Round Table
Manoj Anand
IIM Lucknow
K P Kaushik
National Institute of
Financial Management, Faridabad
Abstract
This paper examines management
motivations for usage of foreign currency
derivatives in corporate India vis--vis
the rest of the world. It identifies significant
differences in the motivations of firms who
either use foreign currency derivatives or
have a documented foreign exchange risk
management policy vis--vis firms that do
not. The paper studies the types of financial
risks that are of concern to Indian managers
and, using a factor-analytic framework,
reduces the management motivations
studied to a few factors for hedging risk.
324
Currency Derivatives:
A Survey of Indian Firms
A
large number of firms engage in financial risk management
activities including foreign exchange risk, interest rate risk,
and commodity price risk through the use of derivatives. In
the present study, a comprehensive survey has been conducted to
understand the current practice of foreign currency derivatives use in
India. The results of the study capture the extent to which firms in
India use foreign currency derivatives vis--vis the rest of the world;
the types of financial risks concerning Indian managers; whether the
usage of foreign currency derivatives in India is driven primarily by
hedging, arbitrage or speculation; and the motivations of Indian managers
in using foreign currency derivatives for hedging risk.
The study converges management motivations for using foreign currency
derivatives for hedging risk in a factor-analytic framework into a few
factors. It is believed that the findings of the present study are of use to
academia and practitioners in learning how corporate India manages
financial risk; and in identifying areas where finance theory has not
been implemented.
A detailed discussion of management motivations for use of foreign
currency derivatives based on a review of the literature is provided
Currency Derivatives: A Survey of Indian Firms
below. The following section discusses research
methodology adopted along with description of data. The
results with discussion appear in the third section,
followed by a summary and the conclusions.
Literature Review
Existing theories of corporate risk management assume
that firms use derivatives solely for hedging purposes.
The question arises whether corporate risk management
is consistent with the shareholder wealth maximisation
objective, the maximising management utility objective,
or both.
Finance theory suggests that the value of a firm is
independent of its hedging policy in a competitive market
situation1. Risk management transactions entered into at
competitive market prices are at best value neutral. Since
firms incur transaction costs in an attempt to hedge risk,
the risk management process is expected to be value-
destroying. Risk hedging through the use of derivatives
creates shareholder value by taking advantage of market
imperfections such as taxes, bankruptcy cost, agency
cost, financing constraints and undiversified stakeholders.
Academic literature provides evidence that hedging policies
do create firm value by reducing expected taxes, expected
costs of financial distress and agency costs2.
Does financial risk affect expected returns on stocks and
hence share price behaviour? Does the use of derivatives
reduce risk? Does the use of derivatives reduce agency
costs? Does reduction in cash flows volatility increase
firm value? Is risk management practice a positive net
present value decision? Extensive surveys3 of academic
literature provide evidence on these issues.
Cash flow volatility may affect a firms liquidity position
and thus its ability to meet fixed operating and financing
costs. The use of financial derivatives can reduce the
probability of such a situation and lower the expected
value of costs associated with financial distress4. This
results in reduced volatility in the firms free cash flows
and hence improves the value of the firm. The risk
management process at the firm level, vis--vis the
shareholder level, is more efficient. Firms with a high
probability of bankruptcy and financial distress are more
likely to benefit from the use of financial derivatives as a
risk management strategy. The benefits of corporate risk
management have been advanced in theory and proven
empirically in many research studies globally5. However,
Hentschel and Kothari6 find no impact of interest rate and
IIMB Management Review, September 2008
foreign currency derivatives use on equity returns of 325
US non-financial firms during the period 1990 to 1993.
Corporate risk management has costs too. Managers are
the agents of the shareholders. In the absence of proper
incentives, managers will not maximise shareholders
wealth. Hence managerial incentive compensation
contracts must be designed in such a manner that actions
taken to increase value to shareholders also lead to increase
in their expected utility. Managers may chose to hedge
due to their undiversified wealth position in order to
maximise their utility. The reduction in earnings volatility
leads to reduction in the volatility of earnings stream of
management. This may be at a cost to the shareholders.
The management compensation has an impact on the use
of derivatives. Smith and Stulz7 argue for a positive
relationship between management shareholding and
derivatives use and a negative relationship between
management option holding and derivatives use. The
empirical relationship between management compensation
and risk management choices has been studied by Tufano8.
Contrary to the general perception, Nguyen and Faff9 and
Heaney and Winata 10 find that both management
shareholding and management option holding are
negatively related with derivatives use. Brailsford et al11
find that utility-maximising managers in the public sector
use derivatives to manage budget constraints (expenditure
equal to allocations) so as to provide the agreed level of
service within the budgeted framework.
Managerial motives drive managerial utility while firm
objectives address shareholder concerns. The cash flow
hedging strategies may be used to destroy shareholder
wealth in the presence of agency conflicts between
managers and shareholders 12 . Managers will prefer
financing of projects through internal generated funds in
order to avoid the scrutiny of capital markets. They may
accept projects and go in for acquisitions that may be
negative net present value to shareholders and lead to free
cash flow conflict. Hence, if managers rank certain
managerial motives that are inconsistent with firm
objectives as high, it can be an indication of agency
concerns.
Economies of scale, financial distress, agency costs,
optimal investment, management compensation and
foreign business exposure explain derivatives usage by
374 large Australian companies, find Heaney and Winata13.
Exhibit 1 provides a comparison of response rates in the
best-known field studies in the international arena in
derivatives use.
325
Survey of Indian Firms
A survey was conducted with the intention of identifying
the objectives and management motivations for use of
currency derivatives in India. The broad objectives of
using derivatives could be hedging risk, speculation, price
discovery or arbitrage. This study examines whether
management motivations differs between users and non-
users of currency derivatives and also between those who
have documented foreign exchange risk management
policy and those who have not. It captures the motivations
for use of currency derivatives in a factor-analytic
framework.
Research Design
A questionnaire was developed based on study of
derivatives use in Australia by Bensen and Oliver14. It lists
in detail both the motivations and hindrances to the use of
derivatives for achieving the hedging risk objective. The
major motivations are to reduce the volatility in earnings
and cash flows; reduce the probability of bankruptcy
and financial distress and costs associated with it; and
thus reduce the cost of capital and improve firm value
and reduce volatility in management earnings. The other
motivation could be to reduce agency costs. The possible
hindrances are complexities in valuation of derivatives;
accounting and disclosure requirements; and legal
restrictions.
The questionnaire is divided into two parts. The aim of
the first section is to find out whether management has a
documented risk management plan/policy/programme and
their ranking of transaction exposure, translation exposure
and economic exposure. It further determines the objective
of derivatives use, whether it is for hedging risk or
speculation or price discovery or arbitrage. The
second section of the survey asks the chief financial
officers (CFOs) of the surveyed companies to rate 18
motivations for use of foreign currency derivatives for

Exhibit 1 Comparison of Response Rate in Derivative Use Studies

Study Country Date of Study Sample Size Number of Response Rate Percentage of
Responses (Percentage) Derivatives Users

Bodner et al17 USA 1994 2000 530 26.5 35

Bodner et al18 USA 1995 2000 350 17.5 41

Bodner et al19 USA 1998 1928 399 20.7 50

Phillips20 USA 1995 3480 657 18.9 63.2

Berkman et al21 New Zealand 1997 124 79 63.7 53.1

Grant and Marshall22 UK 1994 250 91 36.4 89

1995 250 55 22.0 92.7

Alkebach and Hagelin23 Sweden 1996 213 163 76.5 51.5

Bodnar and Gebhardt24 Germany 1997 368 126 34.2 77.8

Fatemi and Glaum25 Germany 1998 153 71 46.4 88.0

26
Jalilvand et al Canada 1996 548 154 28.1 75

Ceuster et al27 Belgium 1997 334 73 21.9 65.8

Lee et al28 UK 1998 200 79 39.5 -

USA 1998 200 47 23.5 -

Asia Pacific 1998 200 53 26.5 -

Benson and Oliver29 Australia 2000 429 100 23.3 76.0

Present study India 2005 640 55 8.6 83.6

This table summarises the findings of earlier research studies in the global context and reports the date of the study, sample size, survey
response rate and extent of derivatives usage and compares it with the present study.

326 Currency Derivatives: A Survey of Indian Firms

hedging risk, irrespective of whether their firm is a 55 completed questionnaires were returned by November
derivatives-user or not. A five-point Likert scale (where 1 2005, resulting in a response rate of 8.59%. This response
means least important and 5 means most important) is rate appears to be low vis--vis other academic surveys
used for this. on the subject (Exhibit 1). However, the sample is
representative of the universe.
The universe of companies selected for this study consisted
of 640 companies with foreign exchange exposure, which
Data and Summary Statistics
are common across two most widely used Indian stock
market indices namely S&P CNX 500 and BSE 50015 firms Financial statistics of the respondent firms and the sample
as at the end of March 31, 2004. The 640 firms included firms have been collected from the CMIE Prowess
in these two indices are truly representative of Corporate database. Exhibit 2 presents industry-wise composition
India. of the respondent firms.
Financial information on the universe and the sample firms
Delivery and Response on profitability, size, forex exposure, and risk criteria has
The two-page questionnaire was sent to the CFOs of the been culled from CMIE PROWESS database. The variables
640 firms through mail between July and August 2005, considered for profitability of firms are: profits after tax,
with follow-up reminders to those who did not reply, in cash flow from operations, return on net worth, and
order to maximise the response rate16. It was indicated in return on capital employed. Firm size has been captured
the request to the CFOs that the identity of the respondents in terms of: net sales, net worth, and net fixed assets.
companies and the executives will be kept strictly Forex exposure has been looked at in terms of: gross
confidential and only aggregate generalisations will be exposure (imports as a percentage of sales) and net
published in order to have objectivity. Of the 640 requests, exposure (imports net of exports as a percentage of sales).
The variables considered for risk are: interest coverage
Exhibit 2 Industry Profile of the Respond- ratio, current ratio, quick ratio, debt-to-equity ratio,
ent Firms and beta.
Exhibit 3 provides summary statistics. The sample is truly
Number of Percentage Derivatives representative of the universe on all the criteria of
Respondent Users
Firms profitability, size, forex exposure and risk, except on net
sales, profits after tax and beta, where there is a
Automobile &
Ancillaries 9 16 8
significant difference between the mean values of the
universe and the sample. The sample consists of large
Banking & Financial
and less risky firms as compared to the universe. Firms
Services 11 20 10
that hedge risk are expected to be large in size and less
Chemicals & risky. Average firms in the universe are expected to be
Fertilisers 6 11 4
smaller in size and more risky. The findings of Exhibit 3
Computer Software 4 7 4 are consistent with this argument.
Drugs & The sample created from the survey process is consistent
Pharmaceuticals 5 9 4
with the expectations and hence the low response rate is
Plastic Products 3 5 3 not expected to be a serious limitation.
Steel 3 5 3

Textiles 4 7 4 Results and Discussion

Others 10 18 6
Derivatives Use
Total 55 100 46
Of the 55 firms that responded to the present survey, 46
This table reports frequency distribution and proportion of industry
profile of the 55 respondent firms and how many of them are or 84% indicated that they use foreign currency derivatives
derivatives users. to manage risk, and 38 or 70% indicated that they have a

IIMB Management Review, September 2008 327

 Exhibit 3 Summary Statistics of Sample

Respondent N Mean Std Deviation Std Error Mean Asymp.

Sig (2-tailed)*

Net Sales (Rs in Crores) Universe 619 1646.04 6821.68 274.19 0.0122
Sample 46 2375.79 5817.61 857.76

PAT (Rs in Crores) Universe 619 146.77 624.92 25.12 0.0284

Sample 46 269.18 626.09 92.31

CFO (Rs in Crores) Universe 619 422.28 1579.88 63.50 0.1386

Sample 46 804.92 2151.99 317.29

Net Worth (Rs in Crores) Universe 619 787.06 2973.94 119.53 0.0640
Sample 46 1166.59 3023.35 445.77

Net Fixed Assets (Rs in Crores) Universe 619 684.75 2682.28 107.81 0.2897
Sample 46 684.29 1451.66 214.04

Gross Forex Exposure Universe 618 0.38 0.44 0.02 0.3659

Sample 46 0.34 0.41 0.06

Net Forex Exposure Universe 618 0.17 0.23 0.01 0.1510

Sample 46 0.13 0.18 0.03

Interest Coverage Ratio Universe 615 23.49 84.30 3.40 0.3693

Sample 46 14.08 22.76 3.36

Current Ratio Universe 619 2.28 4.34 0.17 0.4181

Sample 46 2.20 2.03 0.30

Quick Ratio Universe 619 1.17 2.63 0.11 0.0865

Sample 46 1.16 1.22 0.18

Debt-to-Equity Ratio Universe 611 1.40 5.58 0.23 0.8612

Sample 46 1.07 1.54 0.23

Return on Net Worth (RONW) (%) Universe 608 24.05 231.29 9.38 0.0739
Sample 46 21.64 16.13 2.38

Return on Capital Employed (RONC) (%) Universe 608 25.18 23.57 0.96 0.0280
Sample 46 32.96 25.03 3.69

Beta Universe 545 0.98 0.34 0.01 0.0178

Sample 43 0.84 0.26 0.04

* Mann-Whitney U Test
This table reports descriptive statistics on the representativeness of Indian firms surveyed relative to the universe of 640 Indian companies,
which are common across two most-widely used Indian stock market indices namely S&P CNX 500 and BSE 500, for the financial year
ending March 31, 2004. PAT is profits after tax. Comparison is based on the following variables: Net sales, PAT, cash flows from operating
activities (CFO), Net worth, Net fixed assets, Gross forex exposure, Net forex exposure, Interest coverage ratio, current ratio, quick ratio,
debt-to-equity ratio, RONW, RONC and beta. Net worth, also termed as shareholders funds, is the sum of equity share capital and reserves
and surplus less miscellaneous expenditure to the extent not written off. Net fixed assets are the gross block of assets less accumulated
depreciation. Gross forex exposure is the total of forex earnings and forex spending as a percentage of net sales. Net forex exposure is the net
of forex earnings over forex spending (absolute value) as a percentage of net sales. Interest coverage is the ratio of earnings before interest and
tax to interest. Current ratio is the proportion of current assets to current liabilities. Quick ratio is the proportion of quick assets to current
liabilities. Quick assets are current assets less inventories. Debt-to-equity ratio is based on book values. Return on net worth is the ratio of
profits after tax to shareholders funds. Return on capital employed is the ratio of net operating profits after tax to net capital employed. Net
capital employed is the sum of shareholders funds and loan funds. Beta is a measure of systematic risk. The Mann-Whitney U test has been
used to capture the significant difference, if any, between the mean values of universe and sample firms.

documented foreign exchange risk management plan/ Foreign currency derivatives are the most commonly used
policy/programme (Exhibit 4). The comparative position class of derivatives with 83% of derivatives using firms
in different countries is shown in Exhibit 530. in the US utilising them31. The vast majority of firms in

328 Currency Derivatives: A Survey of Indian Firms

 Exhibit 4 Extent of Use of Derivatives and different exposures such as transaction, translation and
Risk Management Plan economic exposure as foreign exchange risk in terms of
their firms exposure33. The present survey finds that
74.51% (38 out of 51) of the respondents assign rank
Question Number of Yes (N) No (N)
Respondent one to transaction exposure, 58.33% (28 out of 48) assign
(N) rank two to translation exposure, and 54.35% (25 out of
Does your firm 54 38 16 46) assign rank three to economic exposure (Exhibit 6).
have a documented
foreign exchange risk Objectives of Using Derivatives
management plan/
policy/ programme? The reasons the firms hedge are volatility in the financial
markets, tax avoidance, to reduce financial distress cost,
Does your firm use 55 46 9
and to reduce the cost of debt and increase the debt
foreign currency
derivatives to manage
capacity34. Most companies in the UK use derivatives for
risk? the conservative role of risk management35. Market risk,
This table reports the frequency distribution of the 55 respondent
followed by accounting treatment of derivatives, appears
firms in respect of use of foreign currency derivatives to manage the to be the most serious concern regarding the use of
risk and having a documented foreign exchange risk management plan. derivatives among US firms. The use of derivatives to
reduce funding costs is a major factor for New Zealand
Australia, Belgium, Germany, New Zealand, Sweden, and firms, besides hedging contractual commitments36.
UK use derivatives to manage foreign currency risk vis-
The respondents to the present study were asked to
-vis the interest rate, commodity risk, and equity risk.
indicate the relative importance of the different objectives
The derivatives use in financial risk management is more
of using derivatives in their organisation37. While 96.1%
among large-size firms vis--vis small firms across the
(49 out of 51) of the respondents consider the primary
globe. This is because of the huge fixed costs associated
objective of the firm in using derivatives is to hedge risk,
with derivatives usage and the ability of large-size firms
63.2% (24 out of 38) of the respondents consider
to bear the same32.
derivatives usage for arbitrage, and 62.1% (18 out of 29)
The derivatives users and non-users were asked to rank of the respondents do not consider speculation as the

Exhibit 5 Derivatives Usage in Different Countries

Derivatives user

92.7%
88%
83.6%
76% 75%
65.8%
53%
50%

UK Germany India Australia Canada Belgium New Zealand USA

This figure shows a histogram of derivatives users in India based on the findings of the present study and compares it with derivatives usage
in the UK, Germany, Canada, Belgium, New Zealand and the US based on a review of the literature. Extensive use of derivatives in India is
because of the fact that US$ is the defacto international currency and thus US firms are relatively shielded from foreign currency risk.

IIMB Management Review, September 2008 329

 Exhibit 6 Ranking of Different Foreign Exchange Risk Exposures in Terms
of Firms Exposure

Foreign Exchange Number of Valid Mean Rank Rank (N)

Risk Exposure Respondents (N) 1 2 3

Transaction exposure 51 1.33 38 9 4

Translation exposure 48 2.21 5 28 15

Economic exposure 46 2.33 10 11 25

This table reports the frequency distribution of ranking of transaction exposure, translation exposure and economic exposure done by the
respondent firms, and estimates mean rank in respect of each exposure. Mean rank is the weighted average rank, where ranks have been
assigned weights on the basis of the proportion of the total number of respondents who assigned that rank to the said exposure.

objective of using derivatives (Exhibit 7).
Motivations for Derivatives Use
The responses of different country managers on managerial
motivations for use of foreign currency derivatives and
factors that influence the managers to hedge based on
review of literature are summarised in Exhibit 8.
The survey questionnaire asked the respondents to
consider 18 management motivations regarding the use
of foreign currency derivatives for hedging risk38. For
each motivation, users and non-users of foreign currency
derivatives were asked to rank on a five-point Likert scale
(where one is least important and five is most important),
the importance of derivatives for hedging risk purposes.
The management motivations and responses are
summarised in Exhibit 9.
The major motivations for the use of foreign currency
derivatives for hedging are: to reduce volatility in the
profits after tax (PAT) (mean score = 4.23); to reduce
risks faced by the management (mean score = 4.21); to
facilitate budgeting and control process in the firm (mean
score = 3.69); to reduce volatility of cash flows (mean
score = 3.64); and to improve value of the firm (mean
score = 3.53).
Reducing volatility in profits after tax: The present
study finds reducing the volatility in profits after tax the
most important objective amongst Indian firms. However,
reducing volatility in accounting earnings with the use
of derivatives is the major motivation of US firms (42%),
New Zealand firms (62%), German firms (55.3%),
Canadian firms, and Belgium firms. It is the second most
important reason for derivative use for hedging amongst
Australian firms and an important goal of risk management
amongst German firms. The goal of risk management in
theory is to focus on free cash flows and maximise the
value of firm. Firms do not usually focus on an accounting
number such as profits after tax. In practice, managers
across the globe focus on reducing the volatility in
accounting earnings with the use of derivatives as an

Exhibit 7 Relative Importance of Different Objectives of Using Derivatives

N Mean Rank Std Deviation Std Error of Mean Rank (N)

1 2 3 4

Hedging Risk 51 1.04 0.20 0.03 49 2 0 0

Speculation 29 3.41 0.87 0.16 1 4 6 18

Price Discovery 33 2.85 0.87 0.15 1 12 11 9

Arbitrage 38 2.34 0.71 0.11 3 21 12 2

This table reports the frequency distribution of ranking of different objectives of derivatives use according to the respondent firms, and
estimates mean rank, standard deviation and standard error of mean in respect of each objective. Mean rank is the weighted average rank,
where ranks have been assigned weights on the basis of proportion of total number of respondents who assigned that rank to the said
objective.

330 Currency Derivatives: A Survey of Indian Firms

 Exhibit 8 Managerial Motivations of Different Country Managers for Hedging Risk
Management Motivations for Use of Foreign
Currency Derivatives for Hedging Risk
To reduce volatility in profits after tax
To reduce volatility of cash flows
To improve value of firm
To reduce risks faced by management
Factors that Influence Managers to Hedge
Firms with high proportion of ESOPs
outstanding are more likely to resort to it
Firms with high proportion of tax credit
availability are more likely to benefit
Necessary accounting treatment is too complex
Disclosure requirements of accounting standards
This table contrasts the managerial motivations of managers of different countries based on literature review and the findings of the present
study.
objective of risk management.
Reducing risks faced by the management: Indian
respondent firms perceive to reduce the risks faced by
the management as the second important motivation for
risk management with the use of derivatives. Benson and
Oliver39 find this objective at rank four amongst the
Australian respondent firms.
Facilitating budgeting and control process in the firm:
This is the third important motivation among Indian firms
for risk management with the use of derivatives.
Reducing cash flows volatility: The present study finds
it the fourth major motivation for risk management with
the use of derivatives among Indian respondent firms.
Reducing cash flows volatility is the major motivation
of US firms (49%), UK firms, Australian firms, and
Canadian firms for risk management. It is another important
goal of risk management among firms in Germany and
New Zealand. Ceuster et al40 find that reducing the
volatility in cash flows is not important to 38.24% of
the Belgium respondent firms.
Improving the value of the firm: The findings show
that Indian respondent firms do use currency derivatives
for risk management with a view to maximizing the value
of the firm. The respondents ranked this goal fifth.
IIMB Management Review, September 2008
Countries
Most Important Least Important
Australia, Belgium, Canada,
Germany, India,New Zealand, USA
Australia, Canada, Germany, India, Belgium
New Zealand, UK, USA
Australia, Germany, India Belgium, New Zealand
Australia, India
USA Australia, India,
New Zealand
Consistent with reducing cash flows volatility and
reducing earnings volatility, Fatemi and Glaum41 find
increasing the market value of the firm the second most
important goal of risk management amongst the German
firms, while it is the third most important issue for
Australian firms. Berkman et al42 find that only 10% of
the New Zealand respondent firms indicated reducing
fluctuations in the market value of firm as a primary
objective of risk management with the use of derivatives.
Surprisingly 62.5% of the Belgium respondent firms do
not consider the use of derivatives to increase the market
value of firm as important, find Ceuster et al43.
The least important motivations for the use of foreign
currency derivatives for hedging in India are: firms with
high proportion of employee stock ownership plans
(ESOPs) outstanding are more likely to resort to it (mean
score = 1.67); firms with high proportion of tax credit
availability are more likely to benefit from use of foreign
currency derivatives (mean score = 1.70); necessary
accounting treatment is too complex (mean score = 2.19);
disclosure requirements of accounting standards (mean
score = 2.45); and to reduce the political risk (mean
score = 2.48).
To improve management/employee compensation
followed by reduce taxation and complexity of
331
accounting treatment are the least important motivations
of Australian firms using derivatives. None of the New
Zealand respondent firms suggested that minimising
expected taxes is a benefit of using derivatives. The
accounting treatment of derivatives issue causes the most
concern to the derivative-user firms (37%) in the US,
while disclosure requirements of accounting standards
is only a token measure of concern to the derivative non-
users in the US. The UK firms argue for disclosure of
risk management strategies rather than detailed
information.
Managerial incentives such as reducing cost of capital
of the firm (mean score = 3.52) and firms with high
debt ratio are more likely to use foreign currency
derivatives (mean score = 3) are ranked relatively
important by the Indian respondent firms in the present
study.
Jalilvand et al44 find reducing cost of funds to be the
most important objective of using derivatives and strong
and negative correlation between the Canadian derivative-
user firms and their credit rating. Firms with low credit
rating have an incentive to use derivatives in order to
reduce financial distress costs.
Motivations such as difficulties in pricing and valuing
derivatives, perception of derivatives use by investors,
regulators and the public and reducing the probability of
bankruptcy and financial distress and costs associated
with it are ranked as relatively less important by the Indian
respondent firms in the present study.
Bodnar et al45 find that more than 35% of the derivative-
user respondent firms in the US have little or no concern
as to how its use will be viewed by the investors/
Exhibit 9 Summary of Responses in Relation to Derivatives Use from Non-users
and Users
Management Motivations for Use of Number of Std
Foreign Currency Valid Mean Deviation
Derivatives for Hedging Responses
(N)
To reduce volatility in PAT 52 4.23 1.04
To reduce risks faced by the management 52 4.21 0.91
To facilitate budgeting and control process
in the firm 51 3.69 1.26
332
regulators/public. It is of primary concern to 10% of the
derivative non-user respondent firms with an additional
31% citing it as a supporting explanation.
The responses on the importance of the 18 management
motivations listed in Exhibit 9 are classified into responses
applicable to foreign currency derivative users and non-
derivative users and are shown in Exhibit 10.
The five most important motivations of the derivative users
and non-users are identical. These are to reduce volatility
in profits after tax, necessary accounting treatment is
too complex, to reduce risks faced by the management,
availability of alternative means to manage the financial
risk, and high debt in the capital structure. The three
least important attitudinal issues applicable to foreign
currency derivative users and non-users are also identical.
These are proportion of high tax credit availability, to
reduce cost of capital of firm, and to reduce the political
risk. The results from Mann Whitney U test indicate a
significant difference at 5% level between users and non-
users of derivatives for one of the 18 management
motivations. These results are consistent with Benson and
Olivers survey46 of Australian firms.
The responses on the importance of the 18 management
motivations listed in Exhibit 9 are classified into responses
of firms with a documented risk management plan/policy/
programme and those without one (Exhibit 11). The most
important motivations of the two categories are identical.
The results from Mann Whitney U test indicate a significant
difference at 5% level between with and without a
documented risk management plan/policy/programme for
three of the 18 management motivations. These results
are consistent with Benson and Olivers survey47 of
Australian firms.
Std Number of Responses
Error Rank Least Most
of Mean Important Important
1 2 3 4 5
0.14 1 2 2 5 16 27
0.13 2 0 3 8 16 25
0.18 3 4 6 8 17 16
Currency Derivatives: A Survey of Indian Firms
 Exhibit 9 continued

Management Motivations for Use of Number of Std Std Number of Responses

Foreign Currency Valid Mean Deviation Error Rank Least Most
Derivatives for Hedging Responses of Mean Important Important

(N) 1 2 3 4 5

To reduce volatility of cash flows 53 3.64 1.19 0.16 4 3 6 14 14 16

To improve value of the firm 53 3.53 1.25 0.17 5 3 11 8 17 14

To reduce cost of capital of the firm 52 3.52 1.18 0.16 6 4 6 12 19 11

Firms with high debt ratio are more likely

to use foreign currency derivatives 49 3.00 1.41 0.20 7 10 10 7 14 8

Firms with alternate means to manage foreign

currency risk are likely to use derivatives 52 2.96 1.28 0.18 8 7 14 13 10 8

Legal restrictions on use of derivatives 52 2.85 1.29 0.18 9 9 13 14 9 7

Alternate means to manage financial risks 47 2.74 1.22 0.18 10 8 13 14 7 5

Difficulties in pricing and valuing derivatives 50 2.74 1.14 0.16 11 8 12 19 7 4

Perception of derivatives use by investors,

regulators and the public 47 2.68 1.16 0.17 12 7 16 13 7 4

To reduce probability of bankruptcy and

financial distress and their costs 52 2.65 1.40 0.19 13 15 10 12 8 7

To reduce the political risk 48 2.48 1.32 0.19 14 16 8 13 7 4

Factors that Influence Managers to Hedge

Disclosure requirements of accounting

standards 51 2.45 1.29 0.18 15 17 8 16 6 4

Necessary accounting treatment is too

complex 52 2.19 1.14 0.16 16 18 15 12 5 2

Firms with a high proportion of tax credit

availability are more likely to benefit from use
of foreign currency derivatives 46 1.70 0.89 0.13 17 25 12 7 2 0

Firms with high proportion of ESOPs

outstanding are more likely to resort to it 46 1.67 0.97 0.14 18 27 11 4 4 0

This table reports management motivations for use of foreign currency derivatives for hedging on a Likert scale of 1 to 5, where 1 is least
important and 5 is most important. For each response, the frequency distribution is reported. The level of importance of each motivation is
obtained by multiplying the number of responses on each Likert value in respect of each motivation. Thereafter, mean and standard deviations
have been calculated. The average rating for each motivation along with its standard deviation and standard error of mean is reported. Finally,
management motivations for use of foreign currency derivatives for hedging purpose are ranked on the basis of mean score.

Factor Analysis Results
The factor analytic methodology has been used to analyse
management motivation for use of currency derivatives
in corporate India based on responses received from the
55 chief financial officers to the survey questionnaire.
The maximum likelihood method of extraction has been
used to explore and confirm the inter-relatedness between
the occurrences of variables pertaining to management
motivations for derivatives use, the shareholder value
maximisation hypothesis, and the management utility
maximisation hypothesis.
The number of factors to be retained has been decided
based on Kaisers criterion of Eigen value e1, Bartletts
test, Cattells secree test, and Bentlers internal consistency
coefficients48. The Bartletts test of significance led to the
acceptance of seven significant factors. These seven factors

IIMB Management Review, September 2008 333

 Exhibit 10 Motivations for Derivatives Use of Users and Non-users of Derivatives A
Comparison

Motivations Does your firm use foreign

currency derivatives
to manage the risk? Standard p-value
N Mean Deviation (2-tailed)
Users Non-users Users Non-users Users Non-users

To reduce volatility in PAT 44 8 4.25 4.1250 0.9912 1.3562 0.970

To reduce volatility of cash flows 45 8 3.6667 3.50 1.1678 1.41421 0.779

To reduce probability of bankruptcy and financial

distress and their costs 44 8 2.7273 2.25 1.38704 1.48805 0.389

Firms with high debt ratio are more likely to use

foreign currency derivatives 41 8 3.0244 2.8750 1.29398 2.03101 0.863

To reduce cost of capital of the firm 44 8 3.5227 3.5000 1.19083 1.19523 0.891

Firms with a high proportion of ESOPs outstanding

are more likely to resort to it 38 8 1.6842 1.6250 0.96157 1.06066 0.831

To improve value of the firm 45 8 3.5556 3.3750 1.2713 1.1877 0.652

To facilitate budgeting and control process in the firm 43 8 3.6512 3.8750 1.3072 0.9910 0.829

To reduce the political risk 40 8 2.4250 2.7500 1.2987 1.4881 0.559

Firm has alternate means to manage financial risks 39 8 2.7949 2.50 1.2393 1.1952 0.478

Difficulties in pricing and valuing derivatives 42 8 2.6905 3.0000 1.1367 1.1952 0.490

Disclosure requirements of accounting standards 43 8 2.4419 2.500 1.2781 1.4142 0.9490.949

Legal restrictions on use of derivatives 44 8 2.8182 3.00 1.2626 1.5119 0.813

Accounting treatment is too complex 44 8 2.2273 2.0000 1.1587 1.06904 0.663

Perception of derivatives use by investors,

regulators and the public 39 8 2.6923 2.6250 1.1275 1.40789 0.835

To reduce risks faced by the management 44 8 4.1818 4.3750 0.94679 0.74402 0.737

Factors that Influence Managers to Hedge

Firms with high proportion of tax credit availability

are more likely to benefit from use of foreign
currency derivatives 38 8 1.7632 1.3750 0.91339 0.74402 0.283
Firms with alternate means (matching, netting, lead,
and lagging) to manage foreign currency risk are
more likely to use derivatives 44 8 2.7955 3.8750 1.24974 1.12599 0.035

This table compares mean scores of management motivations for use of foreign currency derivatives for hedging derivatives user-firms and
non-user firms. The average rating for each motivation and the P-values for statistical tests are reported, in which the null hypothesis is that
there is no significant difference between the mean score of users and non-users. Mann-Whitney U test has been used to capture the
significant difference, if any.

explain 59.28% of the total variance. The application of Maximum likelihood analysis using varimax rotation
secree test resulted in acceptance of five factors. The method with Kaiser Normalization of correlation matrix
factors loaded by variables having significant loading of of 18 variables led to the extraction of five factors. These
the magnitude of 0.50 and above have been interpreted are hedging to improve value of firm, management utility

334 Currency Derivatives: A Survey of Indian Firms

 Exhibit 11 Attitudes to Derivatives Use from Respondents With and Without a Risk Manage-
ment Plan: A Comparison

Does your firm have a documented

foreign exchange risk management
plan/ policy/ programme? p-value
N Mean Standard Deviation (2-tailed)
Yes No Yes No Yes No

To reduce volatility in PAT 36 15 4.222 4.333 1.045 1.047 0.568

To reduce volatility of cash flows 37 15 3.730 3.333 1.194 1.175 0.195

To reduce probability of bankruptcy and financial

distress and their costs 36 15 2.639 2.533 1.376 1.407 0.807

Firms with high debt ratio are more likely to use

foreign currency derivatives 34 14 2.824 3.357 1.359 1.550 0.237

To reduce cost of capital of the firm 37 14 3.514 3.500 1.261 1.019 0.702

Firms with a high proportion of ESOPs outstanding

are more likely to resort to it 31 14 1.806 1.286 1.014 0.726 0.039

To improve value of the firm 37 15 3.622 3.267 1.210 1.387 0.398

To facilitate budgeting and control process in the firm 35 15 3.886 3.200 1.132 1.474 0.130

To reduce the political risk 33 14 2.667 2.000 1.216 1.519 0.069

Firm has alternate means to manage financial risks 32 14 2.875 2.429 1.185 1.342 0.210

Difficulties in pricing and valuing derivatives 35 14 2.771 2.714 1.190 1.069 0.881

Disclosure requirements of accounting standards 36 14 2.528 2.286 1.253 1.437 0.522

Legal restrictions on use of derivatives 37 14 2.838 2.857 1.302 1.351 0.914

Accounting treatment is too complex 37 14 2.378 1.643 1.114 1.082 0.019

Perception of derivatives use by investors,

regulators and the public 35 11 2.857 2.182 1.115 1.250 0.079

To reduce risks faced by the management 36 15 4.111 4.467 0.919 0.915 0.137

Factors that Influence Managers to Hedge

Firms with high proportion of tax credit availability

are more likely to benefit from use of foreign currency
derivatives 31 14 1.774 1.357 0.845 0.745 0.074

Firms with alternate means (matching, netting, lead,

and lagging) to manage foreign currency risk are
more likely to use derivatives 37 14 3.189 2.357 1.198 1.393 0.049

This table compares mean scores of management motivations for use of foreign currency derivatives for hedging of firms that have a
documented foreign exchange risk management plan and firms that do not. The average rating for each motivation and the P-values for
statistical tests are reported, in which the null hypothesis is that there is no significant difference between the mean scores of the two sets.
Mann-Whitney U test has been used to capture the significant difference, if any.

and compensation, accounting and disclosure accounted for 9.68%, 9.58%, 9.07%, 8.61% and 8.34%
requirements, strengthening control systems, and avail respectively of the total variance explained. The structure
tax benefits and reduce cost of capital. These factors matrix is reported in Exhibit 12.

IIMB Management Review, September 2008 335

 Exhibit 12 Structure (Rotated Factor) Matrix using Factor Analytic Methodology on
Responses on Motivation

Factor 1 Factor 2 Factor 3 Factor 4 Factor 5 Factor 6 Factor 7

To reduce volatility in PAT 0.9323

To reduce volatility of cash flows

To reduce probability of bankruptcy and financial distress

and their costs

Firms with high debt ratio are more likely to use

foreign currency derivatives -0.5026

To reduce cost of capital of the firm 0.6903

Firms with high proportion of ESOPs outstanding are

more likely to resort to it -0.7563

To improve value of the firm 0.5389

To facilitate budgeting and control process in the firm 0.9693

To reduce political risk 0.5209

Firm has alternate means to manage financial risks

Difficulties in pricing and valuing derivatives 0.7702

Disclosure requirements of accounting standards 0.7145 0.5620

Legal restrictions on use of derivatives

Accounting treatment is too complex 0.7102

Perception of derivatives use by investors,

regulators and the public 0.9276

To reduce risks faced by the management 0.6811

Factors that Influence Managers to Hedge

Firms with high proportion of tax credit availability are

more likely to benefit from use of foreign currency derivatives

Firms with alternate means to manage foreign currency

risk are likely to use derivatives

This table reports structure (rotated factor) matrix estimated while using factor analytic methodology on the 55 responses received in respect
of 18 motivations for use of foreign currency derivatives. Varimax with Kaiser Normalisation has been used for rotation. Maximum likelihood
method has been used for extraction. Eigen value e1 criterion has been adopted for identification of factors. The Bartletts test of significance
led to the acceptance of seven significant factors. These seven factors explain 59.28% of the total variance. The application of secree test
resulted in acceptance of five factors. The factors loaded by variables having significant loading of the magnitude of 0.50 and above have been
interpreted.

Factor 1 Hedging to improve value of firm: The first
factor, hedging to improve value of firm, is bipolar in
nature. On one pole, there is one variable pertaining to
firm characteristics that necessitate hedging. This variable
is firm with high debt ratio is more likely to use foreign
currency derivatives, which has a high negative loading
of 0.503 using varimax rotation. On the other pole, there
are two variables pertaining to hedging. These are to
reduce volatility in profits after tax and to improve value
of the firm, which have high positive loading of 0.932
and 0.539 respectively.
Factor 2 Management utility and compensation: The
second factor, management utility and compensation,
is also bipolar in nature. On one pole, there is one variable
pertaining to firm characteristics that necessitate hedging.
This variable is firm with high proportion of ESOPs

336 Currency Derivatives: A Survey of Indian Firms

outstanding is more likely to use foreign currency
derivatives, which has a high negative loading of 0.756
using varimax rotation. On the other pole, there is one
variable pertaining to the management utility maximisation
objective, to reduce risks faced by the management,
which has high positive loading of 0.681. It has a
meaningful loading on the variable namely to reduce the
volatility of cash flows of 0.395 using varimax rotation.
Factor 3 Accounting and disclosure requirements:
The third factor, accounting and disclosure requirements,
has significant positive loading of 0.714 and 0.710 on
two variables, the disclosure requirements of accounting
standards for use of derivatives and necessary accounting
treatment is too complex, respectively using varimax
rotation. It has a meaningful loading on the variable, legal
restrictions on use of derivatives of 0.489 using varimax
rotation.
Factor 4 Strengthen control systems: The fourth
factor, strengthening control systems, encompasses two
variables namely to facilitate budgeting and control
process in the firm, and to reduce political risk. These
variables have significant positive loading of 0.969 and
0.521 respectively using varimax rotation.
Factor 5 Avail of tax benefits and reduce cost of
capital: The fifth factor avail of tax benefits and reduce
cost of capital encompasses two variables namely to
reduce cost of capital of the firm, and firms with high
proportion of tax credit availability are more likely to benefit
from the use of foreign currency derivatives. These
variables have significant positive loading of 0.69 and 0.482
respectively using varimax rotation.
Summary and Conclusions
This study examines management motivations for foreign
currency derivatives usage in corporate India using survey
methodology and identifies significant differences, if any,
in the motivations of the firms who either use foreign
currency derivatives or have a documented foreign
exchange risk management policy vis--vis firms who do
not. The sample ranges across nine industries and
comprises 55 firms.
Most of the respondent firms (70.4%) have documented
foreign exchange risk management plan/policy/
programme. Transaction exposure as a foreign currency
risk is most critical to the firms (74.5%) followed by
translation exposure (58.3% judged it a moderate degree
IIMB Management Review, September 2008
of risk) and economic exposure (54.3% judged it a low
degree of risk). The major objective of using derivatives
is hedging risk (96.1% assigned it rank one objective),
for arbitrage (55.3% assigned it rank two) and price
discovery (36.4% assigned it rank two and 33.3% assigned
it rank three). Speculation as an objective of using foreign
currency derivatives is the least preferred option (62.1%
assigned it rank four).
To reduce the volatility in profits after tax, volatility in
cash flows and cost of capital, and thus increase the value
of the firm at one end, and to reduce the risks faced by
the management at the other end, are the major motivations
of the firms using foreign currency derivatives in India.
Firms with high debt ratio are more likely to use foreign
currency derivatives.
Increased focus on accounting earnings vis--vis cash
flows raises questions on risk management practice vis-
-vis the theory. Firm characteristics such as high degree
of debt ratio and ESOPs usage influence the use of foreign
currency derivatives in India. Management motivations
for the use of foreign currency derivatives captured in
factor-analytic framework are hedging to improve value
of firm, management utility and compensation,
accounting and disclosure requirements, strengthen
control systems, and avail tax benefits and reduce cost
of capital. Management motivations for use of foreign
currency derivatives do not differ between derivative users
and non-users.
References and Notes
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337
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14 Ibid; Benson, Karen, and Barry Oliver, 2004, Management
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Australian Journal of Management, Vol 29, No 2, pp 225-242.
Benson and Oliver in their survey list 19 motivations of
management for using the financial derivatives in Australia. It
lists reduce the use of debt finance and increase the use of debt
finance as separate motivations. The present study uses 18
338
motivations for use of derivatives in India. It includes firms
with high debt ratio are more likely to use foreign currency
derivatives as A single motivation.
15 S&P CNX 500 and BSE 500 are broad-based market indices
representing 93% of the total market capitalisation at the
National Stock Exchange of India Limited and Bombay Stock
Exchange Limited.
16 Dillman, D A, 1978, Mail and Telephone Surveys: The Total
Design Method, New York, NY: John Wiley & Sons.
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Charles W Smithson, 1995,Wharton Survey of Derivatives
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24, No 2, pp 104-114.
18 Bodnar, Gordon M, Gregory S Hayt, and Richard C Marston,
1996, 1995 Wharton Survey of Derivatives Usage by US Non-
financial Firms, Financial Management, Vol 25, No 4, pp 113-
133.
19 Bodnar, Gordon M, Gregory S Hayt, and Richard C Marston,
1998, 1998 Wharton Survey of Financial Risk Management by
US Non-financial Firms, Financial Management, Vol 27, No 4,
pp 70-91.
20 Phillips, Aaron L, 1995, 1995 Derivatives Practices and
Instruments Survey, Financial Management, Vol 24, No 2, pp
115-125.
21 Berkman, Henk, Michael E Bradbury, and Stephen Magan, 1997,
An International Comparison of Derivatives Use, Financial
Management, Vol 26, No 4, pp 69-73.
22 Grant, Kevin, and Andrew P Marshall, 1997, Large UK
Companies and Derivatives, European Financial Management,
Vol 3, No 2, pp 191-208.
23 Alkeback, Per, and Niclas Hagelin, 1999, Derivatives Usage by
Non-financial Firms in Sweden with an International
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24 Bodnar, Gordon M, and Giinther Gebhardt, 1999, Derivatives
Usage in Risk Management by US and German Non-financial
Firms: A Comparative Survey, Journal of International Financial
Management and Accounting, Vol 10, No 3, pp 153-187.
25 Fatemi, Ali, and Martin Glaum, 2000, Risk Management
Practice in German Firms, Managerial Finance, Vol 26, No 3,
pp 1-17.
26 Jalilvand, Abolhassan, Jeannette Switzer, and Caroline Tang,
2000, A Global Perspective on the Use of Derivatives for
Corporate Risk Management Decisions, Managerial Finance,
Vol 26, No 3, pp 29-38.
27 Ceuster, Marc, J K De, Edward Durinck, Eddy Laveren, and
Jozed Lodewyckx, 2000, A Survey into the Use of Derivatives
by Large Non-financial Firms Operating in Belgium, European
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28 Lee, Fah Mei, Andrew Marshall, You Koong Szto, and Joan
Tang, 2001, The Practice of Financial Risk Management: An
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29 Benson and Oliver, Management Motivations for using Financial
Derivatives in Australia.
Currency Derivatives: A Survey of Indian Firms
30 Figures are from the studies cited in Exhibit 1. The exhibit suggests
that more Indian firms use derivatives (83.6%) than US firms
(50%). This is because of the fact that US$ is the defacto
international currency and thus US firms are relatively shielded
from foreign currency risk.
31 Bodnar, Hayt and Marston, 1998 Wharton Survey of Financial
Risk Management by US Non-financial Firms.
32 Berkman, Bradbury and Magan, An International Comparison
of Derivatives Use; Bodnar, Hayt and Marston, 1998 Wharton
Survey of Financial Risk Management by US Non-financial
Firms.
33 Translation exposure or accounting exposure arises during
financial reporting and consolidation of financial statements to
convert financial statements of foreign operations from the local
currency involved to home currency. Transactions involving
known future contractually binding foreign-currency
denominated cash inflows and cash outflows result in to
transaction exposure. Operating exposure captures the impact
of foreign currency changes on a firms revenues and cost. The
combined effect of transaction exposure and operating exposure
is termed as economic exposure.
34 Smith, C W, C Smithson, and D S Wilford, 1989, Managing
Financial Risk, Journal of Applied Corporate Finance, Vol 1,
No 4, pp 27-48; Smithson, Smith and Nance, 1993, On the
Determinants of Corporate Hedging.
35 Grant and Marshall, Large UK Companies and Derivatives.
36 Berkman, Bradbury and Magan, An International Comparison
of Derivatives Use.
37 The management of different exposures requires hedging to protect
a firms cash flows against unexpected exchange rate changes.
Hedging a particular currency exposure means establishing an
offsetting currency position so that whatever is lost or gained on
original currency exposure is exactly offset by corresponding
foreign exchange gain or loss on the currency hedge. The hedging
objective is most consistent with the shareholder wealth
maximisation objective. Speculation refers to the deliberate
creation of a position involving foreign currency exposure with
an objective to profit from it, while accepting the added risk.
The speculator challenges the markets forecasts as reflected in
forward currency rates and attempts to benefit by creating an
open position. Arbitrage refers to a set of transactions in choosing
between assets denominated in different currencies and taking a
position in the forward market to hedge currency risk and target
IIMB Management Review, September 2008
the highest possible return adjusted for exchange rate changes.
The currency futures prices represent the aggregate of all available
information that may affect the market, and are viewed as a price
discovery mechanism.
38 The issues are similar to those described in Benson and Oliver,
Management Motivations for using Financial Derivatives in
Australia, and have been developed on the basis of the literature
review.
39 Benson and Oliver, Management Motivations for using Financial
Derivatives in Australia.
40 Ceuster et al, A Survey into the Use of Derivatives by Large
Non-financial Firms Operating in Belgium.
41 Fatemi and Glaum, Risk Management Practice in German Firms.
42 Berkman, Bradbury and Magan, An International Comparison
of Derivatives Use.
43 Ceuster et al, A Survey into the Use of Derivatives by Large
Non-financial Firms Operating in Belgium.
44 Jalilvand, Switzer and Tang, A Global Perspective on the Use
of Derivatives for Corporate Risk Management Decisions.
45 Bodnar, Hayt and Marston, 1998 Wharton Survey of Financial
Risk Management by US Non-financial Firms.
46 Benson and Oliver, Management Motivations for using Financial
Derivatives in Australia.
47 Ibid.
48 Bentler, P M, 1968, Alpha Maximised Factor Analysis (Alpha
Max): Its Relation to Alpha and Caronical Factor Analysis,
Psycometrica, Vol 31, pp 77; Cattel, R B, 1966, The Secree Test
for Number of Factors, Multivariate Behavioural Research, Vol
1, pp 245-276; Kaiser, H F, 1958, The Varimax Criterion for
Analytic Rotation in Factor Analysis, Psycometrica, Vol 23,
No 3, pp 187-200; Kaiser, H F, and J C Caffrey, 1965, Alpha
Factor Analysis, Psycometrica, Vol 30, p 1.
Manoj Anand is Professor, Indian Institute of Management,
Lucknow. manand@iiml.ac.in
K P Kaushik is Professor, National Institute of Financial
Management, Faridabad. kp_kaushik@hotmail.com
Reprint No 08306
339