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Good One-Money Market Hedge PDF
Good One-Money Market Hedge PDF
SFM
FOREIGN EXCHANGE
EXPOSURE AND RISK
MANAGEMENT
RAJESH RITOLIA, FCA
HELPING HAND INSTITUTE
G-80, 2ND FLOOR, GUPTA COMPLEX, LAXMI NAGAR, DELHI-92
PH: 9350171263, 9910071263
Email: rritolia@correctingmyself.in; Web: correctingmyself.in
Note:
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Positive Thoughts
EVEN A SMALL DOT CAN STOP A BIG SENTENCE. BUT FEW MORE DOTS CAN GIVE A
CONTINUITY. AMAZING BUT TRUE, EVERY ENDING CAN BE A NEW BEGINNING.
DON’T WASTE TODAY FOR WHAT HAPPENED YESTERDAY
LIFE IS JUST LIKE A BEACH. WE ARE MOVING WITHOUT END. NOTHING STAY WITH US.
WHAT REMAIN WITH US IS THE MEMORIES OF SOME SPECIAL PEOPLE WHO TOCHED US
AS WAVE.
I AM RESPONSIBLE FOR WHAT I SAY, NOT FOR WHAT YOU UNDERSTAND.
THE WORLD IS CHANGED BY YOUR EXAMPLE, NOT BY YOUR OPINION.
BE A GOOD PERSON, BUT DO NOT WASTE TIME TO PROVE IT
Chapter Analysis
THEORY
8
7
6
5
4
3
2
1
0
M11 N11 M12 N12 M13 N13 M14 N14 M15 N15
PRACTICAL
25
20
15
10
0
M11 N11 M12 N12 M13 N13 M14 N14 M15 N15
Chap – 10 SUMMARY OF FOREX 10A.1
10.0 FOREIGN EXCHANGE Every firm and individual operating in international environment faces problems with foreign exchange
MARKET i.e., the exchange of foreign currency into domestic currency and vice-a-versa. Because the value of
one currency relative to another is constantly changing, the conversion become risky. It has resulted in
the foreign exchange risk management becoming one of the basic issues in international financial
management.
10.0.2 Fixed and Floating In some countries the government fixes the rate of exchange called ‘fixed exchange rate’ for its own
Exchange Rates currency. This is called ‘official rate of exchange’.
In other countries, the rates move, depending on the demand and supply pressures and will be further
influenced by market forces and economic conditions of the respective countries. This is called ‘floating
exchange rate’.
10.0.3 International Credit Telegraphic or Cable Transfer; Mail Transfer; Banker’s Draft and Banker’s Cheques; Letter of Credit;
Instruments International Money Orders; Buying and Selling Rates; TC Buying and Selling Rates.
10.1.1 RISK CONSIDERATIONS Financial Risk, Business Risk, Credit or Default Risk, Country Risk, Interest Rate Risk, Political Risk,
Market Risk, Foreign Exchange Risk
10.1.2 Techniques for Managing Open position No hedging, Forward contract, Currency Futures or Option, Futures contract, Money
Risk/ Methods of market hedge, Netting, Matching, Leading and lagging, Price variation, Invoicing in foreign Currency,
Managing Risk Assets and liability management, Arbtirage, Foreign Currency Bank Account
10.2 Exchange Rate A foreign exchange rate, represents the value of a specific currency compared to that of another
Determination country.
The currency listed on the left is called the reference (or base) currency while the one listed to the right
is the quote (or term) currency.
In the Foreign exchange market, the quote may be denoted as direct or indirect.
Direct Quote It indicates the number of units of the domestic currency required to buy one unit of foreign currency.
Example: $1 = Rs.45 is a direct quotation for US $ in India.
Indirect Quote It indicates the number of units of foreign currency that can be exchanged for one unit of the domestic
currency.
Example Rs.1 = US $ 0.02065 is an indirect quotation in India.
American Quote It refers to quoting per unit of any currency in terms of American Dollars
European Quote It refers to quoting per unit of American Dollars in terms of any other currency.
10.3 Party who is affected In foreign Exchange transaction, Only one party remains at risk. The Party whose payable/ receivable
by Foreign exchange currency are different from his domestic currency remains at risk.
fluctuation
10.4 Spot and forward rate Spot Exchange Rates: The spot exchange rate is the current rate at which one currency can be
immediately converted into another currency. The spot rate is the rate paid for delivery within two
business days after the day the transaction takes place.
A forward exchange rate occurs when buyers and sellers of currencies agree to deliver the currency
at some future date. They agree to transact a specific amount of currency at a specific rate at a
specified future date.
It is set and agreed by the parties and remains fixed for the contract period regardless of the
fluctuations in the spot exchange rates in future.
If funds to fulfill the contract are available on hand or are due to be received by the business, the
hedge is considered to be ‘covered’.
In situations where funds to fulfill the contract are not available but have to be purchased in the spot
market at some future date, then such a hedge is known as ‘uncovered’.
Forward contract is not entered into for gain or loss but it is entered into to make payable/ receivable
certain or risk free. Entering into forward contract is known as hedging.
10.5 Relationship between Difference between Spot rate and future rate is known as premium or discount in any one currency
Spot Rate and
Premium/Dis on LHC ≠ Dis/Premium on RHC
Forward
Rates/Expected Spot Currency is said to have appreciated if its value has increased, i.e. USD 1 = Rs.40 becomes USD 1 =
Rate/maturity Spot Rs.42. Here the value of USD has increased.
Rate Currency is said to have depreciated if its value has decreased, i.e. USD 1 = Rs.41 becomes USD 1 =
Rs.39. Here the value of USD has decreased.
10.6 If SR and Prem/ Disc If premium/ Dis is on LHC Currency = 1 LHC = SR*(1+-Prem/Disc) 2
is given, then we can If premium/ Dis is on RHC Currency = 1 LHC = SR/(1+-Prem/Disc)
calculate FR or ESR
or MSR as follows
10.7 Calculation of Gain or Rules for calculation of Gain/ Loss on Foreign Exchange Transaction
loss due to foreign
Exchange fluctuation
Rule-2 If required/available currency and LHC is same, then at the time of conversion we will multiply with
Exchange rate
for conversion of one
currency to another If required/available currency and LHC is different, then at the time of conversion we will divide with
currency Exchange rate
10.8 Cross Rates Cross Rate denotes an exchange rate that does not involve the required currency. It is an exchange 8-10 M-14
rate between the currencies of two countries that are not quoted against each other, but are quoted
against one common currency.
10.9 Two Way Quote Two way quotes refer to quoting exchange rates by an exchange dealer in terms of buying (Bid) 11
Rate and selling (Ask) Rate.
Bid rate is the rate at which the dealer is willing to buy LHC. In other words it is selling rate of LHC for
customer.
Offer (Ask) Rate is the rate at which Dealer is willing to sell LHC. In other words it is buying rate of
LHC for customer.
$ 1 = Rs.48.80 - 48.90.
Dealer is willing to buy $ at Rs.48.80 (sell rupees and buy dollars), while he will sell $ at Rs. 48.90 (buy
rupees and sell dollars).
From the Dealer point of view: First is Buying Rate and Second is Selling rate of LHC
From the Customer point of view: First is Selling Rate and Second is Buying rate of LHC
Spread The difference between the bid and the offer is called the spread.
Spread (%) = [Bid – Ask]*100/Bid
Spread (Amt) = [Bid – Ask]
Chap – 10 SUMMARY OF FOREX 10A.4
10.10 Swap Points Swap Points are movement in Exchange Rate expressed in absolute terms, i.e. in value terms 12-13
If Swap points is given in ascending order (increasing order) or spread is positive, we add it to right
hand side currency to calculate Forward Rate. It indicates that the left hand side currency is at
premium.
If forward margin is given in decending order (decreasing order) we deduct it from right hand side
currency to calculate Forward rate. It indicates that the left hand side currency is at discount.
10.12 Money Market Hedge Money Market Operations refers to creating an equivalent asset or liability against a Foreign Currency 16-18 N-15 M-15
Liability or Receivable.
M-10-O N-13
Under money market operation the following steps are taken.
N-09 N-12
If foreign currency is to Borrowing in FC [Creating Liability in FC] = Amount of borrowing (X) = Amount receivable in FC/(1 +
PIRFC) N-08
be received in future
[Assets in FC] Convert FC to DC = Domestic Currency receivable (Y) = (X)*Today SR or (X)/Today SR N-08
Investment in Domestic Currency [Creating Assets in DC] = Amount to be invested = Y M-07
On Maturity Date
Receive and Repay FC
Realisation of Investment in DC - Amount to be received = (Y)*(1+PIRDC)
If foreign currency is to Deposits in FC [Creating Assets in FC] = Deposit (X) = Amount payable in FC/ (1 + PIRFC)
be paid in future Borrowing and Convert [Creating Liability in DC] = Amount to be borrowed (Y) = (X)*Today SR or
[Liability in FC] (X)/Today SR
On Maturity Date
Receive and Repay FC
Repayment of Borrowing in DC = Amt to Repay = (Y)*(1+PIRDC)
10.12.1 Money market with Tax For incorporation of tax, calculate tax saving on Intt and Foreign Exchange Gain/ Loss as follows: 19
rate (a) Interest rate should be taken as net of tax. Intt (1-Tax Rate);
(b) Calculate Gain/ Loss due to change in exchange rate and calculate tax/ tax saving on them.
10.13 Cancellation of Forward contract can be cancelled at the request of the customer. This request may be made on or 20
Forward Contract before or after maturity date. Original forward Contract can be cancelled by entering into reverse
contract.
10.13.1 Cancellation of Forward If the request is made on or before the maturity date 21-23 N-04
& Contract on or before The bank recovers/pays, as the case may be, the difference between the contracted rate and the rate M-02
10.13.2 maturity at which the cancellation is affected.
Chap – 10 SUMMARY OF FOREX 10A.5
10.13.3 Cancellation after If the request is made after the maturity date 24
maturity date but before Gain to Customer is not paid to him, but loss to customer is recovered from him
15th day of maturity
10.13.4 If customer did not In the absence of any instructions from the customer 25
approach bank, then Contracts which have matured are automatically cancelled on the fifteenth day from the date of
cancellation on 15th Day maturity. In case the fifteenth day falls on a Saturday or holiday, the contract is cancelled on the next
from the date of working day. Exchange difference, if any, is recovered from the customer, but customer is not paid any
maturity gain accruing to him from such cancellations.
10.14.1 Extension of Forward If bank charges Margin Money, then Buying/ Selling rate for customer will be 27-28 N-15 M-15
Contract with margin Buying Rate for LHC = Rate Selected as per rule + Margin Money Payable to Bank N-10-O
money
Selling Rate for LHC = Rate Selected as per rule - Margin Money Payable to Bank
10.15 THEORIES OF There are three theories of exchange rate determination - Interest rate parity, Purchasing power parity
EXCHANGE RATE and International Fisher effect
DETERMINATION/PARITY
CONDITIONS IN
INTERNATIONAL
FINANCE
10.15.1 Interest Rate Parity Forward exchange rate of the two countries is determined by various factors like, interest rate, inflation 29-31 N-12 M-13
Theorem rate, GDP, Monetary Policy etc.
N-08
Interest rate parity theory assumes that the forward exchange rate of the two countries is determined
by their interest rate differential assuming other factors remain constant. M-04
Under IRPT, the currency whereof, the interest rate is higher will be at discount and the currency
whereof, the interest rate is lower will be at premium in future.
Arbitrage Profit If IRPT does not exists, then arbitrage profit is possible
10.15.2 PURCHASING POWER PPP says that the exchange rate between two currencies must be proportional to the price level of 32-34 M-10 M-13
PARITY THEORY goods in two countries.
N-08
(PPPT) There are two forms of PPP, Absolute and Relative.
The Absolute PPP The Absolute PPP is based on the preposition that a commodity costs the same regardless of what
currency is used to buy or where it is selling. If a book costs £4 in UK and exchange rate is £.60 per $,
then the book will cost £ 4/.60 = $ 6.66 in the U.S.
The Absolute PPP assumes that:
(i) The transaction costs are nil,
(ii) There is no barrier to trade, and
(iii) The goods are identical.
Relative PPP Relative PPP suggests that the change in exchange rate is determined by the difference in the inflation
rate in two countries.
Under PPPT, the currency whereof, the inflation rate is higher will be at discount and the currency
whereof, the inflation rate is lower will be at premium in future.
Arbitrage Profit If PPPT does not exists, then arbitrage profit is possible
10.15.3 INTERNATIONAL (1+ Nominal Interest) = (1 + Real Interest rate)*(1 + Inflation Rate) 35-36
FISHER EFFECT (IFE)
10.16 Cross Rate in Two All above concepts will be same except cross rates is to be calculated 37-43 N-14
way Quotes
M-14
M-14
N-13
N-13
M-13
N-11
M-09
N-05
M-05
10.17 Arbitrage The process of buying goods/currency in one market and selling the same in another market is known
Operation/Currency as arbitrage. Arbitrage profit is risk less profit.
Arbitrage There are two types of arbitrage in forex markets:
(i) Exchange rate arbitrage and
(ii) Interest rate arbitrage.
10.18 Exchange Rate It refers to a situation in which one currency is cheaper in one foreign exchange market and costlier in
Arbitrage or the other one. A person may purchase the currency at lower rate in one market, may sell at the higher
Geographical rate in the other market and make a profit. This profit arises at the same time.
Arbitrage Buying at lower rate and selling at higher rate.
Exchange rate arbitrage transactions may be classified in terms of the number of markets involved.
Thus, we may have two-point and three-point arbitrage.
10.18.1 Two-point arbitrage Two-point arbitrage concerns two currencies in two geographically separated markets. 45-47
10.18.4 Arbitrage Profit with If LHC is to be bought, Margin money should be added to Exchange Rate 51 N-14
Margin Money If LHC is to be sold, Margin money should be deducted from Exchange Rate
10.19 International Portfolio International Portfolio means investment in foreign securities 52-55 M-12
Chap – 10 SUMMARY OF FOREX 10A.8
Management
10.20 Covered Interest An interest arbitrage is possible when the forward premium or forward discount between two currencies 57-58 N-13
Arbitrage does not equal the interest rate differential.
N-10
If IRPT exists, then Interest arbitrage is not possible. As premium or discount in currency would be
equal to interest rate differential of two countries. N-06
Alternative Method for Arbitrage Profit (in term of %) = Return from Invested Currency – Borrowing Cost
calculation of Arbitrage Borrowing Amt*Arbitrage Profit in %
profit
10.20.2 Covered Interest If there is transaction cost for foreign transaction, then return from foreign investment may be 60
Arbitrage in case of calculated as follows
Single Quote with (1+Return from investment)(1 +- Prem/(Dis) on invested currency)(1-TC)2 – 1
transaction cost
10.21 Foreign Currency Question will give option, whether we should pay immediately or after some time with interest 64-65 M-15
Payment with Interest We will calculate inflow and outflow under both option and then we will accept those option beneficial to N-14
us
N-12
N-11
Chap – 10 SUMMARY OF FOREX 10A.9
10.21.1 Letter of Credit Letter of credit is an instrument issued in the favour of the seller by the buyer bank assuring that 66 N-08-O M-15
payment will be made after certain timer frame depending upon the terms and conditions agreed.
Under letter of credit, Bank charges commission and interest.
Commission is payable at the beginning of period.
Repayment of LC is made along with interest at maturity date.
10.22 International working MNC have various branches or subsidiaries in many countries. MNC manages cash in two ways 67-68 M-07 N-15
capital management
Centralised Cash Under this system, branches having surplus cash transferred immediately to HO and any deficit of cash
Management in any branches are met by HO. Any borrowing/ Surplus of cash is managed by HO
Decentralised Cash Under this system, each branches manage their cash independently. Borrowing/ Deposit are done by
Management branches. At the end of period (like month, quarter etc) surplus cash in any branch are transferred to
HO and deficit of cash in any branch are met by HO
10.23 CURRENCY SWAPS Currency Swaps refer to the arrangement where principal and interest payments in one currency are 69-71 M-13
exchanged for such payments in another currency. It is another method of hedging.
N-12
10.24 NOSTRO, VOSTRO These accounts are Nostro, Vostro and Loro accounts meaning "our", "your" and "their". 72 N-05 M-13
AND LORO ACCOUNTS
Nostro Accounts: A Domestic bank's foreign currency account maintained by the bank in a foreign country and in the
home currency of that country is known as Nostro Account or "our account with you". For example, An
Indian bank's Swiss franc account with a bank in Switzerland.
Actual inflow of foreign currency is credited to this account and actual outflow of foreign currency is
debited to this account.
A Nostro is our account of our money, held by you
Vostro account It is the local currency account maintained by a foreign bank/branch. It is also called "your account with
us". For example, Indian rupee account maintained by a bank in Switzerland with a bank in India.
Loro account Loro account is an account wherein a bank remits funds in foreign currency to another bank for credit
to an account of a third bank.
10.25 Netting [Method of NETTING: Netting involves offsetting exposures in one currency with exposures in the same or another 73-74 N-06
Hedging] currency. The basic idea behind the netting is to transfer only net amounts, usually within a short
period.
Types of netting Bilateral Netting: Company X exports goods to Company Y for US $2 million and imports goods worth
$1.5 million from Company Y. Their dates of maturity are the same, so they can offset net payment.
Chap – 10 SUMMARY OF FOREX 10A.10
Multilateral Netting: It involves netting of risk exposure among more than two company. It is
performed by the central treasury where several subsidiaries interact with head office.
10.26 Matching [Method of The foreign exchange rate risk can be eliminated or reduced, if the company which is having exposure
Hedging] to receipts and payments in the same currency. The company can off set its payments against its
receipts if it can plan properly. This can be managed by operating a bank account in overseas to offset
the transaction. The basic requirement for a matching operation is the two-way cash flow in the same
foreign currency is called ‘natural matching’. If the matching involves between two currencies whose
movements are expected to run closely is called ‘parallel matching’.
10.27 Leading and Lagging Leading: A firm having exposure to pay foreign currency, can make payments in advance prior to 75-76 M-12
[Method of Hedging] due date called “Leads” to take advantage of lesser rate of foreign currency. In such cases, the firm
should consider the interest loss on opportunity to deploy funds elsewhere.
Lagging: If the firms delays the payments over the due date to take advantage of the exchange
fluctuation it is called “Lags”. The technique used in this is to delay payment of weak currencies and
bring forward payment of strong currecies.
10.29 When Transaction We will Compare SR of Contract date and FR for calculating Prem/Dis 77 N-04
date and forward We will Compare SR of Transaction Date and FR for calculating Operating Profit
contract date are
different
10.30 Cross-Currency Roll Cross Currency Roll Over contacts are contracts to cover long term foreign exchange liabilities or 78
Over assets. The cover is initially obtained for six months & later extended for further period of 6 months &
so on. Forward rate beyond 6 months is not available in market.
Under the Roll over contracts the basic rate of exchange is fixed but loss or gain arises at the time of
each Roll over depending upon the market conditions.
Roll-over-forward contract is one where forward contract is initially booked, for the total amount of
loan, etc. to be repaid. As and when installment falls due, the same is paid by the customer in foreign
currency at the exchange rate fixed in forward exchange contract. The balance amount of the contract
is rolled over (extended) till the due date of next installment. The process of extension, continues till
the loan amount has been repaid.
10.32 Theory
What is the meaning of (i) Interest rate parity and (ii) Purchasing power parity 3 M-11
Write short notes on Nostro, Vostro and Loro Account 5 M-12 N-15
A firm dealing with foreign exchange may be exposed to foreign currency exposures. The
exposure is the result of possession of assets and liabilities and transactions denominated 'in
foreign currency. When exchange rate fluctuates, assets, liabilities, revenues, expenses that have
been expressed in foreign currency will result in either foreign exchange gain or loss. A firm
dealing with foreign exchange may be exposed to the following types of risks:
(a) Transaction Exposure: A firm may have some contractually fixed payments and receipts in
foreign currency, such as, import payables, export receivables, interest payable on foreign
currency loans etc. All such items are to be settled in a foreign currency. Unexpected
fluctuation in exchange rate will have favourable or adverse impact on its cash flows. Such
exposures are termed as transactions exposures.
(b) Translation Exposure: The translation exposure is also called accounting exposure or
balance sheet exposure. It is basically the exposure on the assets and liabilities shown in the
balance sheet and which are not going to be liquidated in the near future. It refers to the
probability of loss that the firm may have to face because of decrease in value of assets due
to devaluation of a foreign currency despite the fact that there was no foreign exchange
transaction during the year.
(c) Economic Exposure: Economic exposure measures the probability that fluctuations in
foreign exchange rate will affect the value of the firm. The intrinsic value of a firm is
calculated by discounting the expected future cash flows with appropriate discounting rate.
The risk involved in economic exposure requires measurement of the effect of fluctuations in
exchange rate on different future cash flows.
Direct Quote It indicates the number of units of the domestic currency required to buy one
unit of foreign currency.
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.4
Example: $1 = Rs.45 is a direct quotation for US $ in India.
Indirect It indicates the number of units of foreign currency that can be exchanged for
Quote one unit of the domestic currency.
Example Rs.1 = US $ 0.02065 is an indirect quotation in India.
Direct Quote = 1/Indirect Quote
American It refers to quoting per unit of any currency in terms of American Dollars
Quote
European It refers to quoting per unit of American Dollars in terms of any other currency.
Quote
10.3
Transaction Foreign Exchange Risk (FER)
a) Mr Ram of India, Purchase or sale goods in India. No
b) Mr Ram of India, Purchase or sale goods with USA and He is not in FER but USA importer
Invoice is in Rs. is at FER
[DC-Rs. and payable/receivable currency – Rs.]
c) Mr Ram of India, Purchase or sale goods with USA and He is in FER but USA importer is
Invoice is in $. not at FER
[DC-Rs. and payable/receivable currency – $]
Note In foreign Exchange transaction, Only one party remains at risk. The Party whose payable/
receivable currency are different from his domestic currency remains at risk.
a) There are two types of rates in the market. These are Spot Exchange rate and Forward
Exchange Rates.
b) Spot Exchange Rates: The spot exchange rate is the current rate at which one currency
can be immediately converted into another currency. The spot rate is the rate paid for
delivery within two business days after the day the transaction takes place.
Example
On 01/01/2012 Ram buys goods from UK and paid £1,00,000 on the same day.
Exchange rate as on 01/01/2012 £ 1 = Rs.68 [It is known as spot rate]
Rs. required to buy £1,00,000 at spot rate = £1,00,000*68 = Rs.6800000
c) A forward exchange rate occurs when buyers and sellers of currencies agree to deliver the
currency at some future date. They agree to transact a specific amount of currency at a
specific rate at a specified future date.
The forward exchange rate is set and agreed by the parties and remains fixed for the
contract period regardless of the fluctuations in the spot exchange rates in future.
Forward rates are usually quoted for fixed periods of 30, 60, 90 or 180 days from the day of
the contract.
If funds to fulfill the contract are available on hand or are due to be received by the business,
the hedge is considered to be ‘covered’.
In situations where funds to fulfill the contract are not available but have to be purchased in
the spot market at some future date, then such a hedge is known as ‘uncovered’.
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.5
Example for class On 01/01/2013, Mr A wants to buy flat in 90 days.
Suppose, today rate of Flat 1 = Rs.68 lacs [Known as Spot Rate]
Over the next 90 days the rate of flat may rise or decline
Mr A has two options
(a) He may wait till 90 days and on 90th day, he will buy flat at spot rate prevailing on 90th day.
Due to no hedging, amount of his liability is uncertain as flat rate may increase or decrease.
(b) To make his liability certain, he may enter into contract with Mr B to buy Flat on 90th day.
Flat rate quoted by Mr B for forward contract
£ 1 = Rs.68.10 lacs [This is known as Forward rate for 90 days] [It will be applicable on 90th
day but fixed and quoted today]
On 90th day, whatever may be the spot rate, Mr A will buy Flat @ Flat 1 = Rs.68.10 lacs
Note: We may conclude if no hedging is done, then payable/receivable amt is not certain and
will be decided on the date of maturity. Till maturity date, party remains at risk.
If hedging is done, i.e Mr A enter into forward contract with Mr B for purchase of Flat @ 68.10
lacs
Applicable rate Flat 1 = Rs.68.10 lacs Flat 1 = Rs.68.10 lacs Flat 1 = Rs.68.10 lacs
Conclusion: Forward contract is not entered into for gain or loss but it is entered into to make
payable/ receivable certain or risk free. Entering into forward contract is known as hedging.
Example: On 01/01/2013, an Indian firm buys electronics from a British firm with payment of
£1,00,000 in 90 days.
Suppose, today exchange rate £ 1 = Rs.68 [Known as Spot Rate]
Over the next 90 days the £ may rise or decline against the Rs.
The Indian importer has two options
(c) He may wait till 90 days and on 90th day, he will buy £100000 at spot rate prevailing on 90th
day. Due to no hedging, amount of his liability is uncertain as foreign exchange rate may
increase or decrease.
(d) To make his liability certain, he may enter into contract with bank or forex dealer to buy
£1,00,000 on 90th day.
Exchange rate quoted by Bank or Forex Dealer for forward contract
£ 1 = Rs.68.10 [This is known as Forward rate for 90 days] [It will be applicable on 90th day
but fixed and quoted today]
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.6
On 90th day, whatever may be the spot rate, importer will buy £100000 @ £ 1 = Rs.68.10
Note: We may conclude if no hedging is done, then payable/receivable amt is not certain and
will be decided on the date of maturity. Till maturity date, party remains at risk.
If hedging is done, i.e Indian importer enter into forward contract with bank for purchase of
£100000 @ 68.10
Applicable rate £ 1 = Rs.68.10 £ 1 = Rs.68.10 £ 1 = Rs.68.10
Rs. required to buy £100000*68.10 = £100000*68.10 = £100000*68.10 =
£100000 = Rs.6810000 Rs.6810000 Rs.6810000
Conclusion: Forward contract is not entered into for gain or loss but it is entered into to make
payable/ receivable certain or risk free. Entering into forward contract is known as hedging.
10.5 Relationship between Spot Rate and Forward Rates/Expected Spot Rate/maturity
Spot Rate [Q-1]
ICAI RTP ICWA
a) Difference between Spot rate and future rate is known as premium or discount in any one
currency
b) Premium/Dis on LHC ≠ Dis/Premium on RHC
c) Appreciation/Premium
Currency is said to have appreciated if its value has increased, i.e. an investor is required to
pay more for purchasing that currency
Example: USD 1 = Rs.40 becomes USD 1 = Rs.42. Here the value of USD has increased. An
investor is required to pay more Rupees to acquire one USD.
Depreciation/ Discount
Currency is said to have depreciated if its value has decreased, i.e. an investor is required to
pay less for purchasing that currency.
Example: USD 1 = Rs.41 becomes USD 1 = Rs.39. Here the value of USD has decreased. An
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.7
investor is required to pay lesser amount in Rupees in acquire one USD.
d) Premium/(Discount) in % may be ascertained as follows
Question-1
Today SR $ 1 = Rs.46
Today FR of 6 months $1 = Rs.51 or Rs.44
Calculate Premium/Discount on $ and Rs. for 6 months and p.a.
Question-1A [SP]
SR $ 1 = Rs.48
FR of 3 months $1 = Rs.51 or Rs.47
Calculate Premium/ Discount on $ and Rs. for 3 months and p.a.
10.6 If SR and Prem/ Disc is given, then we can calculate FR or ESR or MSR as follows
[Q-2]
ICAI RTP ICWA
Question–2 [Example-ICWA]
In the spot market USD 1 = Rs.40, if in the forward market (1 Year)
(a) If Dollar is appreciating by 10%.
(b) If Dollar is depreciating by 10%.
(c) If Rupee is appreciating by 10%.
(d) If Rupee is depreciating by 10%.
Question-2A The spot rate of exchange is 2.5 Northland dollars to the pound. If, at the end of
the six months the Northland dollar has (i) gained 4%, (ii) lost 2% or iii) remained stable. What
will be the 6 months forward rate.
Question-2B [SM-12] [SP] Suppose that 1 French franc could be purchased in the foreign
exchange market for 20 US cents today. If the franc appreciated 10% tomorrow against the
dollar, how many francs would a dollar buy tomorrow? [Ans: 4.5455 FF]
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.8
10.7 Calculation of Gain or loss due to foreign Exchange fluctuation [Q-3 to 7]
ICAI IRPT ICWA
M-03 M-06
N-03 M-06
Rule-1
If foreign currency is to be received in future [FC-Sell; DC-Buy]
If foreign currency is to be paid [FC-Buy; DC-Sell]
Example: On 01/01/2013, an Indian firm buys electronics from a British firm with payment of
£1,00,000 in 90 days.
On 01/01/2013
TSR £ 1 = Rs.68
ESR of 90 days £ 1 = Rs.70 or 66
FR of 90 days £ 1 = Rs.68.10
On 31/03/2013
MSR £ 1 = Rs.65 or Rs.71
Question-3A B Ltd, has shipped goods to an USA importer for $ 10000 due in 90 days.
Today Spot Rate $ 1 = Rs.45
If Rs. will depreciate by 10% in 90 days, calculate gain or loss due to foreign exchange
fluctuation. [Ans: Gain of Rs.50000]
Select Higher of ESR and FR for decision Select Lower of ESR and FR for decision
Question-4A [May-1998] A company operating in a country having the dollar as its unit
of currency has today invoiced sales to an Indian company, the payment being due three
months from the date of invoice. The invoice amount is $13750 and at today's spot rate of
$ 0.0275 per Re. is equivalent to Rs.5,00,000.
It is anticipated that exchange rate will decline by 5% over the three month period and in
order to protect the dollar proceeds to take appropriate action through foreign market. The
three months forward rate is quoted as $ 0.0273 per Rs.1
You are required to calculate
(a) Whether forward contract should be entered into or not. [Not Part of Exam Question]
(b) Expected loss if hedging is not done. [Ans: Expected Loss if no Forward Contract is taken – Rs.26315.80;]
(c) Show loss is hedging is done. [Expected Loss under Forward Contract – Rs.3663]
Question-5 [CS-Dec-99] In September, 1998, the Multinational Industries Inc. assessed the
March, 1999 spot rate for pound sterling at the following rates:
$ 1.30/£ with probability 0.15
$ 1.35/£ with probability 0.20
$ 1.40/£ with probability 0.25
$ 1.45/£ with probability 0.20
$ 1.50/£ with probability 0.20
What is the expected spot rate for March, 1999? [Ans: 1.405 $]
If the six-month forward rate is $ 1.40, should the firm sell forward its 1000 pound receivables
due in March, 1999? [Ans: No]
(i) What is the expected spot rate for 1.9.2003? [Ans: $1.81]
(ii) If, as of March, 2003, the 6-month forward rate is $ 1.80, should the firm sell forward its
pound receivables due in September, 2003? [Ans: No]
Question-6 X Ltd. an Indian company has an export exposure of 100 lacs yen, value September
end. The current spot rate is yen 310 = Rs.100
It is estimated that Yen will depreciate and estimated rate will be yen 334.88 = Rs.100. Forward
rate for September, 1998 Yen 320.24 = Rs.100.
You are required:
(i) To calculate the expected loss if hedging is not done. [Ans: Expected Loss if no hedging is done – Rs.2.397
lacs]
(ii) How the position will change with company taking forward cover?[Expected loss if Forward Contract is
entered into – Rs.1.031 lacs]
(iii) If the spot on 30th September, 1998 was eventually Yen 322.23 = Rs.100. Is the decision to
take forward cover justified? [Ans: Yes]
Question-7 [SM-17] A UK company, is due to receive 5,00,000 Northland dollars in six month's
time for goods supplied. The company decides to hedge its currency exposure by using the
forward market. The spot rate of exchange is 2.5 Northland dollars to the pound. The forward
rate of exchange is 2.5354 Northland dollars to the pound.
Calculate how much UK company actually gains or loses as a result of the hedging transaction if,
at the end of the six months, the pound, in relation to the Northland dollar, has (i) gained 4%,
(ii) lost 2% or (iii) remained stable. [Ans: Expected gain – 4900 £; Expected Loss – 6874 £; Expected gain – 2792 £]
Cross Rate denotes an exchange rate that does not involve the required currency. It is an
exchange rate between the currencies of two countries that are not quoted against each other,
but are quoted against one common currency.
Question-8 SR is
$1 = Rs.50;
$1 = Yen 200;
Calculate Exchange rate between Rs. and Yen
Question-9 SR is
$1 = Rs.50;
$1 = Yen 200;
Pound 1 = Yen 300
Calculate Exchange rate between Rs. and Pound
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.12
Question-10 [Nov-1998] X Ltd., an Indian Company has an export exposure of 10
million (100 lacs) yen, payable September end. Yen is not directly quoted against Rupee.
The current spot rates are INR/USD = Rs.41.79 and JPY/USD = 129.75. It is estimated that
yen will depreciate against $ to 144 level and Rs. to depreciate against $ to Rs.43. Forward
rates for September 1998 are INR/USD = Rs. 42.89 and JPY/USD = 137.35.
You are required to:
(i) Calculate the expected loss if hedging is not done. How the position will change if the firm
takes forward cover? [Ans: Expected Loss if no hedging is done – Rs.0.2347M; Expected loss if Forward Contract is entered
into – Rs.0.21921M]
(ii) If the spot rate on 30th September 1998 was eventually INR/USD = Rs.42.78 and JPY/USD =
137.35, is the decision to take forward cover justified? [Ans: Yes]
Question-10A [May-2014] [M-8] JKL Ltd an Indian company has an export exposure of JPY
10,00,000 payable August 31, 2014. Japanese Yen (JPY) is not directly quoted against Indian
Rupee.
The current spot rates are:
USD 1 = Rs.62.22
USD 1 = JPY 102.34
It is estimated that Japanese Yen will depreciate to 124 level and Indian Rupee to depreciate
against US $ to Rs. 65.
Forward rates for August 2014 are
USD 1 = Rs.66.50
USD 1 = JPY 110.35
Required:
(i) Calculate the expected loss, if the holding is not done. How the position will change, if the
firm takes forward cover?
(ii) If the spot rates on August 31,2014 are:
USD 1 = Rs. 66.25
USD 1 = JPY 110.85
Is the decision to take forward cover justified ?
(a) Two way quotes refer to quoting exchange rates by an exchange dealer in terms of
buying (Bid) Rate and selling (Ask) Rate.
(b) Bid rate is the rate at which the dealer is willing to buy LHC. In other words it is selling rate
of LHC for customer.
The bid price is the highest price that someone is willing to pay at that moment.
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.13
(c) Offer (Ask) Rate is the rate at which Dealer is willing to sell LHC. In other words it is
buying rate of LHC for customer.
The asking price is the lowest price at which someone is willing to sell at that moment.
(d) Spread
The difference between the bid and the offer is called the spread.
If the exchange rate is expected to be stable, the spread will be narrow. If the exchange
rate is volatile, the spread will be wider.
Where volume of transactions is very high, the Bid-Offer Spread will be very low. In case of
a thinly-traded currency, the spread will be wider.
From the Dealer point of view: First is Buying Rate and Second is Selling rate of LHC
From the Customer point of view: First is Selling Rate and Second is Buying rate of LHC
Question-11 Calculate how much sterling pounds exporters would receive or how much sterling
pounds importers would pay, in each of the following situations:
(i) A UK exporter receives a payment of 80,000 guilders from a Dutch customer. [Ans: Pound
22408.96]
(ii) A UK exporter receives a payment from a French customer of FF 1,50,000. [Ans: Pound 13940.52]
(iii) A UK importer buys goods from a Japanese supplier and pays 1 million yen. [Ans: Pound 4282.65]
(iv) A UK importer pays a German consultancy firm DM 1,20,000 under service contract. [Ans:
Pound 37825.06]
Question-11A [SP] Calculate how many rupees A Ltd., a New Delhi based firm, will receive or
pay for its following four foreign currency transactions:
i) The firm receives dividend amounting to Euro 1,12,000 from its French Associates
Company. [Ans: Rs.6272000]
ii) The firm pays interest amounting to 2,00,000 Yens for its borrowings from Japanese Bank.
[Ans: Rs.8820000]
iii) The firm exported goods to USA and has just received USD 3,00,000. [Ans: Rs.12000000]
a) Swap Points are movement in Exchange Rate expressed in absolute terms, i.e. in value
terms
a) If Swap points is given in ascending order (increasing order) or spread is positive, we add it
to right hand side currency to calculate Forward Rate. It indicates that the left hand side
currency is at premium.
b) If forward margin is given in decending order (decreasing order) we deduct it from right
hand side currency to calculate Forward rate. It indicates that the left hand side currency is
at discount.
[Example-ICWA]
Spot Rate Swap Points Forward Bid Rate Forward Ask Rate
Question-12 A Foreign Exchange Dealer has forwarded the following quotes on USD spot, 1
month forward, 2 months forward and 3 months forward
Spot 1 Month 2 Months 3 Months
1 USD Rs.45 - 45.20 0.18 - 0.22 0.25 - 0.30 0.32 - 0.30
Calculate 1 month, 2 months and 3 months forward rates.
Question-13 Calculate how many rupees a New Delhi based firm will receive or pay for its
following four foreign currency transactions
a) Purchasing $1,00,000 on 2 months forward basis. [Ans: Rs.4000000]
Spot 1 month Swap Point 2 months Swap Points 3 months Swap Point
1$ Rs.40.00/40.10 5/6 paise 11/10 paise 10/11 paise
1 CD Rs.34.90/35.00 0.10/0.20 0.11/0.12 0.10/0.11
100 Yens Rs.33.00/33.10 0.11/0.10 0.12/0.13 0.14/0.15
10.11 Analysis of decision of hedging under two Quote rates [Q-14 to 15]
ICAI IRPT ICWA
M-09-O M-06
Question-14 A merchant in the U.K. has agreed to sell goods to an importer in the U.S.A at an
invoiced price of $90,000. Of this amount, $45,000 will be receivable at one month of shipment
and $45,000 on the last day of third month after shipment.
The quoted foreign exchange rates ($ per Pound) at the date of shipment are as follows:
One month 1.687 - 1.690
Three month 1.680 - 1.684
The merchant decides to enter into appropriate forward exchange contracts through his bank.
Comment on the wisdom of hedging in this instance, assuming that the spot rates at the dates of
receipt of the two installments of $45,000 were. [Ans: If Forward Cover is taken, then excess receipts of £408]
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.15
First installment 1.694 - 1.696
Second installment 1.700 - 1.704
Question-15 [May-2009-O] [M-6] [ICWA-4] The following 2-way quotes appear in the
foreign exchange market
Spot Rate 2-months FR
Rs/US $ Rs.46.00/Rs.46.25 Rs.47.00/Rs.47.50
Required
(a) How many US dollars should a firm sell to get Rs.25 lakhs after 2 months? [Ans: $53191.49]
(b) How many Rupees is the firm required to pay US $ 2,00,000 in the spot market? [Ans:
Rs.9250000]
(c) Assume the firm has US $ 69,000 in current account earning no interest. ROI on Rupee
investment is 10% p.a. Should the firm encash the US $ now or 2 months later?
Question-15A [ICSI-Dec-2003] [SP] The following rate appear in the foreign exchange
market:
Spot 2-months forward
Rs/US $ Rs.45.80/Rs.46.05 Rs.46.50/Rs.47.00
Required
(i) How many US dollars should a firm sell to get Rs.5 Cr after 2 months? [Ans: $0.107527 Cr]
(ii) How many Rupees is the firm required to pay US $ 2,00,000 in the spot market? [Ans:
Rs.9210000]
(iii) Assume the firm has US $50,000. How many rupees does the firm obtain in exchange of
US$?
a) Money Market Operations refers to creating an equivalent asset or liability against a Foreign
Currency Liability or Receivable.
Under money market operation the following steps are taken.
b) If foreign currency is to be received in future [Assets in FC]
i) Borrowing in FC [Creating Liability in FC]
The concern will borrow an amount in foreign currency, which together with the interest on it
should be equal to foreign currency to be received.
Amount of borrowing (X) = Amount receivable in FC/(1 + PIRFC)
ii) Convert
He will convert FC into Domestic currency at today SR
Domestic Currency receivable (Y) = (X)*Today SR or (X)/Today SR
Question-17 [May-2007] [M-8] [Nov-2015] [M-8] XYZ Ltd. a US firm will need £3,00,000 in
180 days. In this connection, the following information is available:
Spot rate 1 £ = $ 2.00
180 days forward rate of £ as of today = $1.96
Interest rates are as follows:
U.K. US
180 days deposit rate 4.5% 5%
180 days borrowing rate 5% 5.5%
A call option on £ that expires in 180 days has an exercise price of $ 1.97 and a premium of $
0.04.
XYZ Ltd. has forecasted the spot rates 180 days hence as below:
Future rate Probability
$ 1.91 25%
$ 1.95 60%
$ 2.05 15%
Which of the following strategies would be most preferable to XYZ Ltd.?
(i) a forward contract [Ans: $ 588000]
(ii) a money market hedge [Ans: $602933.98]
(iii) an option contract [Ans: $594900]
(iv) no hedging [Ans: $ 586500]
Show calculations in each case.
Question-17A [May-2010-O] [M-8] [SP] A Ltd of U K has imported some chemical worth of
USD 3,64,897 from one of the US suppliers. The amount is payable in six months time. The
relevant spot and forward rates are:
Spot Rate USD 1.5617 – 1.5673
6 months Forward Rate USD 1.5455 – 1.5609
The borrowing rates in UK and US are 7% and 6% respectively and the deposit rates are 5.5%
and 4.5% respectively.
Currency options are available under which one option contract is for GBP 12,500. The option
premium for GBP at a strike price of USD 1.70/GBP is USD 0.037 (call option) and USD 0.096
(put option) for 6 months period
The company has three choices:
(i) Forward Cover [Ans: GBP 236102.89]
(ii) Money Market Cover; and [Ans: GBP 236510.10]
(iii) Currency Option [Ans: GBP 227923.00]
Which of the alternatives is preferable by the company?
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.18
Question-17B
Question-17C
Question-19 On March 1, 1979, the B Ltd. bought from a foreign firm electronic equipment that
will require the payment of LC 9,00,000 on May 31, 1979. The spot rate on March 1, 1979, is LC
10 per dollar, the expected future spot rate is LC 8 per dollar, and the ninety-days forward rate is
LC 9 per dollar. The US interest rate is 12%, and the foreign interest rate is 8%. The tax rate for
both countries is 40%. The B Ltd. is considering three alternatives to deal with the risk of
exchange rate fluctuations.
(i) To enter the forward market to buy LC 9,00,000 at the ninety-days forward rate in effect on
May 31, 1979.
(ii) To borrow an amount in dollars to buy the LC at the current spot rate. This money is to be
invested in government securities of the foreign country; with the interest income, it will
equal LC 9,00,000 on May 31, 1979.
(iii) To wait until May 31, 1979, and buy LCs at whatever spot rate prevails at that time.
Which alternative should the B Ltd. follow in order to minimize its cost of meeting the future
payment in LCs? Explain. [Ans: Under Forward Cover – $96000; Under Money Market - $90533.60; Under no
Hedging - $103500]
a) Forward contract can be cancelled at the request of the customer. This request may be made
on or before or after maturity date. Original forward Contract can be cancelled by entering
into reverse contract.
b) If the request is made on or before the maturity date
The bank recovers/pays, as the case may be, the difference between the contracted rate and
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.19
the rate at which the cancellation is affected.
c) If the request is made after the maturity date
Gain to Customer is not paid to him, but loss to customer is recovered from him
d) In the absence of any instructions from the customer
Contracts which have matured are automatically cancelled on the fifteenth day from the
date of maturity. In case the fifteenth day falls on a Saturday or holiday, the
contract is cancelled on the next working day. Exchange difference, if any, is recovered
from the customer, but customer is not paid any gain accruing to him from such
cancellations.
Question-20
On 01/01/2012, Mr. A entered into Forward sale Contract for $10000 for 31.03.2012
As on 01/01/2012
Spot Rate is $1 = Rs.44.00 – 44.50
3 Months Forward Rate $ 1 = Rs.45.00 – 45.50
Mr A wants to cancel the Forward contract as on
31.01.2012 28.02.2012 31.03.2012 10.04.2012 15.04.2012
Question-22A [ICWA-Dec-2006] [SP] NBA Bank Ltd. transacted the following forward
transactions on March 19, 1999.
(i) Sold $ 10,00,000 three months forward to Alpha Manufacturing Co. Ltd at Rs.44.50
(ii) Purchased Euro 10,00,000 two months forward from Beta Trading Co. Ltd at Rs.47.20
On May 19, 1999 both the customers approached the bank for the cancellation of their contract.
The following exchange rates prevailed on that day:
Rs./$ Rs./Euro
Spot 44.60/65 47.75/85
One-month forward 15/20 25/35
Calculate the amount to be paid to or recovered from customers due to the cancellation of the
forward contract. [Ans: Gain to Alpha – Rs.25000; Loss to Beta – Rs.650000]
Question-23 [ICWA-7]
On 01.04.2007, Sangeet International concluded a contract for purchase of 1,000,000 Blue Ray
Discs from an American Company at $1.48 per Disc, to be supplied over the next 3 Months. SI is
required to make the payment immediately upon receipt of all the discs.
To meet the obligation, SI had booked a Forward Contract with its bankers to buy USD 3 Months
hence. The following are the Exchange Rates on 01.04.2007 —
SR $ 1 = Rs.41.30 -41.70
3 Months FR $ 1 = Rs.42.00 – 42.50
On 01.07.2007, the American Company expressed its inability to supply the last instalment of
300,000 Blue Ray Disks due to export restrictions in US, and requested SI to settle for the
quantity supplied.
Spot Rate on 01.07.2007 was $ 1 = Rs.40.90 - 41.20.
(a) Ascertain the total cash outgo for SI for purchase of 700,000 Discs.
(b) Would total cash outgo undergo any change if the American Company had informed on
01.06.2007, when the following exchange rates were available —
Spot $ 1 = Rs. 41.70 -42.20
1-Months Forward $ 1 = Rs. 42.10 - 42.50
10.13.3 Cancellation after maturity date but before 15th day of maturity
Question-24 XYZ Ltd. booked a forward sale contract for USD 500,000 @ 46.20 due on 5 March.
The customer did not contact the bank on due date. However, on 10th March, the customer
requests the bank to cancel the contract. On this date, spot rate is Rs.46.28/ Rs.46.35. What
amount of gain/loss will be payable to / receivable from customer? [Ans: Loss to Customer - Rs.75000]
Question-24A [SP] Bank of India has booked a forward sale contract for USD 1,00,000 @
48.42 due 10th March, 2003. The customer did not Contact the bank on due date. However, on
14, March, 2003, the customer requests the bank to cancel the contract. On this date, spot rate
is Rs.48.50/Rs.48.57 What amount of gain/loss will be payable to/receivable from customer?
10.13.4 If customer did not approach bank, then cancellation on 15th Day from the date
of maturity
Question-25 ABC Ltd. booked a forward Sale contact for USD 200,000 due on 5 March, @
Rs.46.10. The customer did not contact the bank on / before / after the date of maturity. Given
the following Spot rates, what amount of gain / loss will be payable to/ receivable from
customer?
19 March 46.17/46.25
20 March 46.18/ 46.26
21 March 46.19/46.27
[Ans: Loss to customer - Rs.32000]
Question-25A [SP] A bank had booked a forward sale contract for USD 1,00,000 due 10th
March, 2003 @ 48.42. The customer did not Contact the bank on before/after the date of
maturity. Given the following spot rates, what amount of gain/loss will be payable to/receivable
from customer?
24th March, 2003 (Mon.) 48.49/48.57
25th March, 2003 48.50/48.58
26th March, 2003 48.51/48.59
M-2015 M-09
Question-26A [SP] ABC Ltd. booked a forward sale contract for USD 100,000 @ 46.25 due on
12 August. On 8 August the customer requests the bank to extend the forward contract for 15
September. Foreign exchange rates on 8 August are:
Spot 46.03 - 46.07
Forward rate of 12th August 45.56 - 45.72
Forward rate of 15th September 45.34 - 45.54
At what rate the contract will be extended? What amount of loss/ gain will be receivable from/
payable to customer? [Ans: Rs.53000 gain to customer; New forward rate $ 1 = Rs.45.34]
Question-27 [Nov-2010-O] [M-4] An importer requests his bank to extend the forward
contract for US $20,000 which is due for maturity on 30th Oct, 2010, for a further period of 3
months. He agrees to pay the required margin money for such extension of the contract.
Contracted Rate – US $ 1 = Rs.42.32
The US Dollar quoted on 30.10.2010
Spot – $1 = Rs.41.50 - 41.52
3 month’s Premium – 0.87%-0.93%
Margin money for buying and selling rate is 0.075% and 0.20% respectively.
Compute:
(i) The cost to the importer in respect of the extension of the forward contract, and [Ans: Loss to
customer – Rs.17022.50]
(ii) The rate of new forward contract. [Ans: Rs.41.9898]
Question-28 [May-2015] [M-9] An importer booked a forward contract with his bank on 10th
April for USD 200000 due on 10th June @ Rs.64.4000. The bank covered its position in the
market at Rs.64.2800
The exchange rates for dollar in the interbank market on 10th June and 20th June were:
10th June 20th June
Spot USD 1 = Rs.63.8000/8200 Rs.63.6800/7200
Spot/ June Rs.63.9200/9500 Rs.63.8000/8500
July Rs.64.0500/0900 Rs.63.9300/9900
Aug Rs.64.3000/3500 Rs.64.1800/2500
Sep Rs.64.6000/6600 Rs.64.4800/5600
Exchange Margin 0.10% and interest on outlay of funds @ 12%. The importer requested on 20th
June for extension of contract with due date on 10th Aug.
Rates rounded to 4 decimal in multiples of 0.0025
On 10th June, Bank Swaps by selling spot and buying one month forward.
N-08 M-04
M-10 M-04
N-12 M-05
[May-2011] [M-4] What is the meaning of (i) Interest rate parity and (ii) Purchasing power
parity
There are three theories of exchange rate determination - Interest rate parity, Purchasing power
parity and International Fisher effect
a) Forward exchange rate of the two countries is determined by various factors like, interest
rate, inflation rate, GDP, Monetary Policy etc.
Interest rate parity theory assumes that the forward exchange rate of the two countries is
determined by their interest rate differential assuming other factors remain constant.
b) FR under IRPT = [1 + PIR[RHC]]*SR/[1 + PIR[LHC]]
[PIR[RHC] - PIR[LHC]]*100/[1 + PIR[LHC]] OR
c) Prem/(Dis) on LHC under IRPT =
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.24
[FR[IRPT] - SR]*100/SR
[PIR[LHC] - PIR[RHC]]*100/[1 + PIR[RHC]] OR
Prem/(Dis) on RHC under IRPT =
[SR - FRIRPT]*100/FRIRPT
d) Under IRPT, the currency whereof, the interest rate is higher will be at discount and the
currency whereof, the interest rate is lower will be at premium in future.
e) Whether IRPT Exists or not/Interest If FRIRPT = FRActual then IRPT exists OR
Rate and FR are in equibilrium ?
If Prem/(Dis)IRPT = Prem/(Dis)Actual then IRPT exists
f) If forward exchange rate is determined using interest rate parity theory, one cannot take
advantage of interest rate difference in two countries. Parity Conditions are expected to hold
in the long-run, but not always in the short term
g) If IRPT does not exists, then arbitrage profit is possible
Question-29 [May-2004] [M-9] The US Dollar is selling in India at Rs. 45.50. If the interest
rate for a 6 month borrowing in India is 8% p.a. and the corresponding rate in USA is 2%,
(i) What is the expected/fair 6 month forward rate for US Dollar in India; and
(ii) What is the rate of forward premium or discount on $?
(iii) What is the rate of forward premium or discount on Rs.?
(iv)Do you expect US Dollar to be at a premium or at discount in the Indian forward market;
(v) If actual FR of 6 months is $ 1 = Rs.47, Actual Prem/Dis on $; [Not Part of Exam Question]
(vi)Whether IRPT exists or not? [Not Part of Exam Question]
Question-29A [Nov-2012] [M-5] The US Dollar is selling in India at Rs. 55.50. If the interest
rate for a 6 month borrowing in India is 10% per annum and the corresponding rate in USA is
4%,
(i) What is the expected 6 month forward rate for US Dollar in India; and
(ii) What is the rate of forward premium or discount on $?
(iii) Do you expect US Dollar to be at a premium or at discount in the Indian forward market;
(iv) If actual FR of 6 months is $ 1 = Rs.58, Actual Prem/Dis on $; [Not Part of Exam Question]
(v) Whether IRPT exists or not? [Not Part of Exam Question]
Question-29B [SP]
(a) The spot Danish Krone rate is $ 0.15986 and the three month forward rate is $ 0.1590. The
three month treasury bill rate in the United States is 6.25% p.a. and in Denmark 7.50% p.a.
(i) Calculate forward premium or discount on Danish Krone
(ii) Are the forward rates and interest rate in equilibrium?
(iii) Work out the forward rate if the forward rate or interest rate are in equilibrium.
h) IF SR, FR and Interest rate of one currency is given, then we can calculate Interest rate of
another currency by assuming that IRPT exists
FRGiven = FRIRPT = [1 + PIR[RHC]]*SR/[1 + PIR[LHC]] or
FRIRPT/SR = [1 + PIR[RHC]]/[1 + PIR[LHC]]
i) IF SR, Interest rate of one currency and prem/(Dis) in one currency is given, then we can
calculate Interest rate of another currency by assuming that IRPT exists
1st we will calculate FR
IF premium/ Dis is on LHC, then FR or ESR: 1 LHC = SR*(1+-Prem/Disc)
IF premium/ Dis is on RHC, then FR or ESR: 1 LHC = SR/(1+-Prem/Disc)
Question-31 [Nov-2000] [M-8] [ICWA-9] The following table shows interest rates for the US
dollar and French francs. The spot exchange rate is 7.05 francs per dollar. Complete the missing
entries:
3 Months 6 Months For 1 year
Dollar interest rate (Annually compounded) 11.5% 12.25% ?
Franc interest rate (Annually compounded) 19.5% ? 20%
Forward francs per dollar ? ? 7.52
Forward discount on FF per cent per year ? -6.3% ?
Question-31A [SP]
Nov-2008 M-4
May-2010 M-4
a) In the general economic analysis, the value of a currency in one country is determined by
the amount of goods and services that can be purchased with a unit of the currency, this is
called the purchasing power of the currency. PPP says that the exchange rate between two
currencies must be proportional to the price level of goods in two countries.
Suppose certain bundle of goods in U.S.A. costs U.S. $ 10 and the same bundle in India
costs, Rs. 450/- then the exchange rate between Indian Rupee and U.S. Dollar is $1 = Rs.
45.
b) If the exchange rate is such that purchasing power parity does not exist between the two
currencies, then the exchange rate between these currencies will adjust until the purchasing
power parity prevails.
Example
Suppose current Spot Rate 1 USD = 10 Mexican Pesos (MXN) on the exchange rate market.
In the USA wooden baseball bats sell for $40 while in Mexico they sell for 150 pesos.
Since 1 USD = 10 MXN, then the bat costs $40 USD if we buy it in the U.S. but only 15 USD
if we buy it in Mexico.
Clearly there’s an advantage to buying the bat in Mexico, so consumers are much better off
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.26
going to Mexico to buy their bats.
If consumers decide to do this, we should expect to see three things happen:
1. American consumers desire Mexico Pesos in order to buy baseball bats in Mexico. So they
go to an exchange rate office and sell their American Dollars and buy Mexican Pesos. This
will cause the Mexican Peso to become more valuable relative to the U.S. Dollar.
2. The demand for baseball bats sold in the United States decreases, so the price American
retailers charge goes down.
3. The demand for baseball bats sold in Mexico increases, so the price Mexican retailers
charge goes up.
Eventually these three factors should cause the exchange rates and the prices in the two
countries to change such that we have purchasing power parity.
If the U.S. Dollar declines in value to 1 USD = 8 MXN, the price of baseball bats in the United
States goes down to $30 each and the price of baseball bats in Mexico goes up to 240 pesos
each, we will have purchasing power parity.
This is because a consumer can spend $30 in the United States for a baseball bat, or he can
take his $30, exchange it for 240 pesos (since 1 USD = 8 MXN) and buy a baseball bat in
Mexico and be no better off.
c) Purchasing Power Parity and the Long Run
Purchasing-power parity theory tells us that price differentials between countries are not
sustainable in the long run as market forces will equalize prices between countries and
change exchange rates in doing so. In the long run having different prices in the United
States and Mexico is not sustainable because an individual or company will be able to gain an
arbitrage profit by buying the good cheaply in one market and selling it for a higher price in
the other market.
d) There are two forms of PPP, Absolute and Relative.
The Absolute PPP is based on the preposition that a commodity costs the same regardless
of what currency is used to buy or where it is selling. If a book costs £4 in UK and exchange
rate is £.60 per $, then the book will cost £ 4/.60 = $ 6.66 in the U.S.
The Absolute PPP assumes that:
(iv) The transaction costs are nil,
(v) There is no barrier to trade, and
(vi) The goods are identical.
e) Relative PPP suggests that the change in exchange rate is determined by the difference in
the inflation rate in two countries.
f) FR under PPPT = [1 + PIFR[RHC]]*SR/[1 + PIFR[LHC]]
[PIFR[RHC] - PIFR[LHC]]*100/[1 + PIFR[LHC]] OR
g) Prem/(Dis) on LHC under PPPT =
[FR[PPPT] - SR]*100/SR
[PIFR[LHC] - PIFR[RHC]]*100/[1 + PIFR[RHC]] OR
Prem/(Dis) on RHC under PPPT =
[SR - FRPPPT]*100/FRPPPT
h) Under PPPT, the currency whereof, the inflation rate is higher will be at discount and the
currency whereof, the inflation rate is lower will be at premium in future.
i) Whether PPPT Exists or not/Inflation If FRPPPT = FRActual then PPPT exists OR
Rate and FR are in equibilrium ?
If Prem/(Dis)PPPT = Prem/(Dis)Actual then PPPT exists
j) If PPPT does not exists, then arbitrage profit is possible
k) Criticism of Purchasing Power Parity (PPP) Theory
1. Limitations of the Price Index : As seen above in the relative version the PPP theory
uses the price index in order to measure the changes in the equilibrium rate of exchange.
However, price indices suffer from various limitations and thus theory too.
2. Neglect of the demand / supply Approach : The theory fails to explain the
demand/supply of foreign exchange. Because in actual practice the exchange rate is
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.27
determined according to the market forces such as the demand for and supply of foreign
currency.
3. Unrealistic Approach : Since the PPP theory uses price indices which itself proves to be
unrealistic. The reason for this is that the quality of goods and services included in the
indices differs from nation to nation. Thus, any comparison without due significance for the
quality proves to be unrealistic.
4. Unrealistic Assumptions : PPP theory is based on the unrealistic assumptions such as
absence of transport cost. Also it wrongly assumes that there is an absence of any barriers to
the international trade.
5. Neglects Impact of International Capital Flow : The PPP theory neglects the impact
of the international capital movements on the foreign exchange market. International capital
flows may cause fluctuations in the existing exchange rate.
Question-32 [ICWA-11]
A Laptop Bag is priced at $ 105.00 at New York. The same bag is priced at Rs.4,250 in Mumbai.
(a) Determine Exchange Rate in Mumbai.
(b) If, over the next one year, price of the bag increases by 7% in Mumbai and by 4% in New
York, determine the price of the bag at Mumbai and-New York?
(c) Determine the exchange rate after one year
(d) Determine the appreciation or depreciation in $ and Rs. in one year from now.
Question-32A [SP] The spot rate is Rs.36.00/$. Inflation rates in India and USA are expected
to be 8% and 3% respectively. What is the expected rate of depreciation of the rupee? What is
expected rate of appreciation of dollar?
Question-34A [May-2010] [M-4] The rate of inflation in India is 8% p.a. and in USA it is 4%.
The current spot rate for USD in India is Rs.46. What will be the expected rate after one year and
after 4 years applying the purchasing power parity theory.
Question-35
SR GBP 1 = USD 1.5339
Current Nominal interest rate in the U.S. is 5% and 7% in Great Britain
Question-36 Spot rate 1$ = Rs.45.50, 1 year forward rate 1$ = 45.9461. Real interest rate in
India is 8%. Real interest rate in USA is 6%. Inflation rate in India is 4%. Find the inflation rate
in USA.
N-05 M-04
M-09 M-06
N-11 M-05
M-13 M-05
N-13 M-05
N-13 M-04
M-14 M-05
M-14 M-08
N-14 M-05
N-15 M-05
Question-37
i) Rs./ £: 74.00 -74.50 (ii) Rs./CHF 26.00 -26.60 find CHF/£.
Question-38
Spot rate $1 = Rs.45.00 – 45.40
Pound 1 = $ 1.60 – 1.65
Pound 1 = AD 3.00 – 3.50
AD 1 = SD 1.50 – 1.60
Calculate Cross rate between Rs. and SD
Question-39A [May-2013] [M-5] A Bank sold Hong Kong Dollars 40,00,000 value spot to its
customer at Rs.7.15 and covered itself in London Market on the same day, when the exchange
rates were US$ 1 = HK$ 7.9250 – 7.9290
Local interbank market rates for US$ were
Spot US$ 1 = Rs.55.00 – 55.20
You are required to calculate rate and ascertain the gain or loss in the transaction. Ignore
brokerage.
You have to show the calculations for exchange rate up to four decimal points.
Question-40 [Nov-2013] [M-5] You, a foreign exchange dealer of your bank, are informed
that your bank has sold a TT on Copenhagen for DK 1000000 at the rate of DK 1 = Rs.6.515
You are required to cover the transaction either in London or New York market. The rates on that
date are as under.
Mumbai – London Pound 1 = Rs.74.30 – 74.32
Mumbai – New York $ 1 = Rs.49.25 – Rs.49.2625
London – Copenhagen Pound 1 = DK 11.42 – 11.435
New York – Copenhagen $ 1 = DK 7.567 – 7.584
In which market will you cover the transaction, London or New York, and what will be the
exchange profit or loss on the transaction? Ignore brokerages.
Question-43 [May-2009] [M-6] [RTP-Nov-2014-9] Your forex dealer had entered into a
cross currency deal and had sold US $ 10,00,000 against EURO at US $ 1 = EUR 1.4400 for spot
delivery.
However, later during the day, the market became volatile and the dealer in compliance with his
management's guidelines had to square - up the position when the quotations were:
Spot US$1 INR 31.4300/4500
1 month margin 25/20
2 month margin 45/35
Spot US$1 Euro 1.4400/4450
1 month margin 1.4425/4490
2 month margin 1.4460/4530
What will be the gain or loss in the transaction?
Arbitrage Operations: Arbitrage is the buying and selling of the same commodity in different
markets or with different dealers. Business operation involving the purchase of foreign exchange,
gold, financial securities, or commodities in one market and their almost simultaneous sale in
another market, in order to profit from price differentials existing between the markets.
These transactions refer to advantage derived in the transactions of foreign currencies by taking
the benefits of difference in rates between two currencies at two different centers at the same
time or of difference between cross rates and actual rates.
Arbitrage is not a method of hedging foreign exchange risk in a real sense. It is however a
method of making profits from foreign exchange transactions.
a) The process of buying goods/currency in one market and selling the same in another market
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.31
is known as arbitrage. Arbitrage profit is risk less profit.
b) There are two types of arbitrage in forex markets:
(i) Exchange rate arbitrage or Geographical Arbitrage and
(ii) Interest rate arbitrage.
b) Exchange rate arbitrage transactions may be classified in terms of the number of markets
involved. Thus, we may have two-point and three-point arbitrage.
Question-45 [ICWA-Example]
SR £1 = $1.55 in London and
SR £1 = $1.60 in New York
If you have $ 1000000, is there any arbitrage profit possible?
Note
b) The sale of dollars in London would have strengthened sterling and pushed the value of the
pound above $1.55. At the same time, the sale of sterling in New York would have caused
sterling to weaken there, pushing its value below $1.60. The action of arbitrageurs would
bring the rates of exchange in the two centres together. In long run arbitrage profit is not
possible.
c) If there is transaction costs, there arbitrage profit may not be possible.
Question-46 [ICWA-Example]
SR £1 = $1.5495 – 1.5505 in London and
SR £1 = $1.5995 – 1.6005 in NY and
Note
The profits would have been lower because of the bid-offer spread.
Question-47
Singapore Spot 1$ = CHF 1.3689 - 1.4150
New York 1 CHF = $ 0.7090 - 0.7236
Can you make through Attribute?
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.32
Question-47A
Spot Rate (Switzerland) 1$ = CHF 1.3689 – 1.3695
Spot Rate (USA) 1CHF = $ 0.7090 – 0.7236
You have 1 million CHF. What amount of profit you can make from arbitrage?
a) In three point arbitrage, we will first sell available currency in one market
b) Then we will sell same currency in another market
Question-48 [ICWA-Example]
In NY USD 1 = CHF 1.6639 – 1.6646 – (i) [CHF/USD]
In London USD 1 = Euro 0.9682 – 0.9686 – (ii) [Euro/USD]
In Australia Euro 1 = CHF 1.6410 – 1.6423 – (iii) [CHF/Euro]
Assume we have with $ 1 millon, how we can make profit.
Question-48A [Ex-ICWA] Followings are the spot exchange rates quoted at three different
forex markets.
£1 = $ 1.5715-721 – (i) [$/£]
$1 = ¥ 106.090-120 - (ii) [¥/$]
£1 = ¥ 176.720-831 – (iii) [¥/£]
You have £1m. Calculate arbitrage profit if any.
The arbitrageur has USD1,00,00,000. Assuming that there are no transaction costs, explain
whether there is any arbitrage gain possible from the quoted spot exchange rates.
Question-50 [ICWA-3]
Given the following -
$/£ 1.3670/1.3708
S.Fr/DEM 1.0030/1.0078
$/S.Fr 0.8790 / 0.8803
DEM / £ 1.5560 /1.5576
Find out if any arbitrage opportunity exists.
If so, show how $10,000 available with you can be used to generate risk - less profit.
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.33
10.18.4 Arbitrage Profit with Margin Money
(a) If LHC is to be bought, Margin money should be added to Exchange Rate
(b) If LHC is to be sold, Margin money should be deducted from Exchange Rate
Question-51 [RTP-Nov-2014-10] Followings are the spot exchange rates quoted at three
different forex markets:
USD/INR 59.25/59.35 in Mumbai
GBP/INR 102.50/103.00 in London
GBP/USD 1.70/1.72 in New York
The arbitrageur has USD 1,00,00,000. Assuming that bank wishes to retain an exchange margin
of 0.125%, explain whether there is any arbitrage gain possible from the quoted spot exchange
rates.
M-12 M-05
Question-52 [SM-11] Price of the bond in USA in the beginning of the period is $100 and it is $
105 at the end of the period. The coupon interest during the period is $7. The US dollar
appreciates during this period by 3%.
Find the return of investment of USA Investor from USA Bond.
Find the return of investment of Foreign Investor from USA Bond.
Question-52A Price of the bond in the beginning of the period is $100 and it is $ 105 at the end
of the period. The coupon interest during the period is $7.
If SR at beginning is $ 1 = Rs.50 and SR after 1 year $ 1 = Rs.51.50, then
Find the return of investment of USA Investor from USA Bond.
Find the return of investment of Foreign Investor from USA Bond.
Question-53 [May-2012][M-5] The price of a bond just before a year of maturity is $ 5,000.
Its redemption value is $ 5,250 at the end of the said period. Interest is $ 350 p.a. The Dollars
appreciates by 2% during the said period. Calculate the rate of return.
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.34
Question-53A A French investor invested 1 m Euros in Indian stock market when the spot rate
was 1 Euro = Rs.55.50. The investment appreciated by 8% in terms of rupees during the year.
The year end spot rate is 1 Euro = Rs.57.67. What is the rate of return of the French investor?
Question-53B If the current exchange rate is Euro 1.50/£, one year forward contract rate is
Euro 1.56/£, the interest rate in a British Government security is 7%. Find risk free rate of return
for the French investor if the investment is made for one year.
Question-53C
Question-53D
Question-53E
Question-54 You are a Chinese investor considering the purchase of one of the following
securities. (FV of the Chinese Govt Security is CY 100 and that of the French Govt Security is
Euro 100)
Bond Time Horizon Coupon Price
French Govt 6 months 7.50% 100
Chinese Govt 6 months 6.50% 100
Calculate the expected % change in FE rate which would result in the two having bonds having
equal total return in CY over 6 months time horizon. Verify your calculations assuming the
Chinese investor invested CY 1,00,000 and the foreign exchange rate at the time of investment
was: 1 Euro = 5 CY.
Question-55 An American based FII is looking to invest US$ 10 million in an emerging market.
After a careful analysis of future prospects, India and Malaysia are shortlisted. For the next year,
which is also the holding period for the FII, expected rates of return are 20% and 16% in India
and Malaysian markets respectively. Withholding tax rates applicable on the returns earned are
20% in India and 10% in Malaysia. Other information available with the Fll includes
Exchange rate:
Rs./$ spot 43.50/43.60
MS/$ spot 3.80/3.82
Expected inflation for the next year:
India 4.0%
Malaysia 6.0%
US 2.0%
Assuming that the PPP holds good, where should the FII invest?
Question-56 Risk free rate in China is 12%. An Austrian company is considering the investment
in some Chinese securities. These securities have a beta of 1.48 and the variance of their return
is 20%. Rm in China is 22%. The Chinese Yuan is likely to depreciate by 5.56% annually against
the Euro with a variance of 15%. Coefficient of Correlation between the returns from investment
in these securities and those from exchange fluctuation is 0.21. Find the expected annual return
and variance of the investment of the Austrian investor.
N-10 M-08
N-13 M-08
a) An interest arbitrage is possible when the forward premium or forward discount between
two currencies does not equal the interest rate differential.
This may be done by buying one currency in the spot market and simultaneously selling it in
the forward market and using the spot proceeds to invest in an asset denominated in the
spot currency; when the asset matures, the proceeds are used to fulfill the forward contract
and the arbitrage transaction concludes with a risk free profit.
b) If IRPT exists, then Interest arbitrage is not possible. As premium or discount in currency
would be equal to interest rate differential of two countries.
(i) If FRActual = FRIRPT then arbitrage is not possible
(ii) If Prem/DisActual = Prem/DisIRPT then arbitrage is not possible
Example
SR $ 1 = Rs.50
FR of 1 year $ 1 = Rs.52.83
Invest Rs.100000 in India for 1 year @ Invest $2000 in USA for 1 year @ 6% p.a.
12% p.a.
Investment value at the end of 1 year = Investment value at the end of 1 year =
Rs.100000*1.12 = Rs.112000 $2000*1.06 = $2120
Convert $ 2120 at FR
Rs. receivable at FR = $2120*52.83 =
Rs.112000
Note: In the above situation, IRPT exists hence return from both investment is same.
Interest arbitrage is not possible.
Borrowing in LHC & Investment in RHC Borrowing in RHC & Investment in LHC
If FRIRPT > FRActual i.e. FR Actual is Undervalued If FRIRPT < FRActual i.e. FR Actual is Overvalued
If Prem on LHC < Loss of Intt on LHC OR If Prem on LHC > Loss of Intt on LHC
If Disc on LHC > Gain of Intt on LHC If Disc on LHC < Gain of Intt on LHC
Step for calculation of arbitrage profit if borrowing in LHC and investment in RHC
Action Time Activity
Borrow Now Borrow in LHC at its Borrowing Rate.
Convert Now Sell LHC at Spot Rate and realize the proceeds in Home Currency.
Invest Now Invest in RHC at deposit rate
Realize Maturity Realize the maturity value of RHC
Honour Maturity Convert RHC into LHC at FR
Repay Maturity Repay the LHC Liability.
Gain Maturity LHC Bought Less LHC Settled.
Step for calculation of arbitrage profit in borrowing in RHC and investment in LHC
Action Time Activity
Borrow Now Borrow in RHC at its Borrowing Rate.
Convert Now Buy LHC at Spot Rate, using the amount borrowed.
Invest Now Invest in LHC at deposit rate
Realize Maturity Realize the maturity value of LHC
Honour Maturity Convert LHC into RHC at FR
Repay Maturity Repay borrowing with interest
Gain Maturity RHC Received - RHC paid
Arbitrage Profit (in term of %) = Return from Invested Currency – Borrowing Cost
Question-57B [ICWA-Dec-2004]
Spot rate 1£ = $ 1.50
1 Year Forward rate for 1 £ = $ 1.48
Annualised interest rate in US 5%
Annualised interest rate in UK 8%
Is there any arbitrage possibility? If yes, how an arbitrageur can take the situation, if he is willing
to borrow $10,00,000
Question-58 [Nov-2013] [M-8] Your’s Bank London Office has surplus funds to the extent of
USD 500000 for a period of 3 months. The cost of the funds to the bank is 4% p.a. It proposes to
invest these funds in London, New York or Franfurt and obtain the best yield, without any
exchange risk to the bank. The following rates of interest are available at the three centres for
investment of domestic funds there at for a period of 3 months.
London 5% p.a. ; New York 8% p.a. ; Frankfurt 3% p.a.
The market rates in London for US dollars and Euro are as under:
London on New York
Spot 1.5350/90
1 month 15/18 ; 2 month - 30/35 ; 3 months - 80/85
London on Franfurt
Spot 1.8260/90
1 month 60/55; 2 month - 95/90; 3 months - 145/140
At which center, will be investment made & what will be the new gain (to the nearest pound) to
the bank on the invested funds?
Question-61 [ICWA-Dec-2003]
Interest rates for 3 months in US and Canada are as follows:
Currency Borrow Invest
US 4% 2.5%
Canada 4.5% 3.5%
Sport Rate $ 1 = Can $ 1.235 – 1.240
Forward Rate $ 1 = Can $ 1.255 – 1.260
Advice the currency in which borrowing and lending for 3 months needs to be done for a US
Company. Take 3 months = 90/360 Days.
Question-61A [SP]
Spot 1$ = Rs.47.00 – 47.20
1 year forward 1$ = Rs.47.50 – 47.70
Interest rates = Rs. 8%; $ 5% p.a.
Is there opportunity for covered interest arbitrage? Is there arbitrage opportunity?
N-11 M-06
N-12 M-08
N-14 M-08
M-15 M-05
(a) Question will give option, whether we should pay immediately or after some time with
interest
(b) We will calculate inflow and outflow under both option and then we will accept those option
beneficial to us
Question-65 [Nov-2012] [M-8] Z Ltd importing goods worth $ 2m, requires 90 days to make
the payment. The overseas supplier has offered a 60 days interest free credit period and for
additional credit for 30 days an interest of 8% p.a.
The bankers of Z Ltd offer a 30 day loan at 10% p.a. and their quote for exchange rate is as
follows:
Spot rate $ 1 = Rs.56.50
60 days FR $ 1 = Rs.57.10
90 days FR $ 1 = Rs.57.50
You are required to evaluate the following options:
(i) Pay the supplier in 60 days; or
(ii) Avail the supplier’s offer of 90 days credit.
A MNC have various branches or subsidiaries in many countries. MNC manages cash in two
ways
i) Centralised Cash Management – Under this system, branches having surplus cash transferred
immediately to HO and any deficit of cash in any branches are met by HO. Any borrowing/
Surplus of cash is managed by HO
ii) Decentralised Cash Management – Under this system, each branches manage their cash
independently. Borrowing/ Deposit are done by branches. At the end of period (like month,
quarter etc) surplus cash in any branch are transferred to HO and deficit of cash in any
branch are met by HO
Question-68 An Indian firm wants to take advantage of some short term business opportunity in
France and for this purpose the firm needs Euro 1,00,000 for 4 months. The firm can borrow the
required funds either in rupees or in Euros. The following foreign exchange rates are prevailing in
the market:
Spot Rate 49.95/50.00
4 months forward rate: 50.00/50.05
The interest rate prevailing in the market:
2 months Rs.12.00% p.a. Euro 6.00%
4 months Rs.11.40% p.a. Euro 6.60%
Advise the firm whether it should borrow in Euros or in rupees.
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.42
10.23 CURRENCY SWAPS [Q-69 to 71]
ICAI RTP ICWA
N-12 1
M-13 6
a) Currency Swaps refer to the arrangement where principal and interest payments in one
currency are exchanged for such payments in another currency. It is another method of
hedging.
A currency swap can consist of three stages.
(iv)A spot exchange of principal.
(v) Continuing exchange of interest payments during the term of the swap.
(vi)Re-exchange of principal on maturity
Question-69 A US company wishes to lend $ 1,00,000 to its Japanese subsidiary. At the same
time a Japanese company wishes to land approximately the same amount to its US subsidiary.
The parties are brought together by an Investment Bank for making parallel loans. The US
company will lend $ 1,00,000 to US subsidiary of Japanese company 4 years @ 13%. Principal
and interest are payable only at the end of 4 years in dollars.
The Japanese company will lend to the Japanese subsidiary of US company 14 millions Yen at
10% for 4 years. The current exchange rate is 140 Yen per dollar. However the dollar is expected
to decline by 5 yen per dollar per years. For each of next 4 years
(i) What amount of yens the Japanese company will receive from Japanese subsidiary of US
company after 4 years? What will be dollar equivalent of this company. [Ans: 20497400 Yen;
$170811.67]
(ii) How many dollars US company will receive after 4 years From US subsidiary of Japanese Co?
[Ans: $163047.36]
(iii) Which party is better off in this deal?
Question-70 Galeplus plc has been invited to purchase and operate a new telecommunications
centre in the republic of Perdian. The purchase price is 2,000 million Rubbits. The centre would
be sold back to the Perdian Government for an agreed price of 4,000 million Rubbits after 3
years. Galeplus would supply three years technical expertise and trading for local staff, for three
years, @ annual cost of 40 million Rubbits.
The relevant risk adjusted discount rate may be assumed to be 15% per year.
(i) Whether Project should be accepted or not.
(ii) Galeplus’s bank have suggested using currency swap for the purchase price of the factory,
with the swap of principal immediately and in three year’s time both swaps at today’s spot rate.
The bank would charge a fee of 0.25% per year (in sterling) for arranging the swap.
Exchange rates:
Spot 85.4 Rubbits/£
1 year forward rate 93.94 Rubbits/£
2 year forward rate 103.334 Rubbits/£
3 year forward rate 113.67 Rubbits/£
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.43
Assuming the swap takes place as described, provide a reasoned analysis, as to whether Galeplus
should accept the invitations or not.
Question-71 A Canadian company has been awarded a contract to build a Power House in XYZ
country. The currency of that country is XYZ Mark. The contract price is 150m XYZ Mark, to be
paid on the completion of the work. The work will be completed in one year. The Canadian
company will be required to spend 60m XYZ marks immediately and another 60m after 9
months. The required rate of return is 12%.
A bank has offered the following swap:
(a) A currency swap of 60m XYZ Marks per Canadian Dollar immediately and the reverse
currency swap for the same amount at the same exchange rate after 1 year.
(b) The Canadian company will pay interest @ 15% p.a., payable in XYZ Marks after 1 year .The
bank will pay interest @ 10% p.a., payable in Canadian Dollars after one year.
Applying the following Foreign Exchange rates and assuming that the swap is undertaken, advise
whether the contract should be taken:
Spot rate 1 Canadian Dollars =12 XYZ Marks
1 year forward 1 Canadian Dollars =13 XYZ Marks
[May-2012] [M-4] [RTP-Nov-2015-20a] Write short notes on Nostro, Vostro and Loro
Account
a) In interbank transactions, foreign exchange is transferred from one account to another
account and from one centre to another centre. Therefore, the banks maintain three types of
current accounts in order to facilitate quick transfer of funds in different currencies. These
accounts are Nostro, Vostro and Loro accounts meaning "our", "your" and "their".
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.44
b) Nostro Accounts: A Domestic bank's foreign currency account maintained by the bank in a
foreign country and in the home currency of that country is known as Nostro Account or "our
account with you". For example, An Indian bank's Swiss franc account with a bank in
Switzerland.
Actual inflow of foreign currency is credited to this account and actual outflow of foreign
currency is debited to this account.
A Nostro is our account of our money, held by you
c) Vostro account is the local currency account maintained by a foreign bank/branch. It is also
called "your account with us". For example, Indian rupee account maintained by a bank in
Switzerland with a bank in India.
d) The Loro account is an account wherein a bank remits funds in foreign currency to another
bank for credit to an account of a third bank.
e) Exchange position
Exchange position is the net balance of the aggregate purchases and sales made by the bank
in a particular currency. This is thus an overall position of the bank in a particular currency.
While determining this position, not only actual inflows and outflows of the that currency is
considered but “commitment to pay” and “entitlement to receive” are also considered. For
ex: A bank purchase a foreign currency bill (say $10000). The transaction will be entered
into exchange position immediately on the purchase of the bill. Later on when the bill is
realized, it will not be entered into the exchange position again.
Ex:
Suppose customer in India has to send $50000 to its business associates at USA. How this can be
done through Nostro Account
He will deposit equivalent Rs in India in his account and the bank will transfer the fund/ Issue DD
for foreign currency in USA. This transfer is called TT Sale/ Remittences/ TT Issue. This transfer
will be debited to Nostro Account.
Similarly if person in USA send $50000 in India. He will deposit equivalent $ in USA in Nostro
Account and the bank will transfer Rs. in India. This transfer is called TT Purchase.
Question-72 An Indian Bank has its Nostro account with Bank of America. From the following
details of the transactions of a particular day, prepare the Nostro Account.
$
Opening balance $ 20000 overdrawn
Purchase TT $50000
Issued DD on new York $20000
TT remittance outward $25000
Purchase bill of exchange maturity 1 month $75000
Forward sales $75000
Export bills, purchased earlier, realized $45000
(a) What steps the Indian Bank will take if it wants to maintain a credit balance of $20000 in its
Nostro Account.
(b) Prepare exchange position for the above mentioned question assuming that the opening
exchange position is overbought $5000.
N-06 M-04
(b) Regular settlement may reduce in foreign exchange rate risk of group companies.
Question-73 [Nov-2006] [M-4] [ICWA-22] Following are the details of cash inflows and
outflows in foreign currency denominations of MNP Co. an Indian export firm, which have no
foreign subsidiaries:
Currency Inflow Outflow Spot rate Forward rate
US $ 4,00,00,000 2,00,00,000 48.01 48.82
French Franc (FFr) 2,00,00,000 80,00,000 7.45 8.12
U.K. £ 3,00,00,000 2,00,00,000 75.57 75.98
Japanese Yen 1,50,00,000 2,50,00,000 3.20 2.40
(i) Determine the net exposure of each foreign currency in terms of Rupees.
(ii) Are any of the exposure positions offsetting to some extent?
Question-74 A UK Company has its subsidiaries in three countries- India, USA and South Africa.
At the end of the year the inter- Company balances were as follows:
(a) The Indian subsidiary is owed Rs.14.00 million by the South Africa subsidiary
(b) Indian subsidiary owes $ 1 million to US subsidiary
(c) South Africa subsidiary owed 1.40m south Africa Rands (R) by the US subsidiary
(d) South Africa subsidiary owes $ 1m to US subsidiary
The foreign currency rates are: 1 Pound =2$ =Rs.70 =10R
The holding company instructed the subsidiaries to settle the balances on net basis. Assuming
that the statutes of all the companies permit this type of settlement, what the different
subsidiaries will do?
a) MATCHING: The foreign exchange rate risk can be eliminated or reduced, if the company
which is having exposure to receipts and payments in the same currency. The company can
off set its payments against its receipts if it can plan properly. This can be managed by
operating a bank account in overseas to offset the transaction. The basic requirement for a
matching operation is the two-way cash flow in the same foreign currency is called ‘natural
matching’. If the matching involves between two currencies whose movements are expected
to run closely is called ‘parallel matching’.
Ex: An Indian exporter exports finished goods to US firm and he will also import the raw material
from the US firms. Then the receipts and payment transactions can be offset at the origin itself
by operating a bank account in US for convenience.
M-12 M-08
Question-75A [SP] D Ltd is supplying goods worth $1,00,000 to US importer and the amount is
payable after 4 months time. The current spot rate US $ 1 = Rs.45.36. It is expected that the Rs.
will strengthen against $ in 4 months and the spot rate at the end of 4 moths would be Rs.44.50.
The importer accepts to pay immediately if 2% cash discount is offered by D Ltd. The current
borrowing rate is 8%.
Question-76 [May-2012] [M-8] NP Co. has imported goods for $7,00,000. The amount is
payable after 3 months. The company has also exported goods for $4,50,000 and this amount is
receivable in 2 months. For receivable amount a forward contract is already taken at Rs.48.90
The market rates for Rs. and $ are as follows:
Spot $ 1 = Rs.48.50 – 48.70
2 months $ 1 = 25/30 points
3 months $ 1 = 40/45 points
The company wants to cover the risk and it has two options as under:
(a) To cover payable in the forward market and
(b) To lag the receivable by one month and cover the risk only for the net amount. No interest for
delaying the receivables is earned.
Evaluate both the options if the cost of Rs. funds is 12%. Which option is preferable.
N-04 M-04
Question-77 [Nov-2004] [M-4] Excel Exporters are holding an Export bill in US Dollar
1,00,000, due 60 days hence. They are worried about the falling USD value which is
currently at Rs.45.60 per USD. The concerned Export Consignment has been the priced on
an exchange rate of Rs.45.50 per USD. The firm's bankers have quoted a 60 day forward
rate of Rs.45.20
Calculate:
(i) Rate of discount quoted by Bank [Ans: 5.262% discount on $]
(ii) The probable loss of operating profit if the forward sale is agreed to. [Ans: Expected loss if
hedging is done – Rs.30000]
a) Cross Currency Roll Over contacts are contracts to cover long term foreign exchange
liabilities or assets. The cover is initially obtained for six months & later extended for further
period of 6 months & so on. Forward rate beyond 6 months is not available in market.
b) Under the Roll over contracts the basic rate of exchange is fixed but loss or gain arises at the
time of each Roll over depending upon the market conditions.
c) Roll-over-forward contract is one where forward contract is initially booked, for the total
amount of loan, etc. to be repaid. As and when installment falls due, the same is paid by the
customer in foreign currency at the exchange rate fixed in forward exchange contract. The
balance amount of the contract is rolled over (extended) till the due date of next installment.
The process of extension, continues till the loan amount has been repaid.
Question-78 A person gets an interest free loan of USD 3,00,000. Repayment is to be done in
three equal half yearly installments. Assume the following rates
A Today Six months forward rate Rs.42 - 42.50
B At the end of six months, Spot Rate Rs.43 - 43.10
Six months forward Rs.43.40 - 43.50
C At the end of one year, Spot rate Rs.44 - 44.10
Six months forward Rs.44.50 - 44.60
D At the end of one & half year, Spot rate Rs.45 - 45.10
Find the amount he has to pay in rupees in following three cases
(i) No hedging (ii) Three separate forward contracts one today, one after six months and one
after one year from today (iii) Rupee roll over forward
Question-78A An Indian corporate completes a project of value, $1 million in the middle east on
31/12/96. The contract has been executed on deferred payment terms and the necessary
permission for late realization of export proceeds has been obtained from the RBI. The company
has to bear the currency risk however till 1/1/99 when payment will be realized. When the
corporate approaches its bank, it is informed that contracts of maturity greater than six months
cannot be structured. It hence opts for six-month roll over cover.
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.49
The following are the spot rates (Rs./$) and six-month forward rates (Rs./$) prevailing at the end
of each roll over period. Determine the cash flows and compare the result with a situation when
the corporate leaves the exposure uncovered. Cost of capital for the company is 20%.
Date Spot Rate (Rs./$) Six-month Forward Rate
1/1/97 35.00 35.20
1/7/97 35.15 35.30
1/1/98 35.25 35.35
1/7/98 35.35 35.50
1/1/99 35.45 35.60
Advice AKC Ltd by calculating average contribution to sale ratio whether it should hedge it’s
foreign currency risk or not.
Question-81 [May-2009] [M-6] [ICWA-2] You have following quotes from Bank A and Bank
B:
Bank A Bank B
Spot USD/CHF 1.4650/55 USD/CHF 1.4653/60
3 month 5/10
6 month 10/15
Spot GBP/USD1.7645/60 GBP/USD1.7640/50
3 month 25/20
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.50
6 month 35/25
Calculate
(i) How much minimum CHF amount you have to pay for 1 Million GBP spot?
(ii) Considering the quotes from Bank A only, for GBP/CHF what are the Implied Swap points for
Spot over 3 months?
Question-83 [Nov-2009] [M-12] M/s Omega Electronics Ltd. exports air conditioners to
Germany by importing all the components from Singapore. The company is exporting 2,400 units
at a price of Euro 500 per unit. The cost of imported components is S$ 800 per unit. The fixed
cost and other variables cost per unit are Rs. 1,000 and Rs. 1,500 respectively. The cash flows in
Foreign currencies are due in six months. The current exchange rates are as follows:
Rs/Euro 51.50/55
R/S$ 27.20/25
After six months the exchange rates turn out as follows:
Rs/Euro 52.00/05
R/S$ 27.70/75
(i) You are required to calculate loss/gain due to transaction exposure.
(ii) Based on the following additional information calculate the loss/gain due to transaction and
operating exposure if the contracted price of air conditioners is Rs. 25,000 :
(iii) The current exchange rate changes to
Rs/Euro 51.75/80
R/S$ 27.10/15
Price elasticity of demand is estimated to be 1.5
Payments and receipts are to be settled at the end of six months.
Question-84 [SM-16] U.S. Imports co., purchased 100,000 Mark’s worth of machines from a
firm in Dortmund, Germany the value of the dollar in terms of the mark has been decreasing. The
firm in Dortmund offers 2/10, net 90 terms. The spot rate for the mark is dollar 0.55; the 90
days forward rate is $0.56.
a. Compute the $ cost of paying the account with in the 10 days.
b. Compute the $ cost of buying a forward contract to liquidate the account in 90 days.
c. The differential between part a and part b is the result of the time value of money (the
discount for prepayment) and protection from currency value fluctuation. Determine the
magnitude of each of these components.
A firm dealing with foreign exchange may be exposed to foreign currency exposures. The
exposure is the result of possession of assets and liabilities and transactions denominated 'in
foreign currency. When exchange rate fluctuates, assets, liabilities, revenues, expenses that have
been expressed in foreign currency will result in either foreign exchange gain or loss. A firm
dealing with foreign exchange may be exposed to the following types of risks:
(a) Transaction Exposure: A firm may have some contractually fixed payments and receipts
in foreign currency, such as, import payables, export receivables, interest payable on
foreign currency loans etc. All such items are to be settled in a foreign currency.
Unexpected fluctuation in exchange rate will have favourable or adverse impact on its
cash flows. Such exposures are termed as transactions exposures.
(b) Translation Exposure: The translation exposure is also called accounting exposure or
balance sheet exposure. It is basically the exposure on the assets and liabilities shown in
the balance sheet and which are not going to be liquidated in the near future. It refers to
the probability of loss that the firm may have to face because of decrease in value of
assets due to devaluation of a foreign currency despite the fact that there was no foreign
exchange transaction during the year.
(c) Economic Exposure: Economic exposure measures the probability that fluctuations in
foreign exchange rate will affect the value of the firm. The intrinsic value of a firm is
calculated by discounting the expected future cash flows with appropriate discounting
rate. The risk involved in economic exposure requires measurement of the effect of
fluctuations in exchange rate on different future cash flows.
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.52
Question-3 [May-2011] [M-4] What is the meaning of (i) Interest rate parity and (ii)
Purchasing power parity
Solution-3
Forward exchange rate of the two countries is determined by various factors like, interest rate,
inflation rate, GDP, Monetary Policy etc.
Interest rate parity theory assumes that the forward exchange rate of the two countries is
determined by their interest rate differential assuming other factors remain constant.
FR under IRPT = [1 + PIR[RHC]]*SR/[1 + PIR[LHC]]
In the general economic analysis, the value of a currency in one country is determined by the
amount of goods and services that can be purchased with a unit of the currency, this is called the
purchasing power of the currency. PPP says that the exchange rate between two currencies must
be proportional to the price level of goods in two countries.
Arbitrage Operations: Arbitrage is the buying and selling of the same commodity in different
markets or with different dealers. Business operation involving the purchase of foreign exchange,
gold, financial securities, or commodities in one market and their almost simultaneous sale in
another market, in order to profit from price differentials existing between the markets.
These transactions refer to advantage derived in the transactions of foreign currencies by taking
the benefits of difference in rates between two currencies at two different centers at the same
time or of difference between cross rates and actual rates.
Arbitrage is not a method of hedging foreign exchange risk in a real sense. It is however a
method of making profits from foreign exchange transactions.
Question-6 [Nov-2004 [M-5] Explain the term ‘Exposure Netting’, with an example
[May-2012] [M-4] Meaning and advantage of netting
a) NETTING: Netting involves offsetting exposures in one currency with exposures in the same
or another currency. The basic idea behind the netting is to transfer only net amounts,
usually within a short period.
b) Types of netting
Bilateral Netting: Company X exports goods to Company Y for US $2 million and imports
goods worth $1.5 million from Company Y. Their dates of maturity are the same, so they can
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT 10B.53
offset net payment.
Multilateral Netting: It involves netting of risk exposure among more than two company.
It is performed by the central treasury where several subsidiaries interact with head office.
3 Advantages
(a) Lower transaction costs as a result of fewer transaction
(b) Regular settlement may reduce in foreign exchange rate risk of group companies.
(b)
If Today FR of 6 months $1 = Rs.44
Premium or discount on LHC ($) of 6 months = (FR-SR)/SR = (44-46)/46 = -0.0435 = -4.35%
Discount on ($) p.a. = 4.35%*12/6 = 8.70%
Solution-1A
SR = $ 1 = Rs.48
(a) If FR of 3 months is $1 = Rs.51
Perm/ Disc on LHC [$] = (FR-SR)*100/SR = (51-48)*100/48 = 6.25% for 3 months
Perm/ Disc on LHC [$] = 6.25%*12/3 = 25% for 12 months
(b) If FR is $1 = Rs.47
Perm/ Disc on LHC [$] = (FR-SR)*100/SR = (47-48)*100/48 = -2.08% for 3 months
Perm/ Disc on LHC [$] = -2.08%*12/3 = -8.33% for 12 months
(c) If FR is $1 = Rs.51
Perm/ Disc on RHC [Rs] = (SR-FR)*100/FR = (48-51)*100/51 = - 5.88% for 3 months
Perm/ Disc on LHC [Rs.] = - 5.88%*12/3 for 12 months = -23.5204% p.a.
(d) If FR is $1 = Rs.47
Perm/ Disc on RHC [Rs] = (SR-FR)*100/FR = (48-47)*100/47 = 2.13% for 3 months
Perm/ Disc on LHC [Rs.] = 2.13% *12/3 for 12 months = 8.52%
Solution-2
Today SR: 1 $ = Rs.40.
(a) Appreciation on $ is 10% [Premium on LHC is given]
FR of one year: $ 1 = Rs.40*(1+Prem on $)
1 $ = Rs.40*1.1 = Rs.44
FR of 1 year: 1 US $ = Rs.44
Solution-2B
Today SR is 1 FF = 0.2 US$.
Currency appreciation on FF is 10% [Premium is on LHC given]
Therefore ESR of tomorrow 1 FF = $0.2*(1+Prem on FF)
1 FF = 0.2*1.1 = 0.22 $
Therefore 1 US $ = 1/0.22 = 4.5455 FF
Solution-3
A Fleur Co is to receive $ 124000 in 90 days [$ is FC and FF is DC for Fleur Co] [$ - Sell; FF – Buy]
Today SR: $ 1 = FF 5.70
FF which would have been receivable by selling $124000 at today SR = $124000*5.70 = FF 706800
(a)
FF strengthening by 5%, hence [Premium on RHC is given]
SR at maturity: $ 1 = FF 5.70/(1+Prem on RHC)
SR at maturity: $ 1 = FF 5.70/1.05
SR at maturity: $ 1 = FF 5.428
FF actually receivable by selling $124000 at SR of maturity = $124000*5.428 = FF 673072
Loss due to fluctuation = FF receivable at SR of maturity - FF receivable at today SR = FF673072 - FF706800 = FF 33728
(b)
FF weakening by 5% means [Discount on RHC is given]
SR at maturity: $ 1 = FF 5.70/(1-Dis on RHC)
SR at maturity: $ 1 = FF 5.70/0.95
SR at maturity: $ 1 = FF 6
FF receivable by selling $124000 at SR of maturity = $124000*6 = FF 744000
Expected Gain due to fluctuation = FF744000 – FF706800 = FF 37200
Solution-3A
(a)
B Ltd has shipped goods to USA and is to receive $ 10000 in 90 days [$ is FC and Rs. is DC for B Ltd] [$ - Sell; Rs – Buy]
Today SR is $ 1 = Rs.45
Rs. will depreciate by 10% in 90 days, [Discount on RHC is given]
SR at maturity: $ 1 = Rs.45/(1-Dis on Rs.)
SR at maturity: $ 1 = Rs.45/(1-0.1)
SR at maturity: $ 1 = Rs.50
Rs. which would have been receivable by selling $10000 at today SR = $10000*45 = Rs.450000
Rs. actually receivable by selling $10000 at SR of maturity = $10000*50 = Rs.500000
Gain/ Loss due to fluctuation = Rs. actually receivable at SR of Maturity – Rs. receivable at today SR
= Rs.500000 – Rs.450000 = Rs.50000
Solution-4
Indian company has imported goods worth Yen 108 lacs and will pay in 3 months [Indian Co will buy Yen and will sell Rs.]
(a) Rs. is LHC and Indian Importer will buy Yen and will sell Rs., hence he would like to sell Rs. at higher of ESR and FR
FR is higher than ESR hence Importer should enter into FC.
Suggestion: If the exchange rate risk is not covered with forward contract, the expected exchange loss is Rs. 3.33lakhs.
This could be reduced to Rs. 2.73lakhs if it is covered with Forward contract. Hence, taking forward contract is suggested.
Saving due to Forward Contract = 33.33 –32.73 lacs = Rs.0.6 lacs
Solution-4A
Indian company has imported goods worth $13750 and will pay in 3 months [Indian Co will buy $ and will sell Rs.]
(a) Rs. is LHC and Indian Importer will buy $ and will sell Rs., hence he would like to sell Rs. at higher of ESR and FR
FR is higher than ESR hence Importer should enter into FC.
Suggestion: If the exchange rate risk is not covered with forward contract, the expected exchange loss is Rs.26315.80
This could be reduced to Rs.3663 if it is covered with Forward contract. Hence, taking forward contract is suggested.
Saving due to Forward Contract = 26315.80-3663 = Rs.22652.80
Solution-5
Today Sep, 1998
(i) ESR for March 1999 is
£ 1 = $ 1.30*0.15 + 1.35*0.2 + 1.40*0.25 + 1.45*0.20 + 1.50*0.20 = $ 0.195 + 0.27 + 0.35 + 0.29 + 0.30 = $ 1.405
ESR of March 1999, £ 1 = $1.405
Alternative Method
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.4
$ receivable by selling 1000 pound at ESR = 1000*1.405 = $1405
$ receivable by selling 1000 pound at FR = 1000*1.400 = $1400
Receipts under ESR is more than FR, hence we should not enter into Forward Contract
Solution-5A
Today March, 2003
(i) ESR for Sep 2003 is
£ 1 = $ 1.60*0.15 + 1.70*0.2 + 1.80*0.25 + 1.90*0.20 + 2.00*0.20 = $ 1.81
ESR of Sep 2003, £ 1 = $1.81
Solution-6
Indian company has an export exposure and will receive Yen 100 lacs in 3 months [X Ltd will Sell Yen and will buy Rs.]
Current Spot Rate: Rs.100 = Yen 310
Forward Rate Sept End = Rs.100 = Yen 320.24
Expected Spot Rate Sep end = Rs.100 = Yen 334.88
Rs. receivable by selling Yen 100 Lacs at Current SR = Yen 100/3.10 = Rs.32.258 lacs [Recorded in books]
Rs. receivable by selling Yen 100 Lacs at ESR of Sep = Yen 100/3.3488 = Rs.29.861 lacs
Rs. receivable by selling Yen 100 Lacs at FR of Sep = Yen 100/3.2024 = Rs.31.227 lacs
Loss under forward cover is less than loss under without hedging, hence we should enter into forward cover.
Alternative Solution
LHC is Rs.
Since Exporter will purchase Rs. and sell Yen hence, he would be willing to buy Rs. at lower rate i.e at forward rate.
He should enter into forward contract.
Solution-7
UK company is to receive ND 500000 in 6 months, and it will buy Pound and will sell ND
Current Spot Rate £1 = 2.50 ND
FR of 6 months £1 = 2.5354 ND
As per question, Forward cover is undertaken by UK Company
£ receivable by selling ND 500000 at FR = ND 500000/2.5354 = 1,97,208 £
Solution-8
SR $ 1 = Rs.50 (Rs/$)
SR $ 1 = Yen 400 (Yen/$)
Solution-9
$1 = Rs.50 (Rs./$)
$1 = Yen 200 (Yen/$)
Pound 1 = Yen 300 (Yen/Pound)
Solution-10
X Ltd an Indian Co is to receive Yen 100 lacs in Sep end [X Ltd will sell Yen and will buy Rs.]
In the given situation, the direct quote of INR/USD and JPY/USD are given. We have to calculate cross rate between
USD/INR
Rs. receivable by selling Yen 10M at Current SR = Yen 10M * Rs.0.322081 = Rs.3.22081M
Rs. receivable by selling Yen 10M at ESR of maturity = Yen 10M * Rs.0.298611 = Rs.2.98611 M
Rs. receivable by selling Yen 10M at FR = Yen 10M * Rs.0.312268 = Rs.3.12268 M
(i)
If hedging is not done:
Expected Loss = Rs. Receivable under Current SR – Rs. Receivable under ESR of Maturity
= Rs.3.22081M - Rs.2.98611M = Rs.0.2347M
If hedging is done:
Expected Loss = Rs. Receivable under Current SR – Rs. Receivable under FR
= Rs.3.22081M - Rs.3.12268 M = Rs.0.098 M
Alternative Solution
LHC is Yen
Since Exporter will purchase Rs. and sell Yen Hence, he would be willing to Sell Yen at higher rate i.e at forward rate.
He should enter into forward contract.
(ii) If actual SR on 30th September 1998 was eventually INR/USD = Rs.42.78 and JPY/USD = 137.85, is the decision to
take forward cover justified.
Cross Rate
FR of Sep Yen 1 = Rs.0.300161
Actual SR of Sep Yen1 = Rs.0.299622
Alternative Answer
Yen is to be sold and it is better to sell at higher of FR and ASR. FR is higher that ASR, hence decision was correct
Solution-10A
JKL Ltd an Indian Co is to receive JPY 10 lacs in Aug end [JKL Ltd will sell JPY and will buy Rs.]
In the given situation, the direct quote of Rs./USD and JPY/USD are given. But we have to calculate cross rates between
JPY/Rs.
Rs. receivable by selling Yen 10 L at Current SR = Yen 10L * Rs.0.607973 = Rs.6.07973 Lacs
Rs. receivable by selling Yen 10 L at ESR of maturity = Yen 10L * Rs.0.524194 = Rs.5.24194 Lacs
Rs. receivable by selling Yen 10 L at FR = Yen 10 L * Rs.0.524194 = Rs. 6.02628 Lacs
(i)
If hedging is not done:
Expected Loss = Rs. Receivable under Current SR – Rs. Receivable under ESR of Maturity
= Rs.6.07973 - Rs.5.24194 = Rs.0.83779 Lacs
If hedging is done:
Expected Loss = Rs. Receivable under Current SR – Rs. Receivable under FR
= Rs.6.07973 - Rs.6.02628 = Rs.0.5345 Lacs
Alternative Solution
LHC is Yen
Since Exporter will purchase Rs. and sell Yen Hence, he would be willing to Sell Yen at higher rate i.e at ESR. FR is
greater than RSE, hence he should not enter into forward contract.
(ii) If actual SR on 31st Aug, 2014 was eventually INR/USD = Rs.66.25 and JPY/USD = 110.85, is the decision to take
forward cover justified.
Cross Rate
FR of Sep Yen1 = Rs. Rs. 0.602628
Actual SR of Sep Yen1 = Rs. 0.597654
Alternative Answer
Yen is to be sold and it is better to sell at higher of FR and ASR. FR is higher than ASR, hence decision was correct
Solution-11
(i)
We will check which currency is to be sold and purchased.
[UK exporter receive Guilder 80000 hence he will sell guilders and will buy Pound]
Check out which currency is LHC
SR Pound 1 = Guilders 3.55 – 3.57
Pound is LHC and it is to be purchased, hence 2nd rate would be applicable for customer i.e. 3.57
If available currency and LHC are same then multiply otherwise divide it.
Pound receivable by selling Guilders 80000 at Spot rate = Guilders 80000/3.57 = Pound 22408.96
(ii)
We will check which currency is to be sold and purchased.
[UK exporter receive FF 150000 hence he will sell FF and will buy Pound]
Check out which currency is LHC
SR Pound 1 = FF 10.73 – 10.76
Pound is LHC and it is to be purchased, hence 2nd rate would be applicable for customer i.e. 10.76
If available currency and LHC are same then multiply otherwise divide it.
Pound receivable by selling FF 150000 at Spot rate = FF 150000/10.76 = Pound 13940.52
(iii)
We will check which currency is to be sold and purchased.
[UK importer pay Yen 1M hence he will Purchase Yen and will Sell Pound]
Check out which currency is LHC
SR Pound 1 = Yen 233.50 – 235.50
Pound is LHC and it is to be Sold, hence 1st rate would be applicable for customer i.e. 233.50
If available currency and LHC are same then multiply otherwise divide it.
Pound required to buy Yen 1M at Spot rate = Yen 1 m/233.50 = Pound 4282.655
(iv)
We will check which currency is to be sold and purchased.
[UK importer pay DM 120000 hence he will Purchase Dm and will Sell Pound]
Check out which currency is LHC
SR Pound 1 = FF 3.1725 – 3.1775
Pound is LHC and it is to be Sold, hence 1st rate would be applicable for customer i.e. 3.1725
If available currency and LHC are same then multiply otherwise divide it.
Pound required to buy Dm 120000 at Spot rate = DM 120000/3.1725 = Pound 37825.06
Solution-11A
(i) A Ltd received Euro 112000 and will sell it and will buy Rs.
[Euro is LHC and it is to be sold]
Spot Rate 1 Euro = Rs.56.00 - 56.04
[Euro is LHC and it is to be sold, hence 1st rate would be applicable 56.00
If available currency and LHC are same then multiply otherwise divide it.]
Rs receivable by selling Euro 112000 at Spot rate = Euro 112000*56 = Rs.62,72,000
(iii) A Ltd received $ 300000 and will sell it and will buy Rs.
Exchange Rate 1$ = Rs.40.00 - 40.05
$ is LHC and it is to be sold, hence 1st rate would be applicable 40.00
If available currency and LHC are same then multiply otherwise divide it.
Rs receivable by selling $ 300000 at Spot rate = $ 300000*40 = Rs.12000000
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.9
Solution-12
1 Month 2 Months 3 Months
1 USD 0.18 - 0.22 0.25 - 0.30 0.32 - 0.30
Order Increasing Order Increasing Order Decreasing Order
Spot Rate Rs.45 - 45.20 Rs.45 - 45.20 Rs.45 - 45.20
Action Add Swap rate Add Swap rate Deduct Swap rate
Forward Rate Rs.45.18 - 45.42 Rs.45.25 - 45.50 Rs.44.68 - 44.90
Solution-13
(a)
Delhi based Firm purchases $100000 at Forward rate of 2 months [Buy - $; Sell – Rs.]
Current Spot Rate $ 1 = Rs.40.00 – Rs.40.10
Swap Rate of 2 months = 11 – 10 paise [Decreasing order]
Forward Rate of 2 months $ 1 = Rs. (40.00 - 0.11) – (40.10 - 0.10) = Rs.39.89 – 40.00
[$ is LHC and it is to be purchased, hence 2nd rate would be applicable 40.00
If available currency and LHC are same then multiply otherwise divide it.]
Rs. required to buy $100000 at forward rate of 2 months = $ 100000*40 = Rs.40,00,000
(b)
Delhi based Firm selling CD 70000 at Forward rate of 3 months
Current Spot Rate CD 1 = Rs.34.90 – Rs.35.00
Swap Rate of 3 months = 10 – 11 paise [Increasing order]
Forward Rate of 3 months CD 1 = Rs. (34.90 + 0.10) – (35.00 + 0.11) = Rs.35.00 – 35.11
CD is LHC and it is to be sold, hence 1st rate would be applicable 35.00
If available currency and LHC are same then multiply otherwise divide it.
Rs. receivable by selling CD 70000 at forward rate of 3 months = CD 70000*35 = Rs.24,50,000
(c)
Delhi based Firm purchases Yen 825000 at Forward rate of 1 month
Current Spot Rate Yen 100 = Rs.33.00 – Rs.33.10
Swap Rate of 1 months = 11 – 10 paise [Decreasing order]
Forward Rate of 1 months Yen 100 = Rs. (33.00 - 0.11) – (33.10 - 0.10) = Rs.32.89 – 33.00
[Yen is LHC and it is to be purchased, hence 2nd rate would be applicable 33.00
If available currency and LHC are same then multiply otherwise divide it]
Rs. required to buy Yen 825000 at forward rate of 1 months = Yen 825000*33/100 = Rs.2,72,250
Solution-14
Forward Rate of one Month £1 = $1.687 - $1.690
Forward Rate of Three Month £1 = $1.680 - $1.684
Actual Spot Rate at one month £1 = $1.694 - $1.696
Actual Spot Rate at three month £1 = $1.700 - $1.704
UK exporter will receive $, hence he will sell $ and he will buy £. [For Understanding]
LHC is £, hence he will enter into forward purchase contract of one and three months @ $1.690 and $1.684.
(i) Pounds receivable by selling $ 90,000 at FR = $ 45000/1.690 + $ 45000/1.684 = £ 53349
Had he not been entered into forward cover, then he would have purchased £ at actual spot rate of one and three months
i.e. @ $1.696 & $1.704
(ii) Pounds receivable by selling 90,000 dollars at actual SR of maturity = 45000/1.696 + 45000/1.704 = £ 52941
If forward cover is taken there is an excess receipts of (53349 – 52941) = £408
Hence Decision of Forward Cover was right
Solution-15
(a)
Forward rate of Two Months $1 = Rs.47.00 – Rs.47.50
Firm to get Rs.25 lacs by selling $ at forward rate of 2 months [Firm will buy Rs. and will sell $]
$ is LHC and it is to be sold, hence 1st rate would be applicable @ 47.00
$ required to get Rs.25 lakhs after 2 months at FR = Rs.2500000/47 = $53191.49
(b)
Current Spot Rate $ 1 = Rs.46.00 – Rs.46.25
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.10
Firm to pay $ 2 lacs at Spot market [Firm will buy $ and will sell Rs.]
$ is LHC and it is to be purchased, hence 2nd rate would be applicable @ 46.25
Rs. required to get $ 2 lakhs at CSR = $ 200000*46.25 = Rs.9250000
Solution-15A
(i)
Forward rate of Two Months $1 = Rs.46.50 – Rs.47.00
Firm to receive Rs.5 cr by selling $ at forward of 2 months [For understanding firm will buy Rs. and will sell $] [$ is LHC
and it is to be sold, hence 1st rate would be applicable @ 46.50]
$ required to get Rs.5 cr after 2 months at FR = Rs.5/46.50 = $0.107527 Cr
(ii)
Current Spot Rate $ 1 = Rs.45.80 – Rs.46.05
Firm to pay $ 2 lacs by selling Rs. at Spot market [For understanding firm will buy $ and will sell Rs.] [$ is LHC and it is to
be purchased, hence 2nd rate would be applicable @ 46.05]
Rs. required to get $ 2 lakhs at SR = $ 200000*46.05 = Rs.9210000
(iii)
Current Spot Rate $ 1 = Rs.45.80 – Rs.46.05
Firm has $ 50000 & to receive Rs. by selling $ at spot market [$ is LHC and it is to be sold, hence 1st rate would be
applicable @ 45.80]
Rs. receivable by selling $ 50000 at SR = $ 50000*45.80 = Rs.2290000
Solution-16
Current Spot Rate £ 1 = $1.5865 – 1.5905
3 months forward rate £ 1 = $1.6100 – 1.6140
UK exporter is to receive $350000 in 3 months
(i) Forward Cover
If he takes forward cover of 3 months @ 1.6140 [Selling $ and buying £]
£ receivable by selling $350000 at FR = $350000/1.6140 = £216852.50
(b) UK Exporter will Convert $342298.29 in pounds at CSR @1.5905 [Selling $ and buying £]
Equivalent £ receivable = $342298.29/1.5905 = £215214.27
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.11
(c) UK Exporter will Deposit £215214.27 for 3 months in U K @ 1.25% [Creating Assets in DC]
Solution-16A
Current Spot Rate UA 1 = Rs. 11.50 – 11.80
3 months FR UA 1 = Rs. 11.20 – 11.40
(b) SL will Convert UA 485436.90 in Rs. at spot rate @11.50 [Buying Rs. and Selling UA]
Rs. receivable by selling UA 485436.90 at SR = UA 485436.90*11.50 = Rs.5582524
(c) SL will Deposit Rs.5582524 for 3 months in India @ 2% [Creating Assets in DC]
Alternative Solution
Evaluation: Money Market Hedge is possible only if the 3-Month FR is lower than value of Spot Bid in the next three 3
Months (computed by applying IRPT Formula)
Solution-17
Spot Rate £1 = $ 2
Forward Rate of 180 days £1 = $ 1.96
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.12
XYZ Ltd. a US firm will need £ 3,00,000 in 180 days [Buying £ and selling $]
(c) XYZ Ltd will borrow $ 586797.06 for 180 days in USA @ 2.75% [Creating liability in DC]
Solution-17A
Current Spot Rate GBP 1 = USD 1.5617 – 1.5673
6 months Forward Rate GBP 1 = USD 1.5455 – 1.5609
A Ltd of U K has imported some chemical and has to pay USD 364897 in 6 months [Buy USD and sell GBP]
(i) Forward Cover
If it takes forward cover of 6 months @ 1.5455 [Buying USD and Selling GBP]
GBP required to buy USD 364897 at FR = USD 364897/1.5455 = GBP 236102.89
(b) A Ltd will Convert USD 356867.48 in GBP at spot rate @1.5617 [Buying USD and Selling GBP]
Equivalent GBP payable = USD 356867.48/1.5617 = GBP 228512.18
(c) A Ltd will borrow GBP 228512.18 for 6 months in U K @ 3.50% [Creating Liability in DC]
Option
Forward cover GBP 236102.89
Money market GBP 236510.10
Currency option GBP 227923.00
The company should take currency option for hedging the risk.
Solution-18
SR $ 1 = £ 0.9830-0.9850
3 months FR $ 1 = £ 0.9520-0.9545
(i) CS Inc has imported raw material from UK and £480000 is payable in 3 months
(ii) CS Inc has exported goods in India and receivable £ 138000 in 3 months
Net £342000 is payable in 3 months [$ - Sell; £ - Buy]
(a) Forward Cover
$ required to pay £342000 in 3 months at 3 months FR = £342000/0.9520 = $ 359243.70
(b) CS Inc will convert £333658.50 in $ at spot rate @0.9830 [Buying £ and Selling $]
Equivalent $ payable = £333658.50/0.9830 = $339428.80
(c) CS Inc will borrow $339428.80 for 3 months in USA @ 3.25% [Creating Liability in DC]
Option
Forward cover $ 359243.70
Money market $ 350460.20
(ii) CS Inc has exported goods and €590000 is receivable in 4 months [$ - Buy; € - Sell]
SR € 1 = $ 1.8890-1.8920
4 months FR € 1 = $ 1.9510-1.9540
(b) CS Inc will convert €560128.40 in $ at spot rate @1.8890 [Buying $ and Selling €]
Equivalent $ receivable = €560128.40*1.8890 = $1058083
(c) CS Inc will deposit $1058083 for 4 months in USA @ 3.833% [Creating Assets in DC]
Option
Forward cover $ 1151090
Money market $ 1098639
Solution-19 [P]
On March, 1, 1979, the USA company imports goods having invoice value in exporter currency 900000 LC
USA Company will pay LC 900000 on 31st May, 1979
Spot Rate $1 = LC 10
Forward Rate of three Month $1 = LC 9
Expected Future Spot Rate at the end three Month $1 = LC 8
Tax Rate in both Countries = 40%
$ required to pay LC 900000 at today spot rate = LC 900000/10 = $90000 [Recorded in Books on date of transaction]
Spot Rate $1 = LC 10
(b) US Company will Convert LC 889328.06 in $ at spot rate
$ Required to deposit in LC = LC 889328.06/10 = $ 88932.806
Cost of Equipment is minimum under money market hedging, hence it should be followed
Solution-21
Bank has entered into forward purchase contract, hence customer would have entered into forward sale contract for FF
10000 @ Rs.27.25
From Customers point of view
Original contract is Forward Sale for FF 10000 in 3 months
To cancel the FSC before maturity, customer has to enter into another forward purchase contract of same maturity date
for FF 10000.
After 2 months
One month forward rate: SF 1 = Rs.27.45 – Rs.27.52 [buying FF and Selling Rs.]
Customer will enter into one month forward purchase contract for FF 10000 @Rs.27.52
Gain/ (Loss) to customer on cancellation of Original FSC = Rs. receivable under FSC – Rs. payable under FPC
= FF10000*27.25 – FF10000*27.52 = Rs.272500 – Rs.275200 = Rs.2700 loss to customer
The Banker will receive Rs.2700 from customer on cancellation of original forward sale contract.
Solution-21A
Bank has entered into forward purchase contract, hence customer would have entered into forward sale contract for FF
100000 @Rs.36.25
From Customers point of view
Original contract is Forward Sale for FF 100000 in 3 months
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.16
To cancel the Forward sale contract before maturity, customer has to enter into another forward purchase contract of
same maturity date for FF
After 2 months
One month forward rate SF 1 = Rs.36.45 – Rs.36.52 [buying FF and Selling Rs.]
Customer will enter into one month forward purchase contract for FF 100000 @ Rs.36.52
Gain/ (Loss) to customer on cancellation of Original FSC = Rs. receivable under FSC – Rs. payable under FPC
= FF 100000*36.25 – FF 100000*36.52 = Rs.3625000 – Rs.3652000 = Rs.27000 loss to customer
The Banker will receive Rs.27000 from customer on cancellation of forward sale contract.
Solution-22
Bank has entered into forward purchase contract, hence customer would have entered into forward sale contract for USD
100000 @ Rs.48.25 due on 14th March.
From Customers point of view.
Original contract is Forward Sale for USD 100000
To cancel the Forward sale contract on maturity, customer has to enter into another Spot purchase contract for USD.
On Maturity Date
Spot rate USD 1 = Rs.48.6525 – Rs.48.7325 [buying $ and Selling Rs.]
Customer purchase USD 100000 @ Rs.48.7325
Gain/ (Loss) to customer on cancellation of Original FSC = Rs. receivable under FSC – Rs. payable on spot purchase
= $ 100000*48.25 – $ 100000*48.7325 = Rs.4825000 – Rs.4873250 = Rs.48250 loss to customer
The Banker will receive Rs.48250 from customer on cancellation of forward sale contract.
Solution-22A
(i) Transaction with Alpha Manufacturing Co
On 19, March, 1999, bank has entered into forward sale contract, hence Alpha Manufacturing Co would have entered into
forward purchase contract for $ 100000 @ Rs.44.50 due in 3 months
On May, 19, 1999 - The customer approaches bank for cancellation of contract.
To cancel the Forward purchase contract before maturity, Alpha has to enter into another forward sale contract of same
maturity date for $ 100000.
At the end of 2 months
SR $1 = Rs.44.60 – 44.65
Swap Points of one month = 0.15-0.20 [Increasing Order]
Calculation of one month Forward Rate = SR + Swap Points
One month FR $ 1 = Rs.44.75 – 44.85
For cancellation of FPC, Alpha Manufacturing Co will enter into FSC of 1 month for $ 100000 @44.75
Gain/ (Loss) to Alpha on cancellation of Original FPC = Rs. receivable under FSC – Rs. payable under FPC
= $ 100000*44.75 – $ 100000*44.50 = Rs.4475000 – Rs.4450000 = Rs.25000 Gain to Alpha
Loss to Banker = Rs.25000 and will be paid by Bank to Alpha
On May, 19, 1999 - The customer approaches bank for cancellation of contract.
Spot Rate, Euro 1 = Rs.47.75 – 47.85
To cancel the FSC on maturity, Beta has to purchase Euro 1000000 at SR @47.85
Gain/ (Loss) to Alpha on cancellation of Original FSC = Rs. receivable under FSC – Rs. payable under spot purchase
= Euro 1000000*47.20 – Euro 1000000*47.85 = Rs.47200000 – Rs.47850000 = Rs.650000 Loss to Beta
Gain to Banker = Rs.650000
Solution-23
SR $ 1 = Rs.41.30 -41.70
3 Months FR $ 1 = Rs.42.00 – 42.50
Cost per disc = $ 1.48
Purchase qty of disc = 1000000
$ payable for entire purchase contract = 1000000*1.48 = $1480000 [Buying $ and selling Rs.]
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.17
On 01.04.2007, SI has entered into FPC for $1480000 @ $1 = Rs.42.50 due in 3 months
On 01.07.2007
Actual Purchase = 700000 Disc
$ required to pay for above purchase = 700000*1.48 = $1036000
Spot Rate on 01.07.2007 was $ 1 = Rs.40.90 - 41.20.
1. Out of $1480000, $1036000 will be paid for purchase of 700000 disc
2. Balance $ 444000 will be sold at spot rate of 01.07.2007 @ $ 1 = Rs.40.90
If American Company had informed on 01.06.2007 about non availability of 300000 discs, then SI would cancelle FPC for
$444000 on 01.06.2007 by entering into FSC of 1 months for $ 444000 @ $1 = Rs.42.10
Rs. receivable by selling $ 444000 at FR of 1 months = $444000*42.10 = Rs.18692400
Then net cost of 700000 disc = Rs.62900000 - Rs.18692400 = Rs.44207600
Solution-24
XYZ booked a FSC for $ 500000 @ 46.20 due on 5 March.
XYZ approaches to Bank on 10th March for cancellation. [After maturity Date]
Spot Rate on 10/03 - $ 1 = Rs.46.28 – Rs.46.35
For cancellation of FSC, XYZ will purchase $500000 at spot rate of 10/03 @Rs.46.35 [Buying $, Selling Rs.]
Gain/ (Loss) to XYZ on cancellation of Original FSC = Rs. receivable under FSC – Rs. payable under Spot Purchase
= $ 500000*46.20 – $ 500000*46.35 = Rs.23100000 – Rs.23175000 = Rs.75000 Loss to XYZ
Rs.75000 will be recovered from XYZ.
Note: Had it been gain to customer than it will not be paid to customer as contract is cancelled after due date.
Solution-24A
Bank has booked Forward Sale Contract for $ 100000 @ Rs.48.42 due on 10th March 2003.
It means Customer has booked a forward purchase contract for $ 100000 @ Rs.48.42 due on 10th March 2003.
The customer approaches to Bank on 14th March for cancellation after maturity date.
Spot Rate on 14th March $ 1 = Rs.48.50 - 48.57 [Buying Rs. and selling $]
For cancellation of FPC, customer has to sale $100000 on Spot rate of 14th March @ Rs.48.50
Gain/ (Loss) to customer on cancellation of Original FPC = Rs. receivable on spot sale – Rs. payable under FPC
= $ 100000*48.50 – $ 100000*48.42 = Rs.4850000 – Rs.4842000 = Rs.8000 Gain to Customer
Rs.8000 will not be paid to customer as it has been cancelled after maturity date.
Solution-25
ABC Booked forward sale contract for $ 200000 @ Rs.46.10 due on 5 March.
If the customer does not report, the contract will automatically be cancelled on 20th march by reverse contract.
Spot Rate on 20th march $ 1 = Rs.46.18 – 46.26
For cancellation of FSC of customer, on behalf of customer, bank will purchase $200000 @46.26
Gain/ (Loss) to ABC on cancellation of Original FSC = Rs. receivable under FSC – Rs. payable under spot purchase
= $ 200000*46.10 – $ 200000*46.26 = Rs.9220000 – Rs.9252000 = Rs.32000 loss to Customer
Solution-25A
Bank has booked forward sale contract, hence customer would have booked forward purchase contract for $ 100000 @
Rs.48.42 due on 10th March.
If the customer does not report, the contract will automatically be cancelled on 25th march by reverse contract.
Spot Rate on 25th march $ 1 = Rs.48.50 – 48.58
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.18
For cancellation of FPC of customer, on behalf of customer, bank will sell $100000 @48.50
Gain/ (Loss) to customer on cancellation of Original FPC = Rs. receivable under spot sale – Rs. payable under FPC
= $ 100000*48.50 – $ 100000*48.42 = Rs.4850000 – Rs.4842000 = Rs.8000 gain to Customer
This gain won’t be given to the customer, will be retained by the bank as contract is cancelled after maturity date
Solution-26
Since PNB has entered into forward sale contract, hence customer would have entered into forward purchase contract for
$ 250000 @Rs.48.35 due on 30th Aug,
From Customers point of view
Original contract is Forward Purchase for $.
Extension involves two things
(i) Cancellation of existing contract
(ii) Entering into a new forward Contract
To cancel the Forward purchase contract before maturity, customer has to enter into another forward sale contract for FF
of same maturity date.
On 10th Aug,
Forward rate of 30th Aug, $ 1 = Rs.47.6625 – Rs.47.7175 [buying Rs. and Selling $]
Customer will enter into forward sale contract for $ 250000 @Rs.47.6625
Gain or (Loss) to customer = Sale Value – Purchase Cost
= 250000*47.6625 – 250000*48.35 = 11915625 – 12087500 = Rs.171875 loss to customer
The Banker will receive Rs.171875 from customer against cancellation of forward purchase contract.
On 10th August:
Forward rate of Sep 30, $1 = Rs.47.4425-47.5375
For extension of forward contract, customer will purchase new forward contract for 30th sep for $250000 @47.5375
Solution-26A
ABC Ltd entered into a forward sale contract for $100000 due on 12th Aug @46.25
The customer approaches on 8th Aug for extension of contract to 15th Sep.
Extension involves two things
(i) Cancellation of existing contract
(ii) Entering into new forward sale Contract
On 8th Aug,
FR of 12th Aug - $ 1 = Rs.45.56 – 45.72
For Cancellation of original FSC, ABC Ltd will enter into FPC of 12th Aug for purchase of $ 100000 @ 45.72
Gain or (Loss) to customer on cancellation of original FSC = Sale Value – Purchase Cost
= 100000*46.25 – 100000*45.72 = 4625000 – 4572000 = Rs.53000 gain to customer
On 8th August:
Forward rate of Sep 15, $1 = Rs.45.34 - 45.54
For extension of forward contract, customer will enter into new FSC for 15th sep for $100000 @45.34
Solution-27
Importer have entered into a forward purchase contract for purchase of $20000 due on 30th Oct @42.32
The importer approaches bank on 30th Oct for extension of contract for 3 months
Extension involves two things
(i) Cancellation of existing contract
(ii) Entering into new forward purchase Contract for further 3 months
On 30th Oct,
SR - $ 1 = Rs.41.50 – 41.52
For Cancellation of original FPC, Importer will sell $ 20000 at SR @ 41.50 & Less Margin Money 0.075% [Here Customer
is selling but Bank is buying, hence buying margin money rate will apply]
Sale value of $20000*41.50 Rs.830000.00
Less: Margin Money @0.075% Rs.622.50
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.19
Net Proceeds Rs.829377.50
Less: Purchase cost of $20000 @ 42.32 as contracted Rs.846400.00
Loss on cancellation of Contract to Customer Rs.17022.50
For extension of forward contract, importer will enter into FPC of 3 months for $20000 @41.906
Add: Margin Money 0.20% [Here Customer is buying but Bank is selling, hence selling margin money rate will apply]
Forward purchase rate with margin money - $ 1 = Rs.41.906*1.002 = Rs.41.9898
Solution-27A
Importer have entered into a forward sale contract for purchase of $20000 due on 30th Oct @62.32
The importer approaches bank on 30th Oct for extension of contract for 3 months
Extension involves two things
(i) Cancellation of existing contract
(ii) Entering into new forward purchase Contract for further 3 months
On 30th Oct,
SR - $ 1 = Rs.61.50 – 61.52
For Cancellation of original FSC, exporter will buy $ 20000 at SR @ 61.52 & add Margin Money 0.20% [Here Customer is
buying but Bank is selling, hence selling margin money rate will apply]
Purchase rate = 61.52 + 61.52*0.2% = 61.52+0.12 = 61.64
Sale value of $20000*62.32 Rs.1246400
Less: Purchase Value $20000*61.64 Rs.1232800
Gain to Customer Rs.13600
For extension of forward contract, exporter will enter into FSC of 3 months for $20000 @60.93
Less: Margin Money 0.45% [Here Customer is selling but Bank is buying, hence buying margin money rate will apply]
Forward sale rate with margin money - $ 1 = Rs.60.93*(1 - 0.0045) = Rs.60.66
Solution-27B
An Indian Company entered into a forward sale contract for sale of £ 500000 due on 31.05.2008 @ Rs.61.60 per £.
The customer approaches on 31.05.2008 for extension of contract to 31.07.2008.
Extension involves two things
(i) Cancellation of existing contract
(ii) Entering into new forward sale Contract
On 31.05.2008,
Spot (Rs/£) 62.60/65
For Cancellation of original FSC, An Indian Company will enter into purchase contract for £ 500000 at spot rate @ 62.65
Gain or (Loss) to customer = Sale Value – Purchase Cost
= 500000*61.60 – 500000*62.65 = 30800000 – 31325000 = - Rs.525000 Loss to customer
Flat charges for cancellation = Rs.500
Total loss due to cancellation = Rs.525000 + Rs.500 = Rs.525500
On 31.05.2008:
2 Month Forward Premium 42/46
Since forward premium is in ascending order, hence
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.20
2 Months forward rate (Rs/£) = 63.02/11
For extension of forward contract, customer will enter into FSC for 31.07.2008 for £ 500000 @63.02
Solution-28
Importer have entered into a forward purchase contract for purchase of USD 200000 due on 10th June @64.40
The importer approaches bank on 20th June for extension of contract due on 10th Aug
Extension involves two things
(i) Cancellation of existing contract
(ii) Entering into new forward purchase Contract due on 10th Aug
On 20th June,
SR - USD 1 = Rs.63.68 – 63.72
For Cancellation of original FPC, Importer will sell USD 200000 at SR @ 63.68 & Less Margin Money 0.1%
(i) Cancellation Rate = Rs.63.68 – 63.68*0.1% = 63.68-0.0636 = Rs.63.6163
(ii) Loss to customer = 200000*(64.40 – 63.6163) = Rs.156740
Solution-29
Current Spot Rate $1 = Rs.45.50
Interest Rate (Rs.) = 8% p.a.
PIR of 6 months (Rs.) = 4%
Interest Rate ($) = 2% p.a.
PIR of 6 months ($) = 1%
(i) Calculation of the FR under IRPT [Rs. is RHC and $ is LHC]
FR under IRPT (Rs./$) = (1 + PIRRs.)*SR/(1 + PIR$) = (1 + 0.04)*45.50/(1 + 0.01) = Rs.46.851
Alternative
Prem/ Dis on $ (LHC) under IRPT = (FRIRPT - SR)*100/SR = (46.85 – 45.50)*100/45.50 = 2.967%
(iii) Prem/ Dis on Rs. (RHC) under IRPT = (SR-FRIRPT)*100/FRIRPT = (45.50 – 46.85)*100/46.85 = - 2.881%
Dis p.a. on Rs. = 2.881*2 = 5.762%
(iv) Under the given circumstances, the USD is expected to quote at a premium as the interest rate in India is higher than
interest rate in USA
(v) Actual Prem/ Dis on $ (LHC) = (FRActual - SR)*100/SR = (47.00 – 45.50)*100/45.50 = 3.29%
Prem p.a. on $ = 3.29*2 = 6.58%
Alternative
Prem on $ under IRPT = 2.97%
Prem on $ Actual = 3.29%
Since Prem on $ above is not equal, hence IRPT does not exist.
Solution-29A
Spot $1 = Rs.55.50
Interest Rate (Rs.) = 10% p.a.
PIR of 6 months (Rs.) = 5%
Interest Rate ($) = 4% p.a.
PIR of 6 months ($) = 2%
(i) Calculation of the FR under IRPT [Rs. is RHC and $ is LHC]
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.21
FR under IRPT (Rs./$) = (1 + PIRRs.)*SR/(1 + PIR$) = (1 + 0.05)*55.50/(1 + 0.02) = Rs.57.13
Alternative
Prem/ Dis on $ (LHC) under IRPT = (FRIRPT - SR)*100/SR = (57.13 – 55.50)*100/55.50 = 2.936%
(iii) Under the given circumstances, the USD is expected to quote at a premium as the interest rate in India is higher than
interest rate in USA
(iv) Actual Prem/ Dis on $ (LHC) = (FRActual - SR)*100/SR = (58.00 – 55.50)*100/55.50 = 4.504%
Prem p.a. on $ = 4.504*2 = 9.008%
Alternative
Prem on $ under IRPT = 2.936%
Prem on $ Actual = 4.504%
Since Prem on $ above is not equal, hence IRPT does not exist.
Solution-29B
Spot DK 1 = $0.15986
Actual FR 3 Month DK 1 = $0.15900
Interest Rate (DK) = 7.5% p.a.
PIR of 3 months (DK) = 1.875%
Interest Rate ($) = 6.25% p.a.
PIR of 3 months ($) = 1.5625%
(i) Actual Prem/ Dis on DK (LHC) = (FRActual - SR)*100/SR = (0.159 – 0.15986)*100/0.15986 = - 0.537%
Dis p.a. on DK = - 0.537%*4 = - 2.148%
Solution-30
Spot $1 = DM 1.71
FR of 90 days $ 1 = DM 1.70
(i) To hedge foreign exchange risk, shoe co can take forward contract, by selling DM 50,000 in forward Market @ $ 1 =
DM 1.70
$ receivable by taking forward contract = DM50,000/1.70 = $29411.76
$ receivable under Spot Rate = DM50,000/1.71 = $29239.77
Benefit by forward Contract = 29411.76 – 29239.77 = $171.99
(ii)
Prem/ Dis on $ (LHC) = (FRActual - SR)*100/SR = (1.70 – 1.71)*100/1.71 = - 0.5848%
$ is at discount and DM is at premium
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.22
(iii) Interest rate differential is just another name of premium or discount of one currency in relation to another currency.
IF IRPT exists
Discount on $ under IRPT = Actual Discount on $ = 0.5848%
Solution-31
SR 1 $ = FF 7.05 [$ is LHC and FF is RHC]
Solution-32
Bag price at NY = $ 105
Same bag price in Mumbai = Rs.4250
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.23
a) Exchange Rate in Mumbai (Purchasing Power Parity Theory)
Bag price at NY = Bag price in Mumbai
$ 105 = Rs.4250
$ 1 = Rs.40.476
Exchange Rate in Mumbai per $ = Rs.40.4762
d)
Premium/Discount on $ (LHC) under PPPT = [PIFRRs. – PIFR$]*100/[1 + PIFR$] = (0.07 – 0.04)/1.04 = 0.0288 = 2.88%
OR
Premium/Discount on $ (LHC) under PPPT = [FRPPPT - SR]*100/SR = (41.64-40.476)*100/40.476 = 2.87%
Premium on $ = 2.88%
Premium/Discount on Rs. (RHC) under PPPT = [PIFR$–PIFRRs.]*100/[1+PIFRRs.] = (0.04 – 0.07)/1.07 = - 0.0280 = 2.80%
OR
Premium/Discount on Rs. (RHC) under PPPT = [SR - FRPPPT]*100/ FRPPPT = (40.476 - 41.64)*100/41.64 = - 2.79%
Discount on Rs. = 2.79%
Solution-32A
SR $1 = Rs.36 [Rs. is RHC and $ is LHC]
Inflation Rate (USA) = 3%
Inflation Rate (India) = 8%
Based on PPPT
Premium/Discount on Rs. (RHC) under PPPT = [PIFR$–PIFRRs.]*100/[1+PIFRRs.] = (0.03 – 0.08)*100/1.08 = - 4.629%
Premium/Discount on $ (LHC) under PPPT = [PIFRRs. – PIFR$]*100/[1 + PIFR$] = (0.08 – 0.03)*100/1.03 = 4.854%
Solution-33
SR $1 = DM 1.50 [DM is RHC and $ is LHC]
FR of 3 months $1 = DM 1.51
IFRDM = 4% p.a.;
PIFRDM of 3 months = 1%
PPPT holds good, hence
FRActual = FRPPPT = 1.51
FRPPPT of 3 months = (1 + PIFRDM)*SR/(1 + PIFR$) = (1.01)*1.50/(1 + PIFR$)
(1 + PIFR$) = 1.01*1.50/1.51 = 1.0033
PIFR ($) = 1.0033 – 1 = 0.0033 = 0.33%
Annual Inflation rate ($) = 0.33*4 = 1.32%
Solution-34
SR $1 = Rs. 43.40 [Rs. is RHC and $ is LHC]
IFRRs. = 6.5% p.a.
IFR$ = 3% p.a.
According to Purchasing Power Parity
FRPPPT of 1 year = (1 + IFRRs.)*SR/(1 + IFR$) = 1.065*43.40/1.03 = Rs.44.87
So spot rate after one year $ 1 = Rs.44.87
FRPPPT of 2 year = (1 + IFRRs.)*SR/(1 + IFR$) = 1.065*44.87/1.03 = Rs.46.39
Alternative Solution
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.24
FRPPPT of 3 year = (1 + IFRRs.)3*SR/(1 + IFR$)3 = (1.065*1.065*1.065*43.40)/(1.03*1.03*1.03) = Rs.47.97
FR of 3 years $ 1 = Rs.47.97
Solution-34A
SR $1 = Rs. 46 [Rs. is RHC and $ is LHC]
IFRRs. = 8% p.a.
IFR$ = 4% p.a.
According to Purchasing Power Parity
FRPPPT of 1 year = (1 + IFRRs.)*SR/(1 + IFR$) = 1.08*46/1.04 = Rs.47.77
So spot rate after one year $ 1 = Rs.47.77
FRPPPT of 2 year = (1 + IFRRs.)*SR/(1 + IFR$) = 1.08*47.77/1.04 = Rs.49.60
Alternative Solution
FRPPPT of 4 year = (1 + IFRRs.)4*SR/(1 + IFR$)4 = (1.08*1.08*1.08*1.08*46)/(1.04*1.04*1.04*1.04) = Rs.53.49
FR of 4 years $ 1 = Rs.53.49
Solution-35
SR GBP 1 = USD 1.5339 [GBP is LHC and USD is RHC]
NIRUSD = 5%
NIRGBP = 7%
Solution-36
SR $ 1 = Rs.45.50 [Rs. is RHC and $ is LHC]
1 year FR $ 1 = Rs.45.9461
RIRRs. = 8%
RIR$ = 6%
IFRRs. = 4%
NIR in India = (1 + RIRRs.)(1 + IFRRs.) - 1= (1.08*1.04) – 1 = 12.32%
Apply IFE
FRActual = FR under IFE = 45.9461
FR under IFE = [1 + PNIRRs.]*SR/[1 + PNIR$]
45.9461 = 1.1232*45.50/[1 + PNIR$]
1 + PNIR$ = 1.1232*45.50/45.9461 = 1.11229
PNIR$ = 1.11229 – 1 = 0.11229 = 11.229%
NIR in USA = 11.229%
Solution-37
1£ = Rs.74.00 -74.50 Rs./ £
1 CHF = Rs.26.00 -26.60 Rs./CHF
Required
(a) (CHF/£) = (CHF/Rs.)*(Rs./£) = 74/26.60 – 74.50/26 = 2.7819 – 2.8653
£ 1 = CHF 2.7819 – 2.8653
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.25
(b) (£/CHF) = (£/Rs.)*(Rs./CHF) = 26/74.50 – 26.60/74 = 0.3489 – 0.3594
CHF 1 = £ 0.3489 – 0.3594
Solution-38
Spot rate $1 = Rs.45.00 – 45.40 (Rs/$)
Pound 1 = $ 1.60 – 1.65 ($/P)
Pound 1 = AD 3.00 – 3.50 (AD/P)
AD 1 = SD 1.50 – 1.60 (SD/AD)
Required
Rs./SD = (Rs./$)*($/P)*(P/AD)*(AD/SD) = (45.00*1.60)/(3.50*1.60) – (45.40*1.65)/(3*1.50) = 12.85 – 16.64
SD 1 = Rs.12.85 – 16.64
Solution-38A
Euro 1 = DM 1.95583 (Locked in rate) [DM/Euro]
Euro 1 = $1.0234 - 1.0243 [$/Euro]
$1 = Rs.48.51-48.53 [Rs./$]
Requirement
Rs./DM = Rs./$ * $/Euro * Euro/DM
Bid Price DM 1 = 48.51*1.0234 * 1/1.95583 = 25.382
Ask Price DM 1 = 48.53*1.0243 * 1/1.95583 = 25.416
Solution-39
The Dealer sold HK$ 10000000 on spot @ HK$ 1 = Rs.5.70
To covers it self, He will buy HK$ 10000000 from the market at market selling rate.
Exchange rate
US $ 1 = HK $ 7.588-7.592 [HK $/US $]
US $ 1= Rs.42.70 – 42.85 [Rs./US $]
Required cross rate
Rs./HK $ = (Rs./US $) * (US $/HK $)
HK $ 1 = Rs.42.70*1/7.592 – 42.85*1/7.588
HK $ 1 = Rs.5.624 – 5.647
Since Bank had sold HK $ @ Rs.5.70 and to cover himself, he will purchase HK $ at spot rate @5.647
Gain or loss to Bank = Sale price – Purchase Price
= HK $ 10000000*5.70 – 10000000*5.647 = Gain Rs.530000
Solution-39A
Exchange rate
US $ 1 = HK $ 7.9250-7.9290 [HK $/US $]
US $ 1= Rs.55.00 – 55.20 [Rs./US $]
Required cross rate
Rs./HK $ = (Rs./US $) * (US $/HK $)
HK $ 1 = Rs.55/7.9290 – 55.20/7.9250
HK $ 1 = Rs.6.9365 – 6.9653
Since Bank had sold HK $ @ Rs.7.15 and to cover himself, he will purchase HK $ at spot rate @6.9653
Gain or loss to Bank = Sale price – Purchase Price
= HK $ 4000000*7.15 – 4000000*6.9653 = 28600000 – 27844000 = Gain Rs.738800
Solution-40
Mumbai – London Pound 1 = Rs.74.30 – 74.32 (Rs./P) London Market
London – Copenhagen Pound 1 = DK 11.42 – 11.435 (DK/P) London Market
Mumbai – New York $ 1 = Rs.49.25 – Rs.49.2625 (Rs./$) New York Market
New York – Copenhagen $ 1 = DK 7.567 – 7.584 (DK/$) New York Market
(i) Cross rates between DK and Rs. in London Market
Rs./DK = (Rs./P)*(P/DK) = Rs.74.30/11.435 – 74.32/11.42 = Rs.6.4976 – 6.5078
DK 1 = Rs. 6.4976 – 6.5078
Solution-41
Calculation of Cross Rate between Rs. and SGD on January 28
In Bombay $ 1 = Rs.45.85 – 45.90 [Rs./$]
In London Pound 1 = $ 1.784 – 1.785 [$/P]
In London Pound 1 = SGD 3.1575 – 3.1590 [SGD/P]
Required cross rate between Rs. and SGD
Rs./SGD = (Rs./$) * ($/P) * (P/SGD)
SGD 1 = Rs. 45.85*1.784*1/3.1590 – 45.90*1.785*1/3.1575
SGD 1 = Rs. 25.89313 – 25.94822
Solution-41A
Calculation of Cross Rate between Rs. and DG on 25.03.2007
In Bombay Rs. 1 = Rs.0.022873 – 0.022962 [$/Rs.]
In London Pound 1 = $ 1.912 – 1.9135 [$/P]
In London Pound 1 = DG 4.1125 – 4.1140 [DG/P]
Required cross rate between Rs. and DG
Rs./DG = (Rs./$) * ($/P) * (P/DG)
DG 1 = Rs.1.912/(0.022962*4.1140) – 1.9135/(0.022873*4.1125)
DG 1 = Rs.20.2401 – 20.3422
Solution-42
SR $ 1 = Rs.61.3625 – 61.3700
SR £ 1 = $ 1.5260 – 1.5270
To purchase Rs., XYZ Bank shall first purchase $ by selling £ and then purchase Rs. by selling $
(i) $ required to purchase Rs.2500000 = Rs.25000000/61.3625 = $ 4074150
(ii) £ required to buy $ 40741.50 = $ 4074150/1.5260 = £ 2669823
Solution-43
SR $ 1 = Rs.31.43 – 31.45
SR $ 1 = Euro 1.44 – 1.445
Forex Dealer has sold $ 1000000 @ Euro 1.44 for spot delivery.
To square up his short position, he will buy $ 1000000 @ Euro 1.445
Gain/(Loss) on square up of transaction = Sale – Purchase = $1000000*1.44 - $1000000*1.445 = Euro 5000 Loss
Solution-44
Bank has entered into forward purchase contract, hence customer would have entered into forward sale contract for sale
of SF 100000 @ Rs.32.40
Rs. receivable by selling SF 100000 under forward contract = SF 100000*32.40 = Rs.3240000
On 25th March,
1 month forward rate USD 1 = SF 1.5150/1.5160 [SF – Buy, USD – Sell] [Selling rate would be applicable]
USD required to buy SF 100000 @ 1.5150 = SF 100000/1.5150 = USD 66006.60
Alternative Method
Cross Rate between Rs. and SF
Rs./SF = (Rs./USD)*(USD/SF) = 49.9154/1.5150
SF 1 = Rs.32.9475
Rs. required to buy SF 100000 = SF 100000*32.9475 = Rs.3294750
Loss to Customer on cancellation of FSC = 3294750-3240000 = Rs.54750
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.28
Solution-45
SR £1 = $1.55 in London and
SR £1 = $1.60 in New York
Sterling is undervalued in London and overvalued in New York. Provided that capital was free to
flow between the two centres, arbitrageurs would attempt to exploit, and hence profit from, the
differential by selling dollars for pounds in London and reselling the pounds in New York.
Arbitrage Profit is possible as follows:
Buying Rate of £ 1 in London = $1.55
Selling Rate of £ 1 in NY = $1.60
Since selling rate is more than buying rate, hence arbitrage profit is possible
Arbitrage Profit per £ = Selling Rate – Buying Rate = $1.60 - $1.55 = $0.05
Solution-46
SR £1 = $1.5495 – 1.5505 in London and
SR £1 = $1.5995 – 1.6005 in NY and
Option 1
Buy £ in London and Sell £ in NY
Buying Rate of £ 1 in London = $1.5505
Selling Rate of £ 1 in NY = $1.5995
Since selling rate is more than buying rate, hence arbitrage profit is possible
Arbitrage Profit per £ = Selling Rate – Buying Rate = $1.5995 - $1.5505 = $0.049
Option 2
Buy £ in NY and Sell £ in London
Buying Rate of £ 1 in NY = $1.6005
Selling Rate of £ 1 in London = $1.5495
Since selling rate is less than buying rate, hence arbitrage profit is not possible in potion 2
Solution-47
Singapore 1$ = CHF 1.3689 - 1.4150
New York 1$ = CHF 1/0.7236 – 1/0.7090 = CHF 1.3820 - 1.4104
Option 1
Buy $ in Singapore and Sell $ in NY
Buying Rate of $ 1 in Singapore = CHF 1.4150
Selling Rate of $ 1 in NY = CHF 1.3820
Since selling rate is less than buying rate, hence arbitrage profit is not possible in option 1
Option 2
Buy $ in NY and Sell $ in Singapore
Buying Rate of $ 1 in NY = CHF 1.4104
Selling Rate of $ 1 in Singapore = CHF 1.3689
Since selling rate is less than buying rate, hence arbitrage profit is not possible in option 2
Option 1
Buy CHF in Switzerland and Sell CHF in USA
Buying Rate of CHF 1 in Switzerland = $0.7305
Selling Rate of CHF 1 in USA = $0.7090
Since selling rate is less than buying rate, hence arbitrage profit is not possible in option 1
Option 2
Buy CHF in USA and Sell CHF in Switzerland
Buying Rate of CHF 1 in USA = $0.7236
Selling Rate of CHF 1 in Switzerland = $0.7302
Since selling rate is more than buying rate, hence arbitrage profit is possible in option 2
Arbitrage Profit per CHF = Selling Rate – Buying Rate = $0.7302 - $0.7236 = $0.0066
Solution-48
In NY USD 1 = CHF 1.6639 – 1.6646 – (i) [CHF/USD]
In London USD 1 = Euro 0.9682 – 0.9686 – (ii) [Euro/USD]
In Australia Euro 1 = CHF 1.6410 – 1.6423 – (iii) [CHF/Euro]
We have $ 1000000 and that is to be sold first and it has to be purchased as follows
Option 1
(a) Sell $ 1,000,000 in London, Euro receivable = $ 1000000*0.9682 = Euro 968200
(b) Sell Euro 968200 in Australia, CHF receivable = Euro 968200*1.6410 = CHF1588816
(c) Sell CHF 1588816 in NY, $ receivable = CHF 1588816/1.6646 = $ 954473
Loss due to above process = $1000000 - $ 954473 = $ 45527
Option 2
(a) Sell $ 1,000,000 in NY, CHF receivable = $ 1000000*1.6639 = CHF 1663900
(b) Sell CHF 1663900 in Australia, Euro receivable = CHF 1663900/1.6423 = Euro 1013152
(c) Sell Euro 1013152 in London, $ receivable = Euro 1013152/0.9686 = $ 1045996
Gain due to above process = $1045996 - $ 1000000 = $ 45996
Alternative Method
Calculate Cross rates between USD and CHF from (ii) and (iii)
CHF/USD = (CHF/Euro)*(Euro/USD) = 1.6410*0.9682 – 1.6423*0.9686 = 1.5888 – 1.5907
USD 1 = CHF 1.5888 – 1.5907 in London
USD 1 = CHF 1.6639 – 1.6646 in NY
Option 1
Buy USD in London and Sell USD in NY
Buying Rate of USD 1 in London = CHF 1.5907
Selling Rate of USD 1 in NY = CHF 1.6639
Since selling rate is more than buying rate, hence arbitrage profit is possible in option 1
Arbitrage Profit per USD = Selling Rate – Buying Rate = CHF 1.6639 – CHF 1.5907 = CHF 0.0732
We have $ 1000000 and that is to be sold first and it has to be purchased as follows
Option 1
(a) Sell £ 1,000,000 in (i), $ receivable = £ 1000000*1.5715 = $ 1571500
(b) Sell $ 1571500 in (ii), ¥ receivable = $1571500*106.09 = ¥ 166720435
(c) Sell ¥ 166720435 in (iii), £ receivable = ¥ 166720435/176.831 = £ 942823
Loss due to above process = £1000000 - £ 942823 = £ 57177
Option 2
(a) Sell £ 1,000,000 in (iii), ¥ receivable = £ 1000000*176.72 = ¥ 176720000
(b) Sell ¥ 176720000 in (ii), $ receivable = ¥ 176720000/106.12 = $ 1665284
(c) Sell $ 1665284 in (i), £ receivable = $ 1665284/1.5721 = £ 1059273
Gain due to Arbitrage process = £1059273 - £ 1000000 = £ 59273
Alternative Method
Calculate Cross rates between £ and $ from (ii) and (iii)
$/£ = ($/¥)*(¥/£) = 1176.720/106.120 – 176.831/106.090
£ 1 = $ 1.6652 – 1.6668 – (iv)
£1 = $ 1.5715-721 – (i)
Option 1
Buy £ in (i) and Sell £ in (iv)
Buying Rate of £ 1 in (i) = $ 1.5721
Selling Rate of £ 1 in (iv) = $ 1.6652
Since selling rate is more than buying rate, hence arbitrage profit is possible in option 1
Arbitrage Profit per £ = Selling Rate – Buying Rate = $1.6652 – $1.5721 = $0.0931
Solution-49
Spot rate quoted in Markets
In Mumbai $1 = Rs.48.30
In London GBP1 = Rs.77.52
In New York GBP1 = $1.6231
We have $ 10000000 and that is to be sold first and it has to be purchased as follows
Option 1
(a) Sell $ 10000000 in Mumbai, Rs. receivable = $ 10000000*48.30 = Rs.483000000
(b) Sell Rs.483000000 in London, GBP receivable = Rs.483000000/77.52 = GBP 6230650
(c) Sell GBP 6230650 in NY, $ receivable = GBP 6230650*1.6231 = $ 10112968
Gain due to Arbitrage process = $ 10112968 - $ 10000000 = $ 112968
Alternative Solution
Calculate cross rates between $ and Rs. through New York and London Compare it with rate of Mumbai. OR
Required cross rate
Rs./$ = (Rs./GBP)*(GBP/$) = 77.52*1/1.6231
$1 = Rs.47.76046 [Cross between New York and London]
$1 = Rs.48.30 [Rate in Mumbai given]
Since $ is costly in Mumbai, hence it should be sold in Mumbai and purchased from new York.
1. Rs. receivable by selling $10000000 in Mumbai = $10000000 * 48.30 = Rs.483000000
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.31
2. GBP receivable by selling Rs.483000000 in London = Rs.483000000/77.52 = GBP6230650.15
3. $ receivable by selling GBP6230652.15 in NY = GBP 6230650.15*1.6231 = $10112968.26
Arbitrage gain = $10112968.26 - $10000000 = $112968.26
Solution-50
£ 1 = $ 1.367-1.3708 – (i) [$/£]
DEM 1 = SF 1.003 – 1.0078 - (ii) [SF/DEM]
SF 1 = $ 0.879 – 0.8803 – (iii) [$/SF]
£ 1 = DEM 1.556 – 1.5576 – (iv) [DEM/£]
We have $ 10000 and that is to be sold first and it has to be purchased as follows
Option 1
(a) Sell $ 10000 in (i), £ receivable = $ 10000/1.3708 = £ 7295
(b) Sell £ 7295 in (iv), DEM receivable = £ 7295*1.556 = DEM 11351
(c) Sell DEM 11351 in (ii), SF receivable = DEM 11351*1.003 = SF 11385
(d) Sell SF 11385 in (iii), $ receivable = SF 11385*0.879 = $ 10007
Alternative Method
Calculate Cross rates between £ and $ from (ii), (iii) and (iv)
$/£ = ($/SF)*(SF/DEM)*(DEM/£) = 0.879*1.003*1.556 – 0.8803*1.0078*1.5576 = 1.3718 – 1.3818
£ 1 = $ 1.3718 – 1.3818 – (v)
£ 1 = $ 1.367-1.3708 – (i)
Option 1
Buy £ in (i) and Sell £ in (v)
Buying Rate of £ 1 in (i) = $ 1.3708
Selling Rate of £ 1 in (v) = $ 1.3718
Since selling rate is more than buying rate, hence arbitrage profit is possible in option 1
Arbitrage Profit per £ = Selling Rate – Buying Rate = $1.3718 – $1.3708 = $0.001
Solution-51
USD 1 = Rs. 59.25 – 59.35 – (i) [Rs./$]
GBP 1 = Rs. 102.50 – 103.00 - (ii) [Rs./GBP]
GBP 1 = USD 1.70 – 1.72 (iii) [USD/GBP]
Arbitrageur have $ 10000000 and that is to be sold first and it has to be purchased as follows
Option 1
(a) Sell $ 10,000,000 in (iii) [GBP-LHC-Buy; $-Sell-RHC]
Since GBP is LHC and which is to be purchased, margin money will be added on exchange rate
Exchange rate = 1.72*(1+0.00125) = 1.722
GBP receivable = $ 10000000/1.722 = GBP 5807201
(a) Return of investment of USA Investor from USA Bond = Return of American Bond = 12%
(b) Return of investment of Foreign Investor from USA Bond = (1+Return of American Bond)*(1+Prem on $) – 1
= 1.12*1.03-1 = 0.1536 = 15.36%
Solution-52A
B0 = $ 100
B1 = $105
Interest received from bond = $7
Return of investment of American Bond for one year = (B1 – B0 + Intt)*100/B0 = (105+7-100)*100/100 = 12%
In this question, in place of premium on invested currency, FER at beginning and year end is given, hence we can
calculate Premium/Discount on invested currency as follows
Premium/ Discount on $ (Invested & LHC) = (FR – SR)*100/SR = (51.50-50)*100/50 = 3%
Premium on $ = 3%
(a) Return of investment of USA Investor from USA Bond = Return of American Bond = 12%
(b) Return of investment of Foreign Investor from USA Bond = (1+Return of American Bond)*(1+Prem on $) – 1
= 1.12*1.03-1 = 0.1536 = 15.36%
Solution-52B
In this question, in place of price of securities, Return of security is given
Return of investment in American Bond for one year = 12%
(a) Return of investment of USA Investor from USA Bond = Return of American Bond = 12%
(b) Return of investment of Foreign Investor from USA Bond = (1+Return of American Bond)*(1+Prem on $) – 1
= 1.12*1.03-1 = 0.1536 = 15.36%
Solution-53
B0 = $5000
B1 = $5250
Interest received from bond = $350
Return of investment from Bond for one year = (B1 – B0 + Intt)*100/B0 = (5250+350-5000)*100/5000 = 12%
Return of investment for Foreign Investor = (1+Return of Bond)*(1+Prem on $) – 1 = 1.12*1.02-1 = 0.1536 = 14.24%
Solution-53A
Return of investment in Rs. = 8%
SR at to Euro 1 = Rs.55.50
SR at t1 Euro 1 = Rs.57.67
Invested currency = Rs.
Premium/ Discount on Rs. (Invested & RHC) = (SR – FR)*100/FR = (55.50-57.67)*100/57.67 = -3.76%
Discount on Rs. = 3.76%
Solution-53B
Return of investment in British Security = 7%
SR at to £ 1 = Euro 1.50
FR of t1 £ 1 = Euro 1.56
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.33
Invested currency = £
Premium/ Discount on £ (Invested & LHC) = (FR – SR)*100/SR = (1.56-1.50)*100/1.50 = 4%
Premium on £ = 4%
Solution-54
Return of investment in Chinese Security = 6.50% p.a.
Return of investment in Chinese Security = 3.25% for 6 months
Return of investment in French Security = 7.50% p.a.
Return of investment in French Security = 3.75% for 6 months
As per Question, both investment has equal return to calculate Prem/ Dis on Euro
Return of investment of Chinese Investor in Chinese Security = Return of investment of Chinese Investor in French
Security
0.0325 = 1.0375*(1+Premium/Dis on Euro)-1
1+Premium/Dis on Euro = 1.0325/1.0375
Premium/Dis on Euro = 0.995 – 1 = - 0.005 = - 0.5%
To make both return equal, discount on Euro = 0.5%
(ii)
If Spot Rate Euro 1 =CY 5
Discount on Euro = 0.05%
Expected FER after 6 moths = 5*(1-0.005) = 4.975 CY
To make both return equal, Expected FER after 6 moths Euro 1 = 4.975 CY
Verification of Answer
Option 1 Investment in Chinese Security
CY 100000 is invested in Chinese Security for 6 months
CY receivable at the end of 6 months = CY 100000*1.0325 = CY 103250
Solution-55
IFRRs. = 4% p.a.; IFR$ = 2% p.a.; IFRMS = 6% p.a.
SR $ 1 = Rs.43.50 – 43.60
SR $ 1 = MS 3.80 – 3.82
Assuming PPPT holds good
FRPPPT of 1 year (Rs./$) = (1 + IFRRs.)*SR/(1 + IFR$) = 1.04*43.50/1.02 - 1.04*43.60/1.02 = Rs.44.35 – 44.45
FRPPPT of 1 year (MS/$) = (1 + IFRMS)*SR/(1 + IFR$) = 1.06*3.80/1.02 - 1.06*3.82/1.02 = MS 3.949 – 3.969
Comment: Since return of India is more than Malaysia, hence investment should be made in India.
Alternative Solution
(i) If Investment is made in India
Today
(a) Convert $ 10 m into Rs. at SR = $ 10*43.50 = Rs.435 Million
(b) Rs. 435 M is invested in India @20% or @ 16% (NOT)
At the end of 1st year
(a) Rs. receivable from investment in India = Rs.435*1.16 = Rs.504.60 m
(b) Convert Rs. 504.60 m into $ at FR = Rs.504.60/44.45 = $ 11.352 Million
Comment: Since return of India is more than Malaysia, hence investment should be made in India.
Solution-56
RF in China = 12%; Beta of Chinese Security = 1.48; Variance of Return of Chinese Security = 20%; Rm in China = 22%
Expected return in Chinese Security = Rf + B(Rm – Rf) = 12% + 1.48 (22%-12%) = 26.80%
Currency in which investment is made = CY
Discount in CY = 5.56%
Return from investment of Austrian Company in Chinese Security = (1+Return from Security)(1-Dis on CY) - 1
= (1 + 0.268)(1 - 0.0556) - 1 = 19.75%
Solution-57
Today SR $ 1 = Rs.48.0123
FR of 6 months $ 1 = Rs.48.819
IRRs. = 12%; IR$ = 8%
PIR for 6 months on Rs. = 6%
PIR for 6 months on $ = 4%
Premium or discount on $ [LHC] = (FR-SR)*100/SR = (48.8190 – 48.0123)/48.0213 = 1.679% Prem on $ for 6 months
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.35
Loss of Intt on $ for 6 months = 6% - 4% = 2%
Since loss of interest is more than gain of premium, hence investment should be made in Rs. and borrowing in $.
After 6 months
1. Rs. receivable from investment = Rs.4000000*1.06 = Rs.4240000
2. Convert Rs.4240000 into $ at FR = Rs.4240000/48.8190 = $ 86851.43
3. Repayment of borrowing in $ = $ 83312*1.04 = $86644.48
Solution-57A
Today SR $ 1 = Rs.43.30
FR of 6 months $ 1 = Rs.43.70
IRRs. = 8%; IR$ = 4%
PIR for 6 months on Rs. = 4%
PIR for 6 months on $ = 2%
Method 1
Premium or discount on $ [LHC] = (FR-SR)*100/SR = (43.70 – 43.30)*100/43.30 = 0.923% premium on $ for 6 months
Loss of Intt on $ for 6 months = 4% - 2% = 2%
Since loss of interest is more than gain of premium on $, hence investment should be made in Rs. and borrowing in $.
Method-1
Today
1. Borrow US$ 1000000 for 6 months @ 2%
2. Convert US$ 1000000 into Rs. at SR = $1000000*43.30 = Rs.43300000
3. Invest Rs.43300000 for 6 months @ 4%
After 6 months
1. Rs. receivable from investment = Rs.43300000*1.04 = Rs.45032000
2. Convert Rs.45032000 into $ at FR = Rs. 45032000/43.70 = $ 1030481
3. Repayment of borrowing in $ = $ 1000000*1.02 = $1020000
Method-2 [Ignore]
Borrowing in $ and investment in Rs.
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.36
Currency in which investment is made = Rs.
Discount on Rs. [RHC] = (SR-FR)*100/FR = (43.30 – 43.70)*100/43.70 = - 0.9153% Dis on Rs. for 6 months
Return from investment in Rs. = (1 + PIRRs.)(1 - Dis on Rs.) – 1 = 1.04*(1-0.009153) – 1 = 0.03048 = 3.048%
Solution-57B
Today SR £ 1 = $ 1.50
FR of 1 year £ 1 = $ 1.48
IR£ = 8%; IR$ = 5%
Method 1
Premium or discount on £ [LHC] = (FR-SR)*100/SR = (1.48 – 1.50)*100/1.50 = - 1.333% Dis on £
Gain of Intt on £ = 8% - 5% = 3%
Since Gain of interest is more than Loss of Discount on £, hence investment should be made in £ and borrowing in $.
Today
1. Borrow $ 1000000 for 1 year @ 5%
2. Convert $ 1000000 into £ at SR = $1000000/1.50 = £ 666667
3. Invest £ 666667 for 1 year @ 8%
Solution-58
Surplus fund = $ 500000
Cost of Fund = 4% p.a.
Option 1 Investment in NY
Interest rate of NY = 8% p.a.
PIR of NY for 3 months = 2%
(a) $ 500000 is invested for 3 months in NY @ 2%
(b) $ receivable at the end of 3 months = $ 500000*1.02 = $ 510000
(c) $ payable at the end of 3 months = $ 500000*1.01 = $ 505000
(d) Arbitrage Profit = $ 5000
Option 3 Investment in FF
Interest rate of FF = 3% p.a.
PIR of FF for 3 months = 0.75%
Solution-59
Today SR $ 1 = £ 0.75 [$ is LHC and £ is RHC]
IR£ = 5%; IR$ = 8%
FR of 2 years $ 1 = £ 0.706
Method 1
Premium or discount on $ [LHC] = (FR-SR)*100/SR = (0.85 – 0.75)*100/0.75 = 13.33% Premium on $
Gain of Intt on $ = 8% - 5% = 3% p.a.
Since Gain of interest and there is premium on $, hence investment should be made in $ and borrowing in £.
Solution-60
(i)
Spot Rate DM 1 = $ 0.75
FR of 1 Year DM 1 = $ 0.77
IRDM = 7%; IR$ = 9%
Method 1
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.38
Premium or discount on DM [LHC] = (FR-SR)*100/SR = (0.77-0.75)*100/0.75 = 2.667% Prem p.a.
Loss of Intt on DM for 3 months = 9% - 7% = 2%
Since Loss of interest is less than gain of premium on DM, hence investment should be made in DM and borrowing in $
Method-1
Today
1. Borrow $ 10000 for 1 year @ 9%
2. Convert $ 10000 into DM at SR = $10000/0.75 = DM 13333.33
3. Invest DM 13333.33 for 1 year @ 7%
Method-1
Today
1. Borrow $ 10000 for 1 year @ 9%
2. Convert $ 10000 into DM at SR = $10000/0.75 = DM 13333.33
3. Transaction Cost = DM 13333.33*0.25% = DM 33.33
4. Invest DM 13300 for 1 year @ 7%
Solution-61
SR $ 1 = Can $ 1.235 – 1.240
FR of 3 months $ 1 = Can $ 1.255 – 1.260
After 3 months
(i) CD receivable from investment = CD 12350*1.00875 = CD 12458.06
(ii) Convert CD 12458.06 in $ at FR = CD 12458.06/1.260 = $ 9887.349
(iii) Repay loan in $ = $10000*1.01 = $ 10100
Loss due to above process = 10100 – 9887.349 = $212.651
Solution-61A
Apply Trial and Error method
SR 1$ = Rs.47.00 – 47.20
1 year FR 1$ = Rs.47.50 – 47.70
Solution-62
$ deposit rate = 8% p.a.; £ deposit rate = 10% p.a.
SR £ 1 = $ 1.80
3 months FR £ 1 = $ 1.78
Option 2 – Investment in UK
(a) Convert $ 1000000 into £ at SR = $ 1000000/1.80 = £ 555555.60
(b) Invest £ 555555.60 in Uk for 3 moths @ 2.5%
(c) £ receivable in 3 months from Deposit = £ 555555.60*1.025 = £ 569444.50
(d) Convert £ 569444.50 into $ at FR = £ 569444.50*1.78 = $ 1013611
(ii)
$ deposit rate = 8% p.a.; £ deposit rate = 10% p.a.
SR £ 1 = $ 1.80
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.40
3 months FR under IRPT ($/£) = (1 + PIR$)*SR/(1 + PIR£) = (1 + 0.02)*1.80/(1 + 0.025) = $ 1.7912
3 months FRIRPT £ 1 = $ 1.7912
(iii)
$ deposit rate = 8% p.a.; £ deposit rate = 14% p.a.
SR £ 1 = $ 1.80
3 months FR £ 1 = $ 1.78
Option 1 – Investment in US
(a) Invest $ 1000000 in US for 3 moths @ 2%
(b) $ receivable in 3 months from Deposit = $ 1000000*1.02 = $ 1020000
Option 2 – Investment in UK
(a) Convert $ 1000000 into £ at SR = $ 1000000/1.80 = £ 555555.60
(b) Invest £ 555555.60 in Uk for 3 moths @ 3.5%
(c) £ receivable in 3 months from Deposit = £ 555555.60*1.035 = £ 575000
(d) Convert £ 575000 into $ at FR = £ 575000*1.78 = $ 1023500
Solution-63
Rs. Interest rate = 9% p.a.; FF Interest rate = 12% p.a.
SR FF 1 = Rs. 6.60
90 days FR FF 1 = Rs. 6.50
(i) Arbitrage Profit
Solution-64
SR $ 1 = Rs.48.35/48.36
3 Months FR $ 1 = Rs.48.81/48.83
Interest rate = 15% p.a.
Solution-64A
SR SF 1 = Rs.30 - 30.5
3 Month FR SF 1 = Rs.31.10 – 31.60
Interest rate = 14%
Analysis – Rs. outflow is lesser in case of alternative I, It is suggested to pay bill immediately.
Solution-65
Spot rate $ 1 = Rs.56.50
60 days FR $ 1 = Rs.57.10
90 days FR $ 1 = Rs.57.50
Interest rate for loan = 10% p.a.
Option 1 Pay the supplier in 60 days
Z Ltd to pay $ 2m and for this purpose, it will borrow from Bank for 30 days @ 10% p.a.
Rs. required to pay $ 2m at FR of 2 months = $ 2m*57.10 = Rs.114.20 m
Z Ltd will borrow Rs.114.20 m from bank for 30 days @ 10% p.a.
After 30 days
Borrowing and interest payable to bank = Rs.114.20*1.00833 = Rs.115.15 m
Solution-66
Cost of machine = Yen 7640
Today Spot Rate Rs.100 = Yen 382
Cost of machine in Rs. = Yen 7640/3.82 = Rs.2000
Option 1 (To finance the purchase by availing loan at 12% per annum):
To pay cost of machine, Astro Ltd will take Loan of Rs.2000 for 6 months @12 p.a. quarterly rest
Particulars Rs.
After 6 months
Repayment of Loan with interest taken for commission = Rs.20*1.03*1.03 = Rs.21.22
Payment of LC and interest thereon at the end of 180 days = Yen 7640*1.0075 = Yen 7697.30
Rs. required to pay Yen 7697.30 at FR = Yen 7697.30/3.88 = Yen 1983.84
Solution-66A
Cost of Machine = Yen 7200 lacs
Today SR Rs.100 = Yen 360
Cost of machine in Rs. = Yen 7200/3.60 = Rs.2000 lacs
After 6 months
Repayment of Loan with interest taken for commission = Rs.20*1.0375*1.0375 = Rs.21.53 lacs
Payment of LC and interest thereon at the end of 6 months = Yen 7200*1.01 = Yen 7272lacs
Rs. required to pay Yen 7272 lacs at FR = Yen 7272/3.65 = Rs. 1992.329 lacs
Solution-67
a) Cash Balances: Acting independently Amt (in lacs)
Capital Action Interest Rate Amt in 30 days 30 days FR
India - Rs. Borrowing 6.4%/12 = 0.533% - 5000*1.00533 = - 1 - Rs.5026.65
5000 Rs.5026
U.S $ 125 Deposit 1.5%/12 = 0.125% $ 125*1.00125 = $ 125.15 Rs.1 = $125.15/0.0217 =
$0.217 Rs.5767.28
U.K Pound 60 Deposit 3.7%/12 = P 60*1.003083 = P 60.184 Rs.1 =£ £ 60.184/0.015 = Rs.4012.26
0.3083% 0.015
4752.26
Solution-68
SR Euro 1 = Rs.49.95/50.00
4 months FR Euro 1 = Rs.50.00/50.05
The interest rate prevailing in the market:
2 months Rs.12.00% p.a. Euro 6.00%
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.43
4 months Rs.11.40% p.a. Euro 6.60%
Option 1
Borrowing Euro 100000 for 4 months @ 2.2%
Repayment of borrowing at the end of 4 months = Euro 100000*1.022 = Euro 102200
Rs. required to repay Euro 102200 at FR = Euro 102200*50.05 = Rs.5115110
Option 2
Borrowing in Rs.
Rs. required for Euro 100000 at SR = Euro 100000*50 = Rs.5000000
Borrow Rs.5000000 for 4 months @ 3.8%
Repayment of borrowing at the end of 4 months = Rs.5000000*1.038 = Rs.5190000
Solution-69
Exchange Rate
Year 1 = 140 – 5 = 135
Year 2 = 135 – 5 = 130
Year 3 = 130 – 5 = 125
Year 4 = 125 – 5 = 120
(i) Final Receipts to Japanese Company from Japanese Subsidiary of US Co
Under currency swap,
US Company gave loan of $100000 to US Subsidiary of Japanese Company for 4 years @ 13% p.a.
Total loan repayable by Japanese Subsidiary of US Company to Japanse Co = 14000000*(1.1)4 = Yen 20497400
th
$ equivalent at 4 year end = Yen 20497400/120 = $170811.67
(ii)
Under currency Swap, Japanese Company gave loan of 14 Million Yen to Japan Subsidiary of US Company for 4 years @
10% p.a.
Final Receipts to US Company from US Subsidiary of Japanese Co = 100000*(1.13)4 = $ 163047.36
Solution-70
(i)
Cost of Center = R 2000m Outflow at T0
Operating Cost = R 40m Outflow at T1 to T3
Sale Price of Center = R 4000m Inflow at T3
SR £ 1 = R 85.40
1 Year FR £ 1 = R 93.94
2 Year FR £ 1 = R 103.334
3 Year FR £ 1 = R 113.67
Analysis of Project (Amt in m)
NPV -1.16
(ii)
(a) Under Currency Swap, Galeplus will pay £ 23.419 in its country to it Bank and its Bank will pay R 2000 to Galeplus in
Republic of Perdian for Center at today SR
(b) Under Currency Swap, Galeplus will receive back £ 23.419 in its country from its Bank and its Bank will receive R
2000 from Galeplus in Republic of Perdian from proceeds of R 4000 at Today SR
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.44
(c) For Currency Swap, Bank is charging 0.25% per year (in sterling)
Bank Charges p.a. = £ 23.419*0.25/100 = £ 0.0585
Analysis of Project under currency Swap (Amt in m)
NPV -2.539
Solution-70A
(i)
Cost of Dam = P 2000m Outflow at T0
Sale Price of Dam = P 3000m Inflow at T1
SR $ 1 = P 50
1 Year FR $ 1 = p 48
Analysis of Project (Amt in m)
NPV 16.812
NPV 11.51
Comment: The swap option has reduced the NPV, US co should not go for currency swap
Solution-70B
(a) The following swap arrangements can be entered by Drillip.
(i) Swap a US$ loan today at an agreed rate with any party to obtain Indian Rupees (Rs.) to make initial investment.
(ii) After one year swap back the Indian Rupees with US$ at the agreed rate. In such case the company is expected to be
in risk only on the profit earned from the project.
(b)
Today SR 1 US$ =Rs.50
ESR of 1 year 1 US$ =Rs.54
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.45
Interest rate of US Borrowing = 8%
Cost of Project = Rs.500 Cr Outflow at T0
Sale Price of Project = Rs.740 Cr Inflow at T1
NPV 2.9
NPV 3.64
Swapping in better
Solution-71
SR CD 1 = XYZ Marks 12
1 year FR CD 1 = XYZ Marks 13
Prem on CD = 13-12/12 = 8.33% p.a.
Premium for 9 months = 8.33% * 9/12 = 6.25%
Hence, Forward rate for 9 months CD 1 = XYZ Marks 12*1.0625 = XYZ Marks 12.75
NPV 1.148
Solution-72
Solution-72A
The Bank has to buy spot TT Sw. Fcs. 5,000 to increase the balance in Nostro account to Sw. Fcs. 30,000.
This would bring down the oversold position on Sw. Fcs. As Nil.
Since the bank requires an overbought position of Sw. Fcs. 10,000, it has to buy forward Sw. Fcs. 10,000.
Solution-73
(i) Net exposure of each foreign currency in Rupees
Inflow Outflow Net Flow Spread (FR – SR) Net Exposure
(Millions) (Millions) (Millions) (Millions)
US$ 40 20 20 0.81 16.20
FFr 20 8 12 0.67 8.04
UK 30 20 10 0.41 4.10
Japan Yen 15 25 -10 -0.80 8.00
Solution-74
Indian Subsidiary should pay the USA Subsidiary £ 0.30m = £ 0.30m*2 = $ 0.60m
South Africa Subsidiary should pay the USA Subsidiary 0.56m = 0.56m*2 = $ 1.12m
Solution-75
SR $ 1 = Rs.45.35
ESR at end of 3 months $ 1 = Rs.46.50
Borrowing Cost = 8%p.a.
Solution-75A
SR $ 1 = Rs.45.36
ESR at end of 4 months $ 1 = Rs.44.50
Borrowing Cost = 8%p.a.
$ receivable in 4 months = $ 100000
Solution-76
SR $ 1 = Rs.48.50 – 48.70
2 months Swap Points $ 1 = 25/30 points [Increasing Order]
3 months Swap Points $ 1 = 40/45 points [Increasing Order]
FR of 2 months $ 1 = Rs.48.75 – 49.00
FR of 3 months $ 1 = Rs.48.90 – 49.15
(a)
(i) NP Co is to pay $ 700000 in 3 months for which no Forward Contract has been entered. Hence to cover risk, NP Co will
enter into FPC for $ 700000 @ 49.15 [Buying $ and Selling Rs.]
Rs. Payable in 3 months to pay $ 700000 at FR of 3 months = $ 700000*49.15 = Rs.34405000
(ii) NP Co is to receive $ 450000 in 2 months for which FSC has been entered into @ 48.90.
Rs. receivable in 2 months = $ 450000*48.90 = Rs.22005000
Deposit Rs.22005000 for 1 months @ 12% p.a.
Comment: Since net payable amount is least in case of option 1, hence the company should go for option 1
Note: In the question it has not been clearly mentioned that whether quotes given for 2 and 3 months (in point terms)
are premium points or direct quotes. Although above solution is based on the assumption that these are direct quotes,
but student can also consider them as premium points and solve the question accordingly.
Solution-77
Excel Exporter has exported goods of $100000 @Rs.45.50
$100000 is to be received in 60 days
[For understanding Excel Exporter will sell $ & will buy Rs.]
Today Spot rate $ 1 = Rs.45.60
Today FR of 60 days $ 1 = Rs.45.20
(i) Rate of Discount on $ [LHC] = FR-SR/SR = (45.20 – 45.60)/45.60 = -0.00877 = -0.877% for 2 months
Rate of Discount on $ p.a. = -0.877*12/2 = 5.262%
Expected operating loss if hedging is done = Sale Value as recorded in books – Receipts under Forward Cover
= 4550000 – 4520000 = Rs.30000
Solution-78
A person has to pay $300000 in 3 half yearly equal installments of $100000 each
Payment of $3000000 to be made at 6 months, one year and One & half year $1000000 each time. The person enters
into a contract for 6 months forward purchase of $3000000 @ Rs.42.50
At Six Months time
Purchase of $300000 @42.50 and sale of $200000 at SR Rs.43
Net Payable = Purchase cost – sales value = 300000*42.50 – 200000*43 = Rs.4150000
Now he will enter into a new 6 months forward purchase contract for $200000 @ Rs.43.50
At One year time
Purchase of $200000 @43.50 and sale of $100000 at SR Rs.44
Net Payable = Purchase cost – sales value
= 2000000*43.50 – 1000000*44 = Rs.4300000
Now he will enter into a new 6 months forward purchase contract for $100000 @ Rs.44.60
At One and half year time
Purchase of $1000000 @44.60
Net Payable = Purchase cost
= 1000000*44.60 = 4460000
Total payment under Rupee Roll Over = Rs.(4150000 + 4300000 + 4460000) = Rs.12910000
Solution-78A
Under Forward Contract
On 1-1-97: The company enters 6 months forward sale contract for $ 1 Million @35.20
On 1-7-97: The company sells $ 1 million @35.20 as agreed but purchases $ 1 Million at Spot rate 35.51
Gain or Loss = Sale Value – Purchase Cost
= (35.20– 35.15)* 1 Million = 0.05 Million rupee gain
The company enter into forward sale for $1 million for 6 months @35.30
On 1-1-98: The company sells $ 1 million @35.30 as agreed but purchases $ 1 Million at Spot rate 35.25
Gain or Loss = Sale Value – Purchase Cost
= (35.30– 35.25)* 1 Million = 0.05 Million rupee gain
The company enter into forward sale for $1 million for 6 months @35.35
On 1-7-98: The company sells $ 1 million @35.35 as agreed but purchases $ 1 Million at Spot rate 35.35
Gain or Loss = Sale Value – Purchase Cost
= (35.35– 35.35)* 1 Million = 0
The company enter into forward sale for $1 million for 6 months @35.50
On 1-1-99: The money will be received $ 1 million & it will be sold at agreed rate 35.50
Amt to received = 35.50 x 1 = Rs.35.50 Million
If no hedging is taken
On 1-1-99: The money will be received $ 1 million & it will be sold at Spot rate 35.45
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.50
Amt to received = 35.45 x 1 = Rs.35.45 Million
Solution-79
Spot Rate $1 = Rs.40
Forward Rate of 9 months = Rs.39
[For Understanding Company will buy $ and sell Rs.]
Rs. required to make payment of $50000 at forward rate = $ 50000*39 = Rs.1950000
But for forward contract, company has to pay premium of 2%
Premium amount = Rs.1950000*2% = Rs.39000
Loss of Intt on Payment of Premium today = 39000*9/12*10% = 2925
Hence, total payment under forward cover = 1950000 + 39000 + 2925 = Rs.1991925
(i) If the exchange rate on September 30, 2008 is Rs. 42 per US $.
Rs. required to make payment of $50000 at actual spot rate = $ 50000*42 = Rs.2100000
Gain due to forward cover = Rs.2100000 – Rs.1991925 = Rs.108075
Solution-80
If foreign exchange risk in hedged.
Sum due Yen 7800000 US$ 102300 Euro 95920 Total
Unit input price Yen 650 US$ 10.23 Euro 11.99
Unit sold 12000 10000 8000
Variable cost per unit Rs.225 395 510
Variable cost Rs.2700000 Rs.3950000 Rs.4080000 Rs.10730000
Three months forward rate of selling 2.427 0.0216 0.0178
Rupee value of receipts Rs.3213844 4736111 Rs.5388764 Rs.13338719
Contribution Rs.513844 Rs.786111 Rs.1308764 Rs.2608719
Average contribution to sale ratio 19.56%
1. First to BUY USD against CHF at the cheaper rate i.e. from Bank A.
1 USD = CHF 1.4655
2. Then to BUY GBP against USD at a cheaper rate i.e. from Bank B
1 GBP= USD 1.7650
Cross rate would be
1 GBP = 1.7650*1.4655 CHF
1 GBP = CHF 2.5866
CHF required to buy GBP 1m = CHF 2.5866*1m = CHF 25,86,600
(ii)
SR USD 1 = CHF 1.4650 – 1.4655 [Bank A]
Swap Points of 3 months 5/10 [Increasing Order]
FR of 3 months =USD 1 = CHF 1.4655 - 1.4665
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SOLUTION 10C.51
Cross Rates
Spot rate
GBP 1 = CHF 1.4650*1.7645 - 1.4655*1.7660 = CHF 2.5850 - 2.5881
Forward Rate
GBP 1 = CHF 1.4655*1.7620 – 1.4665*1.7640 = CHF 2.5822 - 2.5869
Solution-82
Performa profit and loss account of the Indian software development unit
Amt Exchange Rate Rs.
Revenue $ 1,00,00,000 $ 1 = Rs.48 48,00,00,000
Less costs:
Rent 15,00,000
Manpower (Rs.400x80x10x365) 11,68,00,000
Administrative and other costs 12,00,000 11,95,00,000
Earning before tax 36,05,00,000
Less tax 10,81,50,000
Earning after tax 25,23,50,000
Less: withholding tax (TDS) 2,53,35,000
Repatriation amount (in rupees) 22,71,15,000
Repatriation amount (in dollars) $ 1 = Rs.48 $4.7million
Note : Students may assume the year of 360 days instead of 365 days as has been done in the answer provided above.
In such a case where a year is assumed to be of 360 days, manpower cost is Rs 11,52,00,000 and repatriated amount Rs
22,87,15,000.
Conclusion: The cost of development software in India for the US based company is $5.268 million. As the USA based
Company is expected to sell the software in the US at $12.0 million, it is advised to develop the software in India.
Solution-83
Sale 2400 units @ Euro 500 p.u.
Purchase 2400 units @ $ 800 p.u.
Fixed Cost = Rs.1000 p.u.
Variable Cost = Rs.1500 p.u.
Current Spot Rate
Euro 1 = Rs.51.50 – 51.55 [Selling rate is applicable]
$ 1 = Rs.27.20 – 27.25 [Buying rate is applicable]
(a) Profit at current Spot rates
2400 [Euro 500*51.50 - ($ 800*27.25 + 1000 + 1500)]
2400 [Rs. 25,750 - Rs. 24,300] = Rs. 34,80,000
Solution-84
U.S. Imports co., purchased 100,000 Mark’s worth of machines from a firm in Dortmund
SR DM 1 = $ 0.55
90 days FR DM 1 = $ 0.56
a) If payment is made within 10 days, then 2% discount is given to US Import Co.
Net Payment payable by US Import Co = DM 100000*(1-0.02) = DM 98000
$ required to pay DM 98000 at SR = DM 98000*0.55 = $ 53900
c)
Loss due to delay = 56000 – 53900 = $ 2100
Loss due to time value of money = DM (100000 – DM 98000)*0.56 = $ 1120
Loss due to FEF = DM 98000*(0.56 – 0.55) = $ 980
Solution-85
Indian Company is importer and is to pay $15000 [For understanding he will buy $ and sell Rs.]
Today SR Rs.1 = $0.0227272
Appreciation of 10% is given on Rs. because Importer gains when Domestic Currency increases.
Expected increase in Rs. = 10% in two months
ESR after 2 months Rs.1 = $0.0227272*1.10 = $0.025
(a) Rs. is LHC and Indian Importer will buy $ and will sell Rs., hence he would like to sell Rs. at higher of ESR and FR
FR is higher than ESR hence Importer should enter into FC.
Suggestion: If the exchange rate risk is not covered with forward contract, the expected exchange loss is Rs.33333.33
This could be reduced to Rs.7377 if it is covered with Forward contract. Hence, taking forward contract is suggested.
Saving due to Forward Contract = 33333.33 - 7377 = Rs.25956.33
Today
(a) Rohit & Bros will borrow from UK for 3 months @ 1.25% [Creating Liability in FC]
Borrowing Amt = Invoice Amt in £/(1 + PIRUK) = £ 500000/1.0125 = £ 493827.20
(c) Rohit & Bros will deposit Rs. 27654323.20 for 3 months in India @ 3% [Creating Assets in DC]
Question-17B F Ltd. is a medium sized UK company with export and import trade with the USA.
The following transaction are due
Sale of finished goods, cash receipts due in three months $ 197,000
Purchase of finished goods cash payment due in six months $ 293,000
Exchange rates (London Market)
$/£
Spot £ 1= $1.7106-1.7140
Three months forward £ 1 = $1.7024-1.7063
Six months forward £ 1 = $1.6967-1.7006
Calculate the net sterling pounds receipts and payments that F Ltd. might expect for both its
three and six months transactions if the company hedges foreign exchange risk on
(1) forward foreign exchange market
(2) on money market operation basis. You may assume following interest rates:
Borrowing Lending
Pound 12.50% p.a. 9.50% p.a.
$ 9% p.a. 6% p.a.
[Ans: Pound receivable Under forward cover = £ 115454.50; Under Money Market = £ 115076.33]
Solution-17B
Spot Rate £1 = $ 1.7106 – 1.7140
Forward Rate of three Month £1 = $ 1.7024 – 1.7063
Forward Rate of six Month £1 = $ 1.6967 – 1.7006
(b) F Ltd will Convert $192665.04 in pounds at spot rate @1.7140 [Selling $ and buying £]
Equivalent £ receivable = $ 192665.04/1.7140 = £ 112406.67
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SELF PRACTICE 10D.3
(c) F Ltd will Deposit £ 112406.67 for 3 months in U K @ 2.375% [Creating Assets in DC]
(b) F Ltd will Convert $ 284466.02 in pounds at spot rate @1.7140 [Selling $ and buying £]
Equivalent £ payable = $ 284466.02/1.7106 = £ 166296.05
(c) F Ltd will borrow £ 166296.05 for 6 months in U K @ 6.25% [Creating Liability in DC]
Foreign Currency options prices (Cents per £ for contract size £ 12,500.
Exercise Price Call Option (June) Put Option (June)
$1.70/£ 3.7 9.6
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SELF PRACTICE 10D.4
Suggest which of the following hedging option is the most suitable for Silver Oak Ltd.
(i) Forward Cover [Ans: £ 472205.80]
(ii) Money Market Cover; and [Ans: £ 473020.30]
(iii) Currency Option [Ans: GBP 227923.00]
Solution-17C
Today Spot Rate £ 1 = USD 1.5617 – 1.5773
6 months Forward Rate £ 1 = USD 1.5455 – 1.5609
(b) Silver Oak Ltd will Convert USD 713735 in £ at spot rate @1.5617 [Buying $ and Selling £]
Equivalent £ payable = $ 713735/1.5617 = £ 457024.4
(c) A Ltd will borrow £ 457024.4 for 6 months in U K @ 3.50% [Creating Liability in DC]
Option
Forward cover £ 472205.80
Money market £ 473020.30
Currency option £ 455845
The company should take currency option for hedging the risk.
Question-29C [Nov-2002] [M-4] [SP] On 1st April, 3 months interest rate in the US
and Germany are 6.5% and 4.5% p.a. respectively. The $/DM spot rate is 0.656. What
would be the forward rate for DM for delivery on 30th June?
Solution-29C
Spot Rate DM 1 = $ 0.656
Interest Rate ($) = 6.5% p.a.
PIR of 3 months ($) = 1.625%
Interest Rate (DM) = 4.5% p.a.
PIR of 3 months (DM) = 1.125%
Calculation of the FR under IRPT [$ is RHC and DM is LHC]
FR under IRPT ($/DM) = (1 + PIR$)*SR/(1 + PIRDM) = 1 + 0.01625)*0.656/(1 + 0.01125) = $0.659
FR of 3 months under IRPT DM 1 = $ 0.659
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SELF PRACTICE 10D.5
Question-29D [Nov-2008] [M-4] [RTP-May-2013-19] On April 1, 3 months interest rate in
the UK and US $ are 7.5% and 3.5% p.a. respectively. The UK £/US $ spot rate is 0.7570. What
would be the forward rate for US $ for delivery on 30th June?
Solution-29D
Spot Rate $1 = £ 0.757
Interest Rate ($) = 3.5% p.a.
PIR of 3 months ($) = 0.875%
Interest Rate (£) = 7.5% p.a.
PIR of 3 months (£) = 1.875%
Calculation of the FR under IRPT [£ is RHC and $ is LHC]
FR under IRPT (£/$) = (1 + PIR£)*SR/(1 + PIR$) = (1 + 0.01875)*0.757/(1 + 0.00875) = £0.764
FR of 3 months under IRPT $ 1 = £ 0.764
Question-31A The financial press recently listed the following information about two currencies,
the dollar ($W) and the Eastland mark (Em).
Spot rates: 2.0725 Em/$W
90 day rates: 2.0687 Em/$W
Westland prime interest rate on the same day was 9.5%. Requirements:
Calculate and comment on the Eastland interest rate.
Solution-31A
SR $W 1 = Em 2.0725 [$W is LHC and Em is RHC]
FR 0f 90 days $W 1 = Em 2.0687
IR$W = 9.5% p.a.
PIR$W for 90 days = 9.5*90/360 = 2.375%
Question-39B [Nov-2014] [M-5] Edelweiss Bank Ltd. sold Hong Kong Dollar 2,00,00,000 on
spot to its customer at Rs.8.025 & covered yourself in London Market on the same day, when the
exchange rates were.
US $ 1 = HK $ 7.588-7.592
Local inter bank market rates for US $ were
US $ 1= Rs.60.70 – 61.00
Calculate cover rate & ascertain the profit or loss in the transaction ignore brokerage.
Solution-39B
The Bank sold HK$ 20000000 on spot @ HK$ 1 = Rs.8.025
To covers it self, Bank will buy HK$ 20000000 from the market at market selling rate.
Exchange rate
US $ 1 = HK $ 7.588-7.592 [HK $/US $]
US $ 1= Rs.60.70 – 61.00 [Rs./US $]
Required cross rate
Rs./HK $ = (Rs./US $) * (US $/HK $)
HK $ 1 = Rs.60.70*1/7.592 – 61*1/7.588
HK $ 1 = Rs.7.9952 – 8.0390
Since Bank had sold HK $ @ Rs.8.025 and to cover himself, he will purchase HK $ at spot rate @8.0390
Gain or loss to Bank = Sale price – Purchase Price
= HK $ 20000000*8.025 – 20000000*8.0390 = Loss Rs.280000
Question-39C [May-2014] [M-5] The Bank sold Hong Kong Dollar 1,00,000 on spot to its
customer at Rs.7.5681 & covered itself in London Market on the same day, when the exchange
rates were.
US $ 1 = HK $ 8.4409-8.4500
Local inter bank market rates for US $ were
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SELF PRACTICE 10D.6
US $ 1= Rs.62.7128 – 62.9624
Calculate cover rate & ascertain the profit or loss in the transaction ignore brokerage.
Solution-39C
The Bank sold HK$ 100000 on spot @ HK$ 1 = Rs.7.5681
To covers it self, Bank will buy HK$ 100000 from the market at market selling rate.
Exchange rate
US $ 1 = HK $ 8.4409 – 8.4500 [HK $/US $]
US $ 1= Rs.62.7128 – 62.9624 [Rs./US $]
Required cross rate
Rs./HK $ = (Rs./US $) * (US $/HK $)
HK $ 1 = Rs.62.7128*1/8.45 – 62.9624*1/8.4409
HK $ 1 = Rs.7.4216 – 7.4592
Since Bank had sold HK $ @ Rs.7.5681 and to cover himself, he will purchase HK $ at spot rate @7.4592
Gain or loss to Bank = Sale price – Purchase Price
= HK $ 100000*7.5681 – 100000*7.4592 = Gain Rs.10890
Question-49A [CS-Dec-2003] Calculate the arbitrage gains possible on £10,000 from the
middle rates given below. Assume there are no transaction cost.
Rs.76.20 = £ 1 In London; Rs.46.60 = $ 1in Delhi $ 1.5820 = £ 1 in New York.
Solution-49A
Currency rates prevailing in different cities
In London Rs.76.20 = £ 1 [Rs/£]
In Delhi Rs.46.60 = $ 1 [Rs/$]
In New York $ 1.5820 = £ 1 [$/£]
We have £ 10000 and that is to be sold first and it has to be purchased as follows
Option 1
(a) Sell £ 10000 in London, Rs. receivable = £ 10000*76.20 = Rs.762000
(b) Sell Rs.762000 in Delhi, $ receivable = Rs.762000/46.60 = $ 16352
(c) Sell $ 16352 in NY, £ receivable = $ 16352/1.582 = £ 10336
Gain due to Arbitrage process = £ 10336 - $ 10000 = £ 336
Alternative
To make arbitrage gains
Calculate cross rates between £ and Rs. through Delhi and New York and Compare it with rate of London.
[Rs./£] = Rs./$ * $/£ = 46.60 * 1.5820
£ 1 = Rs.73.7212 [Cross rates between delhi and new York]
£ 1 = Rs.76.20 [Rate in London]
Since £ is higher in London, hence it should be sold in London and purchased from New York.
1. Rs. receivable by selling £10000 in London = £10000*76.20 = Rs.762000
2. $ receivable by selling Rs.762000 in Delhi = Rs.762000/46.60 = $16351.93
3. £ receivable by selling $16351.93 in NY = $16351.93/1.5820 = £10336.24
Arbitrage gain = £10336.24 - £10000 = £336.24
Question-53C A Italian investor purchased Canadian Securities for CD 1950 1 year ago when
the FER was 1 Euro = 1.50 CD. The value of the security, now is CD 2340 and FER is Euro 1 =
1.80 CD. What is the rate of return of the Italian investor?
Solution-53C
B0 = CD 1950
B1 = CD 2340
Interest received from bond = 0
Return of investment from Canadian Security = (B1 – B0 + Intt)*100/B0 = (2340+0-1950)*100/1950 = 20%
SR at to Euro 1 = CD 1.50
SR at t1 Euro 1 = CD 1.80
Invested currency = CD
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SELF PRACTICE 10D.7
Premium/ Discount on CD (Invested & RHC) = (SR – FR)*100/FR = (1.50-1.80)*100/1.80 = -16.67%
Discount on CD = - 16.67%
SR at to £ 1 = $ 1.70
SR at t1 £ 1 = $ 1.58
Invested currency = £
Premium/ Discount on £ (Invested & LHC) = (FR – SR)*100/SR = (1.58-1.70)*100/1.70 = -7.05%
Discount on £ = 7.05%
Question-53E An MF of Luxemburg plans to invest Euro 15m in domestic securities for 60 days.
What are the rate of return will the MF earn it invest either in China or Australia.
(a) Interest rate 60 days
(b) Chinese Govt = 6% p.a.
(c) Australia Govt = 3% p.a.
(d) Exchange rate Euro per unit of foreign currency.
Spot rate 60 days Forward Rate
Chinese Yuan 0.20 0.2010
Australian Dollar 0.500 0.5025
Assume 360 days in year.
Solution-53E
(i) From Chinese Security
SR CY 1 = Euro 0.20
FR or 60 days CY 1 = Euro 0.2010
Return of investment in CG = 6% p.a.
Return of investment in CG = 1% for 60 days
Invested currency = CY
Premium/ Discount on CY (Invested & LHC) = (FR – SR)*100/SR = (0.201-0.2)*100/0.2 = 0.5%
Premium on CY = 0.5%
Invested currency = AD
Premium/ Discount on AD (Invested & LHC) = (FR – SR)*100/SR = (0.5025-0.5)*100/0.5 = 0.5%
Premium on AD = 0.5%
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SELF PRACTICE 10D.8
Question-57C [May-2006] [M-8] [Nov-2010] [M-8] [N] Given the following information:
SR DM 1 = CD 0.665
FR of 3 months DM 1 = CD 0.670
Interest rate - DM 7% p.a.; Canadian Dollar 9% p.a.
What operations would be carried out to take the possible arbitrage gains?
Solution-57C
Spot Rate DM 1 = CD 0.665
FR of 3 months DM 1 = CD 0.670
IRDM = 7%; IRCD = 9%
PIR of DM for 3 months = 1.75%; PIR of CD for 3 months = 2.25%
Method 1
Premium or discount on DM [LHC] = (FR-SR)*100/SR = (0.670-0.665)*100/0.665 = 0.75188% Prem for 3 months
Loss of Intt on DM for 3 months = 2.25% - 1.75% = 0.5%
Since Loss of interest is less than gain of premium on DM, hence investment should be made in DM and borrowing in CD.
Method 2 [Ignore]
PIRDM = 1.75%; IRCD = 2.25%
Assuming investment is in DM
Premium or discount on DM [LHC] = 0.75188% Prem for 3 months
Return from investment in DM = (1 + PIRDM)*(1+Prem on DM) – 1 = 1.0175*(1+0.0075188) – 1 = 0.02515 = 2.515%
Return from investment in CD = 2.25%
Since Return of DM is more than return of CD, investment should be made in DM and borrowing in CD
Method 3 [Ignore]
FR under IRPT (CD/DM) = (1 + PIRCD)*SR/(1 + PIRDM) = (1.0225*0.665)/1.0175 = CD 0.6682
Actual FR of 3 months DM 1 = CD 0.670
Method-1
Today
1. Borrow CD 10000 for 3 months @ 2.25%
2. Convert CD 10000 into DM at SR = CD 10000/0.665 = DM 15037
3. Invest DM 15037 for 3 months @ 1.75%
Method-2 [Ignore]
Borrowing in CD and investment in DM
Currency in which investment is made = DM
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SELF PRACTICE 10D.9
Return from investment in DM = 2.515%
Question-57D [SP] A person borrowed $ 1,00,000 @ 8% p.a. for 3 months, converted the
Dollars in Rupees at spot rate 1$ =Rs.46.70/46.80. invested the Dollar proceed (i.e. Rupees) @
12% p.a. for three months purchased $ 1,02,000 on 3 months forward basis of $ 1
=46.75/46.80. What is the gain/loss? Assume no loss of time in any transaction.
Solution-57D
SR $ 1 =Rs.46.70/46.80
FR of 3 months $ 1 =Rs.46.70/46.80
Today
(a) Borrow $100000 @ 8% p.a. for 3 months
(b) Convert $100000 at spot rate = $100000*46.70 = Rs.46,70,000
(c) Invest Rs.46,70,000 @12% p.a. for 3 months
After 3 Months
(a) Rs. receivable from investment = Rs.4670000*1.03 = Rs.4810100
(b) Repayment of borrowing in $ = $ 100000*1.02 = $ 102000
(c) Rs. required for repayment of $ 1020000 at FR =102000*46.80 = Rs.4773600
Arbitrage Gain = Rs.4810100 – Rs.4773600 = Rs.36500
Question-57E [CS-June-2010-M-4] The spot exchange rate is Rs.15/€ and the three months
forward exchange rate is Rs.15.20/€. The three month interest rate is 8% per annum in India
and 5.8% per annum in Germany. Assume that you can borrow as much as Rs.15 lakh or € 10
lakh.
(i) Determine whether the interest rate parity is currently holding.
(ii) How would you carry out covered interest arbitrage? Show all steps and determine the
arbitrage profit.
Solution-57E
Today SR € 1 = Rs.15
FR of 3 months € 1 = Rs.15.20
PIR for 3 months on Rs. = 2%
PIR for 3 months on € = 1.45%
(i) IRPT exists or not
FR under IRPT (Rs./ €) = (1 + PIRRs.)*SR/(1 + PIR€) = (1.02*15)/1.0145 = Rs.15.08
Actual FR of 3 months € 1 = Rs.15.20
Comment: Actual FR and FR under IRPT is not equal, hence IRPT does not exist
Method-1
Today
1. Borrow Rs. 1500000 for 3 months @ 2%
2. Convert Rs. 1500000 into € at SR = Rs.1500000/15 = €100000
3. Invest €100000 for 3 months @ 1.45%
After 3 months
1. € receivable from investment = €100000*1.0145 = €101450
2. Convert €101450 into Rs. at FR = €101450*15.20 = Rs.1542040
3. Repayment of borrowing in Rs. = Rs.1500000*1.02 = Rs.1530000
Method-2 [Ignore]
Premium or discount on € [LHC] = (FR-SR)*100/SR = (15.20 – 15)*100/15 = 1.33% premium on € for 3 months
Loss of interest on € = 2% - 1.45% = 0.55%
Premium on € is more than loss of interest on €, hence investment should be made in € and borrowing should be in Rs.
Method-3 [Ignore]
Return from investment in € = (1 + PIR€)*(1+Prem on €) – 1 = 1.0145*(1+0.0133) – 1 = 0.027993 = 2.799%
Hence, arbitrage return % = Total Return from investment – Borrowing Cost
= 2.799% – 2.00% = 0.799%
Arbitrage profit in € = Amount of Borrowing*Arbitrage return = Rs. 1500000*0.799% = Rs.11985
Question-64B [Nov-2014] [M-8] Gibralater Ltd has imported 5000 bottles of shampoo at
landed cost in Mumbai, of US $ 20 each. The company has the choice for paying the goods
immediately or in 3 months time. It has a clean overdraft limited where 14% p.a rate of interest
is charged.
Calculate which of the following method would be cheaper to Gibralater Ltd.
(i) Pay in 3 months time with interest @ 10% and cover risk forward for 3 months.
(ii) Settle now at current Spot rate and pay interest of the overdraft or 3 months.
The rates are as follows:
Spot rate (Rs./$) 60.25 - 60.55
3 Month swap 35/25
Solution-64B
SR $ 1 = Rs.60.25 - 60.55
3 months swap 35/25 (Decreasing Order)
3 Month FR $ 1 = Rs.59.10 – 60.30
Chap – 10 FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT-SELF PRACTICE 10D.11
Interest rate = 14%
Total payment is to be made = 5000*20 = $ 100000
Option 1: Pay immediately the bills for $ 1,00,000
Today
(i) Rs. required to pay $ 1,00,000 at today SR = $ 100000*60.55 = Rs.6055000
(ii) Take Overdraft of Rs.6055000 for 3 months @14% p.a.
(iii) Repayment of OD with interest at the end of 3 months = Rs. 6055000*1.035 = Rs.6266925
Analysis – Rs. outflow is lesser in case of alternative 2, It is suggested to pay bill after 3 months.
Question-64C [May-2015] [M-5] DEF Ltd has imported goods to the extent of USD 1 crore.
The payment terms are 60 days interest free credit. For additional credit of 30 days, interest @
7.75% p.a. will be charged.
The banker of DEF Ltd has offered a 30 days loan at the rate of 9.5% p.a. Their quotes for the
foreign exchange is as follows:
SR INR/USD 62.50
60 days FR INR/USD 63.15
90 days FR INR/USD 63.45
Which one of the following options would be better?
(i) Pay the supplier on 60th day and avail bank loan for 30 days.
(ii) Avail the supplier’s offer of 90 days credit.
Solution-64C
SR USD 1 = Rs.62.50
60 days FR USD 1 = Rs.63.15
90 days FR USD 1 = Rs.63.45
Option 1: Pay supplier within 60 days by taking loan from bank @ 9.5% interest for 30 days
(i) Rs. required to pay USD 1cr at 60 days FR = USD 1Cr*63.15 = Rs.63.15 Cr
(ii) Take Bank Loan of Rs.63.15 cr for 30 days @ 9.5% p.a.
(iii) Repayment of Bank Loan with interest at the end of 90 days = Rs.63.15 + 63.15*0.095/12 = Rs.63.15 + 0.5 =
Rs.63.65 Cr
Option 2: Pay after 3 months, with interest @7.75% p.a. for 30 days
Amount payable = USD 1 Cr
Total payment with interest = USD 1 Cr + 1*0.0775/12 = USD 1.0065 Cr
Rs. required to pay USD 1.0065 Cr at 90 days FR = USD 1.0065*63.45 = Rs.63.86 Cr
Analysis – Rs. outflow is lesser in case of alternative I, It is suggested to pay after 60 days