Hedging Currency Risk at TT Textiles Harvard Case Solution & Analysis

Hedging Currency Risk at TT Textiles Case Study Solution 

Hedging Currency Risk at TT Textiles

Describe the nature of the currency exposure that TT Textiles faces.

TT Textile operates in the Indian economy, and it manufactures and exports multiple goods to various countries. The company’s core business based on commodities therefore, it faces multiple risks at a time. The company’s business is substantially dependent on the exports to other countries, as a result the company faces currency risk that means the operating expenses incurred by the company in a financial year are in Indian rupees whereas, the revenue generated from the overseas exports is in US dollar.

Therefore, the strengthening of Indian rupee against the US dollar will reduce the value of the firm. In developing economies, central government weakens their currency against developed currency in order to increase their exports due to competitiveness. However, the current situation indicates that the Indian currency has been continuously improving against the US dollar, which is not suitable for the exporter operating in the economy.

The TT textile generates revenue in US dollars and the dollar is consistently weakening against the Indian rupee, which imposes a risk for the company such as loss of potential revenue. The company might make credit sales and the spot rate of currency at the time of sales in different from the spot rate of at the time of receipt. The longer settlement timing would result in higher risk to the company.

It is difficult for the company to reduce its transaction risk as there is a higher volatility in the currency rates. TT textile could use derivative instruments to hedge against the transaction risk. Not only the derivatives, the company can hedge it risk through other ways such as lead payment and money market hedge etc.

Describe the instrument used in the deal. What is the payoff profile of this instrument?

Previously TT textile used forward contract to hedge against the negative fluctuation in the currency which led to loss for the company. Recently, the TT textile is aware about the new deal, which is based on derivative instrument, which indicates the instrument which has the value depends on something such as share price, bonds price. Etc.

The company motivates to use another option, which provides better outcomes against the negative fluctuation of the currencies. For the attractiveness of new option, TT textile agrees to make new deal with ABC Bank. The deal comprises of a currency swap contract in which the TT textile will get a semiannual cash flow. In addition to this, the currency swap has the strike rate of 1.04 CHF/Us$ that means after the maturity of Swap term, TT textile and ABC Bank have to exchange their currencies at the 1.04 rate. However, historic data indicates that the CFH rate has not gone below from 1.09, but due to the concern of Sanjay K Jain, the rate will reduce to 1.04 CFH /US$. Moreover, the swap deal has the options attached, which ensure that any currency risk faced by the company would be reduced at the acceptable level. However, TT textile has an obligation to sell dollars at the rate of 1.27 in case when the higher lack of the swap of 1.27 is less than the spot rate.

Furthermore the above deal has a risk involved for the company such as the US$/CHF risk, which indicates that in case the US$/CHF reach 1.04 level, the company has to face huge loss however, the possibility of such a situation from happening is very low as there has been no situation faced in the past.

Is this instrument suitable as a device for hedging TT Textiles’ risks?

The above instrument is very much suitable for the TT textile as compared to the previously used forward contract. The forward contract is not in favor for the company although it could hedge against the currency fluctuation however, it has the default risk, which cannot be minimized or eliminated. In the above deal, the company has the option which can be exercised in case when the conditions are not in favor of the company however, in the past the company had no options available, in fact in forward contract there was difficulty for the company to cancel those contracts.

 

Hedging Currency Risk at TT Textiles Harvard Case Solution & Analysis

 

TT Textile will get semi annually cash flow as an interest income over the INR 225 million, which can be used in the running financial commitments whereas, the company is not obliged to pay any amount to the ABC Bank. TT Textile can easily manage its currency exposure through the new deal as the company will get Indian rupees at the end of the swap maturity, however the deal has negative sides as well, which mainly include the options...........................

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