A foreign institutional investor (FII) manages currency risks (inflation and exchange rate risk) by using traditional tools – such as interest swaps and currency swaps – and by taking advantage of any special programs that the host country has designed to entice foreign investment. For example, the Reserve Bank of India established a program in 2014 to help FIIs hedge currency risks. Since an FII is not necessarily a foreign direct investor, there may or may not be transaction currency risks to committed cash flows.

The term "foreign institutional investor" most frequently refers to non-Indian companies trading in Indian stock exchanges. These are different from the qualified foreign institutional investors operating in Chinese securities markets.

Interest Swaps and Currency Swaps

All firms are sensitive to interest rate risks and inflation risks, but FIIs must contend with domestic and foreign risks at the same time; different currencies have different interest rates.

To compensate, an FII can engage in interest rate and currency swaps with a counterparty company. Each company exchanges a series of cash flows from similar debt services. Think of this as a series of forward contracts in the forex market, with the additional agreement that principal balances are swapped at the end of the series.

India and the Reserve Bank Hedge

The Reserve Bank of India (RBI) helps foreign investors in Indian debt instruments to hedge coupon receipts against currency risks. The RBI has proposed working with the Securities and Exchange Board of India (SEBI) to allow FIIs to hedge currency risk with exchange-traded currency futures.

These measures are designed to help companies that hold claims to rupee-denominated coupon payments from losing real returns due to a falling rupee value.

  1. What risks does a Foreign Institutional Investor (FII) face?

    Read about the types of risks that a foreign institutional investor faces when trading in Indian stock exchanges and dealing ... Read Answer >>
  2. What are some risks a company takes when entering a currency swap?

    Read about the risks associated with performing a currency swap, including counterparty credit risk in the event that one ... Read Answer >>
  3. How do companies benefit from interest rate and currency swaps?

    An interest rate swap involves the exchange of cash flows between two parties based on interest payments for a particular ... Read Answer >>
  4. What would motivate an entity to enter into a swap agreement?

    Learn why parties enter into swap agreements to hedge their risks, and understand how the different legs of a swap agreement ... Read Answer >>
  5. Can bond traders trade on interest rate swaps?

    Read about interest rate swaps and why these transactions are performed by institutional actors in the bond market, not individual ... Read Answer >>
  6. Do interest rate swaps trade on the open market?

    Learn how interest rate swaps are traded on the OTC and interbank markets, and how these swaps can be used to arbitrage different ... Read Answer >>
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