daily turnover of NSE and MCX – SX together is around 30,000 cr.

1.6 Trading Platforms:

Indian Perspective

Trade Station

It is the premier brokerage trading platform for rule-based trading. And we have the
awards to prove it.

Whether you trade stocks, options, futures or forex, Trade Station offers uniquely
powerful strategy creation and testing tools, customizable analytics and fully automated
trading technology in a single trading platform.

1.6 CharacteristicsFOREIGN EXCHANGE

 its huge trading volume, representing the largest asset class in the world leading to
high liquidity;
 its geographical dispersion;
  its continuous operation: 24 hours a day except for weekends, i.e., trading from
22:00 GMT on Sunday (Sydney) until 22:00 GMT Friday (New York);
 the variety of factors that affect exchange rates;
 the low margins of relative profit compared with other markets of fixed income;
and
 the use of leverage to enhance profit and loss margins and with respect to account
size.

1.7 Factors Affecting Foreign Exchange

There are various factors affecting the exchange rate of a currency. They can be classified
as fundamental factors, technical factors, political factors and speculative factors.

1. Fundamental factors:
The fundamental factors are basic economic policies followed by the government
in relation to inflation, balance of payment position, unemployment, capacity
utilization, trends in import and export, etc. Normally, other things remaining
constant the currencies of the countries that follow sound economic policies will
always be stronger. Similarly, countries having balance of payment surplus will
enjoy a favorable exchange rate. Conversely, for countries facing balance of
payment deficit, the exchange rate will be adverse.

2. Technical factors:
Interest rates: Rising interest rates in a country may lead to inflow of hot money
in the country, thereby raising demand for the domestic currency. This in turn
causes appreciation in the value of the domestic currency.
 Inflation rate: High inflation rate in a country reduces the relative competitiveness
of the export sector of that country. Lower exports result in a reduction in demand
of the domestic currency and therefore the currency depreciates.
Exchange rate policy and Central Bank interventions: Exchange rate policy of the
country is the most important factor influencing determination of exchange rates.
For example, a country may decide to follow a fixed or flexible exchange rate
regime, and based on this, exchange rate movements may be less/more frequent.
Further, governments sometimes participate in foreign exchange market through
its Central bank in order to control the demand or supply of domestic currency.

3. Political factors:

Political stability also influences the exchange rates. Exchange rates are susceptible to
political instability and can be very volatile during times of political crises.

4. Speculation:

Speculative activities by traders worldwide also affect exchange rate movements. For
example, if speculators think that the currency of a country is overvalued and will
devalue in near future, they will pull out their money from that country resulting in
reduced demand for that currency and depreciating its value.
1.8 Participants in foreign exchange market

Market Players

Players in the Indian market include (a) ADs, mostly banks who are authorised to deal in
foreign exchange, (b) foreign exchange brokers who act as intermediaries, and (c)
customers – individuals, corporates, who need foreign exchange for their transactions.
Though customers are major players in the foreign exchange market, for all practical
purposes they depend upon ADs and brokers. In the spot foreign exchange market,
foreign exchange transactions were earlier dominated by brokers. Nevertheless, the
situation has changed with the evolving market conditions, as now the transactions are
dominated by ADs. Brokers continue to dominate the derivatives market.

The Reserve Bank intervenes in the market essentially to ensure orderly market
conditions. The Reserve Bank undertakes sales/purchases of foreign currency in periods
of excess demand/supply in the market. Foreign Exchange Dealers’ Association of India
(FEDAI) plays a special role in the foreign exchange market for ensuring smooth and
speedy growth of the foreign exchange market in all its aspects. All ADs are required to
become members of the FEDAI and execute an undertaking to the effect that they would
abide by the terms and condition stipulated by the FEDAI for transacting foreign
exchange business. The FEDAI is also the accrediting authority for the foreign exchange
brokers in the interbank foreign exchange market.

The licences for ADs are issued to banks and other institutions, on their request, under
Section 10(1) of the Foreign Exchange Management Act, 1999. ADs have been divided
into different categories. All scheduled commercial banks, which include public sector
banks, private sector banks and foreign banks operating in India, belong to category I of
ADs. All upgraded full fledged money changers (FFMCs) and select regional rural banks
(RRBs) and co-operative banks belong to category II of ADs. Select financial institutions
such as EXIM Bank belong to category III of ADs. Currently, there are 86 (Category I)
Ads operating in India out of which five are co-operative banks (Table 6.3). All merchant
transactions in the foreign exchange market have to be necessarily undertaken directly
through ADs. However, to provide depth and liquidity to the inter-bank segment, Ads
have been permitted to utilise the services of brokers for better price discovery in their
inter-bank transactions. In order to further increase the size of the foreign exchange
market and enable it to handle large flows, it is generally felt that more ADs should be
encouraged to participate in the market making. The number of participants who can give
two-way quotes also needs to be increased.

The customer segment of the foreign exchange market comprises major public sector
units, corporates and business entities with foreign exchange exposure. It is generally
dominated by select large public sector units such as Indian Oil Corporation, ONGC,
BHEL, SAIL, Maruti Udyog and also the Government of India (for defence and civil debt
service) as also big private sector corporates like Reliance Group, Tata Group and Larsen
and Toubro, among others. In recent years, foreign institutional investors (FIIs) have
emerged as major players in the foreign exchange market.

1.9 main players in foreign exchange market:

1. Customers:

The customers who are engaged in foreign trade participate in foreign exchange market
by availing of the services of banks. Exporters require converting the dollars in to rupee
and importers require converting rupee in to the dollars, as they have to pay in dollars for
the goods/services they have imported.

2. Commercial Bank:

They are most active players in the forex market. Commercial bank dealings with
international transaction offer services for conversion of one currency in to another. They
have wide network of branches. Typically banks buy foreign exchange from exporters
and sells foreign exchange to the importers of goods. As every time the foreign exchange
bought or oversold position. The balance amount is sold or bought from the market.

3. Central Bank:
In all countries Central bank have been charged with the responsibility of maintaining the
external value of the domestic currency. Generally this is achieved by the intervention of
the bank.

4. Exchange Brokers:

Forex brokers play very important role in the foreign exchange market. However the
extent to which services of foreign brokers are utilized depends on the tradition and
practice prevailing at a particular forex market center. In India as per FEDAI guideline
the Ads are free to deal directly among themselves without going through brokers. The
brokers are not among to allowed to deal in their own account allover the world and also
in India.

5. Overseas Forex Market:

Today the daily global turnover is estimated to be more than US $ 1.5 trillion a day. The
international trade however constitutes hardly 5 to 7 % of this total turnover. The rest of
trading in world forex market is constituted of financial transaction and speculation. As
we know that the forex market is 24-hour market, the day begins with Tokyo and
thereafter Singapore opens, thereafter India, followed by Bahrain, Frankfurt, Paris,
London, New York, Sydney, and back to Tokyo.

6. Speculators:

The speculators are the major players in the forex market. Bank dealing are the major
speculators in the forex market with a view to make profit on account of favorable
movement in exchange rate, take position i.e. if they feel that rate of particular currency
is likely to go up in short term. They buy that currency and sell it as soon as they are able
to make quick profit.

Corporation’s particularly multinational corporation and transnational corporation

having business operation beyond their national frontiers and on account of their cash
flows being large and in multi currencies get in to foreign exchange exposures. With a
view to make advantage of exchange rate movement in their favor they either delay
covering exposures or do not cover until cash flow materialize.

Individual like share dealing also undertake the activity of buying and selling of foreign
exchange for booking short term profits. They also buy foreign currency stocks, bonds
and other assets without covering the foreign exchange exposure risk. This also results in
speculations.

1.10 Foreign Exchange Market Structure

 Market Segments

Foreign exchange market activity in most EMEs takes place onshore with many countries
prohibiting onshore entities from undertaking the operations in offshore markets for their
currencies. Spot market is the predominant form of foreign exchange market segment in
developing and emerging market countries. A common feature is the tendency of
importers/exporters and other end-users to look at exchange rate movements as a source
of return without adopting appropriate risk management practices. This, at times, creates
uneven supplydem and conditions, often based on ‘‘news and views’’. The lack of
forward market development reflects many factors, including limited exchange rate
flexibility, the de facto exchange rate insurance provided by the central bank through
interventions, absence of a yield curve on which to base the forward prices and shallow
money markets, in which market-making banks can hedge the maturity risks implicit in
forward positions (Canales-Kriljenko, 2004).

Most foreign exchange markets in developing countries are either pure dealer markets or
a combination of dealer and auction markets. In the dealer markets, some dealers become
market makers and play a central role in the determination of exchange rates in flexible
exchange rate regimes. The bidoffer spread reflects many factors, including the level of
competition among market makers. In most of the EMEs, a code of conduct establishes
the principles that guide the operations of the dealers in the foreign exchange markets. It
is the central bank, or professional dealers association, which normally issues the code of
conduct (Canales-Kriljenko, 2004). In auction markets’ an auctioneer or auction
mechanism allocates foreign exchange by matching supply and demand orders. In pure
auction markets, order imbalances are cleared only by exchange rate adjustments. Pure
auction market structures are, however, now rare and they generally prevail in
combination with dealer markets.

The Indian foreign exchange market is a decentralised multiple dealership market

comprising two segments – the spot and the derivatives market. In the spot market,
currencies are traded at the prevailing rates and the settlement or value date is two
business days ahead. The two-day period gives adequate time for the parties to send
instructions to debit and credit the appropriate bank accounts at home and abroad. The
derivatives market encompasses forwards, swaps and options. Though forward contracts
exist for maturities up to one year, majority of forward contracts are for one month, three
months, or six months. Forward contracts for longer periods are not as common because
of the uncertainties involved and related pricing issues. A swap transaction in the foreign
exchange market is a combination of a spot and a forward in the opposite direction. As in
the case of other EMEs, the spot market is the dominant segment of the Indian foreign
exchange market. The derivative segment of the foreign exchange market is assuming
significance and the activity in this segment is gradually rising.

1.11 Corporate Hedging for Foreign Exchange Risk in India

In 1971, the Bretton Woods system of administering fixed foreign exchange rates was
abolished in favour of market-determination of foreign exchange rates; a regime of
fluctuating exchange rates was introduced. Besides market-determined fluctuations, there
was a lot of volatility in other markets around the world owing to increased inflation and
the oil shock. Corporates struggled to cope with the uncertainty in profits, cash flows and
future costs. It was then that financial derivatives – foreign currency, interest rate, and
commodity derivatives emerged as means of managing risks facing corporations.

In India, exchange rates were deregulated and were allowed to be determined by markets
in 1993. The economic liberalization of the early nineties facilitated the introduction of
derivatives based on interest rates and foreign exchange. However derivative use is still a
highly regulated area due to the partial convertibility of the rupee. Currently forwards,
swaps and options are available in India and the use of foreign currency derivatives is
permitted for hedging purposes only.

The aim is to provide a perspective on managing the risk that firm’s face due to
fluctuating exchange rates. It investigates the prudence in investing resources towards the
purpose of hedging and then introduces the tools for risk management. These are then
applied in the Indian context. The motivation of this study came from the recent rise in
volatility in the money markets of the world and particularly in the US Dollar, due to
which Indian exports are fast gaining a cost disadvantage. Hedging with derivative
instruments is a feasible solution to this situation.

This report is organised in 6 sections. The next section presents the necessity of foreign
exchange risk management and outlines the process of managing this risk. Section 3
discusses the various determinants of hedging decisions by firms, followed by an
overview of corporate hedging in India in Section 4. Evidence from major Indian firms
from different sectors is summarized here and Section 5 concludes.
 CHAPTER 2.

RESEARCH METHODOLOGY

Objectives of the Study

The major objective if my research is “To study the Investor, Investment Behavior in
stock market & suggesting good Investment Strategy”.

Other Objectives

1. To study the investment habit of people in the forex market.

2. To know about the people’s preference for the investment whether investment or
trading.

3. To understand the frequency of the investment in the market.

4. To understand the expected return of people from investment.

5. To find out the common mistakes made by people.

6. To know how much people invest at a time.

7. To know on what basis people invest in forex market.

8. To define certain views for making money in the forex market.

 Limitations of Study

The main limitations of the study are as under:

1. The time of around two months was a little short to study such a wide topic like Stock
Exchanges in India.

2. The executives were hesitating to reveal the complete information since it was
confidential.
3. Mostly in my research I had to face language barrier.

4. Some respondent refused to give answers of questions.

5. Some respondents tried to avoid feeling questionnaire

 SCOPE OF STUDY
The scope of study was limited to Mumbai

 DATA COLLECTION

Data is collected from both the sources i.e. the Primary Source and the Secondary Source.

Primary Data:

Primary data can be collected through the questionnaire. Which contains the different
questions about the investment behavior and investment strategy in the stock exchanges.
Primary data sources are very helpful for research. This provides information related to
investor’s investment behavior and investment strategy.

Primary data, collected from:

Secondary Data:

Secondary data can be collected from e-learning which played an important role in
establishing the detailed information about the topic
 CHAPTER 3
LITERATURE REVIEW
There is much more inequality in the distribution of income and wealth today than there
has ever been in the past, both within and between nations. Inequality is growing and this
is regarded as a threat to social and economic stability. A large part of the blame is laid
on the monetary and financial system. This practice has its origins in the fact that western
banking institutions have profitability rather than social imperatives as their primary
concern. The result of such practices is unequal income distribution, highly skewed
towards the wealthier portion of society, and unjustly deprives non-property holders of
gaining access to finance.

According to the World Bank Research Observer (1996), commercial banks prefer to
lend to low-risk activities and are reluctant to finance high risk projects, even if such
projects present better investment opportunities. They are also less willing to finance
small firms that don’t have adequate collateral.

In contrast, fostering serious economic development is a key objective of Islamic banks

as they seek to maximise social benefit. Islamic banks therefore work hard to overcome
shortages and difficulties to help the economy to progress to a higher stage of self-
sustained development, resulting in a favourable effect on socio economic harmony due
to equal income distribution. It has been widely claimed by development economists that
policy and resource allocation is strongly focused on large firms and that existing
banking institutions prefer to grant credit facilities to clients who are able to offer
sufficient collateral security.

According to Abdouli (1991), Kahf, Ahmad and Homud (1998), Siddiqi (2002), and
Iqbal (1997), maximizing of profitability is not the only concern for Islamic banking
institutes and the principles that Islamic banks are based on are deeply integrated with
ethical and moral values. They also state that Islamic Banks do not depend on tangible
collaterals and lead to a better distribution of income, allowing access to finance for those
in poorer classes of society, and resulting in greater benefits for social justice and long
term growth.
In contrast with conventional methods, Islamic financing is not centred only around
creditworthiness but rather on the worthiness and profitability of a project, and therefore
recovering the principle becomes a result of profitability and worthiness of the actual
project.

Entrepreneurship and risk sharing are therefore promoted by Islamic finance and its
expansion to the unwealthy members of society is an effective development tool. The
social benefits are clear, as currently the poor are often exploited by financial institutions
charging usurious rates. (Iqbal, 1997)

The nature of Islamic banking operations are directly affected by the success or failure of
client enterprises as a result of the profit-loss-sharing process (Abdouli, 1991). The
relationship is based on a partnership, with cash being entrusted to bankers for
investment, and returns shared between depositors and bankers. Losses are carried by
fund owners. This sharing principle is very different to traditional banking practices. It
introduces the concept of sharing to financing and creates a performance incentive within
the mind of bankers that relates deposits to their performance in the use of funds. This
increases the deposit market and gives it more stability (Kahf, 2002).

Iqbal (1997), Martan, Abdul-Fattah, Jabarti, and Sofrata (1984), and Ziauddin (1994) are
of the opinion that Islamic bankers encourage people to invest as investment depositors
receive a share in the bank’s profits.

Investors are motivated by the human desire toward ownership, high rewards and the
satisfaction of being part of a successful project (Martan et al, 1984). Issuers of Islamic
finance have wider latitude in financing services and negotiate a profit share between
zero and 100 when dealing with savers and investors. This allows them to better mobilize
resources and attract investors as a higher profit share results in lower finance costs.
(Ziauddin, 1994)

According to Iqbal (1997), the economic development of Islamic countries can be greatly
enhanced by the Islamic financial system due to the mobilization of savings that are being
kept away from interest basedbanks and the development of the capital markets. This
motivation to invest in Islamic banks may also stem from the fact that research shows
that the share in the bank’s profits may at times be higher than the fixed rate of interest
given by conventional banks.

Some of the literature on Islamic banking states that replacement of interest by profitloss-
sharing may result in high instability of the entire economic system as problems
originating in one part of the economy will rapidly spread to others. However the general
consensus is that interest-free banking tends to enhance stability and it is in fact interest
based debt financing that contributes to economic instability.

Islamic finance allows a closer link between real economic activity that creates value and
financial activity to be forged. According to Iqbal (1997), the Islamic financial system
can be expected to be stable due to the elimination of debt financing and enhanced
allocation efficiency.

Analytical models show that the Islamic banking system is stable as the term and
structure of liabilities and assets are symmetrically matched through profit-sharing, lack
of fixed interest costs and the impossibility of refinancing through debt (Yusri, 2005).

Chapra (1992), Kahf (1982), Siddiqi (1983) and Zarqa (1983) all support the idea that
profit sharing is more stable than the interest based system resulting in prevention of
fluctuations in rates of return. It has been pointed out that interest based debt financing is
a major factor in causing economic instability in capitalist economies. As soon as the
bankers find that business concerns are beginning to incur losses they reduce assistance
and call back loans (Yusri, 2005).

In an Islamic banking system more stability is experienced as in times of crisis

investment depositors automatically share the risk due to profit-and-loss sharing,
meaning that individual banks as well as the entire banking system is less likely to break
down (Zaher and Hassan, 2001).The focus of Islamic finance on profitability and rate of
return of investments due to equity and profit sharing has the potential of directing
financial resources to the most productive investments and hence increases the efficiency
of the financing process and in the real sectors (Kahf et al, 1998). Economic development
requires mobilization of financial resources both internally and externally and any
resources left hoarded indicate unrealized potential for economic development.
Qureshi (1984) and Nagvi (1981 and 1982) claim that Islamic bankers are increasingly
exposed to risk due to equity-based financing, however Islamic scholars believe that the
elimination of interest increases stability. In financial theory a linear relationship exists
between risk and return, meaning that low risk is associated with low return and high risk
brings about high return. (Chapra, 1992)

Risk is a key component of making investment and investors share the risk involved with
those carrying out investment activities. Islamic finance provides depositors with some
influence on investment decisions and gives banks and financial institutions a share in
the decision making process. This allows both risk and decision making to be spread over
a much larger number and variety of people, allowing wider involvement in economic
activities (Ziauddin, 1994).

In a study by Turen (1996) on the risk analysis of Islamic banks, he states that as interest
is abolished for deposit holders and replaced by profit-sharing, the fixed interest payment
is minimized or eliminated and therefore Islamic banks experience higher coverage of
interest charge ratios and therefore lower financial risks.

A further study by Samad and Hassan (1997) that compares an Islamic bank with a group
of conventional banks shows that Islamic banks are less risky than conventional
banks. Sarker (1997), however, found that the risk involved in profit sharing is very high,
but states that many external factors and obstacles interfered with the proper
implementation of the Islamic banking system. Sarker (1997), Samad and Hassan (1997),
concluded that if Islamic banks are supported with appropriate banking laws and
regulation, they can provide efficient banking services which encourage economic
development.

From the literature it is evident that both theoretically and empirically, economists find
Islamic banking viable, acceptable and also efficient and significantly effective in
developing the economy.
 CHAPTER 4.
DATA ANALYSIS AND INTERPRETATION

Foreign Exchange Management Act, 1999

The change in the entire approach towards exchange control regulation has been the
result of the replacement of the Foreign Exchange Regulation Act, 1973, by the Foreign
Exchange Management Act, 1999. The latter came into effect from June 1, 2000. The
change in the preamble itself signifies the dramatic change in approach -- from "for the
conservation of the foreign exchange resources" in FERA 1973, to "facilitate external
trade and payments" under FEMA 1999. Any FEMA violations are civil, not criminal,
offences, attracting monetary penalties, and not arrests or imprisonment.

The scheme of FEMA and the notifications issued thereunder take into the account the
convertibility of the rupee for all current account transactions. Indeed, there is now
general freedom to authorised dealers to sell currency for most current account
transactions. One old limitation continues. All transactions in foreign exchange have to
be with authorised dealers, i.e. banks authorised to act as dealers in foreign exchange by
the Reserve Bank. The original rules, regulations, notifications, etc., under FEMA are
contained in the A.D. (M.A. series) Circular No. 11 of May 16, 2000. Subsequent
circulars have been issued under the A.P. (DIR series) nomenclature. It is obviously
impossible to incorporate all the current regulations in a book of this type, particularly
since the regulations keep changing. An outline of the basic framework of exchange
control under FEMA is in Annexure 5.3. But its contents should not be considered as
either definitive or current and those interested need to keep up with the various circulars
and other communications on the subject.

Exchange rate System

Countries of the world have been exchanging goods and services amongst themselves.
This has been going on from time immemorial. The world has come a long way from the
days of barter trade. With the invention of money the figures and problems of barter trade
have disappeared. The barter trade has given way ton exchanged of goods and services
for currencies instead of goods and services. The rupee was historically linked with
pound sterling. India was a founder member of the IMF. During the existence of the fixed
exchange rate system, the intervention currency of the Reserve Bank of India (RBI) was
the British pound, the RBI ensured maintenance of the exchange rate by selling and
buying pound against rupees at fixed rates. The inter bank rate therefore ruled the RBI
band. During the fixed exchange rate era, there was only one major change in the parity
of the rupee- devaluation in June 1966. Different countries have adopted different
exchange rate system at different time.

The following are some of the exchange rate system followed by various countries.

 The Gold Standard

Many countries have adopted gold standard as their monetary system during the last two
decades of the 19he century. This system was in vogue till the outbreak of World War 1.
Under this system the parties of currencies were fixed in term of gold. There were two
main types of gold standard:

 Gold specie standard

Gold was recognized as means of international settlement for receipts and payments
amongst countries. Gold coins were an accepted mode of payment and medium of
exchange in domestic market also. A country was stated to be on gold standard if the
following condition were satisfied:

 Monetary authority, generally the central bank of the country, guaranteed to buy
and sell gold in unrestricted amounts at the fixed price.
 Melting gold including gold coins, and putting it to different uses was freely
allowed.
 Import and export of gold was freely allowed.

The total money supply in the country was determined by the quantum of gold available
for monetary purpose.

1.Gold Bullion Standard:

Under this system, the money in circulation was either partly of entirely paper and gold
served as reserve asset for the money supply. However, paper money could be exchanged
for gold at any time. The exchange rate varied depending upon the gold content of
currencies. This was also known as “ Mint Parity Theory “ of exchange rates. The gold
bullion standard prevailed from about 1870 until 1914, and intermittently thereafter until
1944. World War I brought an end to the gold standard.

2.Bretton Woods System

During the world wars, economies of almost all the countries suffered. In order to correct
the balance of payments disequilibrium, many countries devalued their currencies.
Consequently, the international trade suffered a deathblow. In 1944, following World
War II, the United States and most of its allies ratified the Bretton Woods Agreement,
which set up an adjustable parity exchange-rate system under which exchange rates were
fixed (Pegged) within narrow intervention limits (pegs) by the United States and foreign
central banks buying and selling foreign currencies. This agreement, fostered by a new
spirit of international cooperation, was in response to financial chaos that had reigned
before and during the war. In addition to setting up fixed exchange parities (par values) of
currencies in relationship to gold, the agreement established the International Monetary
Fund (IMF) to act as the “custodian” of the system. Under this system there were
uncontrollable capital flows, which lead to major countries suspending their obligation to
intervene in the market and the Bretton Wood System, with its fixed parities, was
effectively buried. Thus, the world economy has been living through an era of floating
exchange rates since the early 1970.

3.Floating Rate System

In a truly floating exchange rate regime, the relative prices of currencies are decided
entirely by the market forces of demand and supply. There is no attempt by the
authorities to influence exchange rate. Where government interferes’ directly or through
various monetary and fiscal measures in determining the exchange rate, it is known as
managed of dirty float. PURCHASING POWER PARITY (PPP) Professor Gustav
Cassel, a Swedish economist, introduced this system. The theory, to put in simple terms
states that currencies are valued for what they can buy and the currencies have no
intrinsic value attached to it. Therefore, under this theory the exchange rate was to be
determined and the sole criterion being the purchasing power of the countries. As per this
theory if there were no trade controls, then the balance of payments equilibrium would
always be maintained. Thus if 150 INR buy a fountain pen and the same fountain pen can
be bought for USD 2, it can be inferred that since 2 USD or 150 INR can buy the same
fountain pen, therefore USD 2 = INR 150.For example India has a higher rate of inflation
as compared to country US then goods produced in India would become costlier as
compared to goods produced in US. This would induce imports in India and also the
goods produced in India being costlier would lose in international competition to goods
produced in US. This decrease in exports of India as compared to exports from US would
lead to demand for the currency of US and excess supply of currency of India. This in
turn, cause currency of India to depreciate in comparison of currency of US that is having
relatively more exports.

Fundamentals in Exchange Rate

Exchange rate is a rate at which one currency can be exchange in to another currency, say
USD = Rs.48. This rate is the rate of conversion of US dollar in to Indian rupee and vice
versa.

Methods of Quoting Rate

There are two methods of quoting exchange rates.

1) Direct method:

Foreign currency is kept constant and home currency is kept variable. In direct quotation,
the principle adopted by bank is to buy at a lower price and sell at higher price.

2) Indirect method:

Home currency is kept constant and foreign currency is kept variable. Here the strategy
used by bank is to buy high and sell low. In India with effect from august 2, 1993, all the
exchange rates are quoted in direct method. It is customary in foreign exchange market to
always quote two rates means one for buying and another rate for selling. This helps in
eliminating the risk of being given bad rates i.e. if a party comes to know what the other
party intends to do i.e. buy or sell, the former can take the letter for a ride. There are two
parties in an exchange deal of currencies. To initiate the deal one party asks for quote
from another party and other party quotes a rate. The party asking for a quote is known
as’ asking party and the party giving a quotes is known as quoting party. The advantage
of two–way quote is as under

 The market continuously makes available price for buyers or sellers

 Two way prices limit the profit margin of the quoting bank and
comparison of one quote with another quote can be done instantaneously.
 As it is not necessary any player in the market to indicate whether he
intends to buy or sale foreign currency, this ensures that the quoting bank
cannot take advantage by manipulating the prices.
 It automatically insures that alignment of rates with market rates.
 Two way quotes lend depth and liquidity to the market, which is so very
essential for efficient market. In two way quotes the first rate is the rate for
buying and another for selling.
We should understand here that, in India the banks, which are authorized dealer, always,
quote rates. So the rates quoted- buying and selling is for banks point of view only. It
means that if exporters want to sell the dollars then the bank will buy the dollars from
him so while calculation the first rate will be used which is buying rate, as the bank is
buying the dollars from exporter. The same case will happen inversely with importer as
he will buy dollars from the bank and bank will sell dollars to importer.

• Strength of Economy

Economic factors affecting exchange rates include hedging activities, interest rates,
inflationary pressures, trade imbalance, and euro market activities. Irving fisher, an
American economist, developed a theory relating exchange rates to interest rates. This
proposition, known as the fisher effect, states that interest rate differentials tend to reflect
exchange rate expectation. On the other hand, the purchasing- power parity theory relates
exchange rates to inflationary pressures. In its absolute version, this theory states that the
equilibrium exchange rate equals the ratio of domestic to foreign prices. The relative
version of the theory relates changes in the exchange rate to changes in price ratios.

• Political Factor

The political factor influencing exchange rates include the established monetary policy
along with government action on items such as the money supply, inflation, taxes, and
deficit financing. Active government intervention or manipulations, such as central bank
activity in the foreign currency market, also have an impact. Other political factors
influencing exchange rates include the political stability of a country and its relative
economic exposure (the perceived need for certain levels and types of imports). Finally,
there is also the influence of the international monetary fund.

• Expectation of the Foreign Exchange Market

Psychological factors also influence exchange rates. These factors include market
anticipation, speculative pressures, and future expectations. A few financial experts are of
the opinion that in today’s environment, the only ‘trustworthy’ method of predicting
exchange rates by gut feel. Bob Eveling, vice president of financial markets at SG, is
corporate finance’s top foreign exchange forecaster for 1999. eveling’s gut feeling has,
defined convention, and his method proved uncannily accurate in foreign exchange
forecasting in 1998.SG ended the corporate finance forecasting year with a 2.66% error
overall, the most accurate among 19 banks. The secret to eveling’s intuition on any
currency is keeping abreast of world events. Any event, from a declaration of war to a
fainting political leader, can take its toll on a currency’s value. Today, instead of formal
modals, most forecasters rely on an amalgam that is part economic fundamentals, part
model and part judgment.

Fiscal policy

Interest rates

Monetary policy
Balance of payment

Exchange control

Central bank intervention

Speculation

Technical factors

Foreign Exchange Risk Management: Process & Necessity

Firms dealing in multiple currencies face a risk (an unanticipated gain/loss) on account of
sudden/unanticipated changes in exchange rates, quantified in terms of exposures.
Exposure is defined as a contracted, projected or contingent cash flow whose magnitude
is not certain at the moment and depends on the value of the foreign exchange rates. The
process of identifying risks faced by the firm and implementing the process of protection
from these risks by financial or operational hedging is defined as foreign exchange risk
management. This paper limits its scope to hedging only the foreign exchange risks faced
by firms.

Kinds of Foreign Exchange Exposure

Risk management techniques vary with the type of exposure (accounting or economic)
and term of exposure. Accounting exposure, also called translation exposure, results from
the need to restate foreign subsidiaries’ financial statements into the parent’s reporting
currency and is the sensitivity of net income to the variation in the exchange rate between
a foreign subsidiary and its parent. Economic exposure is the extent to which a firm's
market value, in any particular currency, is sensitive to unexpected changes in foreign
currency. Currency fluctuations affect the value of the firm’s operating cash flows,
income statement, and competitive position, hence market share and stock price.
Currency fluctuations also affect a firm's balance sheet by changing the value of the
firm's assets and liabilities, accounts payable, accounts receivables, inventory, loans in
foreign currency, investments (CDs) in foreign banks; this type of economic exposure is
called balance sheet exposure. Transaction Exposure is a form of short term economic
exposure due to fixed price contracting in an atmosphere of exchange-rate volatility. The
most common definition of the measure of exchange-rate exposure is the sensitivity of
the value of the firm, proxied by the firm’s stock return, to an unanticipated change in an
exchange rate. This is calculated by using the partial derivative function where the
dependant variable is the firm’s value and the independent variable is the exchange rate
(Adler and Dumas, 1984).

Necessity of managing foreign exchange risk

A key assumption in the concept of foreign exchange risk is that exchange rate changes
are not predictable and that this is determined by how efficient the markets for foreign
exchange are. Research in the area of efficiency of foreign exchange markets has thus far
been able to establish only a weak form of the efficient market hypothesis conclusively
which implies that successive changes in exchange rates cannot be predicted by analyzing
the historical sequence of exchange rates.(Soenen, 1979). However, when the efficient
markets theory is applied to the foreign exchange market under floating exchange rates
there is some evidence to suggest that the present prices properly reflect all available
information.(Giddy and Dufey, 1992). This implies that exchange rates react to new
information in an immediate and unbiased fashion, so that no one party can make a profit
by this information and in any case, information on direction of the rates arrives
randomly so exchange rates also fluctuate randomly. It implies that foreign exchange risk
management cannot be done away with by employing resources to predict exchange rate
changes.

Hedging as a tool to manage foreign exchange risk:

There is a spectrum of opinions regarding foreign exchange hedging. Some firms feel
hedging techniques are speculative or do not fall in their area of expertise and hence do
not venture into hedging practices. Other firms are unaware of being exposed to foreign
exchange risks. There are a set of firms who only hedge some of their risks, while others
are aware of the various risks they face, but are unaware of the methods to guard the firm
against the risk. There is yet another set of companies who believe shareholder value
cannot be increased by hedging the firm’s foreign exchange risks as shareholders can
themselves individually hedge themselves against the same using instruments like
forward contracts available in the market or diversify such risks out by manipulating their
portfolio. (Giddy and Dufey, 1992).

There are some explanations backed by theory about the irrelevance of managing the risk
of change in exchange rates. For example, the International Fisher effect states that
exchange rates changes are balanced out by interest rate changes, the Purchasing Power
Parity theory suggests that exchange rate changes will be offset by changes in relative
price indices/inflation since the Law of One Price should hold. Both these theories
suggest that exchange rate changes are evened out in some form or the other.

Also, the Unbiased Forward Rate theory suggests that locking in the forward exchange
rate offers the same expected return and is an unbiased indicator of the future spot rate.
But these theories are perfectly played out in perfect markets under homogeneous tax
regimes. Also, exchange rate-linked changes in factors like inflation and interest rates
take time to adjust and in the meanwhile firms stand to lose out on adverse movements in
the exchange rates.

The existence of different kinds of market imperfections, such as incomplete financial

markets, positive transaction and information costs, probability of financial distress and
agency costs and restrictions on free trade make foreign exchange management an
appropriate concern for corporate management. (Giddy and Dufey, 1992) It has also been
argued that a hedged firm, being less risky can secure debt more easily and this enjoy a
tax advantage (interest is excluded from tax while dividends are taxed). This would
negate the Modigliani-Miller proposition as shareholders cannot duplicate such tax
advantages. The MM argument that shareholders can hedge on their own is also not valid
on account of high transaction costs and lack of knowledge about financial manipulations
on the part of shareholders.

There is also a vast pool of research that proves the efficacy of managing foreign
exchange risks and a significant amount of evidence showing the reduction of exposure
with the use of tools for managing these exposures. In one of the more recent studies,
Allayanis and Ofek (2001) use a multivariate analysis on a sample of S&P 500 non-
financial firms and calculate a firms exchange-rate exposure using the ratio of foreign
sales to total sales as a proxy and isolate the impact of use of foreign currency derivatives
(part of foreign exchange risk management) on a firm’s foreign exchange exposures.
They find a statistically significant association between the absolute value of the
exposures and the (absolute value) of the percentage use of foreign currency derivatives
and prove that the use of derivatives in fact reduce exposure.

Risk Management and Settlement of Transactions in the Foreign Exchange Market

The foreign exchange market is characterized by constant changes and rapid innovations
in trading methods and products. While the innovative products and ways of trading
create new possibilities for profit, they also pose various kinds of risks to the market.
Central banks all over the world, therefore, have become increasingly concerned of the
scale of foreign exchange settlement risk and the importance of risk mitigation measures.
Behind this growing awareness are several events in the past in which foreign exchange
settlement risk might have resulted in systemic risk in global financial markets, including
the failure of Bankhaus Herstatt in 1974 and the closure of BCCI SA in 1991.
The foreign exchange settlement risk arises because the delivery of the two currencies
involved in a trade usually occurs in two different countries, which, in many cases are
located in different time zones. This risk is of particular concern to the central banks
given the large values involved in settling foreign exchange transactions and the resulting
potential for systemic risk. Most of the banks in the EMEs use some form of
methodology for measuring the foreign exchange settlement exposure. Many of these
banks use the single day method, in which the exposure is measured as being equal to all
foreign exchange receipts that are due on the day. Some institutions use a multiple day
approach for measuring risk. Most of the banks in EMEs use some form of individual
counterparty limit to manage their exposures. These limits are often applied to the global
operations of the institution. These limits are sometimes monitored by banks on a regular
basis. In certain cases, there are separate limits for foreign exchange settlement
exposures, while in other cases, limits for aggregate settlement exposures are created
through a range of instruments. Bilateral obligation netting, in jurisdictions where it is
legally certain, is an important way for trade counterparties to mitigate the foreign
exchange settlement risk. This process allows trade counterparties to offset their gross
settlement obligations to each other in the currencies they have traded and settle these
obligations with the payment of a single net amount in each currency.

Several emerging markets in recent years have implemented domestic real time gross
settlement (RTGS) systems for the settlement of high value and time critical payments to
settle the domestic leg of foreign exchange transactions. Apart from risk reduction, these
initiatives enable participants to actively manage the time at which they irrevocably pay
away when selling the domestic currency, and reconcile final receipt when purchasing the
domestic currency. Participants, therefore, are able to reduce the duration of the foreign
exchange settlement risk.

Recognising the systemic impact of foreign exchange settlement risk, an important

element in the infrastructure for the efficient functioning of the Indian foreign exchange
market has been the clearing and settlement of inter-bank USD-INR transactions. In
pursuance of the recommendations of the Sodhani Committee, the Reserve Bank had set
up the Clearing Corporation of India Ltd. (CCIL) in 2001 to mitigate risks in the Indian
financial markets. The CCIL commenced settlement of foreign exchange operations for
inter-bank USD-INR spot and forward trades from November 8, 2002 and for inter-bank
USD-INR cash and tom trades from February 5, 2004. The CCIL undertakes settlement
of foreign exchange trades on a multilateral net basis through a process of novation and
all spot, cash and tom transactions are guaranteed for settlement from the trade date.

Every eligible foreign exchange contract entered between members gets novated or
replaced by two new contracts – between the CCIL and each of the two parties,
respectively. Following the multilateral netting procedure, the net amount payable to, or
receivable from, the CCIL in each currency is arrived at, member-wise. The Rupee leg is
settled through the members’ current accounts with the Reserve Bank and the USD leg
through CCIL’s account with the settlement bank at New York. The CCIL sets limits for
each member bank on the basis of certain parameters such as member’s credit rating, net
worth, asset value and management quality. The CCIL settled over 900,000 deals for a
gross volume of US $ 1,180 billion in 2005-06. The CCIL has consistently endeavoured
to add value to the services and has gradually brought the entire gamut of foreign
exchange transactions under its purview. Intermediation, by the CCIL thus, provides its
members the benefits of risk mitigation, improved efficiency, lower operational cost and
easier reconciliation of accounts with correspondents.

An issue related to the guaranteed settlement of transactions by the CCIL has been the
extension of this facility to all forward trades as well. Member banks currently encounter
problems in terms of huge outstanding foreign exchange exposures in their books and this
comes in the way of their doing more trades in the market. Risks on such huge
outstanding trades were found to be very high and so were the capital requirements for
supporting such trades. Hence, many member banks have expressed their desire in
several fora that the CCIL should extend its guarantee to these forward trades from the
trade date itself which could lead to significant increase in the liquidity and depth in the
forward market. The risks that banks today carry in their books on account of large
outstanding forward positions will also be significantly reduced (Gopinath, 2005). This
has also been one of the recommendations of the Committee on Fuller Capital Account
Convertibility. 6.55 Apart from managing the foreign exchange settlement risk,
participants also need to manage market risk, liquidity risk, credit risk and operational
risk efficiently to avoid future losses. As per the guidelines framed by the Reserve Bank
for banks to manage risk in the inter-bank foreign exchange dealings and exposure in
derivative markets as market makers, the boards of directors of ADs (category-I) are
required to frame an appropriate policy and fix suitable limits for operations in the
foreign exchange market. The net overnight open exchange position and the aggregate
gap limits need to be approved by the Reserve Bank. The open position is generally
measured separately for each foreign currency consisting of the net spot position, the net
forward position, and the net options position. Various limits for exposure, viz.,
overnight, daylight, stop loss, gap limit, credit limit, value at risk (VaR), etc., for foreign
exchange transactions by banks are fixed. Within the contour of these limits, front office
of the treasury of ADs transacts in the foreign exchange market for customers and own
proprietary requirements. These exposures are accounted, confirmed and settled by back
office, while mid-office evaluates the profit and monitors adherence to risk limits on a
continuous basis. In the case of market risk, most banks use a combination of
measurement techniques including VaR models. The credit risk is generally measured
and managed by most banks on an aggregate counter-party basis so as to include all
exposures in the underlying spot and derivative markets. Some banks also monitor
country risk through cross-border country risk exposure limits. Liquidity risk is generally
estimated by monitoring asset liability profile in various currencies in various buckets
and monitoring currency-wise gaps in various buckets. Banks also track balances to be
maintained on a daily basis in Nostro accounts, remittances and committed foreign
currency term loans while monitoring liquidity risk.
To sum up, the foreign exchange market structure in India has undergone substantial
transformation from the early 1990s. The market participants have become diversified
and there are several instruments available to manage their risks. Sources of supply and
demand in the foreign exchange market have also changed in line with the shifts in the
relative importance in balance of payments from current to capital account. There has
also been considerable improvement in the market infrastructure in terms of trading
platforms and settlement mechanisms. Trading in Indian foreign exchange market is
largely concentrated in the spot segment even as volumes in the derivatives segment are
on the rise. Some of the issues that need attention to further improve the activity in the
derivatives segment include flexibility in the use of various instruments, enhancing the
knowledge and understanding the nature of risk involved in transacting the derivative
products, reviewing the role of underlying in booking forward contracts and guaranteed
settlements of forwards. Besides, market players would need to acquire the necessary
expertise to use different kinds of instruments and manage the risks involved.

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.

 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.

 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.

 Benchmarking: Given the exposures and the risk estimates, the firm has to set its
limit 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.

 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.

 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.

 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.

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.

Choice of hedging instruments

The literature on the choice of hedging instruments is very scant. Among the available
studies, Géczy et al. (1997) argues that currency swaps are more cost-effective for
hedging foreign debt risk, while forward contracts are more cost-effective for hedging
foreign operations risk. This is because foreign currency debt payments are long-term and
predictable, which fits the long-term nature of currency swap contracts. Foreign currency
revenues, on the other hand, are short-term and unpredictable, in line with the short-term
nature of forward contracts. A survey done by Marshall (2000) also points out that
currency swaps are better for hedging against translation risk, while forwards are better
for hedging against transaction risk. This study also provides anecdotal evidence that
pricing policy is the most popular means of hedging economic exposures.

These results however can differ for different currencies depending in the sensitivity of
that currency to various market factors. Regulation in the foreign exchange markets of
various countries may also skew such results.

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 Hedging

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. The costs of
hedging, assuming efficiency in foreign exchange markets result in pure transaction
costs. The three main elements of these transaction costs are brokerage or service fees
charged by dealers, information costs such as subscription to Reuter reports and news
channels and administrative costs of exposure management.

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. The measure of sales growth is obtained using the 3-year geometric average
of yearly sales growth rates.

As regards the degree of hedging Allayanis and Ofek (2001) conclude that the sole
determinants of the degree of hedging are exposure factors (foreign sales and trade). In
other words, given that a firm decides to hedge, the decision of how much to hedge is
affected solely by its exposure to foreign currency movements.

This discussion highlights how risk management systems have to be altered according to
characteristics of the firm, hedging costs, nature of operations, tax considerations,
regulatory requirements etc. The next section discusses these issues in the Indian context
and regulatory environment.