A STUDY ON FOREX (HEDGING) AND RUPEE APPRECIATION

ABSTRACT

Today an investor is interested in tracking the value of his investment, whether he

invests directly in the market or indirectly through currency market. This dynamic change
has taken place because of a number of reasons. With globalization and the growing
competition in the investments opportunity available he would have to make guided and
rational decisions on whether he get an acceptable return on his investments in the funds
selected by him.

In order to achieve such an end the investor has to understand the basis of
appropriate preference measurement for the currency, and acquire the basic knowledge of
the different measures of evaluating the performance of the different currency in the
market. Only then would he be in a position to judge correctly whether his currency is
performing well or not and make the right decision.

The research was descriptive in nature Primary data and secondary data are
collected. The collected data was analyzed and it is evident that more returns with
minimum risk is earned from currency market than other markets.

1
TABLE OF CONTENTS

CHAPTER PAGE
TITLE
NO. NO.

INTRODUCTION AND RESAERCH DESIGN

1.1 INTRODUCTION
1
1.2 OBJECTIVE OF THE STUDY
1.3 SCOPE OF THE STUDY
1.4 RESEARCH METHODOLOGY
1.5 LIMITATION OF THE STUDY
1.6 COMPANY PROFILE

2 REVIEW OF LITERATURE

3 DATA ANALYSIS AND INTERPRETATION

FINDINGS, RECOMMENDATIONS &
CONCLUSION
4 4.1 Findings
4.2 Recommendations
4.3 Conclusion

5 BIBLIOGRAPHY

2
 6 ANNEXURE

CHAPTER 1
INTRODUCTION

Indian economy is linked to the world economy through two broad channels:
trade and finance. India’s economic policy reforms of 1991 sought to globalize the closed
Indian economy by opening up both these channels. Despite restrictions, the trade
channel between India and the rest of the world was far more open than financial
markets. Not only was the financial sector closed to international agents, the price of
capital (interest rate) or of the domestic currency (exchange rate) was not market
determined. The nineties saw twin developments in financial markets - prices were
allowed to be determined by the market, and the domestic financial market was
integrating with international financial markets. At that time, Forex trade was well
developed in India. At the end of the 20th century, there were wide discussions across
India as to what was the biggest achievement for India as a country in the 20th century.
India won Independence and crossing $100 billion in foreign exchange (Forex) reserves
were touted as the biggest achievements. Achieving new heights in terms of Forex
reserves made hearts swell with pride. By recognizing the importance of Forex market for
the growth of Indian economy, the researcher is intended to analyze the Forex market.

3
 The Foreign Exchange market, also referred to as the "Forex" or "FX" market, is
the largest financial market in the world, with a daily average turnover of approximately
US$1.5 trillion. Until now, professional traders from major international commercial and
investment banks have dominated the FX market. Other market participants range from
large multinational corporations, global money managers, registered dealers, international
money brokers, and futures and options traders, to private speculators. In finance, a hedge
is an investment that is taken out specifically to reduce or cancel out the risk in another
investment.
Hedging is a strategy designed to minimize exposure to an unwanted business
risk. There are three main reasons to participate in the FX market. One is to facilitate an
actual transaction, whereby international corporations convert profits made in foreign
currencies into their domestic currency. Corporate treasurers and money managers also
enter the FX market in order to hedge against unwanted exposure to future price
movements in the currency market. The third and more popular reason is speculation for
profit. In fact, today it is estimated that less than 5% of all trading on the FX market is
actually facilitating a true commercial transaction

Foreign Exchange is the simultaneous buying of one currency and selling of

another. The world's currencies are on a floating exchange rate and are always traded in
pairs. In every open position, an investor is long in one currency and shorts the other. FX
traders express a position in terms of the first currency in the pair. For example, someone
who has bought dollars and sold yen (USD/JPY) at 104.37 is considered to be long US
Dollars and short Yen. The most often traded or 'liquid' currencies are those of countries
with stable governments, respected central banks, and low inflation. Today, over 85% of
all daily transactions involve trading of the major currencies, including the US Dollar,
Japanese Yen, Euro, British Pound and Swiss Franc. The FX market is considered an
Over The Counter (OTC) or 'Interbank' market, due to the fact that transactions are
conducted between two counterparts over the telephone or via an electronic network.
Trading is not centralized on an exchange, as with the stock and futures markets.

4
FACTORS EFFECTING THE MARKET

Currency prices are affected by a variety of economic and political conditions,

most importantly interest rates, inflation and political stability. Moreover, governments
sometimes participate in the Forex market to influence the value of their currencies,
however, the size and volume of the Forex market makes it impossible for any one entity
to "drive" the market for any length of time.
OBJECTIVES

Primary objective:

 To analyze the perception of investors on hedging and rupee appreciation

Secondary objective:

 To understand the meaning of hedging and types.

 To analyze the relationship between Forex and Stock Market in India.

SCOPE OF STUDY

We are in a rapidly changing complex business world where the market

dynamics are changing its form minute-by-minute, hour-by-hour.From an individual
investor to corporate investor, all the market participants are exposed to the changing
dynamics and they’re by its inherent price risk. Simple remedy to mitigate such risk
could be price forecasting.Hedging can avoid or lessen a loss by making counter-
balancing investments.It gives protection against declining prices

5
RESEARCH METHODOLOGY

Nature of the Research:

The design of the study is descriptive and analytical in nature.

Sampling Design:

Sampling design of the study constitutes of two steps:

 Selection of the study area.
 Selection of the Sample size

The sampling design is considered as non-probability sampling. Convenience

sampling has been taken for conducting the survey.

Sample Size: 50

Sample Unit: Investors and Stock Brokers

Source of data

The primary data is collected through questionnaire survey, direct communication

with respondents and observation.

The Secondary data has been taken from company data base and various sites
related to forex trading.

6
Sources of Data:

For the secondary analyze the past figures and data, the following website were useful:

1. fxdaily.com

2. iforex.com

3. forex.com

4. quote.com

5. ukforex.co.uk

Data Analysis Techniques: Simple financial tool and statistical Tool.

Statistical Tool:
 Correlation Coefficient

A correlation coefficient is an index number that measures …

 The magnitude and

 The direction of the relationship between two variables

The correlation coefficient may take any value between -1.0 and +1.0.

7
 Formula for Correlation Coefficient

r= (X – X) (Y – Y)

(X – X)2 (Y – Y)2

Assumptions:  
 linear relationship between x and y
 continuous random variables
 both variables must be normally distributed
 x and y must be independent of each other

LIMITATIONS OF THE STUDY

 This study is subjected to personal basis of the analyst. Also this study
attracts the limitations of hedging like it is open to interpretation, not all
tools work; it’s too late, etc.

 Apart from this study focuses only on some of the hedging tools and dose
not study all the tools. It stresses on some of important tools and ignores
others.

 The study is done on the past data of limited time period. Hence may not be
effective in better forecasting.

8
CHAPTER-2

REVIEW OF LITERATURE

The foreign exchange market is known as FOREX. Forex is a world wide market
for buying and selling currencies. The foreign exchange (also known as "FX") market is
the place where currencies are traded. The overall forex market is the largest, most liquid
market in the world with an average traded value that exceeds $1.9 trillion per day and
includes all of the currencies in the world. There is no central marketplace for currency
exchange rather trade is conducted over-the-counter. The forex market is open 24 hours a
day, five days a week, with currencies being traded worldwide among the major financial
centers of London, New York, Tokyo, Zürich, Frankfurt, Hong Kong, Singapore, Paris
and Sydney spanning most time zones.

The forex is the largest market in the world in terms of the total cash value traded,
and any person, firm, or country may participate in this market.The foreign exchange
market began in 1971 with the abolishment of fixed currency exchanges. The forex is
comprised of around 5000 trading institutions. Even though there are many large players
in forex, it is accessible to the small investor thanks to recent changes in the regulations.

Hedge

In finance, a hedge is an investment that is taken out specifically to reduce or

cancel out the risk in another investment. Hedging is a strategy designed to minimize
exposure to an unwanted business risk, while still allowing the business to profit from an
investment activity. Typically, a hedger might invest in a security that he believes is
under-priced relative to its "fair value" (for example a mortgage loan that he is then
making), and combine this with a short sale of a related security or securities. Thus the
hedger is indifferent to the movements of the market as a whole, and is interested only in

9
the performance of the 'under-priced' security relative to the hedge. Holbrook Working, a
pioneer in hedging theory, called this strategy "speculation in the basis," where the basis
is the difference between the hedge's theoretical value and its actual value (or between
spot and futures prices in Working's time).

Some form of risk taking is inherent to any business activity. Some risks are
considered to be "natural" to specific businesses, such as the risk of oil prices increasing
or decreasing is natural to oil drilling and refining firms. Other forms of risk are not
wanted, but cannot be avoided without hedging. Someone who has a shop, for example,
expects to face natural risks such as the risk of competition, of poor or unpopular
products, and so on.

The risk of the shopkeeper's inventory being destroyed by fire is unwanted,

however, and can be hedged via a fire insurance contract. Not all hedges are financial
instruments: a producer that exports to another country, for example, may hedge its
currency risk when selling by linking its expenses to the desired currency. Banks and
other financial institutions use hedging to control their asset-liability mismatches, such as
the maturity matches between long, fixed-rate loans and short-term (implicitly variable-
rate) deposits.

Types of hedging

The example above is a "classic" sort of hedge, known in the industry as a "pairs
trade" due to the trading on a pair of related securities. As investors became more
sophisticated, along with the mathematical tools used to calculate values, known as
models, the types of hedges have increased greatly.

10
Natural hedges:

Many hedges do not involve exotic financial instruments or derivatives. A natural

hedge is an investment that reduces the undesired risk by matching cash flows, i.e.
revenues and expenses. For example, an exporter to the United States faces a risk of
changes in the value of the U.S. dollar and chooses to open a production facility in that
market to match its expected sales revenue to its cost structure. Another example is a
company that opens a subsidiary in another country and borrows in the local currency to
finance its operations, even though the local interest rate may be more expensive than in
its home country: by matching the debt payments to expected revenues in the local
currency, the parent company has reduced its foreign currency exposure.

Similarly, an oil producer may expect to receive its revenues in U.S. dollars, but
faces costs in a different currency; it would be applying a natural hedge if it agreed to, for
example, pay bonuses to employees in U.S. dollars. One of the oldest means of hedging
against risk is the purchase of protection against financial loss due to accidental property
damage or loss, personal injury, or loss of life.

Categories of hedgeable risk

For the following categories of the risk, for exporters, that the value of their
accounting currency will fall against the value of the importers, also known as volatility
risk.

 Interest rate risk

It is the risk that the relative value of an interest-bearing asset, such as
a loan or a bond, will worsen due to an interest rate increase. Interest
rate risks can be hedged using fixed income instruments or interest
rate swaps.

11
  Equity
The risk, for those whose assets are equity holdings, that the value of
the equity falls. Futures contracts and forward contracts are a means of
hedging against the risk of adverse market movements. These
originally developed out of commodity markets in the nineteenth
century, but over the last fifty years a huge global market developed in
products to hedge financial market risk.

.
Hedge Fund:

      A hedge fund is a fund that can take both long and short positions, use arbitrage, buy
and sell undervalued securities, trade options or bonds, and invest in almost any
opportunity in any market where it foresees impressive gains at reduced risk. Hedge fund
strategies vary enormously -- many hedges against downturns in the markets -- especially
important today with volatility and anticipation of corrections in overheated stock
markets. The primary aim of most hedge funds is to reduce volatility and risk while
attempting to preserve capital and deliver positive returns under all market conditions.

      There are approximately 14 distinct investment strategies used by hedge funds, each
offering different degrees of risk and return. A macro hedge fund, for example, invests in
stock and bond markets and other investment opportunities, such as currencies, in hopes
of profiting on significant shifts in such things as global interest rates and countries’
economic policies. A macro hedge fund is more volatile but potentially faster growing
than a distressed-securities hedge fund that buys the equity or debt of companies about to
enter or exit financial distress. An equity hedge fund may be global or country specific,
hedging against downturns in equity markets by shorting overvalued stocks or stock
indexes. A relative value hedge fund takes advantage of price or spread inefficiencies.

12
Knowing and understanding the characteristics of the many different hedge fund
strategies is essential to capitalizing on their variety of investment opportunities.

Overview of Hedging Strategies:

There are as many possible-hedging strategies as the creative mind can structure.
There in lays the legitimate concern that hedging strategies can be misused. Furthermore,
financial planners might fear that merely suggesting the consideration of a hedging
strategy could tarnish their reputation. Yet, once the basic strategies are understood,
clients can be educated about their ability to minimize risk, not add risk, in appropriate
situations. At their core, defensive hedging strategies transfer the risk of a price decline to
another party. Given that appreciation rates for equities the last 20 years have been well
above long-term averages, it would seem that clients and their advisors would be open to
the concept of transferring price decline risk to others, if the strategies, including costs,
are appropriate.

Short Sale:

A short-sale strategy involves selling stock borrowed from a third party. If the
stock declines in value, the stock is purchased on the open market at a lower price than
the initial sales price. The purchased stock is returned to the third party, and the
difference between the initial sales price and subsequent purchase price is taxable profit
to the short seller.The short sale can involve stock of a company currently owned in the
portfolio. This technique offers perfect correlation because there is a direct offset to
declines in the stock and increase in the short sale technique. Often called "short against
the box," this hedging technique is fairly straightforward, but has negative tax
implications (see discussion of constructive sale rules under "Tax Analysis of Hedging
Strategies") and is therefore no longer an effective hedging strategy.

13
Alternatively, the short sale can involve stock of a company in the same industry, which
has a close, but not perfect correlation to the stock that is being protected. An example of
this technique might be a client or trust that owns a very significant holding in SBC
Communications and sells short a similar amount of Verizon or Bellsouth, all three being
U.S. local telephone companies with growing wireless businesses. Yet any time
correlation is not absolute, the hedging strategy can go awry. It is impossible to hedge
perfectly against fraud or massive liability that is specific to one company.

More recently, exchange-traded index funds have been introduced that permit certain
baskets of stocks to be sold short. This can provide a more broadly diversified
correlation, such as selling short the S&P health care sector to hedge against a large
Merck position, or selling short a communications sector index to hedge against a large
SBC position.

Put Option:

The purchase of a put option permits investors to limit the downside risk of a
stock while retaining the opportunity for stock appreciation. A put option permits the
purchaser of the put option to sell a certain number of shares at a pre-determined price
(the strike price) within a pre-determined time frame.

The Primary Advantages Of A Put Option Are:

1. The investor retains the appreciation potential on the optioned stock.

2. The investor’s maximum loss on the put option is the amount paid for the put
option.

14
 3. No capital gains tax is triggered on the stock if the transaction is structured
properly.

4. As with short sales, put options can be purchased on the stock that needs
protecting (for direct price movement correlation) or can be purchased against
a similar stock or index with fairly close correlation.

5. Figure 1 illustrates how stock combined with a put option (purple line) can
protect the stock from a decline of more than five percent while permitting full
appreciation, whereas the stock alone (green dotted line) has full downside and
upside potential.

The collar:

A collar involves the purchase of a put option to protect against stock price
declines combined with the sale of a call option. As described previously, the put option
is structured to limit a price decline according to pre-negotiated terms for a cost, or a
premium. By selling a call option, the investor sells to a third party the right to purchase
the optioned stock according to pre-negotiated terms, usually with a corresponding
expiration date to the put option. The investor gives up the stock appreciation above a
certain price but receives a premium in return, which can offset the cost of purchasing the
put option. If the premium received from selling the call option completely covers the
cost of the put option the net cost of the entire hedge is zero, otherwise called a "cashless"
or "zero cost" collar. The collar (purple line) shows a floating value for the hedged stock,
with a limit on the upside and downside even though the unprotected stock price
(indicated by the green dotted line) can proceed higher or lower than the collar limits.

15
Collars can be placed on the appreciated stock for exact correlation, but there are some
tax issues to consider with collars. The tax issues applicable to collars, and other basic
hedge techniques, are discussed later in this article.

Why Hedge, Not Sell

The key question is, why not simply sell a security rather than use a hedge
strategy to protect the appreciation of a security or overall portfolio? While there are
many reasons to consider the use of hedging strategies, the primary ones include, A client
(which may be an individual or a private trust) is uncomfortable with a large percentage
of value in a single stock—that is, a concentrated portfolio—but does not wish to sell and
trigger capital gains taxes at the present time. A client has a large holding that is facing a
potentially substantial decline, but that likelihood is not certain. The holding may
continue to appreciate. Time is needed to make a good decision. A hedge may provide
time with no adverse tax consequence.

A client may own a large position in a stock that has trading restrictions due to IPO
(initial public offering) lock-up provisions, or trading restrictions imposed by the
government or the company due to insider status or other factors. An individual with a
short life expectancy due to advanced age or illness (or as spousal beneficiary of a martial
trust) may wish to protect against a decrease in stock or equity portfolio value, but does
not wish to sell because the appreciated positions would receive a step-up in basis at
death. An individual may be in need of liquidity for a new home purchase, payments to
creditors or other cash flow needs, but does not wish to trigger capital gains taxes. By
entering into a hedge strategy, the minimum value of the appreciated position can be
fixed, providing an asset that can serve as collateral for loans. Hedging Strategies Are not
considered.

16
REASON:

Many advisors to clients and trusts with taxable portfolios do not consider
hedging strategies for several reasons. There is the required time commitment, the
complexity of the issue, and the fear of what other people, including the client or other
advisors, might think of the advisor who recommends consideration of hedging strategies
(that is, reputation risk).11 An underlying trust document might restrict the use of options
and short selling. The investment guidelines of a corporate trustee might prohibit certain
hedging strategies. Also, the client might not be sophisticated enough to make an
informed decision if presented with a hedging strategy. But ignorance on the part of the
financial planner and inaccurate perceptions by others (which themselves are often based
on ignorance) should not be the reason to decline examining a legitimate risk
management tool.

The Basic Straddle Rules:

1. A straddle occurs when an investor owns stock and then enters into an offsetting
position s

2. An option on such stock or substantially identical stock.

3. A position with respect to substantially similar or related property (not including
stock). Property is substantially similar or related to stock when the fair market
value of the offsetting positions primarily reflect the performance of:

 A single firm

17
  The same industry

 The same economic factors such as interest rates, commodity prices,

or foreign currency rates (by way of illustration and not limitation)

 Furthermore, changes in fair market value of the offsetting positions

are reasonably expected to move inversely, whether as a fraction or
multiple of each other. In other words, if appreciated stock is on one
side of the teeter-totter, then a put option on the same stock or
substantially similar stock on the other side of the teeter-totter is a
straddle.

A straddle does not appear to exist with an offsetting position in substantially

similar stock. This is similar to what former Enron CEO Skilling did when he sold short
energy company AES in August 2001 while owning Enron stock. Very important, stock
acquired before January 1, 1984, is not subject to the straddle rules. For these stocks, puts
can be purchased against stock positions with identical correlation and protection, yet
without adverse tax implications under either the constructive sale or straddle rules.
There are many other hedge strategies that have straddle implications, including selling
short or buying puts on an index fund (either broad based or by sector). These strategies
have additional complexity, but can offer higher correlation than hedge strategies on one
other stock in the same industry as the appreciated stock.

Other Related Concepts

Forwards

A contracted agreement specifying an amount of currency to be delivered, at an exchange

rate decided on the date of contract.

18
Forward Rate Agreement

A contract agreement specifying an interest rate amount to be settled, at a pre-

determined interest rate on the date of the contract. This is also known as FRAs.

Currency option

A contract that gives the owner the right but not the obligation to take (call
option) or deliver (put option) a specified amount of currency, at an exchange rate
decided at the date of purchase.

Non-Deliverable Forwards (NDF)

A strictly risk-transfer financial product similar to a Forward Rate Agreement, but

only used where monetary policy restrictions on the currency in question limit the free
flow and conversion of capital. NDFs are, as the name suggests, not delivered, but rather,
these are settled in a reference currency, usually USD or EUR, where the parties
exchange the gain or loss that the NDF instrument yields, and if the buyer of the
controlled currency truly needs that hard currency, he can take the reference payout and
go to the government in question and convert the USD or EUR payout. The insurance
effect is the same, it's just that the supply of insured currency is restricted and controlled
by government.

The simple concept is that two similar investments in two different currencies
ought to yield the same return. If the two similar investments are not at face value
offering the same interest rate return, the difference should conceptually be made up by
changes in the exchange rate over the life of the investment. IRP basically gives you the
math to calculate a projected or implied forward rate of exchange. This calculated rate is
not and cannot be considered a prediction or forecast, but rather is the arbitrage-free

19
calculation for what the exchange rate is implied to be in order for it to be impossible to
make a free profit by converting money to one currency, investing it for a period, then
converting back and making more money than if you had invested in the same
opportunity in the original currency.

Hedging equity & equity futures

Equity in a portfolio can be hedged by taking an opposite position in futures. To

protect your stock picking against systematic market risk, you short futures when you buy
equity. Or long futures when you short stock. There are many ways to hedge, and one is
the market neutral approach. In this approach, an equivalent dollar amount in the stock
trade is taken in futures. Buy 10000 GBP worth of Vodafone and short 10000 worth of
FTSE futures. Another method to hedge is the beta neutral. Beta is the historical
correlation between a stock and an index. If the beta of a Vodafone is 2, then for a 10000
GBP long position in Vodafone you will hedge with a 20000 GBP equivalent short
position in the FTSE futures (the Index that Vodafone trades in).

Futures Hedging:

If you primarily trade in futures, you hedge your futures against synthetic futures.
A synthetic in this case is a synthetic future comprising a call and a put position. Long
synthetic futures means long call and short put at the same expiry price. So if you are
long futures in your trade you can hedge by shorting synthetics, and vice versa.

Currency Swap:

Is a foreign exchange agreement between two parties to exchange a given amount

of one currency for another and, after a specified period of time, to give back the original
amounts swapped. Currency swaps can be negotiated for a variety of maturities up to at

20
least 10 years. Unlike a back-to-back loan, a currency swap is not considered to be a loan
by United States accounting laws and thus it is not reflected on a company's balance
sheet. A swap is considered to be a foreign exchange transaction (short leg) plus an
obligation to close the swap (far leg) being a forward contract. Currency swaps are often
combined with interest rate swaps. For example, one company would seek to swap a cash
flow for their fixed rate debt denominated in US dollars for a floating-rate debt
denominated in Euro. This is especially common in Europe where companies "shop" for
the cheapest debt regardless of its denomination and then seek to exchange it for the debt
in desired currency.

Exchange Rate:

The exchange rate (also known as the foreign-exchange rate, forex rate or FX
rate) between two currencies specifies how much one currency is worth in terms of the
other. For example an exchange rate of 123 Japanese yen (JPY, ¥) to the United States
dollar (USD, $) means that JPY 123 is worth the same as USD 1. The foreign exchange
market is one of the largest markets in the world. The spot exchange rate refers to the
current exchange rate.

Forward Exchange:

The forward exchange rate refers to an exchange rate that is quoted and traded
today but for delivery and payment on a specific future date.

Free or pegged:

If a currency is free-floating, its exchange rate is allowed to vary against that of

other currencies and is determined by the market forces of supply and demand. Exchange

21
rates for such currencies are likely to change almost constantly as quoted on financial
markets, mainly by banks, around the world. A movable or adjustable peg system is a
system of fixed exchange rates, but with a provision for the devaluation of a currency.
For example, between 1994 and 2005, the Chinese yuan renminbi (RMB) was pegged to
the United States dollar at RMB 8.2768 to $1. The Chinese were not the only country to
do this; from the end of World War II until 1970, Western European countries all
maintained fixed exchange rates with the US dollar based on the Bretton Woods system.

Nominal and real exchange rates:

The nominal exchange rate e is the price in domestic currency of one unit of a

foreign currency. The real exchange rate (RER) is defined as , where P

is the domestic price level and P * the foreign price level. P and P * must have the same
arbitrary value in some chosen base year. Hence in the base year, RER = e. The RER is
only a theoretical ideal. In practice, there are many foreign currencies and price level
values to take into consideration. Correspondingly, the model calculations become
increasingly more complex. Furthermore, the model is based on purchasing power parity
(PPP), which implies a constant RER. The empirical determination of a constant RER
value could never be realised, due to limitations on data collection. PPP would imply that
the RER is the rate at which an organization can trade goods and services of one
economy (e.g. country) for those of another.

For example, if the price of good increases 10% in the UK, and the Japanese
currency simultaneously appreciates 10% against the UK currency, then the price of the
good remains constant for someone in Japan. The people in the UK, however, would still
have to deal with the 10% increase in domestic prices. It is also worth mentioning that
government-enacted tariffs can affect the actual rate of exchange, helping to reduce price
pressures. PPP appears to hold only in the long term (3–5 years) when prices eventually

22
correct towards parity. More recent approaches in modelling the RER employ a set of
macroeconomic variables, such as relative productivity and the real interest rate
differential.

Interest Rate Parity

Interest rate parity (IRP) states that an appreciation or depreciation of one

currency against another currency might be neutralized by a change in the interest rate
differential. If US interest rates exceed Japanese interest rates then the US dollar should
depreciate against the Japanese yen by an amount that prevents arbitrage. The future
exchange rate is reflected into the forward exchange rate stated today. In our example, the
forward exchange rate of the dollar is said to be at a discount because it buys fewer
Japanese yen in the forward rate than it does in the spot rate. The yen is said to be at a
premium. IRP showed no proof of working after 1990s. Contrary to the theory, currencies
with high interest rates characteristically appreciated rather than depreciated on the
reward of the containment of inflation and a higher yielding currency.

Balance Of Payments Model

This model holds that a foreign exchange rate must be at its equilibrium level -
the rate which produces a stable current account balance. A nation with a trade deficit
will experience reduction in its foreign exchange reserves which ultimately lowers
(depreciates) the value of its currency. The cheaper currency renders the nation's goods
(exports) more affordable in the global market place while making imports more
expensive. After an intermediate period, imports are forced down and exports rise, thus
stabilizing the trade balance and the currency towards equilibrium. Like PPP, the balance
of payments model focuses largely on tradable goods and services, ignoring the
increasing role of global capital flows. In other words, money is not only chasing goods
and services, but to a larger extent, financial assets such as stocks and bonds. Their flows

23
go into the capital account item of the balance of payments, thus, balancing the deficit in
the current account. The increase in capital flows has given rise to the asset market
model.

Asset market model

The explosion in trading of financial assets (stocks and bonds) has reshaped the
way analysts and traders look at currencies. Economic variables such as economic
growth, inflation and productivity are no longer the only drivers of currency movements.
The proportion of foreign exchange transactions stemming from cross border-trading of
financial assets has dwarfed the extent of currency transactions generated from trading in
goods and services. The asset market approach views currencies as asset prices traded in
an efficient financial market. Consequently, currencies are increasingly demonstrating a
strong correlation with other markets, particularly equities. Like the stock exchange,
money can be made or lost on the foreign exchange market by investors and speculators
buying and selling at the right times. Currencies can be traded at spot and foreign
exchange options markets. The spot market represents current exchange rates, whereas
options are derivatives of exchange rates.

Fluctuations in Exchange Rates:

A market based exchange rate will change whenever the values of either of the
two component currencies change. A currency will tend to become more valuable
whenever demand for it is greater than the available supply. It will become less valuable
whenever demand is less than available supply (this does not mean people no longer want
money, it just means they prefer holding their wealth in some other form, possibly
another currency). Increased demand for a currency is due to either an increased
transaction demand for money, or an increased speculative demand for money. The

24
transaction demand for money is highly correlated to the country's level of business
activity, gross domestic product (GDP), and employment levels. The more people there
are out of work, the less the public as a whole will spend on goods and services. Central
banks typically have little difficulty adjusting the available money supply to
accommodate changes in the demand for money due to business transactions. The
speculative demand for money is much harder for a central bank to accommodate but
they try to do this by adjusting interest rates. An investor may choose to buy a currency if
the return (that is the interest rate) is high enough. The higher a country's interest rates,
the greater the demand for that currency. It has been argued that currency speculation can
undermine real economic growth, in particular since large currency speculators may
deliberately create downward pressure on a currency in order to force that central bank to
sell their currency to keep it stable (once this happens, the speculator can buy the
currency back from the bank at a lower price, close out their position, and thereby take a
profit).

In choosing what type of asset to hold, people are also concerned that the asset
will retain its value in the future. Most people will not be interested in a currency if they
think it will devalue. A currency will tend to lose value, relative to other currencies, if the
country's level of inflation is relatively higher, if the country's level of output is expected
to decline, or if a country is troubled by political uncertainty. For example, when Russian
President Vladimir Putin dismissed his Government on February 24, 2004, the price of
the ruble dropped. When China announced plans for its first manned space mission,
synthetic futures on Chinese yuan jumped (since China's currency is officially pegged,
synthetic markets have emerged that can behave as if the yuan were floating).

Foreign Exchange Markets:

The foreign exchange markets are usually highly liquid as the world's main
international banks provide a market around-the-clock. The Bank for International

25
Settlements reported that global foreign exchange market turnover daily averages in April
was $650 billion in 1998 (at constant exchange rates) and increased to $1.9 trillion in
2004 (Triennial Central Bank Survey of Foreign Exchange and Derivatives Market
Activity 2004 - Final Results). The biggest foreign exchange trading centre is London,
followed by New York and Tokyo. Trade in global currency markets has soared over the
past three years and is now worth more than $3.2 trillion a day (Source:Guardian
September 26, 2007)

Foreign-Exchange Risk

1. The risk of an investment's value changing due to changes in currency exchange

rates. 

2. The risk that an investor will have to close out a long or short position in a foreign
currency at a loss due to an adverse movement in exchange rates. Also known as
"currency risk" or "exchange-rate risk".

This risk usually affects businesses that export and/or import, but it can also affect
investors making international investments. For example, if money must be converted to
another currency to make a certain investment, then any changes in the currency
exchange rate will cause that investment's value to either decrease or increase when the
investment is sold and converted back into the original currency. 

Key Characteristics of Hedge Funds

 Hedge funds utilize a variety of financial instruments to reduce risk,

enhance returns and minimize the correlation with equity and bond
markets. Many hedge funds are flexible in their investment options

26
(can use short selling, leverage, derivatives such as puts, calls, options,
futures, etc.).

 Hedge funds vary enormously in terms of investment returns,

volatility and risk. Many, but not all, hedge fund strategies tend to
hedge against downturns in the markets being traded.

 Many hedge funds have the ability to deliver non-market correlated

returns.

 Many hedge funds have as an objective consistency of returns and

capital preservation rather than magnitude of returns.

 Experienced investment professionals who are generally disciplined

and diligent manage most hedge funds.

 Pension funds, endowments, insurance companies, private banks

and high net worth individuals and families invest in hedge funds to
minimize overall portfolio volatility and enhance returns.

 Most hedge fund managers are highly specialized and trade only
within their area of expertise and competitive advantage.

 Hedge funds benefit by heavily weighting hedge fund managers’

remuneration towards performance incentives, thus attracting the
best brains in the investment business. In addition, hedge fund
managers usually have their own money invested in their fund.

27
Facts about The Hedge Fund Industry:

 Estimated to be a $1 trillion industry and growing at about 20% per year with
approximately 8350 active hedge funds.

 Includes a variety of investment strategies, some of which use leverage and

derivatives while others are more conservative and employ little or no leverage.
Many hedge fund strategies seek to reduce market risk specifically by shorting
equities or through the use of derivatives.

 Most hedge funds are highly specialized, relying on the specific expertise of the
manager or management team.

 Performance of many hedge fund strategies, particularly relative value strategies,

is not dependent on the direction of the bond or equity markets -- unlike
conventional equity or mutual funds (unit trusts), which are generally 100%
exposed to market risk.

 Many hedge fund strategies, particularly arbitrage strategies, are limited as to how
much capital they can successfully employ before returns diminish. As a result,
many successful hedge fund managers limit the amount of capital they will
accept.

 Hedge fund managers are generally highly professional, disciplined and diligent.

 Their returns over a sustained period of time have outperformed standard equity
and bond indexes with less volatility and less risk of loss than equities.

 Beyond the averages, there are some truly outstanding performers.

28
  Investing in hedge funds tends to be favored by more sophisticated investors,
including many Swiss and other private banks, that have lived through, and
understand the consequences of, major stock market corrections.

 An increasing number of endowments and pension funds allocate assets to hedge

funds

Benefits of Hedge Funds

 Many hedge fund strategies have the ability to generate positive returns in
both rising and falling equity and bond markets.

 Inclusion of hedge funds in a balanced portfolio reduces overall portfolio

risk and volatility and increases returns.

 Huge variety of hedge fund investment styles – many uncorrelated with

each other – provides investors with a wide choice of hedge fund strategies
to meet their investment objectives.

 Academic research proves hedge funds have higher returns and lower
overall risk than traditional investment funds.

 Hedge funds provide an ideal long-term investment solution, eliminating

the need to correctly time entry and exit from markets.

 Adding hedge funds to an investment portfolio provides diversification not

otherwise available in traditional investing.

29
Hedge Fund Styles

The predictability of future results shows a strong correlation with the volatility of
each strategy. Future performance of strategies with high volatility is far less predictable
than future performance from strategies experiencing low or moderate volatility.

Aggressive Growth:

Invests in equities expected to experience acceleration in growth of earnings per

share. Generally high P/E ratios, low or no dividends; often smaller and micro cap stocks
which are expected to experience rapid growth. Includes sector specialist funds such as
technology, banking, or biotechnology. Hedges by shorting equities where earnings
disappointment is expected or by shorting stock indexes. Tends to be "long-biased."

Distressed Securities:

Buys equity, debt, or trade claims at deep discounts of companies in or facing

bankruptcy or reorganization. Profits from the market's lack of understanding of the true
value of the deeply discounted securities and because the majority of institutional
investors cannot own below investment grade securities. (This selling pressure creates the
deep discount.) Results generally not dependent on the direction of the markets

Emerging Markets:

Invests in equity or debt of emerging (less mature) markets that tend to have
higher inflation and volatile growth. Short selling is not permitted in many emerging
markets, and, therefore, effective hedging is often not available, although Brady debt can
be partially hedged via U.S. Treasury futures and currency markets.

30
Funds of Hedge Funds:

Mix and match hedge funds and other pooled investment vehicles. This blending
of different strategies and asset classes aims to provide a more stable long-term
investment return than any of the individual funds. Returns, risk, and volatility can be
controlled by the mix of underlying strategies and funds. Capital preservation is generally
an important consideration. Volatility depends on the mix and ratio of strategies
employed.

Income:

Invests with primary focus on yield or current income rather than solely on
capital gains. May utilize leverage to buy bonds and sometimes fixed income derivatives
in order to profit from principal appreciation and interest income.

Macro:

Aims to profit from changes in global economies, typically brought about by

shifts in government policy that impact interest rates, in turn affecting currency, stock,
and bond markets. Participates in all major markets -- equities, bonds, currencies and
commodities -- though not always at the same time. Uses leverage and derivatives to
accentuate the impact of market moves. Utilizes hedging, but the leveraged directional
investments tend to make the largest impact on performance.

Market Neutral - Arbitrage:

Attempts to hedge out most market risk by taking offsetting positions, often in
different securities of the same issuer. For example, can be long convertible bonds and
short the underlying issuers equity. May also use futures to hedge out interest rate risk.

31
Focuses on obtaining returns with low or no correlation to both the equity and bond
markets. These relative value strategies include fixed income arbitrage, mortgage backed
securities, capital structure arbitrage, and closed-end fund arbitrage

Market Neutral - Securities Hedging:

Invests equally in long and short equity portfolios generally in the same sectors
of the market. Market risk is greatly reduced, but effective stock analysis and stock
picking is essential to obtaining meaningful results. Leverage may be used to enhance
returns. Usually low or no correlation to the market. Sometimes uses market index
futures to hedge out systematic (market) risk. Relative benchmark index usually T-bills.

Market Timing:

Allocates assets among different asset classes depending on the manager's view of
the economic or market outlook. Portfolio emphasis may swing widely between asset
classes. Unpredictability of market movements and the difficulty of timing entry and exit
from markets add to the volatility of this strategy.

Opportunistic:

Investment theme changes from strategy to strategy as opportunities arise to profit

from events such as IPOs, sudden price changes often caused by an interim earnings
disappointment, hostile bids, and other event-driven opportunities. May utilize several of
these investing styles at a given time and is not restricted to any particular investment
approach or asset class.

32
Multi Strategy:

Employing various strategies simultaneously to realize short- and long-term gains

diversifies investment approach. Other strategies may include systems trading such as
trend following and various diversified technical strategies. This style of investing allows
the manager to overweight or underweight different strategies to best capitalize on
current investment opportunities

Short Selling:

Sells securities short in anticipation of being able to rebuy them at a future date at
a lower price due to the manager's assessment of the overvaluation of the securities, or
the market, or in anticipation of earnings disappointments often due to accounting
irregularities, new competition, change of management, etc. Often used as a hedge to
offset long-only portfolios and by those who feel the market is approaching a bearish
cycle. High risk.

Special Situations:

Invests in event-driven situations such as mergers, hostile takeovers,

reorganizations, or leveraged buyouts. May involve simultaneous purchase of stock in
companies being acquired, and the sale of stock in its acquirer, hoping to profit from the
spread between the current market price and the ultimate purchase price of the company.
May also utilize derivatives to leverage returns and to hedge out interest rate and/or
market risk. Results generally not dependent on direction of market.

33
Value:

Invests in securities perceived to be selling at deep discounts to their intrinsic or

potential worth. Such securities may be out of favor or underfollowed by analysts. Long-
term holding, patience, and strong discipline are often required until the ultimate value is
recognized by the market.

How does the FOREX market work?

Currencies are always traded in pairs – the US dollar against the Japanese yen, or
the English pound against the euro. Every transaction involves selling one currency dollar
and buying another, so if an investor believes the euro will gain against the dollar, he will
sell dollars and buy euros.

The potential for profit exists:

Because there is always movement between currencies. Even small changes can
result in substantial profits because of the large amount of money involved in each
transaction. At the same time, it can be a relatively safe market for the individual
investor. There are safeguards built in to protect both the broker and the investor and a
number of software tools exist to minimize loss.

Advantages of trading in Forex:

Liquidity- because of the size of the Foreign Exchange Market, investments are
extremely liquid.

34
  Accessibility
The market is open 24 hrs a day, 5 days a week. The market opens
Monday Australian time and closes Friday afternoon New York
time. Trades can be done on the internet from your home or office.

 Open market
Currency fluctuations are usually caused by changes in national
economies. News about these changes is accessible to everyone at
the same time there can be no “insider trading” in FOREX.

 No commission
Broker earns money by setting a spread – the difference between
what a currency can be bought at and what it can be sold at.

Rupee Appreciation:

India witnessed second highest appreciation in its currency of 8.35% between

January and June 2008 after 9.28% of Brazil among emerging economies that are in
direct competition with Indian exporters and find they better off due to sharp rise in rupee
value, revealed ASSOCHAM Eco pulse study. The Indian rupee has appreciated by
around 8.35% , Brazil by 9.28%,thai by 7.56% , Russia by 2.08%, Malaysia by 1.98% ,
China by 1.82%,whereas the appreciation in Singapore , Bangladesh ,Indonesia ,Pakistan
and South Korea is less than 1% and quiet insignificant. According to the study, the
major export sectors that come directly under appreciation threat are IT services, textile,
leather, sugar and pharmaceuticals.

While the rupee's rise has helped some exporters to rein in costs and increase their
competitiveness in the global market, in general, profit margins have eroded. Indian
importers, borrowers of foreign currency and the consumer have, however, all gained.

35
The clamour for government intervention to depreciate the rupee thus seems overdone.

APPRECIATION

Appreciation is an art, and a fine one at that. Through aeons of human history
much thought and effort have been invested in perfecting it. The finely turned
compliment, the winner's laurel wreath, the perfect rose, the solitary diamond, the garland
of beautiful flowers are all forms of appreciation which have been honed through the
centuries. While appreciation is a fine art, knowing how to accept appreciation gracefully
is an even greater art. The angst voiced at the rupee's appreciation in newspaper columns
and seminars conducted by industry and exporter bodies seem to fly in the face of the
time honored cultural habit of accepting appreciation gracefully. Normally, currencies
appreciate when the economies are doing well and the rise in their values is a cause for
celebration. The high value of the deutsche mark when Germany was the trendsetter for
the world economy in the 1960s and the 1970s, the high value of the yen in the 1980s
when Japan Inc seemed set to take over the world and the dollar's high value in the later
1990s when the US new economy brooked no competition were sources of immense
pride for their respective countries.

An appreciating currency is the natural corollary of a booming economy with

rising exports and is normally looked on favorably. The high-decibel lamentation over
the rupee's appreciation, therefore, needs closer examination. Has the rupee really
appreciated? Taken over a three-year frame, from June 2000 to September 2003, the
conclusion is a firm no. The rupee depreciated by 1.69 per cent against the dollar, by
24.13 per cent against the euro, by 12.19 per cent against the pound, and appreciated by
1.79 per cent against the yen during the period. Narrowing the period to May 2002, when
the rupee hit its low against the dollar, to mid-October, 2003 the result is mixed, with the

36
rupee appreciating by 7.30 per cent against the dollar, and depreciating by 18 per cent
against the euro, by 6.12 per cent against the pound and by 7.28 per cent against the yen.
In both periods the rupee appreciated only against one of the major international
currencies in which India's foreign trade is mainly denominated. The rupee is now seen to
be fairly valued on trade weighted REER terms.

The causes for rupee's appreciation after years of continuous depreciation are
readily apparent. The current account surplus for the first time in years (it has since
reversed), due to increased merchandise exports and invisibles, has resulted in supplies of
foreign currency going up sharply. The huge FII inflows into financial asset markets
(over $3.9 billion net inflows in the first 10 months of this fiscal), and increasing reliance
on low cost foreign loans (the RBI has approved ECB borrowings to the tune of $1.7
billion in the April June quarter alone) add to the supply glut, and help power the rupee
higher. The rupee's appreciation is a result of forces of demand and supplies operating in
the forex markets and involves no cost to the exchequer. The heartburn on the rupee's
appreciation against the dollar is due to the fact that most of India's external trade is
invoiced in dollars and any change in the dollar's rupee value has a disproportionate
effect on the various stakeholders in the rupee's external value such as importers,
exporters, borrowers, lenders and consumers of imported goods.

The differing impact of the changes in the rupee's value on various stakeholders
explains the sudden outcry against appreciation. Importers and borrowers in foreign
currency are delighted with the rupee's appreciation to the dollar as most imports and
external borrowings are denominated in dollars. The Indian consumer is a big beneficiary
too, as costs of a host of imported goods; from petro products to electronic, electrical and
consumer items would be higher but for the rupee's appreciation. The rupee's appreciation
is one of the reasons for the current low inflation rate. The effect of the rupee's
appreciation is not marginal as according to the World Bank, imports account for about
16 per cent of India's GDP. Importers, borrowers in foreign currency and the average

37
Indian consumer are the unambiguous gainers from the rupee's appreciation.

Since Indian lenders in foreign currency normally hedge their exposures, the brunt of the
negative effects of the rupee's appreciation falls on exporters, giving rise to calls for
government action to depreciate the rupee. However, the effect on exporters too is not all
negative.

With increasing global integration an ever-increasing proportion of exports

consist of imported raw materials and components. This is particularly true of the
diamond, high-end textile and engineering industries that use a high proportion of
imported goods in their exports. The rupee's rise has helped these exporters to rein in
their costs and increased their competitiveness in the global market place. However,
exporters, in general, have seen their profit margins erode as a result of the rupee's
unexpected appreciation. Though exporters have seen their profit margins shrink, exports
on the whole do not seem to have been affected seriously the rupee's appreciation. The
slowdown in exports in the past few years has been more due to global economic
conditions than due to the rupee's rise. Exports in dollar terms grew by an impressive17.2
per cent in 1999-2000 when the rupee depreciated by 2.90 per cent. For the period 2000-
01, when the rupee depreciated by 7.07 per cent, exports grew by a slow 1.7 per cent. In
2001-02, when the rupee depreciated by 4.78 per cent, exports crawled up 1.74 per cent.

The trend continued in 2002-03. Contrary to expectations, however, exports

registered their highest growth of 11.06 per cent in the April-June 2003 quarter when the
rupee appreciated by a high 2.11 per cent. For the period April-August 2003, for which
provisional figures are available, exports grew 8.99 per cent in dollar terms. Available
data do not support the claim that the appreciating rupee has affected Indian exports.
Another claim being loudly bruited is that exports have suffered because the currencies of
our main Asian competitors have depreciated and but for the rupee's rise exports would
have been much higher. This claim too does not hold water. Since the rupee hit its low in

38
May 2002, it has appreciated by 7.30 per cent, while the Pakistani rupee has appreciated
by 3.97 per cent, the Korean won by 8.56 per cent, the Indonesian rupiah by 8.93 per cent
and the Thai baht by 7.07 per cent.. Against the yuan and the ringitt too it cannot be said
that the Indian exports have suffered due to the rupee's appreciation because in the post-
Asian crisis period from 1998 to May 2002 these currencies remained steady while the
rupee depreciated by about 25 per cent to the dollar.

In this period, when Indian exports should have gained a competitive advantage
of 25 per cent compared to Chinese and Malaysian exports, both Chinese exports (by a
large margin) and Malaysian exports (by a narrow margin) outperformed India. Data
again do not support the claim that Indian exports would have been much higher had the
rupee not appreciated. Statistics seem to prove that the rupee’s rise, and Indian importers,
borrowers of foreign currency and the Indian consumer have not affected Indian exports
seriously have all gained. The clamour for government intervention to depreciate the
rupee seems overdone. However, as the rupee continues to rise, the demands for
intervention are likely to become shriller. An artificially managed depreciation would
result in higher cost to Indian importers and to the consumer in exchange for a probable
boost to exports.Much needed public money would go to transferring cash flows from
importers and consumers to exporters leading to a misallocation of resources.

Market forces if left unhindered will soon correct the imbalance arising out of the
rupees current rise. The inward flow of foreign currency will not continue indefinitely.
Loans will have to be repaid and FII investments can reverse. A dearer rupee will make
imports more attractive leading to increased demand for foreign currencies and
eventually a fall in the value of the rupee. The start of such a process is already evident.
Imports grew by a rapid 22.14 per cent in April-August 2003. Non-oil imports, made
attractive by the rupee's current levels and fuelled by an expanding economy, grew by a
high 28.35 per cent in the same period. The markets have already begun the work of
correcting the imbalances and given time will settle at a new equilibrium.

39
Intervening to artificially depreciate the rupee will involve outlay of public funds which
can be better used elsewhere. And as data show, this may not result in any appreciable
rise in exports as the past slowdown in export growth was determined by global
economic conditions and not only by the rupee's value. The rupee's value seems to have
but a marginal effect on export performance. The rupee, with centuries of history behind
it, is capable of depreciating with elegance and appreciating with grace. If only we would
let it.

Reasons for rupee appreciation:

The main reason for rupee appreciation since late 2006 has been flood of foreign
exchange inflows, especially US dollars. The surge of capital & other inflows into India
has taken a variety of forms ranging from foreign direct investment (FDI) to remittances
sent home by Indian expatriates. The main impact of these various types of flows is as
follows:

1. FDI
2. External Commercial Borrowings
3. Foreign Portfolio Inflows
4. Investment & Remittances

40
CHAPTER 3

DATA ANALYSIS & INTERPRETATION

Reason for Appreciation

Particulars No.of Respondent Percentage

Service Industry 25 50
Manufacturing 7 14
Both 18 36

Reason for Appreciation

3.5 36%
3

2.5
14%
2 Percentage
1.5 50%

0.5

0
Service Industry Manufacturing Both

Inference:
50% of the contribution towards the appreciation has been given by the
service industries alone.
Credit for Rupee Appreciation:

41
Credit for Appreciation No:of Respondent Percentage
RBI Reforms 12 24
Booming Economy 30 60
Capital Inflow/outflow 8 16

Credit For Rupee Appreciation

24 16
Captial Inflow/Outflow
Booming Economy
RBI Reforms
60

Inference:

It is been found in the survey that Booming Economy is reason for the Rupee
Appreciation

Measures to be taken by RBI to correct trend in economy

42
 Percentage

30
25
20
15
10
5
0
Apprecia Reduce
Both Any One
tion go Int. Rate
Percentage 30 26 28 16

Inference:

Maximum of the respondents had suggested to allow appreciation go up and

with a slight difference followed by mixed action to correct the economy

43
Whether to allow Further FDI

Particulars No:of Respondent Percentage

Yes 36 72

No 14 28

Whether to allow Further FDI

80
70
60
percentage
50
40
30
20
10
0
Yes No

Inference:

Maximum of the respondents are in supportive of further FDI.

44
Secondary Analysis:

Hedging is a practice done to reduce the risk, by locking the price at the spot price
(current price) to meet the futures requirement.

Hedge Ratio:

A ratio comparing the value of a position protected via a hedge with the size of the

entire position itself.

Amount Hedged / Total Amount Invested

Other related formula:

Sterling Ratio:

Compounded Annual Return

_______________________________

Average Maximum Draw down- 10%

Compound Annual Growth Rate – CAGR

Example to calculate Hedging Ratio:

45
A person is holding Rs.10, 000 in foreign equity, which exposes his to currency risk. If he
hedges Rs.5, 000 worth of the equity with a currency position.

Hedge ratio = 5000 / 10000

=0.5
Therefore we say that 50% of his equity position is sheltered from exchange rate risk.

Example to calculate Compound Annual Growth Rate:

We invested Rs.10, 000 in a portfolio on Jan 1, 2005. Let's say by Jan 1, 2006, your
portfolio had grown to Rs.13, 000, then Rs.14, 000 by 2007, and finally ended up at
Rs.19, 500 by 2008.

CAGR =(Rs.19, 500 / Rs.10, 000 = 1.95) raised to the power of 1/3 (since 1/# of years =
1/3), then subtracting 1 from the resulting number:
1.95 rose to 1/3 power = 1.2493. 1.2493 - 1 = 0.2493
0.2493 is 24.93%. Thus, your CAGR for your three-year investment is equal to 24.93%,

RELATIONSHIP BETWEEN FOREX MARKET AND STOCK MARKET IN

INDIA

Relationship Between The Stock Market Price Index And The Exchange Rate In Terms
Of USD

To test the relationship between the stock market index and exchange rate (in
terms of USD), the monthly average BSE 100 index and monthly average of exchange
rate in terms of USD have been collected. The Karl Person Coefficient of Correlation has

46
 been used to find out the relationship between the above two variables. To test the
statistical relationship between those variables student t distribution test is used. The
values and the results are presented in the Table .

RELTIONSHIP BETWEEN THE STOCK MARKET PRICE INDEX AND THE

EXCHANGE RATE IN TERMS OF USD

Month BSE USD Month BSE USD Month BSE USD

Index $ Index $ Index $
(Rs.) (Rs.) (Rs.)
Apr-07 3042.03 43.93 Jul-05 4046.72 43.54 Oct-06 6909.72 45.47
May-07 2533.57 45.25 Aug-05 4154.2 43.62 Nov-06 7003.56 44.85
Jun-07 2590.84 45.51 Sep-05 4576.91 43.92 Dec-06 7218.08 44.64
Jul-07 2738.4 46.04 Oct-05 4072.27 44.82 Jan-07 6606.14 44.33
Aug-07 2787.23 46.34 Nov-05 4732.11 45.73 Feb-07 6555.49 44.16
Sep-07 2980.38 46.1 Dec-05 4918.27 45.64 Mar-07 6806.20 44.03
Oct-07 3052.37 45.78 Jan-06 5205.53 44.4 Apr-07 7244.49 42.15
Nov-07 3324.96 45.13 Feb-06 5403.74 44.33 May-07 7392.34 40.78
Dec-07 3545.05 43.98 Mar-06 5907.97 44.48 Jun-07 7897.30 40.77
Jan-08 3469.12 43.75 Apr-06 6164.51 44.95 Jul-07 7594.81 40.41
Feb-08 3552 43.68 May-06 5523.41 45.41 Aug-07 8310.95 40.82
Mar-08 3433.54 43.69 Jun-06 5230.07 46.06 Sep-07 9587.50 40.34
Apr-08 3377.75 43.74 Jul-06 5425.55 46.46 Oct-07 10203.18 39.51
May-08 3573.75 43.49 Aug-06 5977.07 46.54 Nov-07 10789.70 39.44
Jun-08 3787.3 43.58 Sep-06 6307.44 46.12 Dec-07 6909.72 39.44
Karl Pearson coefficient of correlation -0.675035505

The Table explains the relationship between the stock market price index and the
exchange rate in USD has been presented. For that, Karl Pearson coefficient of
correlation is used. The correlation coefficient of the above variables is recorded as
-0.675. This shows that there was a negative relationship between the Forex in terms of

47
USD and the stock market price index. From the result it can be inferred that the
relationship is poor between the Indian stock market and the Forex market in terms of
USD.
Testing of Hypothesis:

To test whether there is any significant relationship between the correlated value
and the population value of the stock prices and the exchange rates in terms of USD t-test
has been used.

NULL HYPOTHESIS:

There is no significant relationship between the correlated value and the population
value of the stock prices and the exchange rates in terms of USD.
The above hypothesis is tested by using the following formula.
r
X √n−2
2
t = √1−r
where,
‘r’ represents the correlated value between the stock market price
index and the exchange rate in terms of USD.
‘n’ represents the study period taken for the analysis.
−0.675
X √ 45−2
t = √1−(−0.675)2

48
 The calculated value, -5.99 is less than the Table value 2.173. Hence the
hypothesis is accepted. This shows that there is no significant relationship between the
correlated value and the population value of stock prices and exchange rates in terms of
USD. Like wise the relationship is to be tested between the stock market price index and
the exchange rate in terms of EUR.

RELTIONSHIP BETWEEN THE STOCK MARKET PRICE INDEX

AND THE EXCHANGE RATE IN TERMS OF EUR

To test the relationship between the stock market index and exchange rate (in
terms of EUR), the monthly average BSE 100 index and monthly average
of exchange rate in terms of EUR have been collected. To find out the
relationship between the above two variables, the Karl person coefficient
of correlation has been used. To test the statistical significance between
those variables student t distribution test has been used. The collected
values and the result of the analysis are presented in the Table .

RELTIONSHIP BETWEEN STOCK MARKET PRICE INDEX AND

EXCHANGE RATE IN TERMS OF EUR

Month BSE EUR Month BSE EUR Month BSE EUR

Index Index Index
(Rs.) (Rs.) (Rs.)
Apr-07 3042.03 52.66 Jul-05 4046.72 52.45 Oct-06 6909.72 57.39
May-07 2533.57 54.35 Aug-05 4154.2 53.59 Nov-06 7003.56 57.75
Jun-07 2590.84 55.25 Sep-05 4576.91 53.83 Dec-06 7218.08 58.99
Jul-07 2738.4 56.51 Oct-05 4072.27 53.91 Jan-07 6606.14 57.67
Aug-07 2787.23 56.43 Nov-05 4732.11 53.93 Feb-07 6555.49 57.74
Sep-07 2980.38 56.27 Dec-05 4918.27 54.12 Mar-07 6806.20 58.27
Oct-07 3052.37 57.19 Jan-06 5205.53 53.75 Apr-07 7244.49 56.96

49
 Nov-07 3324.96 58.51 Feb-06 5403.74 52.99 May-07 7392.34 55.11
Dec-07 3545.05 58.95 Mar-06 5907.97 53.46 Jun-07 7897.30 54.71
Jan-08 3469.12 57.52 Apr-06 6164.51 55.15 Jul-07 7594.81 55.43
Feb-08 3552 56.87 May-06 5523.41 57.97 Aug-07 8310.95 55.65
Mar-08 3433.54 57.66 Jun-06 5230.07 58.34 Sep-07 9587.50 56.03
Apr-08 3377.75 56.62 Jul-06 5425.55 58.96 Oct-07 10203.18 56.22
May-08 3573.75 55.26 Aug-06 5977.07 59.62 Nov-07 10789.70 57.92
Jun-08 3787.3 53.04 Sep-06 6307.44 58.76 Dec-07 6909.72 57.51
Karl Pearson coefficient of correlation
0.233026818

The Table gives the details of the relationship between the stock market price
index and the exchange rate in EUR terms. For the purpose of finding out the relationship
between the stock market and the Forex market, Karl Pearson coefficient of correlation
has been used. The correlation coefficient of the above variables is recorded as 0.233.
This shows that there was a positive relationship between Forex in terms of EUR and
stock market. Since the correlation coefficient is less than 0.5, there exists a low degree
relationship between those variables.

Testing of Hypothesis:

To test whether there is any significant relationship between the correlated value
and the population value of the stock price index and the exchange rates in terms of EUR,
student ‘t’ distribution test has been used.
NULL HYPOTHESIS
There is no significant relationship between the correlated value and the population
value of the stock market index and the exchange rates in terms of EUR.
The above hypothesis is tested by using the following formula.
r
X √n−2
2
t = √ 1−r
where

50
 ‘r’ represents the correlated value between stock market price
index and the exchange rate in terms of USD.
‘n’ represents the number of study period taken for the analysis.
0.233
X √ 45−2
t = √1−(0.233)2
The calculated value, 1.571317 is less than the Table value 2.173. Hence the
hypothesis is accepted. This shows that there is no significant relationship between the
correlated value and the population value of stock prices and exchange rates in terms of
EUR. In the subsequent section, the relationship between the stock market price index
and the exchange rate in terms of GBP has been tested.

51
FINDINGS

 In the last six years, from 2002-03 to 2008-09, trading volume in the foreign
exchange market This is in keeping with global patterns. Trend in turnover of
forex purchase and sale is analysed in the present study.. The trend in turnover in
forex market through interbank transactions has been continuously increasing. .

 However, the inter-bank to merchant turnover ratio in sale has declined from 4.81
to 2.68

 In the year 1997-98, the ratio was 6.69 and in 2008-09, the ratio was reduced to
half of the former, 2.63.

Top 6 Most Traded Currencies

Rank Currency Code Symbol

  United States dollar USD $
1

  Euro zone Euro EUR €

2

  Japanese yen JPY ¥

3
  British pound sterling GBP £
4
  Swiss franc CHP -
5-6
SUGGESTION
  Australian dollar AUD $
5-6
 Indian forex market has also developed significantly over the years. As per the
BIS global survey the percentage share of the rupee in total turnover covering all
Currencies increased from 0.5 percent in 2008 to 0.9 percent in 2009. As per
geographical distribution of foreign exchange market turnover, the share of India
increased from 0.6 in 2008 to 0.9 percent in 2009. The present study also reveals that the
Forex market is developing at a faster phase and the development of Forex market is
considered as a boon to the Indian economy.

PRECAUTION:

 The Forex market involves high risk.

 Proper analysis with statistical tools can be done to minimize the risk involved.

 Compare the market trend with the global market to predict right movement of the
price .

CONCLUSION

The decision-making process for diversification and risk management of highly

appreciated securities and portfolios is becoming more prevalent and more complex..
Hedging strategies can be used to effectively manage risk, with favorable tax treatment.
In the limited situations where hedging strategies are appropriate, the same diligent
attention that is given to evaluation and implementation of hedges must be given to
proper management and monitoring of hedges.
 BIBLIOGRAPHY

Websites:
1. www.fxdaily.com
2. www.investopidea.com
3. www.wikipedia.com
4. http://www.easyforex.com
5. http://www.iforex.com
QUESTIONNAIRE

PERCEPTION ON HEDGING & RUPEE APPRECIATION & ITS IMPACT ON

FOREX TRADING

NAME :
CONTACT :

1. Have you ever practiced Hedging while trading in your business:

Yes No

2. Do you think hedging is very much necessary in order to reduce loss:

Yes No

3. What sort of Hedging you follow:

Short Hedging
Long Hedging

4. Do you think India is suitable for Investing in Forex :

Yes No

5. Rank your preference in Forex Trading:

US Dollar Canadian Dollar
Euro Great Britain Pound
Pound Swiss Franc
Australian Dollar Yen
6. Are you affected by Inflationary Trend of the Economy:

Yes No

7. Do you think, the Liberalization made by RBI is enough to trade freely with Forex :

Yes No

8. Reason for Rupee Appreciation in the Economy :

Service Industry
Manufacturing Industry
Both

9. To whom do you give Credit for Rupee Appreciation

RBI Reforms
Booming Economy
Capital Inflow/Outflow

10. Whether to allow further FDI into Economy/Country:

Yes No

11. To correct the current trend of economy, what RBI must do :

Allow the rate of Appreciation go up

Reduce the Interest rate
Both
Any one