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Hedging Currency Risk at TT Textiles

Solution Id Length Case Author Case Publisher
2826 1392 Words (5 Pages) Rajesh Chakrabarti Indian School of Business : ISB009
This solution includes: A Word File A Word File

TT Textiles, an export-oriented enterprise in India, was exposed to currency risk when INR started to appreciate against the US$ due to foreign investment in India. The company entered an attractive deal with ABC bank, which allowed TT Textiles to swap US$ with Swiss Franc CHF at 1.27 to limit its losses from INR appreciation. TT Textiles were making fortunes from this deal until the events of the 2008 financial meltdown affected the Indian and US economy. The depreciation of INR due to the flight of foreign investment following the crash of the SENSEX and the recession in the US economy made the Swiss franc strong against US$ and exposed TT textiles to enormous losses. One year later and six months until the instrument’s maturity, when the US dollar started to gain momentum against the Swiss Franc, the management of TT Textiles was left with a decision to hold the derivative until maturity to make hefty returns or to sell the instrument now to save the business from huge losses.

Following questions are answered in this case study solution:

  1. Describe the deal between TT Textiles and ABC bank

  2. What is he instrument in this deal? What is the nature of the pay-outs?

  3. What is the motivation for TT Textiles to get into a deal with ABC bank?

Case Study Questions Answers

1. Describe the deal between tt textiles and abc bank

The deal between TT Textiles and ABC Bank was a currency swap deal in which TT Textiles exchanged US dollars for Swiss Franc (CHF), equivalent to 225 million INR at a rate of 1.27 CHF/US$. The contract consisted of an initial notional principal exchange of INR 225 million, equating to $4965791.22 and CHF6306554.84. It is to be noted that notional principal, in reality, is never exchanged; instead, it is a theoretical amount on which interest payments are based. Similarly, there was no exchange of the principal amount between TT Limited and ABC Bank, and TT was entitled to interest payments of 1.77% semi-annually on the notional amount. This meant that TT Textiles would earn an interest income of INR 2 million semi-annually. In return, TT Textiles had to pay no interest to ABC Bank and was granted a credit limit of INR 80 million by the latter. The contract had a life of 3 years commencing from 19th October 2006 to 15th October 2006, with 19th October 2006 to be the maturity date of the deal on which TT textiles had to return the notional principal amount of CHF6306554.84 to ABC bank and, on the other hand, ABC had to return to $4965791.22. However, the deal had some partial barriers which were to be implemented if the CHF/US$ exchange rate moved beyond a specific interval between 15th September 2009 to 15th October 2009. The barriers stated that if the CHF/USD exchange rate touched 1.04 or went below this level within the window mentioned above, the payouts of the deal, i.e., the interest payments and principal exchange, would then be matched with the current exchange rate of the time (spot rate). This knock-out option meant that TT Textiles could sell (put) the notional principal amount at an exchange rate of 1.27 as long as the CHF/US$ exchange rate did not trade at 1.04 or below between 15th September to 15th October 2009. Moreover, the partial barriers placed another restriction if the CHF/US$ were to trade above 1.27. In this scenario, TT Textile was bound to sell or put the option at the rate of 1.27.

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