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Intelligent FX Borrowing

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Institution Affiliation

Intelligent FX Borrowing

Instructors Name

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Intelligent FX Borrowing

Case

Considering the case of an Indian firm raising capital with a quote from ICICI (an

Indian Bank) and Citibank (a US bank). The loan and market variables assume that the

foreign exchange rate for INR/USD is 70 INR/USD. ICICI wants to borrow INR 700 million

for five years. The external financing is a bullet loan with repayment at the end of the 5th year.

The Indian bank-ICICI quotes a rate of 12% for the INR loan, whereas Citibank offers a USD

10 million loan at 7.5%, which equals INR 700 million at the current exchange rate.

Assuming the 5-year risk-free rate in India is 9%, and the 5-year risk-free rate in the US is

5%. Should the firm take the loan in USD or INR?

Answer; ICICI should take the loan in USD as the currency. The approach is

founded on investor sentiment data that shows that the yields of Indian foreign exchange

mortgage holders grow increasingly vulnerable to fluctuations in the dollar/rupee currency

rate as individuals borrow increasingly. This suggests that the corporation's indebtedness is

not sufficiently diversifying the foreign exchange exposure posed by the new indebtedness.

Companies that are more prone to take out loans whenever the carry trade seems more

lucrative, known as 'carry trade borrowers,' face the greatest rise in volatility (Acharya & Vij,

2020). We may utilize the taper tantrum scenario as a theoretical model to investigate what

transpires to carry trade borrowers, especially ICICI in this case, amidst economic tension.

The taper tantrum of early 2013 was triggered by US Reserve Bank pronouncements hinting

that monetary stimulus would be tapered soon. This increased market volatility and equity

market decreases in Emerging market economies (Estrada et al., 2015). This case study is

about taper announcements, and so it shows that carry trade borrowers encountered

considerably bigger stock market falls as a result of the declaration.

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Because ICICI Limited does' operations all over the country, it may face exchange

rate risk, which is the vulnerability that the currency value will fluctuate while exchanging

foreign money back into national currency. Currency swaps are a means to assist hedge

against this form of currency volatility by exchanging foreign currency cash flows for home

currency free cash flow at a predictable rate (Bejol & Livingstone, 2018). Currency swaps,

regarded as foreign exchange activity, are not legally required to somehow be recorded on a

statement of financial position in the same way that a forward or options transaction does.

Many currency-hedged ETFs and mutual funds are now available to provide stockholders

with integration with the global investment opportunities without having to worry about

currency fluctuations.

Report

Introduction

Foreign exchange market loans made by unhedged debtors are common in many

countries worldwide. Notwithstanding this backdrop, we investigate if the demand for

international capital markets is motivated by a failure to understand the currency fluctuations

associated with such arrangements. Specialists use individual-level survey data over the

period to assess market participants' understanding of currency fluctuations. Initially, the

results reveal that most consumers are aware that devaluation raises loan payments.

Furthermore, researchers discover that understanding the currency fluctuations has a

substantial impact on the mortgage currency selection. Credit in international currencies

towards the non-financial corporate companies is not a novel phenomenon, although, in most

jurisdictions, it accounts for just a small portion of overall bank lending. Nonetheless, there

are some nations where financing in international currencies has resulted in significant

currency discrepancies on private industry investment portfolios.

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With the expansion of the international economic meltdown from banking systems

in developed markets, certain countries, such as India, saw their rupee depreciate. This

resulted in ICICI's debt repayment expenses rising. However, the short-term interest rates on

international capital markets lessened the short-term repercussions of currency existence in

India is crucial in understanding the robustness of foreign exchange financing.

Discussion

Emerging economies companies usually finance in a different currency (FX),

although their holdings are typically valued in national currency. This behavior causes a

currency mismatch on enterprises' investment portfolios, which could hurt their net value if

the currency depreciates. The study employs a large, unexpected, and extraneous devaluation

occurrence as well as a novel dataset to determine the actual and economic repercussions of

firm liquidity disruptions (Dunham & Garcia, 2021). Synthetic data of any registered non-

financial enterprises associated with their institutions are being generated. This data

incorporates firm-level liquidity position and actual results, currency breakdown of the

statement of financial position, and loan-level financing from institutions in rupees and

foreign currencies. This data enables control shocks to enterprises' access to credit to

determine the solvency disturbance and investigate its true repercussions. It has been

discovered that non-exporting enterprises with a greater FX discrepancy suffer more adverse

liquidity implications due to the devaluation (Chuffart & Dell'Eva, 2020). Smaller enterprises

experience a slower loan portfolio, culminating in installed employment creation and slower

physical and human capital expansion when compared to their peers with lesser FX

mismatches. Large corporations with a substantial FX discrepancy see a declining trend in

FX loans after the disruption but seem ready to broaden financing in rupee loans, coupled

with relatively stronger economic growth and capital investments. These findings show that
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enterprises face net worth-based financing limits and that such restrictions are much more

stringent for small organizations and mortgages in foreign currency.

Aryawan & Indriani (2020) note that organization working capital implications may

significantly influence causing or exacerbating liquidity problems. Nonetheless,

consequences might occur concurrently with market volatility to mortgage lending or

company consumption. This renders determining whether a shift in business performance is

attributable to the liquidity disruption or other variables challenging. Using details on what

each corporation loans from every financial institution, the article separates variations in

lending and expenditure caused by firm-specific balance-sheet disruptions from changes

caused by how much money is lent in principle, as well as many other relevant drivers.

Conclusion

The current financial crisis underscored the possible institutional concerns linked

with the predominance of foreign exchange financing to ICICI and the necessity to overcome

the matter in terms of avoiding the inventory of international capital markets from increasing

significantly. As a basic guideline, an operational and financial condition for market

participants fosters responsible and well-informed lending and borrowing decisions is critical

to preventing rising currency imbalances in corporate sector investment portfolios. This

entails pursuing prudent, stability-oriented monetary policies. Furthermore, implementing

regulatory and institutional policy initiatives could play an essential role in minimizing the

risks associated with foreign currency loans.

Recommendations

Albeit only customized at the national and regional level, a predetermined

integration of supervisory and regulatory, and organizational metrics (such as constraints on

loan-to-value proportions of mortgage-backed lines of credit, a mandated minimum down-

payment, and the precondition of substantiation of a debtor's legal earnings) appear to have
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the potential to adversely affect overarching lending practices if implemented in a reasonable

timeframe. The integration of loan-to-value proportion limitations and the necessity of

mandatory minimum monthly payments as a proportion of the purchase price appears to limit

the possible alternatives to both financial institutions and their consumers to avoid the

restrictions.
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References

Acharya, V. V., & Vij, S. (2020). Foreign Currency Borrowing of Corporations as carry

Trades: Evidence from India. SSRN Electronic Journal.

https://doi.org/10.2139/ssrn.3727686

Aryawan, I., & Indriani, A. (2020). Working capital management and profitability: evidence

from Indonesian manufacturing companies. Diponegoro International Journal of

Business, 3(1), 36–46. https://doi.org/10.14710/dijb.3.1.2020.36-46

Bejol, P., & Livingstone, N. (2018). Revisiting currency swaps: hedging real estate

investments in global city markets. Journal of Property Investment & Finance, 36(2),

191–209. https://doi.org/10.1108/jpif-04-2017-0026

Chuffart, T., & Dell’Eva, C. (2020). The role of carry trades on the effectiveness of Japan's

quantitative easing. International Economics, 161, 30–40.

https://doi.org/10.1016/j.inteco.2019.11.001

Dunham, L. M., & Garcia, J. (2021). Measuring the effect of investor sentiment on financial

distress. Managerial Finance, ahead-of-print(ahead-of-print).

https://doi.org/10.1108/mf-02-2021-0056

Estrada, G. B., Park, D., & Ramayandi, A. (2015). Taper Tantrum and Emerging Equity

Market Slumps. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.2707543