BUSI 303
(Liberty University)
CURRENCY TRADING RISKS AND THEIR
MANAGEMENT
One of the critical problems a company with international enterprise may
encounter is the currency exchange fee risk. Trade risk is the probability
that a enterprise could be unable to modify fees and costs to offset
changes within the alternate rate. Fluctuations in exchange rates may
cause a loss or profit to a company. For example, if an Indian exporter
invoices exports in dollars and gets paid three months later, changes in
the dollar's value can impact the rupee equivalent of the receipts.
Assume a trade rate between the dollar and the rupee changes from $1 =
Rs. 48 to Rs. 50. If the export value was $1 million, the exporter can
receive Rs. 50 million instead of Rs. 48 million if the dollar appreciates.
However, a depreciation of the dollar would have the opposite effect.
Appreciation of the foreign currency can adversely affect importers.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
1. Trade Risk Avoidance: Conducting business locally to eliminate
trade risk.
2. Change/Diversify Sourcing: Changing the source of purchase to
countries with more favorable conditions.
3. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
4. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
An important distinction between FERA and FEMA is that while in FEMA,
only the required acts relating to forex are regulated, in FERA, anything
and everything that has to do with forex was controlled. Additionally, the
intention of FEMA is facilitating trade as against that of FERA, which was
to prevent misuse. In other words, the theme of FERA was: 'everything
that is not expressly permitted is prohibited.' While the theme of FEMA is:
'everything not expressly included is not controlled.' Hence there is a lot
of deregulations.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
5. Trade Risk Avoidance: Conducting business locally to eliminate
trade risk.
6. Change/Diversify Sourcing: Changing the source of purchase to
countries with more favorable conditions.
7. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
8. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
9. Trade Risk Avoidance: Conducting business locally to eliminate
trade risk.
10. Change/Diversify Sourcing: Changing the source of
purchase to countries with more favorable conditions.
11. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
12. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
13. Trade Risk Avoidance: Conducting business locally to
eliminate trade risk.
14. Change/Diversify Sourcing: Changing the source of
purchase to countries with more favorable conditions.
15. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
16. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
17. Trade Risk Avoidance: Conducting business locally to
eliminate trade risk.
18. Change/Diversify Sourcing: Changing the source of
purchase to countries with more favorable conditions.
19. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
20. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
21. Trade Risk Avoidance: Conducting business locally to
eliminate trade risk.
22. Change/Diversify Sourcing: Changing the source of
purchase to countries with more favorable conditions.
23. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
24. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
25. Trade Risk Avoidance: Conducting business locally to
eliminate trade risk.
26. Change/Diversify Sourcing: Changing the source of
purchase to countries with more favorable conditions.
27. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
28. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
29. Trade Risk Avoidance: Conducting business locally to
eliminate trade risk.
30. Change/Diversify Sourcing: Changing the source of
purchase to countries with more favorable conditions.
31. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
32. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
33. Trade Risk Avoidance: Conducting business locally to
eliminate trade risk.
34. Change/Diversify Sourcing: Changing the source of
purchase to countries with more favorable conditions.
35. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
36. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
37. Trade Risk Avoidance: Conducting business locally to
eliminate trade risk.
38. Change/Diversify Sourcing: Changing the source of
purchase to countries with more favorable conditions.
39. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
40. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
41. Trade Risk Avoidance: Conducting business locally to
eliminate trade risk.
42. Change/Diversify Sourcing: Changing the source of
purchase to countries with more favorable conditions.
43. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
44. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
45. Trade Risk Avoidance: Conducting business locally to
eliminate trade risk.
46. Change/Diversify Sourcing: Changing the source of
purchase to countries with more favorable conditions.
47. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
48. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
49. Trade Risk Avoidance: Conducting business locally to
eliminate trade risk.
50. Change/Diversify Sourcing: Changing the source of
purchase to countries with more favorable conditions.
51. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
52. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
53. Trade Risk Avoidance: Conducting business locally to
eliminate trade risk.
54. Change/Diversify Sourcing: Changing the source of
purchase to countries with more favorable conditions.
55. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
56. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
57. Trade Risk Avoidance: Conducting business locally to
eliminate trade risk.
58. Change/Diversify Sourcing: Changing the source of
purchase to countries with more favorable conditions.
59. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
60. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
61. Trade Risk Avoidance: Conducting business locally to
eliminate trade risk.
62. Change/Diversify Sourcing: Changing the source of
purchase to countries with more favorable conditions.
63. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
64. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
65. Trade Risk Avoidance: Conducting business locally to
eliminate trade risk.
66. Change/Diversify Sourcing: Changing the source of
purchase to countries with more favorable conditions.
67. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
68. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
69. Trade Risk Avoidance: Conducting business locally to
eliminate trade risk.
70. Change/Diversify Sourcing: Changing the source of
purchase to countries with more favorable conditions.
71. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
72. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
Types of Foreign Exchange Risks
There are two types of foreign exchange risks or exposures: financial
exposure and accounting exposure (translation exposure).
Financial Exposure
Financial exposure arises from financial transactions and other financial
activities. It focuses on the impact of an exchange rate change on future
cash flows. Financial exposure is divided into transaction exposure and
operating exposure.
Transaction Exposure: Arises from various transactions requiring
settlement in a foreign currency.
Operating Exposure: Arises due to currency fluctuations affecting a
company's future sales and expenses, considering long-term
perspectives.
Accounting Exposure (Translation Exposure)
Accounting exposure arises from the need to convert financial statements
of foreign operations to the home currency for reporting and
consolidation. The possible gains or losses due to exchange rate changes
are measured through translation exposure figures.
Strategies for Managing Exchange Rate Risks
To manage currency trading price risk, a company can employ various
strategies:
73. Trade Risk Avoidance: Conducting business locally to
eliminate trade risk.
74. Change/Diversify Sourcing: Changing the source of
purchase to countries with more favorable conditions.
75. Currency Diversification: Spreading financial assets across
multiple currencies to even out exchange rate movements.
76. Exchange Risk Hedging: Using hedging techniques such as
forward contracts, futures, and currency options to protect against
exchange rate fluctuations.
Foreign Exchange Management Act (FEMA)
FEMA, enacted in 1999, replaced the Foreign Exchange Regulation Act
(FERA). It aims to facilitate foreign trade and payments while promoting
the orderly development of the foreign exchange market. FEMA provides
guidelines for current and capital account transactions, export of goods
and services, realization and repatriation of foreign exchange, and
penalties for contraventions.
Comparison Between FERA and FEMA
FERA was a more comprehensive regulation, controlling all aspects related
to foreign exchange, while FEMA focuses only on required acts. FEMA is
more deregulated and streamlined, with fewer sections. Various provisions
of FERA have been withdrawn or simplified in FEMA.
In summary, understanding and managing currency trading risks are
crucial for companies engaged in international business, and strategies
such as hedging and diversification play a vital role in mitigating these
risks. The regulatory framework, as outlined by FEMA, provides guidelines
for conducting foreign exchange transactions and managing associated
risks.
According to the file of the Committee on Capital Account Convertibility
(CAC) appointed through the RBI underneath the chairmanship of S.S.
Tarapore, submitted on May 30, 1997, CAC refers to the freedom to
convert neighborhood financial belongings into foreign economic assets
and vice versa at marketplace decided fees of exchange. It's far related to
adjustments of possession in foreign/domestic economic property and
liabilities and embodies the introduction and liquidation of claims on, or by
way of, the rest of the arena. CAC may be, and is, coexistent with
restrictions aside from on outside payments. It additionally does now not
avert the imposition of economic/fiscal measures referring to forex
transactions which might be of a prudential nature.
Based totally on an evaluation of the macro financial situations, the
Tarapore Committee became of the considered view that the time turned
into apposite to initiate a circulate towards CAC. The Committee, however,
has pointed out that the initial conditions contained certain weaknesses
and the entrenchment of preconditions could be accomplished inside the
Indian context most effective over a time frame. Although the Committee
had laid down a 3-year road map finishing in 1999-2000 for conducting
the CAC, no big development has been tailor-made towards capital
account convertibility, especially due to the failure of the government to
fulfill the preconditions. Further, the South-East Asian monetary crisis has
tailor-made many sceptic about capital account convertibility.
Change risk management is one of the crucial issues a firm with
worldwide commercial enterprise may come upon. It involves the foreign
exchange rate risk, which is the probability that a organization may be
unable to adjust costs and prices to offset adjustments within the change
charge. There are varieties of foreign exchange dangers or exposures:
financial publicity and accounting exposure (translation exposure)
Financial exposure refers to the risks arising from financial factors through
economic transactions and other financial activities. There are two forms
of financial exposure: transaction exposure and operating exposure.
Transaction exposure arises from various forms of transactions (such as
international trade, borrowing and lending in foreign currencies, and the
local buying and sales activities of foreign subsidiaries) that require
agreement in a foreign currency. Operating exposure arises because
currency fluctuations can adjust a company's future revenues and
expenses—that is, its operating cash flows. Accounting exposure arises
from the need, for purposes of reporting and consolidation, to convert the
financial statements of foreign operations from the local currencies
involved to the home currency.
A firm needs to develop strategies for dealing with currency trading fee
risk because it is often impossible to pass along exchange rate increases
in the form of higher prices. The measures an importer can take to
overcome the effects of an appreciation of the foreign currency in which
the imports are invoiced include the following: (1) Negotiate a lower price
with the foreign supplier. (2) Absorb the cost increase by the buyer to the
extent possible and pass on the rest to the customers. (3) Take steps to
reduce exchange risk. The four most common ways of doing this are
exchange risk avoidance, changing sourcing, exchange risk model, and
currency diversification. Of these four strategies, exchange risk adaptation
is most widely used. Exchange risk avoidance is the elimination of
exchange risk by doing business domestically. For example, the negative
effects of a devaluation of the domestic currency can be mitigated by
procuring the item locally if devaluation has made domestic goods
cheaper than the foreign goods. Another strategy is to change the source
purchasing. Currency diversification is the spreading of financial assets
across several currencies so that exchange rate movements of different
currencies can be evened out, thereby effectively protecting the value of
the global company.
Exchange risk model is using hedging to provide protection against
exchange rate fluctuations. Hedging refers to covering export risks, and it
provides a mechanism to exporters and importers to shield themselves
against losses arising from fluctuations in exchange rates. In other words,
hedging a specific currency exposure means establishing an offsetting
currency position so that anything lost or gained on the original currency
exposure is exactly offset by a corresponding currency gain or loss at the
currency hedge. Giddy identifies three conditions when hedging can be
used: (1) Hedging transaction exposure: this involves buying or selling
foreign exchange for future delivery to match a known foreign currency
rate or receipt. This is commonly called financial or contractual hedging;
(2) Hedging balance-sheet exposure: this means using short-term forward
contracts to offset 'paper' profits and losses on the long-term assets and
liabilities of foreign subsidiaries; (3) Hedging financial exposure: this
involves estimating neither immediate transactions nor the accounting
exposure but instead the impact of an exchange rate change on the
company's overall profitability. Hedging instruments include forward
contracts, futures and currency options, money market hedge, hedging by
lead and lag, etc.
When a company has a portfolio of currency positions, i.e., both
receivables and payments in different currencies, it is unnecessary to
hedge every position if the adverse effects of exchange rate movements
in some cases are likely to be offset by the favorable movements in other
cases.
The Foreign Exchange Management Act (FEMA), 1999, replaced the
Foreign Exchange Regulation Act (FERA), 1973, which regulated the forex
transactions in India and which sought to control certain aspects of the
conduct of business outside the country by Indian companies and in India
by foreign companies. The FEMA, which came into effect from January 1,
2000, extends to the whole of India and also applies to all branches,
offices, and agencies outside India, owned or controlled by a person
resident in India.
The objectives of FEMA are to facilitate foreign trade and payments and to
promote the orderly development and protection of the forex market. The
Reserve Bank of India is assigned an important role in the administration
of this Act. The FEMA empowers the central government to impose
restrictions on dealings in foreign exchange and foreign security and
payments to and receipts from any person outside India. The Act imposes
regulations on individuals resident in India on acquiring, holding, or
owning foreign exchange, foreign security, and immovable property
abroad and on transfer of foreign exchange or security abroad. The FEMA
lays down that all dealings in foreign exchange or foreign security and all
payments from outside the country to India will be made only through
authorized persons, except with the general or specific permission of the
Reserve Bank. The Act also prohibits any payment outside India except
with the general or specific permission of the Reserve Bank.
The FEMA allows dealings in foreign exchange by authorized persons for
current account transactions. However, the central government can
impose reasonable restrictions in public interest. Any person may sell or
draw foreign exchange to or from an authorized person for a capital
account transaction approved by the Reserve Bank. However, the Act
empowers the RBI to impose a number of restrictions on capital account
transactions.
The FEMA permits a person resident in India to maintain, own, transfer, or
invest in foreign currency, foreign security, or any immovable property
located outside India if such currency, security, or property was acquired,
held, or owned by such person when he was resident outside India or
inherited from a person who was resident outside India. Additionally, a
person resident outside India may maintain, own, transfer, or invest in
Indian currency, security, or any immovable property located in India if
such currency, security, or property was acquired, held, or owned by such
individual when he was resident in India or inherited from a person who
was resident in India.
The Reserve Bank is empowered by this Act to prohibit, restrict, or
regulate the establishment in India of a branch, office, or other place of
business by a person resident outside India, for carrying on any activity
relating to such branch, office, or other place of business. However, the
RBI shall not impose any restriction on the drawal of foreign exchange for
payments due to amortization of loans or for depreciation of direct
investments in the normal course of business. The Act requires the
exporters to furnish to the Reserve Bank or to such other authority certain
details regarding the exports. For the purpose of ensuring that the export
value of the goods is received without any delay, the Reserve Bank may
direct any exporter to comply with such requirements as it deems fit.
Where any amount of foreign exchange is due or has accrued to any
person, he shall take all reasonable steps to realize and repatriate it to
India within the time and in the manner prescribed by the RBI. Several
exemptions are, however, granted to this clause. Under this chapter, the
penalty for any type of contravention under this Act is liable to a penalty
up to three times the amount involved where it is quantifiable or up to Rs.
2 lakhs where it is not quantifiable and where such contravention is
continuing one, further penalty which may also extend to five thousand
rupees for each day after the first day during which the contravention
continues. This provision is in total contrast to the respective provision in
the erstwhile FERA which provided for imprisonment and no limit on the
fine. Under FEMA, a person may be liable to civil imprisonment only if he
does not pay the fine within ninety days from the date of notice and that
too after formalities of show cause notice and personal hearing. If he does
not respond to the notice, there may be a warrant of arrest.
