SYNOPSIS Foreign Exchange

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SYNOPSIS

ON

HEDGING TOOLS

IN

FOREIGN EXCHANGE MARKET

SUBMITTED BY:MR.

PGDBM FINANCE

ENROLMENT NO.

SESSION -

INSTITUTE OF MANAGEMENT TECHNOLOGY (CENTRE FOR DISTANCE

LEARNING)

GHAZIABAD


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PROFORMA FOR SYNOPSIS OF PROJECT WORK

Name :

Enrolment No. :

Address :

Course : PGPM - 3 years

Submitted To : Institute of Management TechnologGhaziabad (UP)

Mobile No. :

Major Area of SpecializationQuestionnaire AttachedPhone No. of the project GuideDate of Submission

::::

FinanceYes


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CHAPTERISATION SCHEME

Introduction

Statement About the Problem Objectives and Scope of the Study

Methodology

Questionnaire

Bibliography

Guides CV & Consent Letter


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INTRODUCTION

Most of the countries like Australia, India, Japan, and France currently adopt the

floating exchange rate system; therefore the value of the respective currency issubject to volatility due to the influence of changing domestic and international

economic circumstances. This volatility of the respective exchange rate system is an

issue that affects the majority of those countries businesses. By considering the

example of Australia, with over fifty percent of Australian trading invoiced in foreign

currencies, movements in the value of the Australian dollar can potentially improve

or worsen Australian companies financial performance, and consequently, affect the

national economic indicators. The importance of managing these currency risks not

only stimulates countless studies attempting to capture a set of factors that are most

relevant in contributing to the volatility of the Australian exchange rate system or any

of the exchange rate system, but also encourages research attempting to develop

an optimal hedging model that can assist that country businesses to manage foreign

exchange risk. From the review of existing literature, there appears to be a

noticeable gap between theory and practice. Indeed, there exists a vast literature

that looks at traditional financial derivatives such as options, futures, forward, and

swaps for example; the Black-Scholes model is used for options pricings in the

share and foreign exchange market. However, there is a paucity of research

focusing on the leveraged spot market, both from an empirical and theoretical point

of view. This thesis aims to minimize this omission by developing a model of

speculation as well as a model of hedging, providing a theoretical framework and

empirical simulations.

Every company is exposed several different risks in its daily business. Of those

risks, currency risk is major concern in current business scenario. Currency risk is

unpredictable fluctuations in currency exchange rates and it is an inevitable by-

product in all international operations. The primary objective to do this thesis work is

to provide the best tools and their understanding in simplest way so as to prevent

from currency risk.


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The model of speculation has been developed further in this thesis which

adapts/considers the Krugmans (1991) model of target zones, in order to

theoretically determine the optimal number of leveraged spot contracts taken by aspeculator. Moreover, using historical data on interest rates and spot rates, we

conduct a simulation to provide insights into how changing economic factors affects

the speculators position in the real world. In Chapter 4, we extend this model to

show how speculation gains can be hedged with forward contracts. Traditional

hedging methods involve the use of money markets and forward contracts; however,

in Chapter 4, we describe how leveraged spot contracts can be used for hedging

purposes. Moreover, we show that under some circumstances, the leveraged spot

contract hedge outperforms these traditional hedging methods.

STATEMENT ABOUT THE PROBLEM

To determine the hedging tools available in foreign exchange market to prevent

currency risk.

OBJECTIVE OF THE STUDY

Research Objectives:

According to our review of the available literature, there appears to be a significant

gap between theory and practice. Indeed, most popular models, such as the Black-

Scholes, Merton and Whaley Option Pricing Models have the same assumption that

the volatility of the underlying asset is constant. This assumption is obviously not

realistic. With the aim to close this gap between theory and practice, a new model is

developed in this thesis using the assumptions that the interest rate definitely

changes according to economic conditions or policies and that the exchange rate

movement follows the pattern of a random walk, which is a stochastic process.

Moreover, during the course of our research, we did not encounter any literature that

dealt with leveraged spot contracts as both speculative and hedging instruments. It

is obvious that the leveraged spot market is relatively less commonly used by


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financial derivatives traders, compared to traditional instruments such as forward,

futures, options, swaps, and the money market. Our objective is therefore to develop

a model using leveraged spot contracts as an effective financial instrument that canbe used for both speculative and hedging purposes.

Scope of the Study:

The completion of this thesis contributes to the studies of global finance and

economics in two ways. Firstly, we demonstrate here how the leveraged spot market

can be used for speculating and hedging purposes, and that under certain

circumstances, the leveraged spot contract can generate risk-free profit. Secondly,

we show that under those circumstances, the leveraged spot contract is a better

hedging tool than traditional financial instruments used for this purpose, such as the

forward and money market hedges. Further we will illustrate how the leveraged spot

market allows speculators and hedgers to gain additional interest as their risk-free

profit from a transaction. This is a distinctive feature which is absent when using

traditional financial tools. The opportunity of obtaining risk free interest profit helps to

lower the risk of trading (both speculating and hedging) in the foreign exchange

market. This feature of the leveraged spot market allows traders (both hedgers and

speculators) to achieve a specific expected return at a lower risk or a higher

expected return for a given level of risk. This makes the leveraged spot market

suitable for both risk averse and risk neutral individuals. While our hedging model

using the leveraged spot market can yield superior results when compared to

forward and money market hedges, it is vital to understand that the effectiveness of

this technique can be reduced under certain circumstances. In fact, the potential of

this model is dependant on the leverage ratio and the interest rate differentials. In

other words, the higher the leverage ratio and interest rate differentials between

nations, the greater the return. Our methodology can secure using leveraged spot

contracts.


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RESEARCH METHODOLOGY

The methodology for this research will involve primarily quantitative data analysis,

qualitative data analysis and mathematic modeling. The methodology is designed to:

Illustrate how the leveraged spot market can be utilized both as a

speculating as well as a hedging tool.

Derive insights into how real world data will affect the optimal number

of contracts that a trader should trade (or invest) at any given time.

Present a simulation model for speculation using leveraged spot

contracts based on Krugmans (1991) model of exchange rate dynamics

within a target zone.

Demonstrate how a trader can hedge an open position in the

leveraged spot market with a simultaneous position in the forward market to

generate profit.

Explain how a hedger can hedge an existing business transaction

exposure using the leveraged spot.

Data Collection

The data collected for this research are secondary data as well as primary data.

Primary Data:The qualitative data has been collected by taking face to face interviews of money

exchanger, and Bank Employees who deals in foreign exchange. The length of the

questionnaire was about 15 minutes i.e. the questionnaire contains 9 questions with

one open ended question and 8 closed ended questions. This data reveals the

prevailing speculative and hedging tools as well as strategies in India. The gathered

data has been shown through graphs in this thesis.


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Secondary Data:

They consist of real world data on interest rates for Australia, the United States (US),and Japan, and historical spot rates of the Australian dollar, the US dollar, and the

Japanese yen. The sources of these data include (but are not limited to) the

websites of Reserve Bank of Australia, the Federal Reserve Bank of New York, the

Bank of Japan, and the Australian Bureau of Statistics. Information regarding

derivative contracts specifications and features was mainly gathered from world

leading stock exchanges as the Australian Stock Exchange (ASX), the Chicago

Mercantile Exchange (CME), the Philadelphia Stock Exchange (PHLX), the New

York Mercantile Exchange (NYMEX) and the International Swaps and Derivatives

Association (ISDA). As far as the Indian Forex market is concerned the data has

been collected through the website of Reserve Bank of India.


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TABLE OF CONTENTS

Sl.No. Topic

1. Chapter 1INTRODUCTION2. Chapter 2 INDUSTRY PROFILE

3. Chapter 3 LITERATURE REVIEW

4. Chapter 4 OBJECTIVES

5. Chapter 5 METHODOLOGY

6. Chapter 6 RESULTS REPORT OF DATA COLLECTION

7. Chapter 7 RECOMMENDATIONS

8. Chapter 8 CONCLUSIONS & IMPLICATIONS

9. REFERENCES

10. Appendices QUESTIONNAIRE


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QUESTIONNAIRE

Contact Person

Phone No............................

Location ..

Designation

Q1. How many currencies you are dealing with?

Q2. Do you invest in Forex market?

o Yes o No

If yes, then please answer the following question.

Q3. How frequently you invest in the market?

o Monthly

o Quarterly

o Half Yearly

o Yearly

Q4. In how many currencies do you invest?

Q5. Do you use hedging for currency risk?


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o Yes o No

Q6. What all are the hedging tools which you use as hedging?

o Derivatives

o Forward contract

o Future contract

o options

o Speculation

o Arbitrage

o Others (please

specify)..


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Q7. How frequently do you use these tools, please rate them on 1-5 scale? 5-most

frequent, 1-less frequent.

1 2 3 4 5

Q8. Which one is the most effective tool; please rate them on 1-5 scale? 5-most

effective, 1-less effective

1 2 3 4 5

Q9. Have you find any specific or new tool for hedging in the Forex market? Please

name them.

.

Thank you, for your co-operation.


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BIBLIOGRAPHY

The Asian Crisis: Causes and Remedies, Finance & Development, Vol. 36,No. 2, June, International Monetary Fund

http://www.imf.org/external/pubs/ft/fandd/1999/06/aghevli.htm

Hedging Your Bets, Electronic Business March.http://www.eb-mag.com

Australian Stock Exchange (ASX), 2005(a), Futures: Futures Contract

Specifications, ASX

A Hedging Strategy for New Zealands Exporters in Transaction Exposure

to Currency Risk,Multinational Finance Journal, Vol.

Chicago Mercantile Exchange (CME), 2005(a), About Futures: History of

Futures, CME

Chicago Mercantile Exchange (CME), 2005(b), Trading CME FX Futures:

How CME FX Futures Work, CME

Option Pricing: A Simplified Approach,Journal of Financial Economics,

J.C., and Rubinstein, M., 1985, Options Markets Prentice Hall, New Jersey

2004, Swaps/ Financial Derivatives: Products, Pricing, Applications and Risk

Management, 3rd edn, John Wiley & Sons (Asia), Singapore

Currency Option Pricing with Mean Reversion and Uncovered Interest

Parity: A Revision of the Garman-Kohlhagen Model, European Journal of

Operational Research,

A Test of the Intertemporal CAPM in the Equity Market, Journal of

International Financial Markets,Institutions and Money

Pricing in Foreign Currency vs. U.S. dollars how is your company

managing currency risk?, AFP Exchange,
http://www.imf.org/external/pubs/ft/fandd/1999/06/aghevli.htmhttp://www.imf.org/external/pubs/ft/fandd/1999/06/aghevli.htmhttp://www.eb-mag.com/http://www.eb-mag.com/http://www.eb-mag.com/http://www.eb-mag.com/http://www.imf.org/external/pubs/ft/fandd/1999/06/aghevli.htm


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Financial Institutions and the Financial Crisis in East Asia Growth,

Repression, and Liberalisation, European Economic Review,

International Swaps and Derivatives Association (ISDA), 2002, An

Introduction to the Documentation of OTC Derivatives by Allen andOvery, ISDA

http://www.isda.org/educat/pdf/documentation_of_derivatives.pdf

International Swaps and Derivatives Association (ISDA), 2006, About ISDA,

ISDA

The Hedging Imperative: Making the Choices, Balance Sheet, Vol. 10,

No. 2, pp.32-40www.Emeraldinsight.com/0965-7967.htm

1993, The Exchange Rate, Monetary Policy, and Intervention, Reserve

Bank of India Bulletin, Dec., pp.16-25

The Practice of Central Bank Intervention: Federal Reserve Bank

New York Mercantile Exchange (NYMEX), 2005, All about Options: Options

Information: What is an Options Contract?, NYMEX

Pasminco Limited, 2001, Annual Report 2001, Pasminco Limited
http://www.isda.org/educat/pdf/documentation_of_derivatives.pdfhttp://www.isda.org/educat/pdf/documentation_of_derivatives.pdfhttp://www.emeraldinsight.com/0965-7967.htmhttp://www.emeraldinsight.com/0965-7967.htmhttp://www.emeraldinsight.com/0965-7967.htmhttp://www.emeraldinsight.com/0965-7967.htmhttp://www.isda.org/educat/pdf/documentation_of_derivatives.pdf


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GUIDES CV & CONSENT LETTER

Name : Mr.xxxxxxAddress :

Qualification : BBA & MBA.

Work Experience : (Accumulated Experience-5 years 5 months)

Organization: Icici Bank Ltd.

New Delhi.

Designation : Finance Manager,

Job Profile : Planning and development

Take responsibility for overall management and delivery of the business plan. In

conjunction with the governing body, draft, monitor and assess the business and

development plan Assess options for co-ordinating the activities, procedures and

systems so as to promote common policies and practices. Manage the development of

the service to ensure that the promotion of equality of opportunity and challenging

discrimination are central to strategic development, management and its services to

clients. Maintain day-to-day financial control of the service within budget heads agreed

by the trustee board. Ensure that all finances are properly administered and monitored,

Including credit control. Support the Honorary Treasurer in the provision of information

for the estimates. Advise on the proper allocation of resources.

Ensure that appropriate financial regulations and controls are in place and in use at all

times.

Prepare and review detailed budgets for approval by the governing body in conjunction

with the Honorary Treasurer and/or appropriate Sub-Committee.

Make regular reports to the governing body on income, expenditure and any variations

from budgets. Ensure that all financial reporting obligations are met in relation to

submissions for funding, for grant aid, for contracts and any other initiatives.


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Act as cheque signatory for and authorise expenditure up to limits as agreed by the

governing body

Mr.Varun Kumar

Documents

SYNOPSIS Foreign Exchange