Sanjay Saraf SFM Volume 1 Forex

CONTENTS
Page No.
Normal Problems
o International Project Appraisal ................................................................................ 1
o ADR/GDR ............................................................................................................... 9
o Investment Abroad .................................................................................................. 11
o Currency Conversion ............................................................................................... 12
o Forward Cover Vs No Cover ................................................................................... 14
o Swap Points ............................................................................................................. 22
o IRP Equation........................................................................................................... 25
o Cross Rate ............................................................................................................... 34
o Leading And Lagging............................................................................................... 42
o Triangular Arbitrage................................................................................................ 47
o Covered Interest Arbitrage ...................................................................................... 48
o FC Vs MMC ............................................................................................................ 54
o PPP ......................................................................................................................... 59
o Extension ................................................................................................................. 61
o International Working Capital Management ........................................................... 64
o Currency Of Borrowing............................................................................................ 68
o Cancellation ............................................................................................................. 71
o Automatic Cancellation ........................................................................................... 76
o Economic Exposure.................................................................................................. 84
o Currency Of Investment .......................................................................................... 87
o FX Swap .................................................................................................................. 92
o NOSTRO Account................................................................................................... 94
o Transaction Exposure .............................................................................................. 97
o Early Delivery.......................................................................................................... 98
o Forward Premium Or Discount On A Currency..................................................... 100
o Exposure Strategy Matrix....................................................................................... 102
o Residual .................................................................................................................. 104
CONTENTS
Page No.
Advanced Problems
o International Project Appraisal .............................................................................. 106
o Exposure ................................................................................................................. 122
o Forward Cover Vs No Cover .................................................................................. 123
o Foreign Currency Borrowing................................................................................... 124
o Forward Vs Futures Arbitrage ............................................................................... 126
o Leading And Lagging.............................................................................................. 127
o Early Delivery......................................................................................................... 128
o ADR/GDR ............................................................................................................. 130
o International Working Capital Management .......................................................... 131
o Cross Rate .............................................................................................................. 133
Mind Map ..................................................................................................135

Summary ....................................................................................................137
NORMAL
PROBLEMS
Forex
INTERNATIONAL PROJECT APPRAISAL

PROBLEM - 1
ABC Ltd. is considering a project in US, which will involve an initial investment
of US $ 1,10,00,000. The project will have 5 years of life. Current spot exchange
rate is ` 48 per US $. The risk free rate in US is 8% and the same in India is 12%.
Cash inflow from the project is as follows:
Year Cash inflow

1 US $ 20,00,000
2 US $ 25,00,000
3 US $ 30,00,000
4 US $ 40,00,000
5 US $ 50,00,000
Calculate the NPV of the project using foreign currency approach. Required rate of
return on this project is 14%.
SOLUTION :-
(1 + 0.12) (1 + Risk Premium) = (1 + 0.14)
Or, 1 + Risk Premium = 1.14/1.12 = 1.0179
Therefore, Risk adjusted dollar rate is = 1.0179 x 1.08 = 1.099 – 1 = 0.099
Calculation of NPV
Year Cash flow (Million) PV Factor at P.V.

US$ 9.9%
1 2.00 0.910 1.820
2 2.50 0.828 2.070
3 3.00 0.753 2.259
4 4.00 0.686 2.744
5 5.00 0.624 3.120
12.013
Less: Investment 11.000
NPV 1.013
Sanjay Saraf Sir 1
Strategic Financial Management
Therefore, Rupee NPV of the project is = ` (48 x 1.013) Million

= ` 48.624 Million
PROBLEM - 2
XY Limited is engaged in large retail business in India. It is contemplating for
expansion into a country of Africa by acquiring a group of stores having the
same line of operation as that of India.
The exchange rate for the currency of the proposed African country is extremely
volatile. Rate of inflation is presently 40% a year. Inflation in India is currently 10%
a year. Management of XY Limited expects these rates likely to continue for the
foreseeable future.
Estimated projected cash flows, in real terms, in India as well as African

country for the first three years of the project are as follows:
Year – 0 Year – 1 Year – 2 Year - 3

Cash flows in India `(000) -50,000 -1,500 -2,000 -2,500
Cash flows in African Rands (000) -2,00,000 +50,000 +70,000 +90,000
XY Ltd. assumes the year 3 nominal cash flows will continue to be earned
each year indefinitely. It evaluates all investments using nominal cash flows and
a nominal discounting rate. The present exchange rate is African Rand 6 to ` 1.
You are required to calculate the net present value of the proposed
investment considering the following:
i. African Rand cash flows are converted into rupees and discounted at a risk
adjusted rate.
ii. All cash flows for these projects will be discounted at a rate of 20% to
reflect it’s high risk.
iii. Ignore taxation.
Year - 1 Year - 2 Year - 3

PVIF @ 20% .833 .694 .579
2 Sanjay Saraf Sir

Forex
SOLUTION :-
Calculation of NPV
Year 0 1 2 3
Inflation factor in India 1.00 1.10 1.21 1.331
Inflation factor in Africa 1.00 1.40 1.96 2.744
Exchange Rate (as per IRP) 6.00 7.6364 9.7190 12.3696
Cash Flows in ` ’000
Real -50000 -1500 -2000 -2500
Nominal (1) -50000 -1650 -2420 -3327.50
Cash Flows in African Rand ’000
Real -200000 50000 70000 90000
Nominal -200000 70000 137200 246960
In Indian ` ’000 (2) -33333 9167 14117 19965
Net Cash Flow in ` ‘000 (1)+(2) -83333 7517 11697 16637
PVF@20% 1 0.833 0.694 0.579
PV -83333 6262 8118 9633
NPV of 3 years = -59320 (` ‘000)

16637
NPV of Terminal Value =  0.579  48164 ( ` 000)
0.20
Total NPV of the Project = -59320 (` ‘000) + 48164 ( ` ’000) = -11156 ( ` ’000)
Sanjay Saraf Sir 3

PROBLEM - 3
A multinational company is planning to set up a subsidiary company in India (where
hitherto it was exporting) in view of growing demand for its product and
competition from other MNCs. The initial project cost (consisting of Plant and
Machinery including installation) is estimated to be US$ 500 million. The net
working capital requirements are estimated at US$ 50 million. The company
follows straight line method of depreciation. Presently, the company is exporting
two million units every year at a unit price of US$ 80, its variable cost per unit being
US$ 40.
The Chief Financial Officer has estimated the following operating cost and other
data in respect of proposed project:
i. Variable operating cost will be US $ 20 per unit of production;
ii. Additional cash fixed cost will be US $ 30 million p.a. and project's share
of allocated fixed cost will be US $ 3 million p.a. based on principle of ability to
share;
iii. Production capacity of the proposed project in India will be 5 million units;
iv. Expected useful life of the proposed plant is five years with no salvage value;
v. Existing working capital investment for production & sale of two million
units through exports was US $ 15 million;
vi. Export of the product in the coming year will decrease to 1.5 million
units in case the company does not open subsidiary company in India, in
view of the presence of competing MNCs that are in the process of setting up
their subsidiaries in India;
vii. Applicable Corporate Income Tax rate is 35%, and
viii. Required rate of return for such project is 12%.
Assuming that there will be no variation in the exchange rate of two currencies and
all profits will be repatriated, as there will be no withholding tax, estimate Net
Present Value (NPV) of the proposed project in India.
4 Sanjay Saraf Sir

Forex
Present Value Interest Factors (PVIF) @ 12% for five years are as below:
Year 1 2 3 4 5
PVIF 0.8929 0.7972 0.7118 0.6355 0.5674
SOLUTION :-
Financial Analysis whether to set up the manufacturing units in India or not
may be carried using NPV technique as follows:
i. Incremental Cash Outflows
$ Million
Cost of Plant and Machinery 500.00
Working Capital 50.00
Release of existing Working Capital (15.00)
535.00
ii. Incremental Cash Inflow after Tax (CFAT)
a. Generated by investment in India for 5 years
$ Million
Sales Revenue (5 Million x $80) 400.00
Less: Costs
Variable Cost (5 Million x $20) 100.00
Fixed Cost 30.00
Depreciation ($500Million/5) 100.00
EBIT 170.00
Taxes@35% 59.50
EAT 110.50
Add: Depreciation 100.00
CFAT (1-5 years) 210.50
Cash flow at the end of the 5 years 35.00
(Release of Working Capital)
Sanjay Saraf Sir 5

b. Cash generation by exports (Opportunity Cost)
$ Million
Sales Revenue (1.5 Million x $80) 120.00
Less: Variable Cost (1.5 Million x $40) 60.00
Contribution before tax 60.00
Tax@35% 21.00
CFAT (1-5 years) 39.00
c. Additional CFAT attributable to Foreign Investment
$ Million
Through setting up subsidiary in India 210.50
Through Exports in India 39.00
CFAT (1-5 years) 171.50
iii. Determination of NPV
Year CFAT ($ Million) PVF@12% PV($ Million)

1-5 171.50 3.6048 618.2232
5 35 0.5674 19.8590
638.0822
Less: Initial Outflow 535.0000
103.0822
Since NPV is positive the proposal should be accepted.
6 Sanjay Saraf Sir

Forex
PROBLEM - 4
ABC Ltd. is considering a project in Germany, which will involve an initial
investment of € 2,20,00,000. The project will have 5 years of life. Current spot
exchange rate is ` 72 per €. The risk-free rate in Germany is 4% and the same
in India is 6%. Cash inflow from the project is as follows:
Year Cash inflow

1 € 40,00,000
2 € 50,00,000
3 € 60,00,000
4 € 80,00,000
5 € 100,00,000
Calculate the NPV of the project using
i. Home Currency Approach

ii. Foreign Currency Approach.
Required rate of return on this project is 7%.
SOLUTION :-
i. Calculation of Forward Exchange Rates
End of Year ` `/€

1
 1  0.06  
1 ` 72.00    73.38
  1  0.04  
2
 1  0.06  
2 ` 72.00    74.80
 1  0.04  
3
 1  0.06  
3 ` 72.00    76.23
 1  0.04  
4
 1  0.06  
4 ` 72.00    77.70
 1  0.04  
5
 1  0.06  
5 ` 72.00    79.19
  1  0.04  
Sanjay Saraf Sir 7
Calculation of NPV
Cash Flow Expected PV Factor

Year Cash flow P.V.
(Million) € Rate @ 7%
1 4.00 73.38 293.52 0.935 274.44
2 5.00 74.80 374.00 0.873 326.50
3 6.00 76.23 457.38 0.816 373.22
4 8.00 77.70 621.60 0.763 474.28
5 10.00 79.19 791.90 0.713 564.62
Total PV of Cash Inflows 2013.06
Less: Investment 22.00 72.00 1584.00
NPV 429.06
Therefore, Rupee NPV of the project is = ` 429.06

and € NPV = ` 429.06/ `72.00 = € 5.96 Million
ii. (1 + 0.06) (1 + Risk Premium) = (1 + 0.07)
Or, 1 + Risk Premium = 1.07/1.06 = 1.00943
Therefore, Risk adjusted dollar rate is = 1.00943 x 1.04 = 1.0498 – 1 = 0.0498
Calculation of NPV
Year Cash flow (Million) € PV Factor at 4.98% P.V.

1 4.00 0.953 3.812
2 5.00 0.907 4.535
3 6.00 0.864 5.184
4 8.00 0.823 6.584
5 10.00 0.784 7.840
27.955
Less: Investment 22.000
NPV 5.955
Therefore, Rupee NPV of the project is = ` (72 x 5.955) Million

= ` 428.76 Million
8 Sanjay Saraf Sir

Forex
ADR/GDR
PROBLEM - 5
Odessa Limited has proposed to expand its operations for which it requires
funds of $ 15 million, net of issue expenses which amount to 2% of the issue size.
It proposed to raise the funds though a GDR issue. It considers the following factors
in pricing the issue:
i. The expected domestic market price of the share is ` 300

ii. 3 shares underly each GDR
iii. Underlying shares are priced at 10% discount to the market price
iv. Expected exchange rate is ` 60/$
You are required to compute the number of GDR's to be issued and cost of GDR to
Odessa Limited, if 20% dividend is expected to be paid with a growth rate of 20%.
SOLUTION :-
Net Issue Size = $15 million
$15 million
Gross Issue =  $15.306 million
0.98
Issue Price per GDR in ` (300 x 3 x 90%) = ` 810

Issue Price per GDR in $ (` 810/ ` 60) = $13.50
Dividend Per GDR (D1) = ` 2* x 3 = ` 6
* Assumed to be on based on Face Value of ` 10 each share.
Net Proceeds Per GDR = ` 810 x 0.98 = ` 793.80
i. Number of GDR to be issued
$15.306 million
= 1.1338 million
$13.50
ii. Cost of GDR to Odessa Ltd.
6.00
Ke   0.20= 20.76%
793.80
Sanjay Saraf Sir 9
PROBLEM - 6
Omega Ltd. is interested in expanding its operation and planning to install
manufacturing plant at US. For the proposed project, it requires a fund of
$10 million (net of issue expenses or floatation cost). The estimated floatation
cost is 2%. To finance this project, it proposes to issue GDRs.
As a financial consultant, you are requested to compute the number of GDRs to be

issued and cost of the GDR with the help of following additional information:
i. Expected market price of share at the time of issue of GDR is ` 250

(Face Value being ` 100)
ii. 2 shares shall underlay each GDR and shall be priced at 4% discount to market
price.
iii. Expected exchange rate ` 64/$
iv. Dividend expected to be paid is 15% with growth rate 12%.
SOLUTION :-
` 10 million
Gross Issue =  $10.2041 million
0.98
Issue Price per GDR in ` (250 x 2 x 96%) = ` 480
Issue Price per GDR in $ (` 480/ ` 64) = $7.50
Dividend Per GDR (D1) = ` 15 x 2 = ` 30
Net Proceeds Per GDR = ` 480 x 0.98 = ` 470.40

$10.2041 million
= 1.360547 million
$7.50
ii. Cost of GDR to Omega Ltd.

Ke  30  0.12  18.378%
470.40
10 Sanjay Saraf Sir

Forex
INVESTMENT ABROAD
PROBLEM - 7
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 Dollar appreciates by
2% during the said period. Calculate the rate of return from US Investor’s and
Non-US Investor’s view point.
SOLUTION :-
Here we can assume two cases (i) If investor is US investor then there will be
no impact of appreciation in $. (ii) If investor is from any other nation other than US
say Indian then there will be impact of $ appreciation on his returns.
First we shall compute return on bond which will be common for both investors.
(Price at end - Price at begining) + Interest

Return =
Price at begining
(5250 - 5000) + 350

=
5000
250 + 350
= =0.12 say 12%
500
i. For US investor the return shall be 12% and there will be no impact of
appreciation in $.
ii. If $ appreciate by 2% then return for non-US investor shall be:
Return x 1.02 = 0.12 x 1.02=0.1224 i.e. 12.24%
Alternatively, it can also be considered that $ appreciation will be applicable to

the amount of principal as well. The answer therefore could also be
(1+0.12)(1+0.02) -1 =1.12X1.02 - 1 = 0.1424 i.e. 14.24%
Sanjay Saraf Sir 11

CURRENCY CONVERSION
PROBLEM - 8
ABN-Amro Bank, Amsterdam, wants to purchase ` 15 million against US$ for
funding their Nostro account with Canara Bank, New Delhi. Assuming the
inter-bank, rates of US$ is ` 51.3625/3700, what would be the rate Canara Bank
would quote to ABN-Amro Bank? Further, if the deal is struck, what would be the
equivalent US$ amount.
SOLUTION :-
Here Canara Bank shall buy US$ and credit ` to Vostro account of ABN-Amro Bank.
Canara Bank’s buying rate will be based on the Inter-bank Buying Rate (as this is
the rate at which Canara Bank can sell US$ in the Interbank market)
Accordingly, the Interbank Buying Rate of US$ will be ` 51.3625 (lower of two) i.e.
(1/51.3625) = $ 0.01947/ `
Equivalent of US$ for ` 15 million at this rate will be

15,000,000
= = US$ 2,92,041.86
51.3625
or, = 15,000,000 x $ 0.01947 = US$ 2,92,050
PROBLEM - 9
The following 2-way quotes appear in the foreign exchange market:
Spot 2-months forward
RS/US $ `46.00/`46.25 `47.00/`47.50
Required:
i. How many US dollars should a firm sell to get ` 25 lakhs after 2 months?
ii. How many Rupees is the firm required to pay to obtain US $ 2,00,000 in the spot
market?
iii. 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?
12 Sanjay Saraf Sir
Forex
SOLUTION :-
i. US $ required to get ` 25 lakhs after 2 months at the Rate of ` 47/$

25,00,000
 = US $ 53191.489
` 47
ii. ` required to get US$ 2,00,000 now at the rate of ` 46.25/$

∴ US $ 200,000 × ` 46.25 = ` 92,50,000
iii. Encashing US $ 69000 Now Vs 2 month later

Proceed if we can encash in open mkt $ 69000 × `46 = ` 31,74,000
Opportunity gain
10 2
= 31,74,000  = ` 52,900
100 12
Likely sum at end of 2 months = 32,26,900
Proceeds if we can encash by forward rate :

$ 69000 × ` 47.00 = 32,43,000
It is better to encash the proceeds after 2 months and get opportunity gain.
Sanjay Saraf Sir 13

FORWARD COVER VS NO COVER

PROBLEM - 10
ABC Ltd. of UK has exported goods worth Can $ 5,00,000 receivable in 6 months.
The exporter wants to hedge the receipt in the forward market. The following
information is available:
Spot Exchange Rate Can $ 2.5/£

Interest Rate in UK 12%
Interest Rate In Canada 15%
The forward rates truly reflect the interest rates differential. Find out the
gain/loss to UK exporter if Can $ spot rates (i) declines 2%, (ii) gains 4% or
(iii) remains unchanged over next 6 months.
SOLUTION :-
2.50 (1 + 0.075)
Forward Rate = = Can$ 2.535/£
(1 + 0.060)
i. If spot rate decline by 2%
Spot Rate = Can$ 2.50 x 1.02 = Can$ 2.55/£
£
£ receipt as per Forward Rate (Can $ 5,00,000/ Can$ 2.535) 1,97,239
£ receipt as per Spot Rate (Can $ 5,00,000/ Can$ 2.55) 1,96,078
Gain due to forward contract 1,161
ii. If spot rate gains by 4%

Spot Rate = Can$ 2.50 x 0.96 = Can$ 2.40/£
£
Loss due to forward contract 11,094
14 Sanjay Saraf Sir

Forex
iii. If spot rate remains unchanged
£
Loss due to forward contract 2,761
PROBLEM - 11
JKL Ltd., an Indian company has an export exposure of JPY 10,000,000 receivable
August 31, 2014. Japanese Yen (JPY) is not directly quoted against Indian Rupee.
The current spot rates are:
INR/US $ = ` 62.22
JPY/US$ = JPY 102.34
It is estimated that Japanese Yen will depreciate to 124 level and Indian Rupee to
depreciate against US $ to ` 65.
Forward rates for August 2014 are
INR/US $ = ` 66.50
Required:
i. Calculate the expected loss, if the hedging is not done. How the position will
change, if the firm takes forward cover?
ii. If the spot rates on August 31, 2014 are:
INR/US $= ` 66.25
Is the decision to take forward cover justified?
Sanjay Saraf Sir 15

SOLUTION :-
Since the direct quote for ¥ and ` is not available it will be calculated by cross
exchange rate as follows:
`/$ x $/¥ = `/¥
62.22/102.34 = 0.6080
Spot rate on date of export 1¥ = ` 0.6080
Expected Rate of ¥ for August 2014 = ` 0.5242 (` 65/¥124)
Forward Rate of ¥ for August 2014 = ` 0.6026 (` 66.50/¥110.35)
i. Calculation of expected loss without hedging
Value of export at the time of export (` 0.6080 x ¥10,000,000) ` 60,80,000

Estimated payment to be received on Aug. 2014
(` 0.5242 x ¥10,000,000) ` 52,42,000
Loss ` 8,38,000
Hedging of loss under Forward Cover
` Value of export at the time of export (` 0.6080 x ¥10,000,000) ` 60,80,000

Payment to be received under Forward Cover
(`0.6026 x ¥10,000,000) ` 60,26,000
Loss ` 54,000
By taking forward cover loss is reduced to ` 54,000.
ii. Actual Rate of ¥ on August 2014 = ` 0.5977 (` 66.25/¥110.85)
Value of export at the time of export (` 0.6080 x ¥10,000,000) ` 60,80,000

Estimated payment to be received on Aug. 2014
(` 0.5977 x ¥10,000,000) ` 59,77,000
Loss ` 1,03,000
The decision to take forward cover is still justified.
16 Sanjay Saraf Sir

Forex
PROBLEM - 12
In March, 2009, the Multinational Industries make the following assessment of
dollar rates per British pound to prevail as on 1.9.2009:
$/Pound Probability
1.60 0.15
1.70 0.20
1.80 0.25
1.90 0.20
2.00 0.20
i. What is the expected spot rate for 1.9.2009?
ii. If, as of March, 2009, the 6-month forward rate is $ 1.80, should the firm sell
forward its pound receivables due in September, 2009?
SOLUTION :-
i. Calculation of expected spot rate for September, 2009:
$ for £ Probability Expected $/£

(1) (2) (1) × (2) = (3)
1.60 0.15 0.24
1.70 0.20 0.34
1.80 0.25 0.45
1.90 0.20 0.38
2.00 0.20 0.40
1.00 EV = 1.81
Therefore, the expected spot value of $ for £ for September, 2009 would be
$ 1.81.
ii. If the six-month forward rate is $ 1.80, the expected profits of the firm can be
maximised by retaining its pounds receivable.
Sanjay Saraf Sir 17

PROBLEM - 13
A company is considering hedging its foreign exchange risk. It has made a purchase
on 1st July, 2016 for which it has to make a payment of US$ 60,000 on
December 31, 2016. The present exchange rate is 1 US $ = ` 65. It can purchase
forward 1 $ at ` 64. The company will have to make an upfront premium @ 2%
of the forward amount purchased. The cost of funds to the company is 12%
per annum.
In the following situations, compute the profit/loss the company will make if
it hedges its foreign exchange risk with the exchange rate on 31 st December, 2016
as :
i. ` 68 per US $.
ii. ` 62 per US $.
iii. ` 70 per US $.
iv. ` 65 per US $.
SOLUTION :-
(`)
Present Exchange Rate `65 = 1 US$
If company purchases US$ 60,000 forward premium is 60000 × 64 × 2% 76,800
Interest on `76,800 for 6 months at 12% 4,608
Total hedging cost 81,408
If exchange rate is `68
Then gain (`68 – `64) for US$ 60,000 2,40,000
Less: Hedging cost 81,408
Net gain 1,58,592
If US$ = `62
Then loss (`64 – `62) for US$ 60,000 1,20,000
Add: Hedging Cost 81,408
Total Loss 2,01,408
If US$ = `70
Then Gain (`70 – `64) for US$ 60,000 3,60,000
Less: Hedging Cost 81,408
Total Gain 2,78,592
18 Sanjay Saraf Sir
Forex
If US$ = `65
Then Gain (` 65 – ` 64) for US$ 60,000 60,000
Less: Hedging Cost 81,408
Net Loss 21,408
PROBLEM - 14
Following information relates to AKC Ltd. which manufactures some parts of
an electronics device which are exported to USA, Japan and Europe on 90 days
credit terms.
Cost and Sales information:
Japan USA Europe

Variable cost per unit `225 `395 `510
Export sale price per unit Yen 650 US$10.23 Euro 11.99
Receipts from sale due in 90 days Yen 78,00,000 US$1,02,300 Euro 95,920
Foreign exchange rate information:
Yen/` US$/` Euro/`

Spot market 2.417-2.437 0.0214-0.0217 0.0177-0.0180
3 months forward 2.397-2.427 0.0213-0.0216 0.0176-0.0178
3 months spot 2.423-2.459 0.02144-0.02156 0.0177-0.0179
Advice AKC Ltd. by calculating average contribution to sales ratio whether it should
hedge it’s foreign currency risk or not.
Sanjay Saraf Sir 19

SOLUTION :-
If foreign exchange risk is hedged
Total (`)
Sum due Yen 78,00,000 US$1,02,300 Euro 95,920
Unit input price Yen 650 US$10.23 Euro 11.99
Unit sold 12000 10000 8000
Variable cost per unit `225/- 395 510
Variable cost `27,00,000 ` 39,50,000 ` 40,80,000 ` 1,07,30,000
Three months forward
rate for selling 2.427 0.0216 0.0178
Rupee value of receipts `32,13,844 ` 47,36,111 ` 53,88,764 ` 1,33,38,719
Contribution `5,13,844 ` 7,86,111 ` 13,08,764 ` 26,08,719
Average contribution to
sale ratio 19.56%
If risk is not hedged
Rupee value of receipt `31,72,021 ` 47,44,898 ` 53,58,659 ` 1,32,75,578
Total contribution ` 25,45,578
Average contribution to 19.17%

sale ratio
AKC Ltd. Is advised to hedge its foreign currency exchange risk.
PROBLEM - 15
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 $ 7,500 and at todays spot rate of $0.025
per `.1, is equivalent to ` 3,00,000.
It is anticipated that the exchange rate will decline by 10% over the three months
period and in order to protect the dollar proceeds, the importer proposes to take
appropriate action through foreign exchange market. The three months forward
20 Sanjay Saraf Sir
Forex
rate is quoted as $0.0244 per ` 1.
You are required to calculate the expected loss and to show, how it can be hedged
by forward contract.
SOLUTION :-
Calculation of the expected loss due to foreign exchange rate fluctuation
Present Cost
US $7,500 @ today spot rate of US $0.025 per Re. 1 ` 3,00,000

Cost after 3 months
US $7,500 @ expected spot rate of US $0.0225 per Re. 1 ` 3,33,333
(Refer to working note)
Expected loss ` 33,333
Forward cover is available today at 1 Re. = US $0.0244 for 3 months
If we take forward cover now for payment after 3 months net amount to be paid is
(US $ 7,500/0.0244) = ` 3,07,377
Hence, by forward contract the company can cover `25,956 (`33,333 – `7,377) i.e.
about 78% of the expected loss.
Working Note:
Expected spot rate after 3 months
It is anticipated by the company that the exchange rate will decline by 10%
over the three months period. The expected rate will be
Present rate - 10% of the present rate.
= US $ 0.025 – 10% of US $ 0.025

= US $ 0.0225
Alternatively, the expected rate may also be calculated as follows:
90
= US $ 0.025   US $0.0225
100
Sanjay Saraf Sir 21

SWAP POINTS
PROBLEM - 16
On April 3, 2016, a Bank quotes the following:
Spot exchange Rate (US $ 1) INR 66.2525 INR 67.5945

2 months’ swap points 70 90
3 months’ swap points 160 186
In a spot transaction, delivery is made after two days.
Assume spot date as April 5, 2016.

Assume 1 swap point = 0.0001,
You are required to:
i. ascertain swap points for 2 months and 15 days. (For June 20, 2016),
ii. determine foreign exchange rate for June 20, 2016, and
iii. compute the annual rate of premium/discount of US$ on INR, on an average
rate.
SOLUTION :-
i. Swap Points for 2 months and 15 days
Bid Ask
Swap Points for 2 months (a) 70 90
Swap Points for 3 months (b) 160 186
Swap Points for 30 days (c) = (b) – (a) 90 96
Swap Points for 15 days (d) = (c)/2 45 48
Swap Points for 2 months & 15 days (e) = (a) + (d) 115 138
22 Sanjay Saraf Sir

Forex
ii. Foreign Exchange Rates for 20th June 2016
Bid Ask
Spot Rate (a) 66.2525 67.5945
Swap Points for 2 months & 15 days (b) 0.0115 0.0138
66.2640 67.6083
iii. Annual Rate of Premium
Bid Ask
Spot Rate (a) 66.2525 67.5945
Foreign Exchange Rates for 20th June
2016 (b) 66.2640 67.6083
Premium (c) 0.0115 0.0138
Total (d) = (a) + (b) 132.5165 135.2028
Average (d) / 2 66.2583 67.6014
Premium 0.0115 12 0.0138 12
  100   100
66.2583 2.5 67.6014 2.5
= 0.0833% = 0.0980%
PROBLEM - 17
An importer customer of your bank wishes to book a forward contract with
your bank on 3rd September for sale to him of SGD 5,00,000 to be delivered on
30th October.
The spot rates on 3rd September are USD 49.3700/3800 and USD/SGD 1.7058/68.
The swap points are:
USD /` USD/SGD
st
Spot/September 0300/0400 1 month forward 48/49
nd
Spot/October 1100/1300 2 month forward 96/97
rd
Spot/November 1900/2200 3 month forward 138/140
Spot/December 2700/3100
Spot/January 3500/4000
Calculate the rate to be quoted to the importer by assuming an exchange margin of

paisa.
Sanjay Saraf Sir 23
SOLUTION :-
USD/ ` on 3rd September 49.3800
Swap Point for October 0.1300
49.5100
Add: Exchange Margin 0.0500
49.5600
USD/ SGD on 3rd September 1.7058
Swap Point for 2nd month Forward 0.0096
1.7154
Cross Rate for SGD/ ` of 30th October
USD/ ` selling rate = ` 49.5600

SGD/ ` buying rate = SGD 1.7154
SGD/ ` cross rate = ` 49.5600 / 1.7154 = ` 28.8912
24 Sanjay Saraf Sir

Forex
IRP EQUATION
PROBLEM - 18
If the present interest rate for 6 months borrowings in India is 9% per
annum and the corresponding rate in USA is 2% per annum, and the US$ is selling
in India at ` 64.50/$.
Then :
i. Will US $ be at a premium or at a discount in the Indian forward market?

ii. Find out the expected 6 month forward rate for US$ in India.
iii. Find out the rate of forward premium/discount.
SOLUTION :-
i. Under the given circumstances, the USD is expected to quote at a premium in
India as the interest rate is higher in India.
ii. Calculation of the forward rate:
1  Rh F1

1  R f Eo
Where: Rh is home currency interest rate, Rf is foreign currency interest rate, F1 is

end of the period forward rate, and Eo is the spot rate.
1 + (0.09/2) F
Therefore  1
1 + (0.02/2) 64.50
1  0.045 F
 1
1  0.01 64.50
1.045
or  64.50  F1
1.01
67.4025
or  F1
1.01
or F1 = `66.74
Sanjay Saraf Sir 25
iii. Rate of premium:
66.74 - 64.50 12
  100  6.94%
64.50 6
PROBLEM - 19
The US dollar is selling in India at `55.50. If the interest rate for a 6 months
borrowing in India is 10% per annum and the corresponding rate in USA is 4%.
i. Do you expect that US dollar will be at a premium or at discount in the

Indian Forex Market?
ii. What will be the expected 6-months forward rate for US dollar in India? and
iii. What will be the rate of forward premium or discount?
SOLUTION :-
1  Rh F1

1  R f Eo

1 +  0.10/2  F
Therefore  1
1   0.04 / 2  55.50
1  0.05 F
 1
1  0.02 55.50
1.05
or  55.50  F1
1.02
58.275
 F1
1.02
or F1 = `57.13
26 Sanjay Saraf Sir
Forex
57.13 - 55.50 12
  100  5.87%
55.50 6
PROBLEM - 20
On 1st April, 3 months interest rate in the US and Germany are 6.5 per cent and 4.5
per cent per annum respectively. The $/DM spot rate is 0.6560. What would be the
forward rate for DM for delivery on 30th June?
SOLUTION :-
USD DM
Spot 0.6560 1.000
Interest rate p.a. 6.5% 4.5%
Interest for 91 days 0.0106 0.0112
Amount after 91 days 0.6666 1.0112
Hence forward rate 0.6666 0.6592
1.0112
OR
  91  
0.6560  1   0.065  
  365  
Forward rate=
  91  
1   0.045  
  365  
= 0.6592
PROBLEM - 21
On April 1, 3 months interest rate in the UK £ and US $ are 7.5% and 3.5% per
annum respectively. The UK £/US $ spot rate is 0.7570. What would be the forward
rate for US $ for delivery on 30th June?
Sanjay Saraf Sir 27

SOLUTION :-
As per interest rate parity
 1 + in A 
S1  S 0 
 1 + in B 
 1   0.075  3 
S1 = £0.7570  12 
 1   0.035  3 
 12 
 1.01875 
= £0.7570 
 1.00875 
= £0.7570 × 1.0099 = £0.7645
= UK £0.7645 / US$
PROBLEM - 22
Shoe Company sells to a wholesaler in Germany. The purchase price of a shipment
is 50,000 deutsche marks with term of 90 days. Upon payment, Shoe Company
will convert the DM to dollars. The present spot rate for DM per dollar is 1.71,
whereas the 90-day forward rate is 1.70.
You are required to calculate and explain:
i. If Shoe Company were to hedge its foreign-exchange risk, what would it

do? What transactions are necessary?
ii. Is the deutsche mark at a forward premium or at a forward discount?
iii. What is the implied differential in interest rates between the two countries?
(Use interest-rate parity assumption).
28 Sanjay Saraf Sir

Forex
SOLUTION :-
i. If Shoe Company were to hedge its foreign exchange risk, it would enter
into forward contract of selling deutsche marks 90 days forward. It would sell
50,000 deutsche marks 90 days forward. Upon delivery of 50,000 DM 90 days
hence, it would receive US $ 29,412 i.e. 50,000 DM/1.70. If it were to receive
US $ payment today it would receive US $ 29,240 i.e. 50,000 DM/1.71. Hence,
Shoe Company will be better off by $ 172 if it hedges its foreign exchange
risk.
ii. The deutsche mark is at a forward premium. This is because the 90 days forward
rate of deutsche marks per dollar is less than the current spot rate of deutsche
marks per dollar. This implies that deutsche mark is expected to be strengthen i.e.
Fewer deutsche mark will be required to buy dollars.
iii. The interest rate parity assumption is that high interest rates on a currency are
offset by forward discount and low interest rate on a currency is offset by forward
premiums.
Further, the spot and forward exchange rates move in tandem, with the link
between them based on interest differential. The movement between two
currencies to take advantage of interest rates differential is a major determinant of
the spread between forward and spot rates. The forward discount or premium is
approximately equal to interest differential between the currencies i.e.
FDM/US$  SDM/US$ 365

  rDM  rUS$
S(DM/US$) 90
1.70  1.71 365

or   rDM  rUS$
1.71 90
or –0.0237 = rDM – rUS $
Therefore, the differential in interest rate is –2.37%, which means if interest rate
parity holds, interest rate in the US should be 2.37% higher than in Germany.
Sanjay Saraf Sir 29

PROBLEM - 23
The following table shows interest rates for the United States Dollar and
French Franc. The spot exchange rate is 7.05 Franc per Dollar. Complete the missing
entries:
3 Months 6 Months 1 Year

Dollar interest rate
(annually compounded) 11½% 12¼% ?
Franc interest rate
(annually compounded) 19½% ? 20%
Forward Franc per Dollar ? ? 7.5200
Forward discount per Franc
percent per year ? 6.3%
SOLUTION :-
Computation of Missing Entries in the Table: For computing the missing entries in
the table we will use Interest Rates Parity (IRP) theorem. This theorem states that the
exchange rate of two countries will be affected by their interest rate differential.
In other words, the currency of one country with a lower interest rate should be
at a forward premium in terms of currency of country with higher interest rates and
vice versa. This implies that the exchange rate (forward and spot) differential will be
equal to the interest rate differential between the two countries i.e.
Interest rate differential = Exchange rate differential
or
1  rf   Sf/d
1  rd  Ff/d
Where rf is the rate of interest of country F (say the foreign country), r d is rate
of interest of country D (say domestic country), Sf/d is the spot rate between the two
countries F and D and Ff/d is the forward rate between the two countries F and D.
30 Sanjay Saraf Sir

Forex
3 months
1
Dollar interest rate = 11 %  annually compounded 
2
1
Franc interest rate = 19 %(annually compounded)
2
Then Forward Franc per Dollar rate would be
 0.195 
1 4   1  0.04875 
 7.05    7.05  
0.115  1  0.02875 
1 
 4 
= Franc 7.19 per US Dollar
Further Forward discount per Franc per cent per year = Interest Differential i.e.
1 1
 19 %  11 %= 8%
2 2
Alternatively, more precisely it can also be computed as follows:
Spot Per Franc Rate = 1 / 7.05 = US Dollar 0.142 per Franc
 1  0.115 
One Year Forward Rate = 0.142    US Dollar 0.132 per Franc
 1  0.195 
0.142 - 0.132
Accordingly, the discount per annum will be =  100  7.04%
0.142
6 months
Forward discount on Franc % per year = − 6.3% or – 3.15% for 6 months

Hence 6 months Forward rate = 7.05/ (100% − 3.15%)
Forward Francs per Dollar = 7.28 Francs
Let r be the Franc interest rate (annually compounded) then as per IRP Theory:
 r 
 1 
7.05  2   Franc 7.28 per Dollar
0.1225 
1 
 2 
On solving the equation we get the value of r = 19.17% i.e. Franc interest
rate (annually compounded)
Sanjay Saraf Sir 31
1 Year
Franc interest rate = 20% (annually compounded)
Forward Franc per Dollar = 7.5200
As per Interest Rate Parity the relationship between the two countries rate and spot
1 + Dollar interest rate 7.05
rate is i.e. 
1  0.20 7.52
Accordingly, the Dollar interest rate = 1.20 × 0.9374 – 1 = 1.125 – 1 = 0.125 or 12.5%
The completed Table will be as follows:
3 Months 6 Months 1 Year

Dollar interest rate
(annually compounded) 11½% 12¼% 12.50%
Franc interest rate
(annually compounded) 19½% 19.17% 20%
Forward Franc per Dollar 7.19 7.28 7.5200
Forward discount per Franc
percent per year 8% or 7.04% 6.3%
PROBLEM - 24
Six-month T-bills have a nominal rate of 7 percent, while default-free Japanese
bonds that mature in 6 months have a nominal rate of 5.5 percent. In the spot
exchange market, 1 yen equals $0.009. If interest rate parity holds, what is the
6-month forward exchange rate?
SOLUTION :-
(1.035 / 1.0275) × .009 = 0.00907
32 Sanjay Saraf Sir

Forex
PROBLEM - 25
The United States Dollar is selling in India at ` 45.50. If the interest rate for
a 6-months borrowing in India is 8% per annum and the corresponding rate in USA
is 2%.
i. Do you expect United States Dollar to be at a premium or at discount in

the Indian forward market?
ii. What is the expected 6-months forward rate for United States Dollar in India;
and
iii. What is the rate of forward premium or discount?
SOLUTION :-
1  Rh F1

1  R f Eo

1   0.08 / 2  F
Therefore  1
1   0.02 / 2  45.50
1  0.04 F
 1
1  0.01 45.50
or
1.04   45.50  F
1
1.01
47.32
or  F1
1.01
or F1 = 46.85
46.85 - 45.50 12
  100  5.93%
45.50 6
Sanjay Saraf Sir 33
CROSS RATE
PROBLEM - 26
XYZ Bank, Amsterdam, wants to purchase ` 25 million against £ for funding
their Nostro account and they have credited LORO account with Bank of London,
London.
Calculate the amount of £’s credited. Ongoing inter-bank rates are per $,
` 61.3625/3700 & per £, $ 1.5260/70.
SOLUTION :-
To purchase Rupee, XYZ Bank shall first sell £ and purchase $ and then sell $ to
purchase Rupee. Accordingly, following rate shall be used:
(£/`)ask
The available rates are as follows:
($/£)bid = $1.5260
($/£)ask = $1.5270
(`/$)bid = ` 61.3625
(`/$)ask = ` 61.3700
From above available rates we can compute required rate as follows:
(£/`)ask = (£/$)ask x ($/`)ask

= (1/1.5260) x (1/61.3625)
= £ 0.01068 or £ 0.0107
Thus amount of £ to be credited
= ` 25,000,000 x £ 0.0107
= £ 267,500
34 Sanjay Saraf Sir

Forex
PROBLEM - 27
You sold Hong Kong Dollar 1,00,00,000 value spot to your customer at ` 5.70
& covered yourself in London market on the same day, when the exchange rates
were
US$ 1 = H.K.$ 7.5880 7.5920
Local inter bank market rates for US$ were
Spot US$ 1 = ` 42.70 42.85
Calculate cover rate and ascertain the profit or loss in the transaction. Ignore
brokerage.
SOLUTION :-
The bank (Dealer) covers itself by buying from the market at market selling rate.
Rupee – Dollar selling rate = ` 42.85
Dollar – Hong Kong Dollar = HK $ 7.5880
Rupee – Hong Kong cross rate = ` 42.85 / 7.5880

= ` 5.6471
Profit / Loss to the Bank
Amount received from customer (1 crore × 5.70) ` 5,70,00,000

Amount paid on cover deal (1 crore × 5.6471) ` 5,64,71,000
Profit to Bank ` 5,29,000
Sanjay Saraf Sir 35

PROBLEM - 28
You, a foreign exchange dealer of your bank, are informed that your bank has sold
a T.T. on Copenhagen for Danish Kroner 10,00,000 at the rate of Danish Kroner
1 = ` 6.5150. You are required to cover the transaction either in London or New
York market. The rates on that date are as under:
Mumbai-London ` 74.3000 ` 74.3200

Mumbai-New York ` 49.2500 ` 49.2625
London-Copenhagen DKK 11.4200 DKK 11.4350
New York-Copenhagen DKK 07.5670 DKK 07.5840
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.
SOLUTION :-
Amount realized on selling Danish Kroner 10,00,000 at ` 6.5150 per Kroner

= ` 65,15,000.
Cover at London:
Bank buys Danish Kroner at London at the market selling rate.
Pound sterling required for the purchase (DKK 10,00,000 ÷ DKK 11.4200)
= GBP 87,565.67
Bank buys locally GBP 87,565.67 for the above purchase at the market selling
rate of ` 74.3200.
The rupee cost will be = ` 65,07,88
Profit (` 65,15,000 - ` 65,07,881) = ` 7,119
Cover at New York:
Bank buys Kroners at New York at the market selling rate.
Dollars required for the purchase of Danish Kroner (DKK10,00,000 ÷ 7.5670)

= USD 1,32,152.77
36 Sanjay Saraf Sir
Forex
Bank buys locally USD 1,32,152.77 for the above purchase at the market selling
rate of ` 49.2625.
The rupee cost will be = ` 65,10,176.

Profit (` 65,15,000 - ` 65,10,176) = ` 4,824
The transaction would be covered through London which gets the maximum
profit of ` 7,119 or lower cover cost at London Market by (` 65,10,176 -
` 65,07,881) = ` 2,295
PROBLEM - 29
On January 28, 2013 an importer customer requested a Bank to remit Singapore
Dollar (SGD) 2,500,000 under an irrevocable Letter of Credit (LC). However, due to
unavoidable factors, the Bank could effect the remittances only on February 4,
2013. The inter-bank market rates were as follows:
January 28, 2013 February 4, 2013

US$ 1 ` 45.85/45.90 ` 45.91/45.97
GBP £ 1 US$ 1.7840/1.7850 US$ 1.7765/1.7775
GBP £ 1 SGD 3.1575/3.1590 SGD 3. 1380/3.1390
The Bank wishes to retain an exchange margin of 0.125%
Required:
How much does the customer stand to gain or lose due to the delay?
(Note: Calculate the rate in multiples of 0.0001)
Sanjay Saraf Sir 37

SOLUTION :-
On January 28, 2013 the importer customer requested to remit SGD 25 lakhs.
To consider sell rate for the bank:
US $ ` 45.90
Pound 1 US$ 1.7850
Pound 1 SGD 3.1575
` 45.90  1.7850
Therefore, SGD 1 =
SGD 3.1575 ` 25.9482
Add: Exchange margin (0.125%) ` 0.0324
` 25.9806
On February 4, 2013 the rates are
US $ ` 45.97
Pound 1 US$ 1.7775
Pound 1 SGD 3.1380
` 45.97  1.7775
Therefore, SGD 1 =
SGD 3.1380 ` 26.0394
Add: Exchange margin (0.125%) ` 0.0325
` 26.0719
Hence, loss to the importer

= SGD 25,00,000 (` 26.0719 – ` 25.9806) = ` 2,28,250
38 Sanjay Saraf Sir

Forex
PROBLEM - 30
Your forex dealer had entered into a cross currency deal and had sold US $
10,00,000 against EURO at US $ 1 = EURO 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 months margin 45/35
Spot US $ 1 EURO 1.4400/4450
1 month forward 1.4425/4490
2 months forward 1.4460/4530
What will be the gain or loss in the transaction?
SOLUTION :-
The amount of EURO bought by selling US$
US$ 10,00,000  EURO 1.4400 = EURO 14,40,000

The amount of EURO sold for buying USD 10,00,000  1.4450 = EURO 14,45,000
Net Loss in the Transaction = EURO 5,000
To acquire EURO 5,000 from the market @
a. USD 1 = EURO 1.4400 &
b. USD1 = INR 31.4500
Cross Currency buying rate of EUR/INR is ` 31.4500 / 1.440 i.e. ` 21.8403

Loss in the Transaction ` 21.8403  5000 = ` 1,09,201.50
Alternatively, if delivery to be affected then computation of loss shall be as follows:
EURO to be surrendered to acquire $ 10,00,000 = EURO 14,45,000

EURO to be received after selling $ 10,00,000 = EURO 14,40,000
Loss = EURO 5,000
Sanjay Saraf Sir 39
To acquire EURO 5,000 from market @
US $ 1 = EURO 1.4400
US $ 1 = INR 31.45
31.45
Cross Currency =  ` 21.8403
1.440
Loss in Transaction (21.8403 x EURO 5,000) = ` 1,09,201.50
PROBLEM - 31
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 months 5/10
6 months 10/15
SPOT GBP/USD 1.7645/60 GBP/USD 1.7640/50
3 months 25/20
6 months 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?
SOLUTION :-
i. To Buy 1 Million GBP Spot against CHF
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
By applying chain rule Buying rate would be

1 GBP = 1.7650  1.4655 CHF
1 GBP = CHF 2.5866
Amount payable CHF 2.5866 Million or CHF 25,86,600
40 Sanjay Saraf Sir
Forex
ii. Spot rate Bid rate GBP 1 = CHF 1.4650  1.7645 = CHF 2.5850
Offer rate GBP 1 = CHF 1.4655  1.7660 = CHF 2.5881
GBP / USD 3 months swap points are at discount
Outright 3 Months forward rate GBP 1 = USD 1.7620 / 1.7640
USD / CHF 3 months swap points are at premium
Outright 3 Months forward rate USD 1 = CHF 1.4655 / 1.4665
Hence
Outright 3 Months forward rate GBP 1 = CHF 2.5822 / 2.5869
Spot rate GBP 1 = CHF 2.5850 / 2.5881
Therefore 3 month swap points are at discount of 28/12.
Sanjay Saraf Sir 41

LEADING AND LAGGING

PROBLEM - 32
Z Ltd. importing goods worth USD 2 million, 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% per annum.
The bankers of Z Ltd offer a 30 days loan at 10% per annum and their
quote for foreign exchange is as follows:
`
Spot 1 USD 56.50
60 days forward for 1 USD 57.10
90 days forward for 1 USD 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.
SOLUTION :-
i. Pay the supplier in 60 days
If the payment is made to supplier in 60 days the
applicable forward rate for 1 USD ` 57.10
Payment Due USD 2,000,000
Outflow in Rupees (USD 2000000 × `57.10) `114,200,000
Add: Interest on loan for 30 days@10% p.a. ` 9,51,667
Total Outflow in ` `11,51,51,667
ii. Availing supplier’s offer of 90 days credit

Amount Payable USD 2,000,000
Add: Interest on credit period for 30 days@8% p.a. USD 13,333
Total Outflow in USD USD 2,013,333
Applicable forward rate for 1 USD `57.50
Total Outflow in ` (USD 2,013,333 × ` 57.50) `115,766,648
Alternative 1 is better as it entails lower cash outflow.

42 Sanjay Saraf Sir
Forex
PROBLEM - 33
An Indian importer has to settle an import bill for $ 1,30,000. The exporter has
given the Indian exporter two options:
i. Pay immediately without any interest charges.

ii. Pay after three months with interest at 5 percent per annum.
The importer's bank charges 15 percent per annum on overdrafts. The exchange
rates in the market are as follows:
Spot rate (` /$) : 48.35 /48.36

3-Months forward rate (`/$) : 48.81 /48.83
The importer seeks your advice. Give your advice.
SOLUTION :-
If importer pays now, he will have to buy US$ in Spot Market by availing
overdraft facility. Accordingly, the outflow under this option will be
`
Amount required to purchase $130000[$130000 X ` 48.36] 6286800
Add: Overdraft Interest for 3 months @15% p.a. 235755
6522555
If importer makes payment after 3 months then, he will have to pay interest for
3 months @ 5% p.a. for 3 month along with the sum of import bill.
Accordingly, he will have to buy $ in forward market. The outflow under this option
will be as follows:
$
Amount of Bill 130000
Add: Interest for 3 months @5% p.a. 1625
131625
Amount to be paid in Indian Rupee after 3 month under the forward purchase
contract
` 6427249 (US$ 131625 X ` 48.83)
Since outflow of cash is least in (ii) option, it should be opted for.

Sanjay Saraf Sir 43
PROBLEM - 34
DEF Ltd. has imported goods to the extent of US$ 1 crore. The payment terms
are 60 days interest-free credit. For additional credit of 30 days, interest at the rate
of 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
quote for the foreign exchange is as follows:
Spot rate INR/US$ 62.50

60 days forward rate INR/US$ 63.15
90 days forward rate INR/US$ 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 :-
i. Pay the supplier in 60 days
If the payment is made to supplier in 60 days the applicable

forward rate for 1 USD ` 63.15
Payment Due USD 1 crore
Outflow in Rupees (USD 1 crore × ` 63.15) ` 63.15 crore
Add: Interest on loan for 30 days@9.5% p.a. ` 0.50 crore
Total Outflow in ` ` 63.65 crore
ii. Availing supplier’s offer of 90 days credit

Amount Payable USD 1.00000 crore
Add: Interest on credit period for 30 days@7.75% p.a. USD 0.00646 crore
Total Outflow in USD USD 1.00646 crore
Applicable forward rate for 1 USD ` 63.45
Total Outflow in ` (USD 1.00646 crore × ` 63.45) ` 63.86 crore
Alternative 1 is better as it entails lower cash outflow.
44 Sanjay Saraf Sir

Forex
PROBLEM - 35
NP and Co. has imported goods for US $ 7,00,000. The amount is payable after
three months. The company has also exported goods for US $ 4,50,000 and this
amount is receivable in two months. For receivable amount a forward contract is
already taken at ` 48.90.
The market rates for Rupee and Dollar are as under:
Spot ` 48.50/70
Two months 25/30 points
Three months 40/45 points
The company wants to cover the risk and it has two options as under :
i. To cover payables in the forward market and

ii. To lag the receivables 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 Rupee Funds is 12%. Which option is preferable?
SOLUTION :-
i. To cover payable and receivable in forward Market
Amount payable after 3 months $7,00,000

Forward Rate ` 48.45
Thus Payable Amount (`) (A) ` 3,39,15,000
Amount receivable after 2 months $ 4,50,000
Thus Receivable Amount (`) (B) ` 2,20,05,000
Interest @ 12% p.a. for 1 month (C) ` 2,20,050
Net Amount Payable in (`) (A) – (B) – (C) ` 1,16,89,950
ii. Assuming that since the forward contract for receivable was already booked
it shall be cancelled if we lag the receivables. Accordingly any profit/ loss on
cancellation of contract shall also be calculated and shall be adjusted as follows:
Sanjay Saraf Sir 45

Amount Payable ($) $7,00,000

Amount receivable after 3 months $ 4,50,000
Net Amount payable $2,50,000
Applicable Rate ` 48.45
Amount payable in (`) (A) ` 1,21,12,500
Profit on cancellation of Forward cost
(48.90 – 48.30) × 4,50,000 (B) ` 2,70,000
Thus net amount payable in (`) (A) - (B) ` 1,18,42,500
Since net payable amount is least in case of first option, hence the company
should cover payable and receivables in forward market.
Note: In the question it has not been clearly mentioned that whether quotes
given for 2 and 3 months (in points terms) are premium points or direct quotes.
Although above solution is based on the assumption that these are direct quotes,
but students can also consider them as premium points and solve the question
accordingly.
46 Sanjay Saraf Sir

Forex
TRIANGULAR ARBITRAGE
PROBLEM - 36
Followings are the spot exchange rates quoted at three different forex markets:
USD/INR 48.30 in Mumbai

GBP/INR 77.52 in London
GBP/USD 1.6231 in New York
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.
SOLUTION :-
The arbitrageur can proceed as stated below to realize arbitrage gains.
i. Buy ` from USD 10,000,000 At Mumbai 48.30 × 10,000,000 = `483,000,000
 ` 483,000,000 
ii. Convert these ` to GBP at London   = GBP 6,230,650.155
 ` 77.52 
iii. Convert GBP to USD at New York GBP 6,230,650.155 × 1.6231 =USD 10,112,968.26
There is net gain of USD 10,112968.26 less USD 10,000,000 i.e. USD 112,968.26
Sanjay Saraf Sir 47

COVERED INTEREST ARBITRAGE

PROBLEM - 37
Spot rate 1 US $ = `48.0123
180 days Forward rate for 1 US $ = `48.8190
Annualised interest rate for 6 months – Rupee = 12%
Annualised interest rate for 6 months – US $ = 8%
Is there any arbitrage possibility? If yes how an arbitrageur can take

advantage of the situation, if he is willing to borrow ` 40,00,000 or US $83,312.
SOLUTION :-
Spot Rate = `40,00,000 /US$83,312 = 48.0123
Forward Premium on US$ = [(48.8190 – 48.0123)/48.0123] x 12/6 x 100
= 3.36%
Interest rate differential = 12% - 8%
= 4%
Since the negative Interest rate differential is greater than forward premium
there is a possibility of arbitrage inflow into India.
The advantage of this situation can be taken in the following manner:
1. Borrow US$ 83,312 for 6 months

Amount to be repaid after 6 months
= US $ 83,312 (1 + 0.08 x 6/12) = US$86,644.48
2. Convert US$ 83,312 into Rupee and get the principal i.e. `40,00,000
Interest on Investments for 6 months – `40,00,000/- x 0.06= `2,40,000/-
Total amount at the end of 6 months = `(40,00,000 + 2,40,000) = `42,40,000/-
Converting the same at the forward rate
= `42,40,000/ `48.8190= US$ 86,851.43
Hence the gain is US $ (86,851.43 – 86,644.48) = US$ 206.95
OR
`10,103 i.e., ($206.95 x `48.8190)
48 Sanjay Saraf Sir
Forex
PROBLEM - 38
Given the following information:
Exchange rate – Canadian dollar 0.665 per DM (spot)

Canadian dollar 0.670 per DM (3 months)
Interest rates – DM 7% p.a.
Canadian Dollar – 9% p.a.
What operations would be carried out to take the possible arbitrage gains?
SOLUTION :-
In this case, DM is at a premium against the Can$.
Premium = [(0.67 – 0.665) /0.665] x (12/3) x 100 = 3.01 per cent
Interest rate differential = 9% - 7% = 2 per cent.
Since the interest rate differential is smaller than the premium, it will be
profitable to place money in Deutschmarks the currency whose 3-months interest is
lower.
The following operations are carried out:
i. Borrow Can$ 1000 at 9 per cent for 3- months;
ii. Change this sum into DM at the spot rate to obtain DM

= (1000/0.665) = 1503.76
iii. Place DM 1503.76 in the money market for 3 months to obtain a sum of DM
Principal 1503.76
Add: Interest @ 7% for 3 months 26.32
Total 1530.08
iv. Sell DM at 3-months forward to obtain Can$= (1530.08 x 0.67) = 1025.15
Sanjay Saraf Sir 49

v. Refund the debt taken in Can$ with the interest due on it, i.e.,
Can$
Principal 1000.00
Add: Interest @9% for 3 months 22.50
Total 1022.50
Net arbitrage gain = 1025.15 – 1022.50 = Can$ 2.65
PROBLEM - 39
Following are the rates quoted at Bombay for British pound:
BP/` 52.60/70 Interest Rates India London

3 m Forward 20/70 3 months 8% 5%
6 m Forward 50/75 6 months 10% 8%
Verify whether there is any scope for covered interest arbitrage if you borrow
rupees.
SOLUTION :-
Particulars Option I (3 months) Option II (6months)
Amount borrowed 100000 100000
Pound obtained by
100000/52.70 = 1897.53 100000/52.70 = 1897.53
converting at spot rate
Invest pound for the
1.25% 4%
period
Amount of pound
received at the end Of 1897.53 × 1.0125 = 1,921.25 1897.53 × 1.0= 1,973.43
the period
Convert pounds to ` At
1,921.25 × 52.80 = 1,01,442 1,973.43 × 53.10= 1,04,789
forward rate
Amount of Re. Loan to
100000 × 1.02= 102000 100000 × 1.05 = 105000
be repaid
As the amount of Re. Received is less than the amount repaid there is no scope for
covered interest arbitrage.
50 Sanjay Saraf Sir
Forex
PROBLEM - 40
Given the following information:
Exchange rate-Canadian Dollar 0.666 per DM (Spot)

Canadian Dollar 0.671 per DM (3 months)
Interest rates-DM 8% p.a.
Canadian Dollar 10% p.a.
What operations would be carried out to earn the possible arbitrage gains?
SOLUTION :-
In this case, DM is at a premium against the Canadian $ premium
= [(0.671 – 0.666) /0.666] x 12/3 x 100 = 3.00 %.
Whereas interest rate differential = 10% – 8% = 2%
Since the interest rate differential is smaller than the premium, it will be
profitable to place money in Deutsch Marks the currency whose 3 months interest is
lower.
The following operations are carried out:-
i. Borrow CAN $ 1000 at 10% for 3 months,
ii. Change this sum into DM at the Spot Rate to obtain DM = (CAN
$1000/0.666) = 1501.50
iii. Place DM 1501.50 in the money market for 3 months to obtain a sum of DM-
A sum of DM –
Principal DM 1501.50
Add: interest @ 8% for 3 months DM 30.03
DM 1531.53
iv. Sell DM at 3 months forward to obtain DM 1531.53 x 0.671 = CAN $ 1027.66
Sanjay Saraf Sir 51

v. Refund the debt taken in CAN $ with the interest due on it, i.e.
Principal CAN $ 1000.00

Add: interest @ 10% for 3 months CAN $ 25.00
Total CAN $ 1025.00
∴ Net arbitrage gain = CAN $ 1027.66 – CAN $ 1025.00 = CAN $ 2.66.
PROBLEM - 41
Spot rate 1 US$ = ` 68.50
USD premium on a six month forward is 3%. The annualized interest in US is 4% and
9% in India.
Is there any arbitrage possibility? If yes, how a trader can take advantage of
the situation if he is willing to borrow USD 3 million.
SOLUTION :-
Spot Rate = `68.50

Forward Rate = ` 68.50 x 1.03 = ` 70.56
Forward Premium on US$ = 3.00% x 12/6 = 6.00%
Interest rate differential = 9% - 4% = 5%
Since the Interest rate differential is less than forward premium there is a
possibility of arbitrage outflow from India.
The advantage of this situation can be taken in the following manner:
i. Borrow equivalent amount of US$ 3000000 in India for 6 months at Spot Rate
` 68.50 x US$ 3000000 = ` 20,55,00,000

Amount to be repaid after 6 months
= ` 20,55,00,000 (1 + 0.09 x 6/12) = ` 21,47,47,500
52 Sanjay Saraf Sir

Forex
ii.
Convert ` 20,55,00,000 into US$ and get the principal i.e. US$ 30,00,000
Interest on Investments for 6 months – US$ 3000000 x 0.02 US$ 60,000
Total amount at the end of 6 months = US$ (30,00,000+60,000) US$ 30,60,000
Converting the same at the forward rate
= US$ 30,60,000 x ` 70.56 = ` 21,59,13,600
Hence the gain is ` (21,59,13,600 – 21,47,47,500) = ` 11,66,100

or
` 11,66,100/ ` 70.56 = US$ 16,526
Sanjay Saraf Sir 53

FC VS MMC
PROBLEM - 42
An Indian exporting firm, Rohit and Bros., would be cover itself against a likely
depreciation of pound sterling. The following data is given:
Receivables of Rohit and Bros £500,000

Spot rate ` 56.00/£
Payment date 3-months
3 months interest rate India : 12 per cent per annum
UK : 5 per cent per annum
What should the exporter do?
SOLUTION :-
The only thing lefts Rohit and Bros to cover the risk in the money market. The
following steps are required to be taken:
i. Borrow pound sterling for 3- months. The borrowing has to be such that at
the end of three months, the amount becomes £ 500,000. Say, the amount
borrowed is £ x. Therefore
 3
x 1  0.05    500,000 or x = £493,827
 12 
ii. Convert the borrowed sum into rupees at the spot rate. This gives:
£493,827 × ` 56 = ` 27,654,312
iii. The sum thus obtained is placed in the money market at 12 per cent to obtain at
the end of 3- months:
 3
S = ` 27,654,312 × 1  0.12    ` 28,483,941
 12 
iv. The sum of £500,000 received from the client at the end of 3- months is used to
refund the loan taken earlier.
54 Sanjay Saraf Sir

Forex
From the calculations. It is clear that the money market operation has resulted
into a net gain of ` 483,941 (` 28,483,941 – ` 500,000 × 56).
If pound sterling has depreciated in the meantime. The gain would be even bigger.
PROBLEM - 43
An exporter is a UK based company. Invoice amount is $3,50,000. Credit
period is three months. Exchange rates in London are :
Spot Rate ($/£) 1.5865 – 1.5905

3-month Forward Rate ($/£) 1.6100 – 1.6140
Rates of interest in Money Market :
Deposit Loan
$ 7% 9%
£ 5% 8%
Compute and show how a money market hedge can be put in place.
Compare and contrast the outcome with a forward contract.
SOLUTION :-
Identify: Foreign currency is an asset. Amount $ 3,50,000.
Create: $ Liability.
Borrow: In $. The borrowing rate is 9% per annum or 2.25% per quarter.
Amount to be borrowed: 3,50,000 / 1.0225 = $ 3,42,298.29
Convert: Sell $ and buy £. The relevant rate is the Ask rate, namely, 1.5905 per £,
(Note: This is an indirect quote). Amount of £s received on conversion is

2,15,214.27 (3,42,298.29/1.5905).
Invest: £ 2,15,214.27 will be invested at 5% for 3 months and get £ 2,17,904.45
Settle: The liability of $3,42,298.29 at interest of 2.25 per cent quarter matures to
$3,50,000 receivable from customer.
Sanjay Saraf Sir 55

Using forward rate, amount receivable is = 3,50,000 / 1.6140 = £2,16,852.54
Amount received through money market hedge = £2,17,904.45
Gain = 2,17,904.45 – 2,16,852.54 = £1,051.91
So, money market hedge is beneficial for the exporter
PROBLEM - 44
Columbus Surgicals Inc. is based in US, has recently imported surgical raw materials
from the UK and has been invoiced for £ 480,000, payable in 3 months. It has also
exported surgical goods to India and France.
The Indian customer has been invoiced for £ 138,000, payable in 3 months, and
the French customer has been invoiced for € 590,000, payable in 4 months.
Current spot and forward rates are as follows:
£ / US$
Spot: 0.9830 – 0.9850
Three months forward 0.9520 – 0.9545
US$ / €
Spot: 1.8890 – 1.8920
Four months forward 1.9510 – 1.9540
Current money market rates are as follows:
UK 10.0% – 12.0% p.a.

France 14.0% – 16.0% p.a.
USA: 11.5% – 13.0% p.a.
You as Treasury Manager are required to show how the company can hedge
its foreign exchange exposure using Forward markets and Money markets hedge
and suggest which the best hedging technique is.
56 Sanjay Saraf Sir

Forex
SOLUTION :-
£ Exposure
Since Columbus has a £ receipt (£ 138,000) and payment of (£ 480,000) maturing at

the same time i.e. 3 months, it can match them against each other leaving a net
liability of £ 342,000 to be hedged.
i. Forward market hedge

Buy 3 months' forward contract accordingly, amount payable after 3 months will
be £ 342,000 / 0.9520 = US$ 359,244
ii. Money market hedge

To pay £ after 3 months' Columbus shall requires to borrow in US$ and translate
to £ and then deposit in £.
For payment of £ 342,000 in 3 months (@2.5% interest) amount required to be
deposited now (£ 342,000 ÷ 1.025) = £ 333,658
With spot rate of 0.9830 the US$ loan needed will be = US$ 339,429
Loan repayable after 3 months (@3.25% interest) will be = US$ 350,460
In this case the money market hedge is a cheaper option.
€ Receipt
Amount to be hedged = € 590,000
i. Forward market hedge
Sell 4 months' forward contract accordingly, amount receivable after 4 months

will be
(€ 590,000 x1.9510) = US$ 1,151,090
ii. Money market hedge
For money market hedge Columbus shall borrow in € and then translate to
US$ and deposit in US$
For receipt of € 590,000 in 4 months (@ 5.33% interest) amount required to be

borrowed now (€590,000 ÷ 1.0533) = € 560,144
Sanjay Saraf Sir 57
With spot rate of 1.8890 the US$ deposit will be = US$ 1,058,113
Deposit amount will increase over 3 months (@3.83% interest) will be

= US$ 1,098,639
In this case, more will be received in US$ under the forward hedge.
PROBLEM - 45
A company is considering hedging its foreign exchange risk. It has made a purchase
on 1st. January, 2008 for which it has to make a payment of US $ 50,000 on
September 30, 2008. The present exchange rate is 1 US $ = ` 40. It can
purchase forward 1 US $ at ` 39. The company will have to make a upfront
premium of 2% of the forward amount purchased. The cost of funds to the
company is 10% per annum and the rate of corporate tax is 50%. Ignore taxation.
Consider the following situations and compute the Profit/Loss the company will
make if it hedges its foreign exchange risk:
i. If the exchange rate on September 30, 2008 is ` 42 per US $.

ii. If the exchange rate on September 30, 2008 is ` 38 per US $.
SOLUTION :-
`
Present Exchange Rate `40 = 1 US$
If company purchases US$ 50,000 forward premium is
39,000
50000 × 39 × 2%
Interest on `39,000 for 9 months at 10% 2,925
Total hedging cost 41,925
If exchange rate is `42
Then gain (`42 – `39) for US$ 50,000 1,50,000
Less: Hedging cost 41,925
Net gain 1,08,075
If US$ = `38
Then loss (39 – 38) for US$ 50,000 50,000
Add: Hedging Cost 41,925
Total Loss 91,925
58 Sanjay Saraf Sir

Forex
PPP
PROBLEM - 46
The rate of inflation in India is 8% per annum and in the U.S.A. it is 4%. The current
spot rate for USD in India is ` 46. What will be the expected rate after 1
year and after 4 years applying the Purchasing Power Parity Theory.
SOLUTION :-
The differential inflation is 4%. Hence the rate will keep changing adversely by 4%
every year. Assuming that the change is reflected at the end of each year, the rates
will be:
End of Year ` ` /USD

1 ` 46.00 x 1.04 47.84
2 ` 47.84 x 1.04 49.75
3 ` 49.75 x 1.04 51.74
4 ` 51.74 x 1.04 53.81
Alternative Answer
End of Year ` ` /USD
` 46.00 
1  0.08 
1 47.77
1  0.04 
` 47.77 
1  0.08 
2 49.61
1  0.04 
` 49.61 
1  0.08 
3 51.52
1  0.04 
` 51.52 
1  0.08 
4 53.50
1  0.04 
Sanjay Saraf Sir 59

PROBLEM - 47
The rate of inflation in USA is likely to be 3% per annum and in India it is
likely to be 6.5%. The current spot rate of US $ in India is ` 43.40. Find the
expected rate of US $ in India after one year and 3 years from now using purchasing
power parity theory.
SOLUTION :-
According to Purchasing Power Parity forward rate is

t
 1 r H 
Spot rate  r 
1 F 
So spot rate after one year

1
 1  0.065 
= ` 43.40 
 1  0.03 
= ` 43.4 (1.03399)
= ` 44.8751
After 3 years
3
 1  0.065 
` 43.40 
 1  0.03 
= ` 43.40 (1.03398)³
= ` 43.40 (1.10544) = ` 47.9761
60 Sanjay Saraf Sir

Forex
EXTENSION
PROBLEM - 48
An importer requests his bank to extend the forward contract for US$ 20,000 which
is due for maturity on 30th October, 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= ` 42.32

The US Dollar quoted on 30-10-2010:-
Spot – 41.5000/41.5200
3 months’ 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
ii. The rate of new forward contract.
SOLUTION :-
i.
The contract is to be cancelled on 30-10-2010 at
the spot buying rate of US$ 1 ` 41.5000
Less: Margin Money 0.075% ` 0.0311
` 41.4689 or ` 41.47
US$ 20,000 @ ` 41.47 ` 8,29,400
US$ 20,000 @ ` 42.32 ` 8,46,400
The difference in favour of the Bank/Cost to the
importer ` 17,000
ii. The Rate of New Forward Contract
Spot Selling Rate US$ 1 ` 41.5200

Add: Premium @ 0.93% ` 0.3861
` 41.9061
Add: Margin Money 0.20% ` 0.0838
` 41.9899 or ` 41.99
Sanjay Saraf Sir 61
PROBLEM - 49
Suppose you are a banker and one of your export customer has booked a US$
1,00,000 forward sale contract for 2 months with you at the rate of ` 62.5200 and
simultaneously you covered yourself in the interbank market at
62.5900. However on due date, after 2 months your customer comes to you
and requests for cancellation of the contract and also requests for extension of the
contract by one month. On this date quotation for US$ in the market was as
follows:
Spot ` 62.7200/62.6800
1 month forward ` 62.6400/62.7400
Determine the extension charges payable by the customer assuming exchange

margin of 0.10% on buying as well as selling.
SOLUTION :-
Cancellation
First the original contract shall be cancelled as follows:
US$/` Spot Selling Rate ` 62.7200

Add: Margin @ 0.10% ` 0.06272
Net amount payable by customer per US$ ` 62.78272
Rounded off ` 62.7825
Bank buys US$ under original contract at ` 62.5200
Bank Sells at ` 62.7825
` 0.2675
Thus total cancellation charges payable by the customer for US$ 1,00,000 is ` 26,750.
Rebooking
Forward US$/` Buying Rate ` 62.6400

Less: Margin @ 0.10% ` 0.06264
Rounded off ` 62.5775
62 Sanjay Saraf Sir
Forex
PROBLEM - 50
Suppose you as a banker entered into a forward purchase contract for US$ 50,000
on 5th March with an export customer for 3 months at the rate of ` 59.6000. On the
same day you also covered yourself in the market at ` 60.6025. However on 5th
May your customer comes to you and requests extension of the contract to 5 thJuly.
On this date (5th May) quotation for US$ in the market is as follows:
Spot ` 59.1300/1400 per US$

Spot/ 5th June ` 59.2300/2425 per US$
Spot/ 5thJuly ` 59.6300/6425 per US$
Assuming a margin 0.10% on buying and selling, determine the extension charges
payable by the customer and the new rate quoted to the customer.
SOLUTION :-
i. Cancellation of Original Contract
The forward purchase contract shall be cancelled at the for the forward sale rate
for delivery June.
Interbank forward selling rate ` 59.2425
Add: Exchange Margin ` 0.0592
Rounded off, the rate applicable is ` 59.3000
Buying US$ under original contract at original rate ` 59.6000
Selling rate to cancel the contract ` 59.3000
Difference per US$ ` 00.3000
Exchange difference for US$ 50,000 payable to the customer is ` 15,000.
ii. Rate for booking new contract
The forward contract shall be rebooked with the delivery 15th July as follows:
Forward buying rate (5th July) ` 59.6300

Less: Exchange Margin ` 0.0596
Rounded off to ` 59.5700
Sanjay Saraf Sir 63
INTERNATIONAL WORKING CAPITAL MANAGEMENT

PROBLEM - 51
Suppose you are a treasurer of XYZ plc in the UK. XYZ have two overseas
subsidiaries, one based in Amsterdam and one in Switzerland. The Dutch subsidiary
has surplus Euros in the amount of 725,000 which it does not need for the next
three months but which will be needed at the end of that period (91 days). The
Swiss subsidiary has a surplus of Swiss Francs in the amount of 998,077 that, again,
it will need on day 91. The XYZ plc in UK has a net balance of £75,000 that is not
needed for the foreseeable future.
Given the rates below, what is the advantage of swapping Euros and Swiss
Francs into Sterling?
Spot Rate (€) £0.6858- 0.6869

91 day Pts 0.0037 0.0040
Spot Rate(£) CHF 2.3295- 2.3326
91 day Pts 0.0242 0.0228
Interest rates for the Deposits
Amount of Currency 91 day Interest Rate % pa

£ € CHF
0 – 100,000 1 ¼ 0
100,001 – 500,000 2 1½ ¼
500,001 – 1,000,000 4 2 ½
Over 1,000,000 5.375 3 1
64 Sanjay Saraf Sir

Forex
SOLUTION :-
Individual Basis
Interest Amt. after 91 Conversion in £

days
Holland £502,414.71
€ 725,000 x 0.02 x 91/360 € 3,665.28 € 728,665.28 (728,665.28 x 0.6895)
Switzerland £432,651.51
CHF 998,077 x 0.005 x 91/360 CHF 1,261.46 CHF 999,338.46 (999,338.46÷2.3098)
UK
£ 75,000 x 0.01 x 91/360 £ 189.58 £ 75,189.58 £ 75,189.58
Total GBP at 91 days £ 1,010,255.80
Swap to Sterling
Sell € 7,25,000 (Spot at 0.6858) buy £ £ 4,97,205.00

Sell CHF 9,98,077(Spot at 2.3326) buy £ £ 4,27,881.76
Independent GBP amount £ 75,000.00
£ 1,000,086.76
Interest (£ 1,000,086.76 x 0.05375 x 91/360) £ 13,587.98
Total GBP at 91 days £ 1,013,674.74
Less: Total GBP at 91 days as per individual basis £ 1,010,255.80
Net Gain £ 3,418.94
Sanjay Saraf Sir 65

PROBLEM - 52
AMK Ltd. an Indian based company has subsidiaries in U.S. and U.K.
Forecasts of surplus funds for the next 30 days from two subsidiaries are as below:
U.S. $12.5 million

U.K. £ 6 million
Following exchange rate information is obtained:
$/` £/`
Spot 0.0215 0.0149
30 days forward 0.0217 0.0150
Annual borrowing/deposit rates (Simple) are available.
` 6.4%/6.2%
$ 1.6%/1.5%
£ 3.9%/3.7%
The Indian operation is forecasting a cash deficit of `500 million.
It is assumed that interest rates are based on a year of 360 days.
i. Calculate the cash balance at the end of 30 days period in ` for each
company under each of the following scenarios ignoring transaction costs and
taxes:
a. Each company invests/finances its own cash balances/deficits in local

currency independently.
b. Cash balances are pooled immediately in India and the net balances are
invested/borrowed for the 30 days period.
ii. Which method do you think is preferable from the parent company’s point of
view?
66 Sanjay Saraf Sir

Forex
SOLUTION :-
Cash Balances: (‘000)
Acting independently
Capital Interest ` in 30 days

India -5,00,000 -2,666.67 -5,02,667
U.S. 12,500 15.63 5,76,757
U.K. 6,000 18.50 4,01,233
4,75,323
Cash Balances:-
Immediate Cash pooling
`
India - 5,00,000
12,500
U.S. 5,81,395
0.0215
6,000
U.K. 4,02,685
0.0149
4,84,080
Immediate cash pooling is preferable as it maximizes interest earnings
Note: If the company decides to invest pooled amount of `4,84,080/- @ 6.2% p.a.
for 30 days an interest of `2,501/- will accrue.
Sanjay Saraf Sir 67

CURRENCY OF BORROWING
PROBLEM - 53
Sun Ltd. is planning to import equipment from Japan at a cost of 3,400 lakh
yen. The company may avail loans at 18 percent per annum with quarterly
rests with which it can import the equipment. The company has also an offer
from Osaka branch of an India based bank extending credit of 180 days at 2 percent
per annum against opening of an irrecoverable letter of credit.
Additional information:
Present exchange rate ` 100 = 340 yen

180 day’s forward rate ` 100 = 345 yen
Commission charges for letter of credit at 2 per cent per 12 months.
Advice the company whether the offer from the foreign branch should be accepted.
SOLUTION :-
Option I (To finance the purchases by availing loan at 18% per annum):
Cost of equipment ` in lakhs

3400 lakh yen at `100 = 340 yen 1,000.00
Add: Interest at 4.5% I Quarter 45.00
Add: Interest at 4.5% II Quarter (on `1045 lakhs) 47.03
Total outflow in Rupees 1,092.03
Alternatively, interest may also be calculated on compounded basis, i.e.,
`1000 × [1.045]² `1092.03
Option II (To accept the offer from foreign branch):
Cost of letter of credit

At 1 % on 3400 lakhs yen at `100 = 340 yen ` 10.00 lakhs
Add: Interest for 2 Quarters ` 0.90 lakhs
(A) ` 10.90 lakhs
68 Sanjay Saraf Sir

Forex
Payment at the end of 180 days:

Cost 3400.00 lakhs yen
Interest at 2% p.a. [3400 × 2/100 × 180/365] 33.53 lakhs yen
3433.53 lakhs yen
Conversion at `100 = 345 yen [3433.53 / 345 ×100] (B) ` 995.23 lakhs
Total Cost: (A) + (B) ` 1006.13 lakhs
Advise: Option II is cheaper by (1092.03 – 1006.13) lakh or ` 85.90 lakh. Hence,

the offer may be accepted.
PROBLEM - 54
An Indian company obtains the following quotes (`/$)
Spot 35.90/36.10
3-Months forward rate 36.00/36.25
6-Months forward rate 36.10/36.40
The company needs $ funds for six months. Determine whether the company
should borrow in $ or ` Interest rates are :
3-Months interest rate: ` : 12%, $ : 6%

6-Months interest rate: ` : 11.50%, $ : 5.5%
Also determine what should be the rate of interest after 3-months to make the
company indifferent between 3-months borrowing and 6-months borrowing in the
case of:
i. Rupee borrowing
ii. Dollar borrowing
Note : For the purpose of calculation you can take the units of dollar and rupee as
100 each.
Sanjay Saraf Sir 69

SOLUTION :-
i. If company borrows in $ then outflow would be as follows:
Let company borrows $ 100 $ 100.00

Add: Interest for 6 months @ 5.5% $ 2.75
Amount Repayable after 6 months $ 102.75
Applicable 6 month forward rate 36.40
Amount of Cash outflow in Indian Rupees ` 3,740.10
If company borrows equivalent amount in Indian Rupee, then outflow would be

as follows:
Equivalent ` amount ` 36.10 x 100 ` 3,610.00

Add: Interest @11.50% ` 207.58
` 3817.58
Since cash outflow is more in ` borrowing then borrowing should be made in $.
ii.
a. Let ‘ir’ be the interest rate of ` borrowing make indifferent between 3
months borrowings and 6 months borrowing then
(1 + 0.03) (1 + ir) = (1 + 0.0575)
ir = 2.67% or 10.68% (on annualized basis)
b. Let ‘id’ be the interest rate of $ borrowing after 3 months to make indifference
between 3 months borrowings and 6 months borrowings. Then,
(1 + 0.015) (1 + id) = (1 + 0.0275)
id = 1.232% or 4.93% (on annualized basis)
70 Sanjay Saraf Sir

Forex
CANCELLATION
PROBLEM - 55
A customer with whom the Bank had entered into 3 months’ forward purchase
contract for Swiss Francs 10,000 at the rate of ` 27.25 comes to the bank after
2 months and requests cancellation of the contract. On this date, the rates,
prevailing, are:
Spot CHF 1 ` 27.30 27.35

One month forward ` 27.45 27.52
What is the loss/gain to the customer on cancellation?
SOLUTION :-
The contract would be cancelled at the one month forward sale rate of ` 27.52.
`
Francs bought from customer under original forward contract at 27.25
It is sold to him on cancellation at 27.52
Net amount payable by customer per Franc 0.27
At ` 0.27 per Franc, exchange difference for CHF 10,000 is ` 2,700.
Loss to the Customer:
Exchange difference (Loss) ` 2,700
Note: The exchange commission and other service charges are ignored.
PROBLEM - 56
A bank enters into a forward purchase TT covering an export bill for Swiss Francs
1,00,000 at ` 32.4000 due 25th April and covered itself for same delivery in the local
inter bank market at ` 32.4200. However, on 25th March, exporter sought for
cancellation of the contract as the tenor of the bill is changed.
Sanjay Saraf Sir 71

In Singapore market, Swiss Francs were quoted against dollars as under:
Spot USD 1 = Sw. Fcs. 1.5076/1.5120

One month forward 1.5150/ 1.5160
Two months forward 1.5250 / 1.5270
Three months forward 1.5415/ 1.5445
and in the interbank market US dollars were quoted as under:
Spot USD 1 = ` 49.4302/.4455

Spot / April .4100/.4200
Spot/May .4300/.4400
Spot/June .4500/.4600
Calculate the cancellation charges, payable by the customer if exchange margin

required by the bank is 0.10% on buying and selling.
SOLUTION :-
First the contract will be cancelled at TT Selling Rate
USD/ Rupee Spot Selling Rate ` 49.4455

Add: Premium for April ` 0.4200
` 49.8655
Add: Exchange Margin @ 0.10% ` 0.04987
` 49.91537 or 49.9154
USD/ Sw. Fcs One Month Buying Rate Sw. Fcs. 1.5150
Sw. Fcs. Spot Selling Rate (`49.91537/1.5150) ` 32.9474
Rounded Off ` 32.9475
Bank buys Sw. Fcs. Under original contract ` 32.4000
Bank Sells under Cancellation ` 32.9475
Difference payable by customer ` 00.5475
Exchange difference of Sw. Fcs. 1,00,000 payable by
customer (Sw. Fcs. 1,00,000 x ` 0.5475) ` 54,750
72 Sanjay Saraf Sir

Forex
PROBLEM - 57
On 15th January 2015 you as a banker booked a forward contract for US$
250000 for your import customer deliverable on 15 th March 2015 at ` 65.3450. On
due date customer request you to cancel the contract. On this date quotation for
US$ in the inter-bank market is as follows:
Spot ` 65.2900/2975 per US$

Spot/ April 3000/ 3100
Spot/ May 6000/ 6100
Assuming that the flat charges for the cancellation is ` 100 and exchange
margin is 0.10%, then determine the cancellation charges payable by the customer.
SOLUTION :-
Bank will buy from customer at the agreed rate of ` 65.40.
Since this is sale contract the contract shall be cancelled at ready buying rate on the
date of cancellation as follows:
Spot Buying Rate on 15 March 2015 ` 65.2900

Less: Exchange Margin ` 0.0653
` 65.2247
Rounded to ` 65.2250
Dollar sold to customer at ` 65.3450

Dollar bought from customer ` 65.2250
Net amount payable by the customer per US$ ` 0.1200
Amount payable by the customer
Flat Charges ` 100.00

Cancellation Charges (` 0.12 x 250000) `30,000.00
`30,100.00
Sanjay Saraf Sir 73

PROBLEM - 58
You as a banker has entered into a 3 month’s forward contract with your
customer to purchase AUD 1,00,000 at the rate of ` 47.2500. However after 2
months your customer comes to you and requests cancellation of the contract. On
this date quotation for AUD in the market is as follows:
Spot ` 47.3000/3500 per AUD

1 month forward ` 47.4500/5200 per AUD
Determine the cancellation charges payable by the customer.
SOLUTION :-
The contract shall be cancelled at the 1 month forward sale rate of ` 47.5200 as
follows:
AUD bought from customer under original forward contract at ` 47.2500

On cancellation it is sold to him at ` 47.5200
Net amount payable by customer per AUD ` 00.2700
Thus total cancellation charges payable by the customer ` 27,000
PROBLEM - 59
A customer with whom the Bank had entered into 3 months forward
purchase contract for Swiss Francs 1,00,000 at the rate of ` 36.25 comes to
the bank after two months and requests cancellation of the contract. On this
date, the rates are:
Spot CHF 1 = ` 36.30 36.35

One month forward 36.45 36.52
Determine the amount of Profit or Loss to the customer due to cancellation of the
contract.
74 Sanjay Saraf Sir

Forex
SOLUTION :-
Original contract for Swiss Francs 1,00,000 @ 36.25 - amount receivable by the
customer To cancel the purchase contract 1 month before the due date - The
contract will be cancelled at 1 month forward sale rate i.e. Swiss Francs 1 = 36.52
payable by the customer.
Hence, Swap profit / loss to the customer:
` 36.52 payable by the customer

` 36.25 receivable by the customer
` 0.27 Net payable by the customer i.e. loss
Therefore, total loss to the customer is
Swiss Francs 1,00,000  ` 0.27 = ` 27,000
Sanjay Saraf Sir 75

AUTOMATIC CANCELLATION
PROBLEM - 60
An importer booked a forward contract with his bank on 10 th April for USD
2,00,000 due on 10th June @ ` 64.4000. The bank covered its position in the
market at ` 64.2800.
The exchange rates for dollar in the interbank market on 10 th June and 20th June
were:
10th June 20th June

Spot USD 1= ` 63.8000/8200 ` 63.6800/7200
Spot/June ` 63.9200/9500 ` 63.8000/8500
July ` 64.0500/0900 ` 63.9300/9900
August ` 64.3000/3500 ` 64.1800/2500
September ` 64.6000/6600 ` 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 August.
Rates rounded to 4 decimal in multiples of 0.0025.
On 10th June, Bank Swaps by selling spot and buying one month forward.
Calculate:
i. Cancellation rate
ii. Amount payable on $ 2,00,000
iii. Swap loss
iv. Interest on outlay of funds, if any
v. New contract rate
vi. Total Cost
76 Sanjay Saraf Sir

Forex
SOLUTION :-
i. Cancellation Rate:
The forward sale contract shall be cancelled at Spot TT Purchase for $ prevailing
on the date of cancellation as follows:
$/ ` Market Buying Rate ` 63.6800

Less: Exchange Margin @ 0.10% ` 0.0636
` 63.6164
Bank sells $2,00,000 @ ` 64.4000 ` 1,28,80,000

Bank buys $2,00,000 @ ` 63.6163 ` 1,27,23,260
Amount payable by customer ` 1,56,740
iii. Swap Loss
On 10th June the bank does a swap sale of $ at market buying rate of
` 63.8000 and forward purchase for June at market selling rate of ` 63.9500.
Bank buys at ` 63.9500

Bank sells at ` 63.8000
Amount payable by customer ` 0.1500
Swap Loss for $ 2,00,000 in ` = ` 30,000
iv. Interest on Outlay of Funds
On 10th June, the bank receives delivery under cover contract at ` 64.2800 and sell
spot at ` 63.8000.

Outlay for $ 2,00,000 in ` 96,000

Interest on ` 96,000 @ 12% for 10 days ` 320
Sanjay Saraf Sir 77

v. New Contract Rate
The contract will be extended at current rate
$/ ` Market forward selling Rate for August ` 64.2500

` 64.3143
vi. Total Cost
Cancellation Charges ` 1,56,740.00

Swap Loss ` 30,000.00
Interest ` 320.00
` 1,87,060.00
PROBLEM - 61
On 10th July, an importer entered into a forward contract with bank for US $
50,000 due on 10th September at an exchange rate of ` 66.8400. The bank
covered its position in the interbank market at ` 66.6800.
How the bank would react if the customer requests on 20th September:
i. to cancel the contract?

ii. to execute the contract?
iii. to extend the contract with due date to fall on 10th November?
The exchange rates for US$ in the interbank market were as below:
10th September 20th September

Spot US$1 = 66.1500/1700 65.9600/9900
Spot/September 66.2800/3200 66.1200/1800
Spot/October 66.4100/4300 66.2500/3300
Spot/November 66.5600/6100 66.4000/4900
Exchange margin was 0.1% on buying and selling.
Interest on outlay of funds was 12% p.a.
78 Sanjay Saraf Sir

Forex
You are required to show the calculations to:

i. cancel the Contract,
ii. execute the Contract, and
iii. extend the Contract as above.
SOLUTION :-
In each of the case first the FEADI Rule of Automatic Cancellation shall be
applied and customer shall pay the charges consisted of following:
a. Exchange Difference
b. Swap Loss
c. Interest on Outlay Funds
a. Exchange Difference
1. Cancellation Rate:
The forward sale contract shall be cancelled at Spot TT Purchase for $

prevailing on the date of cancellation as follows:

` 65.8940
2. Amount payable on $ 50,000
Bank sells $50,000 @ ` 66.8400 ` 33,42,000

Bank buys $50,000 @ ` 65.8950 ` 32,94,750
Amount payable by customer ` 47,250
b. Swap Loss
On 10th September the bank does a swap sale of $ at market buying rate of
` 66.1500 and forward purchase for September at market selling rate of
` 66.3200.
Sanjay Saraf Sir 79


Swap Loss for $ 50,000 in ` = ` 8,500
c. Interest on Outlay of Funds
On 10th September, the bank receives delivery under cover contract at ` 66.6800
and sell spot at ` 66.1500.
Outlay for $ 50,000 in ` 26,500

d. Total Cost
Cancellation Charges ` 47,250.00
Swap Loss ` 8,500.00
Interest ` 87.00
` 55,837.00
e. New Contract Rate
$/ ` Market forward selling Rate for November ` 66.4900

` 66.5565
i. Charges for Cancellation of Contract = ` 55,838.00 or ` 55,837.00
ii. Charges for Execution of Contract

Charges for Cancellation of Contract ` 55,837.00
Spot Selling US$ 50,000 on 20th September at ` 65.9900
+ 0.0660 (Exchange Margin) = ` 66.0560 rounded to ` 33,02,750.00
` 66.0550
` 33,58,587.00
80 Sanjay Saraf Sir
Forex
iii. Charges for Extension of Contract
Charges for Cancellation of Contract 55837

New Forward Rate ` 66.5575
PROBLEM - 62
Y has to remit USD $1,00,000 for his son’s education on 4 th April 2018. Accordingly,
he has booked a forward contract with his bank on 4 th January @ 63.8775. The
Bank has covered its position in the market @ ` 63.7575.
The exchange rates for USD $ in the interbank market on 4 th April and 14th April
were:
4th April ` 14th April `

Spot USD 1= 63.2775/63.2975 63.1575/63.1975
Spot/April 63.3975/63.4275 63.2775/63.3275
May 63.5275/63.5675 63.4075/63.7650
June 63.7775/63.8250 63.6575/63.7275
July 64.0700/64.1325 63.9575/64.0675
Exchange margin of 0.10 percent and interest outlay of funds @ 12 percent

are applicable. The remitter, due to rescheduling of the semester, has requested on
14th April 2018 for extension of contract with due date on 14th June 2018.
Rates must be rounded to 4 decimal place in multiples of 0.0025.
Calculate:
i. Cancellation Rate;
ii. Amount Payable on $ 100,000;
iii. Swap loss;
iv. Interest on outlay of funds, if any;
v. New Contract Rate; and
vi. Total Cost
Sanjay Saraf Sir 81

SOLUTION :-
i. Cancellation Rate:
The forward sale contract shall be cancelled at Spot TT Purchase for $ prevailing
on the date of cancellation as follows:

` 63.0943
Bank sells $1,00,000 @ ` 63.8775 ` 63,87,750

Bank buys $1,00,000 @ ` 63.0950 ` 63,09,500
Amount payable by customer ` 78,250
iii. Swap Loss
On 4th April, the bank does a swap sale of $ at market buying rate of ` 63.2775
and forward purchase for April at market selling rate of ` 63.4275.
Swap Loss for $ 1,00,000 in ` = ` 15,000
iv. Interest on Outlay of Funds
On 4th April, the bank receives delivery under cover contract at ` 63.7575 and sell
spot at ` 63.2775.
Outlay for $ 1,00,000 in ` 48,000

82 Sanjay Saraf Sir

Forex
v. New Contract Rate

$/ ` Market forward selling Rate for June ` 63.7275
` 63.7912
vi. Total Cost
Cancellation Charges ` 78,250.00

Swap Loss ` 15,000.00
Interest ` 158.00
` 93,408.00
Sanjay Saraf Sir 83

ECONOMIC EXPOSURE
PROBLEM - 63
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 ` 1,000 and ` 1,500 respectively. The
cash flows in Foreign currencies are due in six months. The current exchange rates
are as follows:
`/Euro 51.50/55
`/S$ 27.20/25
After six months the exchange rates turn out as follows:
`/Euro 52.00/05
`/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 ` 25,000 :
i. the current exchange rate changes to
`/Euro 51.75/80
`/S$ 27.10/15
ii. Price elasticity of demand is estimated to be 1.5

iii. Payments and receipts are to be settled at the end of six months.
84 Sanjay Saraf Sir

Forex
SOLUTION :-
i. Profit at current exchange rates
2400 [€ 500 × ` 51.50 – (S$ 800 × ` 27.25 + ` 1,000 + ` 1,500)]

2400 [` 25,750 - ` 24,300] = ` 34,80,000
Profit after change in exchange rates
2400[€500× ` 52 – (S$ 800 × ` 27.75 + ` 1000 + ` 1500)]

2400[` 26,000 - ` 24,700] = ` 31,20,000
LOSS DUE TO TRANSACTION EXPOSURE
` 34,80,000 – ` 31,20,000 = ` 3,60,000
ii. Profit based on new exchange rates
2400[` 25,000 - (800 × ` 27.15 + ` 1,000 + ` 1,500)]

2400[` 25,000 - ` 24,220] = ` 18,72,000
Profit after change in exchange rates at the end of six months
2400 [` 25,000 - (800 × ` 27.75 + ` 1,000 + ` 1,500)]

2400 [`. 25,000 - ` 24,700] = ` 7,20,000
Decline in profit due to transaction exposure
` 18,72,000 - ` 7,20,000 = ` 11,52,000

` 25,000
Current price of each unit in € =  € 485.44
` 51.50
` 25,000
Price after change in Exch. Rate = = € 483.09
` 51.75
Change in Price due to change in Exch. Rate
€ 485.44 - € 483.09 = € 2.35 or (-) 0.48%
Price elasticity of demand = 1.5
Increase in demand due to fall in price 0.48 × 1.5 = 0.72%
Size of increased order = 2400 ×1.0072 = 2417 units
Profit = 2417 [ ` 25,000 – (800 × ` 27.75 + ` 1,000 + ` 1,500)]
= 2417 [ ` 25,000 - ` 24,700] = ` 7,25,100
Sanjay Saraf Sir 85
Therefore,
decrease in profit due to operating exposure ` 18,72,000 – ` 7,25,100

= ` 11,46,900
Alternatively, if it is assumed that Fixed Cost shall not be changed with change in
units then answer will be as follows:
Fixed Cost = 2400[` 1,000] = ` 24,00,000
Profit = 2417 [ ` 25,000 – (800 × ` 27.75 + ` 1,500)] – ` 24,00,000

= 2417 ( ` 1,300) – ` 24,00,000 = ` 7,42,100
Therefore,
decrease in profit due to operating exposure ` 18,72,000 – ` 7,42,100

= ` 11,29,900
86 Sanjay Saraf Sir

Forex
CURRENCY OF INVESTMENT
PROBLEM - 64
Your bank’s London office has surplus funds to the extent of USD 5,00,000/- 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 Frankfurt 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 Frankfurt
Spot 1.8260/90
1 month 60/55
2 month 95/90
3 month 145/140
At which centre, will be investment be made & what will be the net gain (to the
nearest pound) to the bank on the invested funds?
Sanjay Saraf Sir 87

SOLUTION :-
i. If investment is made at London
Convert US$ 5,00,000 at Spot Rate (5,00,000/1.5390) £ 3,24,886

Add: £ Interest for 3 months on £ 324,886 @ 5% £ 4,061
£ 3,28,947
Less: Amount Invested $ 5,00,000
Interest accrued thereon $ 5,000
$ 5,05,000
Equivalent amount of £ required to pay the
above sum ($ 5,05,000/1.5430*) £ 3,27,285
Arbitrage Profit £ 1,662
ii. If investment is made at New York
Gain $ 5,00,000 (8% - 4%) x 3/12 $ 5,000

Equivalent amount in £ 3 months ($ 5,000/ 1.5475) £ 3,231
iii. If investment is made at Frankfurt
Convert US$ 500,000 at Spot Rate (Cross Rate) 1.8260/1.5390 € 1.1865

Euro equivalent US$ 500,000 € 5,93,250
Add: Interest for 3 months @ 3% € 4,449
€ 5,97,699
3 month Forward Rate of selling € (1/1.8150) £ 0.5510
Sell € in Forward Market € 5,97,699 x £ 0.5510 £ 3,29,332
Less: Amounted invested and interest thereon £ 3,27,285
Arbitrage Profit £ 2,047
Since out of three options the maximum profit is in case investment is

made in New York. Hence it should be opted.
* Due to conservative outlook.
88 Sanjay Saraf Sir

Forex
PROBLEM - 65
With relaxation of norms in India for investment in international market upto
$ 2,50,000, Mr. X to hedge himself against the risk of declining Indian economy
and weakening of Indian Rupee during last few years, decided to diversify in the
International Market.
Accordingly, Mr. X invested a sum of Rs. 1.58 crore on 1.1.20x1 in Standard

& Poor Index. On 1.1.20x2 Mr. X sold his investment. The other relevant data is
given below:
1.1.20x1 1.1.20x2
Index of Stock Market in India 7395 ?
Standard & Poor Index 2028 1919
Exchange Rate (Rs./$) 62.00/62.25 67.25/67.50
You are required to Calculate:
i. The return for a US investor.

ii. Holding Period Return to Mr. X.
iii. The value of Index of Stock Market in India as on 1.1.20x2 at which Mr.
X would be indifferent between investment in Standard & Poor Index and India
Stock Market.
SOLUTION :-
i. Return of a US Investor
Ending Price - Initial Price

  100
Initial Price
1919 - 2028
  100  5.37%
2028
Sanjay Saraf Sir 89

ii. Return of Mr. X

Initial Investment (Rs.) 1.58 Crore
Applicable Exchange Rate on 1.1.20x1 Rs. 62.25
Equivalent US$ US$ 2,53,815.26
Purchase Price of Standard & Poor Index 2028
No. of Standard & Poor Indices Purchased 125.16
Ending Price of Standard & Poor Index 1919
Proceeds realised in US$ on sale of Standard & Poor Index US$ 2,40,182.04
Applicable Exchange Rate on 1.1.20x2 Rs. 67.25
Proceeds realised in INR on sale of Standard & Poor Index Rs. 1,61,52,242
 16152242 - 15800000 
Rate of Return   100  2.23%
 15800000 
iii. Rate of Return had the amount been invested in India

Initial Investment (Rs.) 1.58 Crore
Purchase Price of Indian Index 7395
No. of Indian Indices Purchased 2136.58
Let Ending Price of Indian Index X
Then to be indifferent with return in 2136.58  X - 1.58
 100 = 2.23
International Market 1.58
Price of Indian Index to be indifferent 7559.90 say 7560
PROBLEM - 66
The Treasury desk of a global bank incorporated in UK wants to invest GBP 200
million on 1st January, 2019 for a period of 6 months and has the following
options:
i. The Equity Trading desk in Japan wants to invest the entire GBP 200 million in
high dividend yielding Japanese securities that would earn a dividend income of
JPY 1,182 million. The dividends are declared and paid on 29 th June. Post
dividend, the securities are expected to quote at a 2% discount. The desk
also plans to earn JPY 10 million on a stock borrow lending activity because
of this investment. The securities are to be sold on June 29 with a T+1
settlement and the amount remitted back to the Treasury in London.
90 Sanjay Saraf Sir

Forex
ii. The Fixed Income desk of US proposed to invest the amount in 6 month G -Secs
that provides a return of 5% p.a.
The exchange rates are as follows:
Currency Pair 1-Jan-2019 (Spot) 30-Jun-2019(Forward)
GBP-JPY 148.0002 150.0000
GBP- USD 1.28000 1.30331
As a treasurer, advise the bank on the best investment option. What would be
your decision from a risk perspective. You may ignore taxation.
SOLUTION :-
i. Yield from Investment in Equity Trading Index in Japan
Conversion of GBP 200 million in JPY (148.0002) JPY 29600.04 Million

Dividend Income JPY 1182.00 Million
Stock Lending JPY 10.00 Million
Investment Value at End JPY 29008.0392 Million
Amount available at End JPY 30200.0392 Million
Forward Rate of 30.06.2019 JPY 150/ GBP
Amount to be Remitted back to London GBP 201.3336 Million
Gain = GBP 201.3336 – GBP 200 GBP 1.3336 Million
ii. Fixed Income Desk of US
Conversion of GBP 200 million in USD(1.28000) USD 256.00 Million

Add: Interest @ 5% p.a. for 6 months USD 6.40 Million
Amount available at End USD 262.40 Million
Forward Rate of 30.06.2019 USD 1.30331/ GBP
Amount to be Remitted back to London GBP 201.3335 Million
Gain = GBP 201.3335 – GBP 200 GBP 1.3335 Million
Decision:
The equivalent amount at the end of 6 months shall be almost same in both
the options. The bank can go for any of the options.
However, from risk perspective, the investment in fixed income desk of US
is more beneficial as the chance of variation in fixed income securities is less
as compared to Equity Desk.
Sanjay Saraf Sir 91
FX SWAP
PROBLEM - 67
Drilldip Inc. a US based company has a won a contract in India for drilling oil field.
The project will require an initial investment of ` 500 crore. The oil field along with
equipments will be sold to Indian Government for ` 740 crore in one year time.
Since the Indian Government will pay for the amount in Indian Rupee (`) the
company is worried about exposure due exchange rate volatility.
You are required to:
i. Construct a swap that will help the Drilldip to reduce the exchange rate risk.
ii. Assuming that Indian Government offers a swap at spot rate which is 1US$
= ` 50 in one year, then should the company should opt for this option or should
it just do nothing. The spot rate after one year is expected to be 1US$ = ` 54.
Further you may also assume that the Drilldip can also take a US$ loan at 8%
p.a.
SOLUTION :-
i. The following swap arrangement can be entered by Drilldip.
a. Swap a US$ loan today at an agreed rate with any party to obtain
Indian Rupees (`) to make initial investment.
b. After one year swap back the Indian Rupees with US$ at the agreed rate. In
such case the company is exposed only on the profit earned from the project.
ii. With the swap

Year 0 Year 1
(Million US$) (Million US$)
Buy ` 500 crore at spot rate of 1US$ = ` 50 (100.00) ----
Swap ` 500 crore back at agreed rate of ` 50 ---- 100.00
Sell ` 240 crore at 1US$ = ` 54 ---- 44.44
Interest on US$ loan @8% for one year ---- (8.00)
(100.00) 136.44
Net result is a net receipt of US$ 36.44 million.

92 Sanjay Saraf Sir
Forex
Without the swap
Year 0 Year 1
(Million US$) (Million US$)
Buy ` 500 crore at spot rate of 1US$ = ` 50 (100.00) ----
Sell ` 740 crore at 1US$ = ` 54 ---- 137.04
Interest on US$ loan @8% for one year ---- (8.00)
(100.00) 129.04
Net result is a net receipt of US$ 29.04 million.
Decision: Since the net receipt is higher in swap option the company should opt
for the same.
Sanjay Saraf Sir 93

NOSTRO ACCOUNT
PROBLEM - 68
You as a dealer in foreign exchange have the following position in Swiss
Francs on 31st October, 2009:
Swiss Francs
Balance in the Nostro A/c Credit 1,00,000
Opening Position Overbought 50,000
Purchased a bill on Zurich 80,000
Sold forward TT 60,000
Forward purchase contract cancelled 30,000
Remitted by TT 75,000
Draft on Zurich cancelled 30,000
What steps would you take, if you are required to maintain a credit Balance of
Swiss Francs 30,000 in the Nostro A/c and keep as overbought position on Swiss
Francs 10,000?
SOLUTION :-
Exchange Position:
Particulars Purchase Sw. Fcs. Sale Sw. Fcs.

Opening Balance Overbought 50,000
Bill on Zurich 80,000
Forward Sales – TT 60,000
Cancellation of Forward Contract 30,000
TT Sales 75,000
Draft on Zurich cancelled 30,000 —
1,60,000 1,65,000
Closing Balance Oversold 5,000 —
1,65,000 1,65,000
94 Sanjay Saraf Sir

Forex
Cash Position (Nostro A/c)
Credit Debit
Opening balance credit 1,00,000 —
TT sales — 75,000
1,00,000 75,000
Closing balance (credit) — 25,000
1,00,000 1,00,000
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.
PROBLEM - 69
Suppose you are a dealer of ABC Bank and on 20.10.2014 you found that balance in
your Nostro account with XYZ Bank in London is £65000 and you had overbought
£65000. During the day following transaction have taken place:
£
DD purchased 12,500
Purchased a Bill on London 40,000
Sold forward TT 30,000
Forward purchase contract cancelled 15,000
Remitted by TT 37,500
Draft on London cancelled 15,000
What steps would you take, if you are required to maintain a credit Balance
of £15000 in the Nostro A/c and keep as overbought position on £7,500?
Sanjay Saraf Sir 95

SOLUTION :-
Exchange Position:
Particulars Purchase £ Sale £

Opening Balance Overbought 35,000 —
DD Purchased 12,500 —
Purchased a Bill on London 40,000 —
Sold forward TT — 30,000
Forward purchase contract cancelled — 15,000
TT Remittance 37,500
Draft on London cancelled 15,000 —
1,02,500 82,500
Closing Balance Overbought — 20,000
1,02,500 1,02,500
Cash Position (Nostro A/c)
Credit £ Debit £
Opening balance credit 65,000 —
TT Remittance — 37,500
65,000 37,500
Closing balance (credit) — 27,500
65,000 65,000
To maintain Cash Balance in Nostro Account at £7500 you have to sell £20000 in Spot
which will bring Overbought exchange position to Nil. Since bank require Overbought
position of £7500 it has to buy the same in forward market.
96 Sanjay Saraf Sir

Forex
TRANSACTION EXPOSURE
PROBLEM - 70
Fleur du lac, a French co., had shipped on Jan 2, 2012 goods to an American
importer under a letter of credit arrangement, which calls for payment at the end
of 90 days. The invoice is for $ 124,000. On the date of shipment the exchange
rate was 5.70 French francs to the $ if the French franc were to strengthen
by 5% by the end of 90 days what would be the transactions gain or loss in French
francs? If it were to weaken by 5%,what would happen?
(Note: may calculate in francs per $)
SOLUTION :-
The French franc strengthening by 5 percent means an exchange rate of 5.70

× .95 = 5.415 French francs to the dollar. The French franc weakening by 5 percent
means an exchange rate of 5.70 × 1.05 = 5.985 French francs to the dollar.
French franc strengthens French franc weakens

Before: $124,000 × 5.70 FF 706,800 Before: $124,000 × 5.70 FF 706,800
After : 124,000 × 5.415 FF 671,460 After: 124,000 × 5.985 FF 742,140
Transaction loss - FF 35,340 Transaction gain + FF 35,340
Sanjay Saraf Sir 97

EARLY DELIVERY
PROBLEM - 71
On 19th January, Bank A entered into forward contract with a customer for a
forward sale of US $ 7,000, delivery 20th March at ` 46.67. On. the same day, it
covered its position by buying forward from the market due 19 th March, at the rate
of `46.655. On 19th February, the customer approaches the bank and requests for
early delivery of US $.
Rates prevailing in the interbank markets on that date are as under:
Spot (`/$) 46.5725/5800

March 46.3550/3650
Interest on outflow of funds is 16% and on inflow of funds is 12%. Flat charges for
early delivery are ` 100.
What is the amount that would be recovered from the customer on the
transaction?
Note: Calculation should be made on months basis than on days basis.
SOLUTION :-
The bank would sell US $ to its customer at the agreed rate under the contract.
However, it would recover loss from the customer for early delivery.
On 19th February bank would buy US$ 7000 from market and shall sell to customer.
Further, Bank would enter into one month forward contract to sell the US $
acquired under the cover deal.
i. Swap Difference
Swap loss per US $ 0.225
Swap loss for US $ 7000 ` 1,575
98 Sanjay Saraf Sir

Forex
ii. Interest on Outlay of Funds
On 19th February, Bank sell to customer ` 46.67

It buys from spot Market ` 46.58
Inflow of funds per US $ ` 0.09
Inflow of funds for US $ 7000 is ` 630

Interest on ` 630 at 12% for one month ` 6.30
Charges for early delivery
Swap loss ` 1,575.00

Flat charges ` 100.00
Less: Interest on outflow of funds ` 6.30
` 1,668.70
Total amount to be recovered from the customer
Amount as per Forward Contract ` 46.67 x 7000 ` 3,26,690.00

Add: Charges for early delivery ` 1,668.70
` 3,28,358.70
Sanjay Saraf Sir 99

FORWARD PREMIUM OR DISCOUNT ON A CURRENCY

PROBLEM - 72
Digital Exporters are holding an Export bill in United States Dollar (USD)
5,00,000 due after 60 days. They are worried about the falling USD value, which
is currently at ` 75.60 per USD. The concerned Export Consignment has been
priced on an Exchange rate of ` 75.50 per USD. The Firm's Bankers have
quoted a 60-day forward rate of ` 75.20.
Calculate:
i. Rate of discount quoted by the Bank, assuming 365 days in a year.

ii. The probable loss of operating profit if the forward sale is agreed to.
SOLUTION :-
i. Rate of discount quoted by the bank
(75.20 - 75.60) × 365 ×100

 3.22%
75.60 × 60
ii. Probable loss of operating profit:
(75.20 – 75.50)  5,00,000 = ` 1,50,000
PROBLEM - 73
Excel Exporters are holding an Export bill in United States Dollar (USD) 1,00,000 due
60 days hence. They are worried about the falling USD value which is currently at
` 45.60 per USD. The concerned Export Consignment has been priced on an
Exchange rate of ` 45.50 per USD. The Firm’s Bankers have quoted a 60-day
forward rate of ` 45.20.
Calculate:
i. Rate of discount quoted by the Bank

ii. The probable loss of operating profit if the forward sale is agreed to.
100 Sanjay Saraf Sir

Forex
SOLUTION :-
i. Rate of discount quoted by the bank
(45.20 - 45.60) × 365 × 100

 5.33%
45.60 × 60
ii. Probable loss of operating profit:
(45.20 – 45.50) × 1,00,000 = ` 30,000
Sanjay Saraf Sir 101

EXPOSURE STRATEGY MATRIX

PROBLEM - 74
Place the following strategies by different persons in the Exposure Management
Strategies Matrix.
Strategy 1: Kuljeet a wholesaler of imported items imports toys from China to sell
them in the domestic market to retailers. Being a sole trader, he is always so much
involved in the promotion of his trade in domestic market and negotiation
with foreign supplier that he never pays attention to hedge his payable in
foreign currency and leaves his position unhedged.
Strategy 2: Moni, is in the business of exporting and importing brasswares to

USA and European countries. In order to capture the market he invoices the
customers in their home currency. Lavi enters into forward contracts to sell the
foreign exchange only if he expects some profit out of it other-wise he leaves his
position open.
Strategy 3: TSC Ltd. is in the business of software development. The company has
both receivables and payables in foreign currency. The Treasury Manager of TSC
Ltd. not only enters into forward contracts to hedge the exposure but carries
out cancellation and extension of forward contracts on regular basis to earn profit
out of the same. As a result management has started looking Treasury Department
as Profit Centre.
Strategy 4: DNB Publishers Ltd. in addition to publishing books are also in the
business of importing and exporting of books. As a matter of policy the movement
company invoices the customer or receives invoice from the supplier immediately
covers its position in the Forward or Future markets and hence never leave the
exposure open even for a single day.

Forex
SOLUTION :-
Strategy 1: This strategy is covered by High Risk: Low Reward category and worst as it
leaves all exposures unhedged. Although this strategy does not involve any time and
effort, it carries high risk.
Strategy 2: This strategy covers Low Risk: Reasonable reward category as the
exposure is covered wherever there is anticipated profit otherwise it is left.
Strategy 3: This strategy is covered by High Risk: High Reward category as to earn
profit, cancellations and extensions are carried out. Although this strategy leads to
high gains but it is also accompanied by high risk.
Strategy 4: This strategy is covered by Low Risk : Low Reward category as company
plays a very safe game.
Diagrammatically all these strategies can be depicted as follows:
High Risk
Low Strategy 1 Strategy 3 High
Reward Strategy 4 Strategy 2 Reward
Low Risk

RESIDUAL
PROBLEM - 75
The directors of Implant Inc. wishes to make an equity issue to finance a $10 m
(million) expansion scheme which has an excepted Net Present Value of $2.2m and
to re-finance an existing $6 m 15% Bonds due for maturity in 5 years time.
For early redemption of these bonds there is a $3,50,000 penalty charges. The Co.
has also obtained approval to suspend these pre-emptive rights and make a $15 m
placement of shares which will be at a price of $0.5 per share. The floatation
cost of issue will be 4% of Gross proceeds. Any surplus funds from issue will be
invested in IDRs which is currently yielding 10% per year.
The Present capital structure of Co. is as under:
’000
Ordinary Share ($1 per share) 7,000
Share Premium 10,500
Free Reserves 25,500
43,000
15% Term Bonds 6,000
11% Debenture (2012-2020) 8,000
57,000
Current share price is $2 per share and debenture price is $ 103 per debenture.
Cost of capital of Co. is 10%. It may be further presumed that stock market is
semi -strong form efficient and no information about the proposed use of funds
from the issue has been made available to the public. You are required to calculate
expected share price of company once full details of the placement and to
which the finance is to be put, are announced.

Forex
SOLUTION :-
In semi-strong form of stock market, the share price should accurately reflect
new relevant information when it is made publicly available including Implant
Inc. expansion scheme and redemption of the term loan.
The existing Market Value $ 2 x 7,000,000 $ 14,000,000

The new investment has an expected NPV $ 2,200,000
Proceeds of New Issue $ 15,000,000
Issue Cost of ($ 600,000)
PV of Benefit of early redemption
Interest of $ 900,000 ($,6,000,000 x 15 %)x 3.791 3,411,900
PV of Repayment in 5 years $ 6,000,000 x 0.621 3,726,000
7,137,900
Redemption Cost Now (6,000,000)
Penalty charges (350,000) 787,900
Expected Total Market value 31,387,900
New No. of shares (30 Million + 7 Million) 37,00,000
Expected Share Price of Company $ 0.848

ADVANCED
PROBLEMS
INTERNATIONAL PROJECT APPRAISAL

PROBLEM - 1
A USA based company is planning to set up a software development unit in
India. Software developed at the Indian unit will be bought back by the US parent
at a transfer price of US $10 millions. The unit will remain in existence in India for
one year; the software is expected to get developed within this time frame.
The US based company will be subject to corporate tax of 30 per cent and a
withholding tax of 10 per cent in India and will not be eligible for tax credit in the
US. The software developed will be sold in the US market for US $ 12.0 millions.
Other estimates are as follows:
Rent for fully furnished unit with necessary hardware in India ` 15,00,000
Man power cost (80 software professional will be working for ` 400 per
10 hours each day) man hour
Administrative and other costs ` 12,00,000
Advise the US Company on the financial viability of the project. The rupee-dollar
rate is `48/$.
Note: Assume 365 days a year.
SOLUTION :-
Proforma profit and loss account of the Indian software development unit
` `
Revenue 48,00,00,000
Less: Costs:
Rent 15,00,000
Manpower (`400 x 80 x 10 x 365) 11,68,00,000
Administrative and other costs 12,00,000 11,95,00,000
Earnings before tax 36,05,00,000
Less: Tax 10,81,50,000
Earnings after tax 25,23,50,000
Less: Withholding tax(TDS) 2,52,35,000
Repatriation amount (in rupees) 22,71,15,000
Repatriation amount (in dollars) $4.7 million
Forex
Advise: 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.
Alternatively, if is assumed that since foreign subsidiary has paid taxes it will not
pay withholding taxes then solution will be as under:
` `
Revenue 48,00,00,000
Less: Costs:
Rent 15,00,000
Manpower (`400 x 80 x 10 x 365) 11,68,00,000
Less: Tax 10,81,50,000
Earnings after tax 25,23,50,000
Repatriation amount (in dollars) $ 5,257,292
Advise: The cost of development software in India for the US based company is
$4.743 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.
Alternatively, if it assumed that first the withholding tax @ 10% is being paid and
then its credit is taken in the payment of corporate tax then solution will be as
follows:
` `
Revenue 48,00,00,000
Less: Costs:
Rent 15,00,000
Manpower (`400 x 80 x 10 x 365) 11,68,00,000
Less: Withholding Tax 3,60,50,000
Earnings after Withholding tax @ 10% 32,44,50,000
Less: Corporation Tax net of Withholding Tax 7,21,00,000
Repatriation amount (in dollars) $ 5,257,292
Advise: The cost of development software in India for the US based company
is $4.743 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.
PROBLEM - 2
XYZ Ltd., a company based in India, manufactures very high quality modem
furniture and sells to a small number of retail outlets in India and Nepal. It is
facing tough competition. Recent studies on marketability of products have clearly
indicated that the customer is now more interested in variety and choice rather
than exclusivity and exceptional quality. Since the cost of quality wood in India is
very high, the company is reviewing the proposal for import of woods in bulk
from Nepalese supplier.
The estimate of net Indian (`) and Nepalese Currency (NC) cash flows in Nominal
terms for this proposal is shown below:
Net Cash Flow (in millions)
Year 0 1 2 3
NC -25.000 2.600 3.800 4.100
Indian (`) 0 2.869 4.200 4.600
The following information is relevant:
i. XYZ Ltd. evaluates all investments by using a discount rate of 9% p.a. All
Nepalese customers are invoiced in NC. NC cash flows are converted to Indian
(`) at the forward rate and discounted at the Indian rate.
ii. Inflation rates in Nepal and India are expected to be 9% and 8% p.a.
respectively. The current exchange rate is ` 1= NC 1.6
Assuming that you are the finance manager of XYZ Ltd., calculate the net
present value (NPV) and modified internal rate of return (MIRR) of the proposal.
You may use following values with respect to discount factor for ` 1 @9%.
Present Value Future Value
Year 1 0.917 1.188
Year 2 0.842 1.090
Year 3 0.772 1
Forex
SOLUTION :-
Working Notes:
i. Computation of Forward Rates
End of Year NC NC/`

 1  0.09  
1 NC1.60 x   1.615
  1  0.08  
 1  0.09  
2 NC1.615 x   1.630
 1  0.08  
 1  0.09  
3 NC1.630 x   1.645
 1  0.08  
ii. NC Cash Flows converted in Indian Rupees
Year NC (Million) Conversion Rate ` (Million)

0 -25.00 1.600 -15.625
1 2.60 1.615 1.61
2 3.80 1.630 2.33
3 4.10 1.645 2.49
Net Present Value
(` Million)
Year Cash Flow Cash Flow Total PVF @ 9% PV
in India in Nepal
0 --- -15.625 -15.625 1.000 -15.625
1 2.869 1.61 4.479 0.917 4.107
2 4.200 2.33 6.53 0.842 5.498
3 4.600 2.49 7.09 0.772 5.473
-0.547

Modified Internal Rate of Return
Year
0 1 2 3
Cash Flow (` Million) -15.625 4.479 6.53 7.09
Year 1 Cash Inflow reinvested for
2 years (1.188 x 4.479) 5.32
Year 2 Cash Inflow reinvested for
1 years (1.090 x 6.53) 7.12
19.53
Terminal Cash Flow 19.53

MIRR = n 1  3  1= 0.0772 say 7.72%
Initial Outlay 15.625
PROBLEM - 3
Perfect Inc., a U.S. based Pharmaceutical Company has received an offer from
Aidscure Ltd., a company engaged in manufacturing of drugs to cure Dengue,
to set up a manufacturing unit in Baddi (H.P.), India in a joint venture.
As per the Joint Venture agreement, Perfect Inc. will receive 55% share of revenues
plus a royalty @ US $0.01 per bottle. The initial investment will be `200 crores for
machinery and factory. The scrap value of machinery and factory is estimated at
the end of five (5) year to be `5 crores. The machinery is depreciable @ 20% on the
value net of salvage value using Straight Line Method. An initial working capital to
the tune of `50 crores shall be required and thereafter `5 crores each year.
As per GOI directions, it is estimated that the price per bottle will be `7.50 and
production will be 24 crores bottles per year. The price in addition to inflation of
respective years shall be increased by `1 each year. The production cost shall be
40% of the revenues.
The applicable tax rate in India is 30% and 35% in US and there is Double
Taxation Avoidance Agreement between India and US. According to the agreement
tax credit shall be given in US for the tax paid in India. In both the countries, taxes
shall be paid in the following year in which profit have arisen.

Forex
The Spot rate of $ is `57. The inflation in India is 6% (expected to decrease by 0.50%
every year) and 5% in US.
As per the policy of GOI, only 50% of the share can be remitted in the year
in which they are earned and remaining in the following year.
Though WACC of Perfect Inc. is 13% but due to risky nature of the project it
expects a return of 15%.
Determine whether Perfect Inc. should invest in the project or not (from subsidiary
point of view).
SOLUTION :-
Working Notes:
i. Estimated Exchange Rates (Using PPP Theory)
Year 0 1 2 3 4 5 6
Exchange rate * 57 57.54 57.82 57.82 57.54 56.99 56.18
ii. Share in sales

Year 1 2 3 4 5
Annual Units in crores 24 24 24 24 24
Price per bottle (`) 7.50 8.50 9.50 10.50 11.50
Price fluctuating Inflation Rate 6.00% 5.50% 5.00% 4.50% 4.00%
Inflated Price (`) 7.95 8.97 9.98 10.97 11.96
Inflated Sales Revenue (` Crore) 190.80 215.28 239.52 263.28 287.04
Sales share @55% 104.94 118.40 131.74 144.80 157.87
iii. Royalty Payment

Year 1 2 3 4 5
Annual Units in crores 24 24 24 24 24
Royalty in $ 0.01 0.01 0.01 0.01 0.01
Total Royalty ($ Crore) 0.24 0.24 0.24 0.24 0.24
Exchange Rate 57.54 57.82 57.82 57.54 56.99
Total Royalty (` Crore) 13.81 13.88 13.88 13.81 13.68
iv. Tax Liability
Year 1 2 3 4 5
Sales Share 104.94 118.40 131.74 144.80 157.87
Total Royalty 13.81 13.88 13.88 13.81 13.68
Total Income 118.75 132.28 145.61 158.61 171.55
Less: Expenses
Production Cost
(Sales share x 40%) 41.98 47.36 52.69 57.92 63.15
Depreciation (195 x 20%) 39.00 39.00 39.00 39.00 39.00
PBT 37.77 45.92 53.92 61.69 69.40
Tax on Profit @30% 11.33 13.78 16.18 18.51 20.82
Net Profit 26.44 32.14 37.74 43.18 48.58
v. Free Cash Flow
Year 0 1 2 3 4 5 6
Sales Share 0.00 104.94 118.40 131.74 144.80 157.87 0.00
Total Royalty 0.00 13.81 13.88 13.88 13.81 13.68 0.00
Production Cost 0.00 -41.98 -47.36 -52.69 -57.92 -63.15 0.00
Initial Outlay -200.00 0.00 0.00 0.00 0.00 0.00 0.00
Working Capital -50.00 -5.00 -5.00 -5.00 -5.00 70.00 0.00
Scrap Value 0.00 0.00 0.00 0.00 0.00 5.00 0.00
Tax on Profit 0.00 0.00 -11.33 -13.78 -16.18 -18.51 -20.82
Free Cash Flow -250.00 71.77 68.59 74.15 79.51 164.89 -20.82
vi. Remittance of Cash Flows
Year 0 1 2 3 4 5 6
Free Cash Flow -250.00 71.77 68.59 74.15 79.51 164.89 -20.82
50% of Current
Year Cash Flow 0.00 35.89 34.29 37.07 39.76 82.45 0.00
Previous year
remaining cash 0.00 0.00 35.88 34.30 37.08 39.75 82.44
flow
Total Remittance -250.00 35.88 70.17 71.37 76.84 122.20 61.62

Forex
NPV of Project under Appraisal
Year 0 1 2 3 4 5 6
Total Remittance
(` Crore) -250.00 35.88 70.17 71.37 76.84 122.20 61.62
Exchange Rate 57.00 57.54 57.82 57.82 57.54 56.99 56.18
Remittance ($mn) -43.86 6.24 12.14 12.34 13.35 21.44 10.97
US Tax @35% ($mn) 0.00 0.00 2.18 4.25 4.32 4.67 7.50
Indian Tax ($mn) 0.00 0.00 1.96 2.38 2.82 3.25 3.71
Net Tax ($mn) 0.00 0.00 0.22 1.87 1.51 1.42 3.79
Net Cash Flow ($mn) -43.86 6.24 11.92 10.47 11.84 20.02 7.18
PVF @ 15% 1.000 0.870 0.756 0.658 0.572 0.497 0.432
Present Value ($mn) -43.86 5.43 9.01 6.89 6.77 9.95 3.10
Net Present Value ($mn) -2.71
Decision: Since NPV of the project is negative, Perfect inc. should not invest in the
project.
* Estimated exchange rates have been calculated by using the following formula:
Expected spot rate = Current Spot Rate x expected difference in inflation rates
E(S1 ) = S0 
1  ld 
 1  1f 
Where
E(S1) is the expected Spot rate in time period 1

S0 is the current spot rate (Direct Quote)
Id is the inflation in the domestic country (home country)
If is the inflation in the foreign country

PROBLEM - 4
Its Entertainment Ltd., an Indian Amusement Company is happy with the success of
its Water Park in India. The company wants to repeat its success in Nepal also
where it is planning to establish a Grand Water Park with world class amenities.
The company is also encouraged by a marketing research report on which it has
just spent ` 20,00,000 lacs.
The estimated cost of construction would be Nepali Rupee (NPR) 450 crores
and it would be completed in one years time. Half of the construction cost will be
paid in the beginning and rest at the end of year. In addition, working capital
requirement would be NPR 65 crores from the year end one. The after tax
realizable value of fixed assets after four years of operation is expected to be NPR
250 crores. Under the Foreign Capital Encouragement Policy of Nepal,
company is allowed to claim 20% depreciation allowance per year on reducing
balance basis subject to maximum capital limit of NPR 200 crore. The company
can raise loan for theme park in Nepal @ 9%.
The water park will have a maximum capacity of 20,000 visitors per day. On
an average, it is expected to achieve 70% capacity for first operational four years.
The entry ticket is expected to be NPR 220 per person. In addition to entry
tickets revenue, the company could earn revenue from sale of food and
beverages and fancy gift items. The average sales expected to be NPR 150 per
visitor for food and beverages and NPR 50 per visitor for fancy gift items.
The sales margin on food and beverages and fancy gift items is 20% and 50%
respectively. The park would open for 360 days a year.
The annual staffing cost would be NPR 65 crores per annum. The annual insurance
cost would be NPR 5 crores. The other running and maintenance costs are expected
to be NPR 25 crores in the first year of operation which is expected to increase NPR
4 crores every year. The company would apportion existing overheads to the tune
of NPR 5 crores to the park.
All costs and receipts (excluding construction costs, assets realizable value and
other running and maintenance costs) mentioned above are at current prices (i.e. 0
point of time) which are expected to increase by 5% per year.

Forex
The current spot rate is NPR 1.60 per `. The tax rate in India is 30% and in Nepal it is
20%.
The current WACC of the company is 12%. The average market return is 11% and
interest rate on treasury bond is 8%. The company’s current equity beta is 0.45. The
company’s funding ratio for the Water Park would be 55% equity and 45% debt.
Being a tourist Place, the amusement industry in Nepal is competitive and

very different from its Indian counterpart. The company has gathered the
relevant information about its nearest competitor in Nepal. The competitor’s
market value of the equity is NPR 1850 crores and the debt is NPR 510 crores and
the equity beta is 1.35.
State whether Its Entertainment Ltd. should undertake Water Park project in Nepal
or not.
SOLUTION :-
Working Notes:
1. Calculation of Cost of Funds/ Discount Rate
Competing Company's Information

Equity Market Value 1850.00
Debt Market Value 510.00
Equity Beta 1.35
Assuming debt to be risk free i.e. beta is zero, the beta of competitor is un-geared
as follows:
E 1850
Asset Beta = Equity Beta x  1.35   1.106
E  D 1  t  1850  510 1  0.20 
Equity beta for Its Entertainment Ltd. in Nepal
Assets beta in Nepal 1.106

Ratio of funding in Nepal
Equity 55.00%
Debt 45.00%

55
1. 1.106 = Equity Beta 
55 + 45(1- 0.30)
Equity Beta = 1.74
Cost of Equity as per CAPM
Market Return 11.00%

Risk free return 8.00%
Cost of Equity = Risk free return + β (Market Return - Risk free return)
= 8.00% + 1.74(11.00% - 8.00%) = 13.22%
WACC = 13.22% x 0.55 + 9%(1- 0.20) x 0.45 = 10.51%
2. Present Value Factors at the discount rate of 10.51%

Year 0 1 2 3 4 5
PVAF 1.000 0.905 0.819 0.741 0.670 0.607
3. Calculation of Capital Allowances

Year 1 2 3 4
Opening Balance (NPR Crore) 200.00 160.00 128.00 102.40
Less: Depreciation (NPR Crore) 40.00 32.00 25.60 20.48
Closing Balance (NPR Crore) 160.00 128.00 102.40 81.92
Calculation of Present of Free Cash Flow

Year 0 1 2 3 4 5
Expected Annual 5040000 5040000 5040000 5040000
visitors
Entry ticket price per 242.55 254.68 267.41 280.78
visitor (NPR)
Profit from sale of
Food and Beverages 33.08 34.73 36.47 38.29
per visitor (NPR)
Profit from sale of 27.56 28.94 30.39 31.91
Fancy Gift Items
per visitor (NPR)
Revenue per visitor 303.19 318.35 334.26 350.98
(NPR)
Forex
Total Revenue (NPR 152.81 160.45 168.47 176.89

crores)
Less: Annual
Staffing Cost (NPR 71.66 75.25 79.01 82.96
crores)
Annual Insurance 5.51 5.79 6.08 6.38
Costs (NPR crores)
Other running and 25.00 29.00 33.00 37.00
maintenance costs
(NPR crores)
Depreciation
Allowances (NPR 40.00 32.00 25.60 20.48
crores)
Total Expenses 142.18 142.03 143.69 146.82
(NPR crores)
PBT (NPR crores) 10.63 18.41 24.78 30.07
Tax on Profit (NPR 2.13 3.68 4.96 6.01
crores)
Net Profit (NPR 8.51 14.73 19.83 24.06
crores)
Add: Depreciation
Allowances (NPR 40 32 25.6 20.48
crores)
Park Construction -225 -225
Cost (NPR crores)
After tax assets 250
realisation value
(NPR crores)
Working capital -65.00 -3.25 -3.41 -3.58 75.25
(NPR crores)
Net cash Flow (NPR -225.00 -290.00 45.26 43.32 41.84 369.78
crores)
PVF at discount rate 1.00 0.90 0.82 0.74 0.67 0.61
Present Values -225.00 -262.42 37.06 32.10 28.06 224.35
(NPR crores)
Net Present Value (NPR crores) -165.86

PROBLEM - 5
Opus Technologies Ltd., an Indian IT company is planning to make an investment
through a wholly owned subsidiary in a software project in China with a shelf life of
two years. The inflation in China is estimated as 8 percent. Operating cash flows are
received at the year end.
For the project an initial investment of Chinese Yuan (CN¥) 30,00,000 will be in
land. The land will be sold after the completion of project at estimated value
of CN¥ 35,00,000. The project also requires an office complex at cost of CN¥
15,00,000 payable at the beginning of project. The complex will be depreciated
on straight-line basis over two years to a zero salvage value. This complex is
expected to fetch CN¥ 5,00,000 at the end of project.
The company is planning to raise the required funds through GDR issue in
Mauritius. Each GDR will have 5 common equity shares of the company as
underlying security which are currently trading at ` 200 per share (Face Value
= `10) in the domestic market. The company has currently paid the dividend of 25%
which is expected to grow at 10% p.a. The total issue cost is estimated to be 1
percent of issue size.
The annual sales is expected to be 10,000 units at the rate of CN¥ 500 per unit. The
price of unit is expected to rise at the rate of inflation. Variable operating costs
are 40 percent of sales. Fixed operating costs will be CN¥ 22,00,000 per year and
expected to rise at the rate of inflation.
The tax rate applicable in China for income and capital gain is 25 percent and as per
GOI Policy no further tax shall be payable in India. The current spot rate of
CN¥ 1 is ` 9.50. The nominal interest rate in India and China is 12% and 10%
respectively and the international parity conditions hold
You are required to

i. Identify expected future cash flows in China and determine NPV of the project in
CN¥.
ii. Determine whether Opus Technologies should go for the project or not
assuming that there neither there is restriction on the transfer of funds
from China to India nor any charges/taxes payable on the transfer of funds.

Forex
SOLUTION :-
Working Notes:
1. Calculation of Cost of Capital (GDR)

Current Dividend (D0) 2.50
Expected Divedend (D1) 2.75
Net Proceeds (Rs. 200 per share – 1%) 198.00
Growth Rate 10.00%
2.75
ke   0.10  0.1139 i.e. 11.39%
198
2. Calculation of Expected Exchange Rate as per Interest Rate Parity

Year Expected Rate
9.50 
1  0.12   9.67
1
1  0.10 
1  0.12   9.85
2
2 9.50 
1  0.10 
2
3. Realization on the disposal of Land net of Tax

CN¥
Sale value at the end of project 3500000.00
Cost of Land 3000000.00
Capital Gain 500000.00
Tax paid 125000.00
Amount realized net of tax 3375000.00
4. Realization on the disposal of Office Complex

(CN¥)
Sale value at the end of project 500000.00
WDV 0.00
Capital Gain 500000.00
Tax paid 125000.00
Amount realized net of tax (A) 375000.00

5. Computation of Annual Cash Inflows

Year 1 2
Annual Units 10000 10000
Price per bottle (CN¥) 540.00 583.20
Annual Revenue (CN¥) 5400000.00 5832000.00
Less: Expenses
Variable operating cost (CN¥) 2160000.00 2332800.00
Depreciation (CN¥) 750000.00 750000.00
Fixed Cost per annum (CN¥) 2376000.00 2566080.00
PBT (CN¥) 114000.00 183120.00
Tax on Profit (CN¥) 28500.00 45780.00
Net Profit (CN¥) 85500.00 137340.00
Add: Depreciation (CN¥) 750000.00 750000.00
Cash Flow 835500.00 887340.00
i. Computation of NPV of the project in CN¥

(CN¥)
Year 0 1 2
Initial Investment -4500000.00
Annual Cash Inflows 835500.00 887340.00
Realization on the disposal of Land net 3375000.00
of Tax
Realization on the disposal of Office 375000.00
Complex
Total -4500000.00 835500.00 4637340.00
PVF @11.39% 1.000 0.898 0.806
PV of Cash Flows -4500000.00 750279.00 3737696.00
NPV -12,025

Forex
ii. Evaluation of Project from Opus Point of View
a. Assuming that inflow funds are transferred in the year in which same are
generated i.e. first year and second year.
Year 0 1 2
Cash Flows (CN¥) -4500000.00 835500.00 4637340.00
Exchange Rate (`/ CN¥) 9.50 9.67 9.85
Cash Flows (`) -42750000.00 8079285.00 45677799.00
PVF @ 12% 1.00 0.893 0.797
-42750000.00 7214802.00 36405206.00
NPV 870008.00
b. Assuming that inflow funds are transferred at the end of the project i.e.
second year.
Year 0 2
Cash Flows (CN¥) -4500000.00 5472840.00
Exchange Rate (Rs./ CN¥) 9.50 9.85
Cash Flows (Rs.) -42750000.00 53907474.00
PVF 1.00 0.797
-42750000.00 42964257.00
NPV 214257.00
Though in terms of CN¥ the NPV of the project is negative but in Rs. it has
positive NPV due to weakening of Rs. in comparison of CN¥. Thus Opus can accept
the project.

EXPOSURE
PROBLEM - 6
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?
SOLUTION :-
i. Net exposure of each foreign currency in Rupees
Inflow Outflow Net Inflow Spread 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
ii. The exposure of Japanese yen position is being offset by a better forward rate

Forex
FORWARD COVER VS NO COVER

PROBLEM - 7
A company operating in Japan has today effected sales to an Indian company,
the payment being due 3 months from the date of invoice. The invoice amount is
108 lakhs yen. At today's spot rate, it is equivalent to ` 30 lakhs. It is anticipated
that the exchange rate will decline by 10% over the 3 months period and in order to
protect the yen payments, the importer proposes to take appropriate action in
the foreign exchange market. The 3 months forward rate is presently quoted as
3.3 yen per rupee. You are required to calculate the expected loss and to show how
it can be hedged by a forward contract.
SOLUTION :-
Spot rate of ` 1 against yen = 108 lakhs yen/` 30 lakhs = 3.6 yen
3 months forward rate of Re. 1 against yen = 3.3 yen
Anticipated decline in Exchange rate = 10%.
Expected spot rate after 3 months = 3.6 yen – 10% of 3.6 = 3.6 yen – 0.36 yen
= 3.24 yen per rupee
` (in lakhs)
Present cost of 108 lakhs yen 30
Cost after 3 months: 108 lakhs yen/ 3.24 yen 33.33
Expected exchange loss 3.33
If the expected exchange rate risk is hedged by a Forward contract:
Present cost 30
Cost after 3 months if forward contract
is taken 108 lakhs yen/ 3.3 yen 32.73
Expected loss 2.73
Suggestion: If the exchange rate risk is not covered with forward contract, the
expected exchange loss is ` 3.33 lakhs. This could be reduced to ` 2.73 lakhs
if it is covered with Forward contract. Hence, taking forward contract is suggested.

FOREIGN CURRENCY BORROWING

PROBLEM - 8
ABC Co. have taken a 6 month loan from their foreign collaborators for US Dollars 2
millions. Interest payable on maturity is at LIBOR plus 1.0%. Current 6-month LIBOR
is 2%.
Enquiries regarding exchange rates with their bank elicits the following
information:
Spot USD 1 ` 48.5275

6 months forward ` 48.4575
i. What would be their total commitment in Rupees, if they enter into a forward
contract?
ii. Will you advise them to do so? Explain giving reasons.
SOLUTION :-
Firstly, the interest is calculated at 3% p.a. for 6 months. That is:
USD 20,00,000 × 3/100 × 6/12 = USD 30,000
From the forward points quoted, it is seen that the second figure is less than
the first, this means that the currency is quoted at a discount.
i. The value of the total commitment in Indian rupees is calculated as below:
Principal Amount of loan USD 20,00,000

Add: Interest USD 30,000
Amount due USD 20,30,000
Spot rate ` 48.5275
Forward Points (6 months) (–) 0.0700
Value of Commitment ` 9,83,68,725

Forex
ii. It is seen from the forward rates that the market expectation is that the
dollar will depreciate. If the firm's own expectation is that the dollar will
depreciate more than what the bank has quoted, it may be worthwhile not to
cover forward and keep the exposure open.
If the firm has no specific view regarding future dollar price movements, it
would be better to cover the exposure. This would freeze the total
commitment and insulate the firm from undue market fluctuations. In other
words, it will be advisable to cut the losses at this point of time.
Given the interest rate differentials and inflation rates between India and USA,
it would be unwise to expect continuous depreciation of the dollar. The US
Dollar is a stronger currency than the Indian Rupee based on past trends and it
would be advisable to cover the exposure.

FORWARD VS FUTURES ARBITRAGE

PROBLEM - 9
In International Monetary Market an international forward bid for December, 15
on pound sterling is $ 1.2816 at the same time that the price of IMM sterling future
for delivery on December, 15 is $ 1.2806. The contract size of pound sterling is £
62,500. How could the dealer use arbitrage in profit from this situation and how
much profit is earned?
SOLUTION :-
Buy £ 62500 × 1.2806 $ 80037.50
Sell £ 62500 × 1.2816 $ 80100.00
Profit $ 62.50
Alternatively if the market comes back together before December 15, the
dealer could unwind his position (by simultaneously buying £ 62,500 forward
and selling a futures contract. Both for delivery on December 15) and earn the
same profit of $ 62.5.

Forex
LEADING AND LAGGING

PROBLEM - 10
Gibralater Limited has imported 5000 bottles of shampoo at landed cost in
Mumbai, of US $ 20 each. The company has the choice for paying for 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 Gibralter Limited.
i. Pay in 3 months’ time with interest @ 10% and cover risk forward for 3 months.
ii. Settle now at a current spot rate and pay interest of the over draft for 3
months.
The rates are as follows:
Mumbai ` /$ spot 60.25-60.55

3 months swap 35/25
SOLUTION :-
Option - I
$20 x 5000 = $ 1,00,000

Repayment in 3 months time = $1,00,000 x (1 + 0.10/4) = $ 1,02,500
3-months outright forward rate = ` 59.90/ ` 60.30
Repayment obligation in ` ($1,02,500 X ` 60.30) = ` 61,80,750
Option -II
Overdraft ($1,00,000 x ` 60.55) ` 60,55,000

Interest on Overdraft (` 60,55,000 x 0.14/4) ` 2,11,925
` 62,66,925
Option I should be preferred as it has lower outflow.

EARLY DELIVERY
PROBLEM - 11
On 1 October 2015 Mr. X an exporter enters into a forward contract with a
BNP Bank to sell US$ 1,00,000 on 31 December 2015 at ` 65.40/$. However,
due to the request of the importer, Mr. X received amount on 28 November 2015.
Mr. X requested the bank the take delivery of the remittance on 30 November
2015 i.e. before due date. The inter-banking rates on 28 November 2015 was
as follows:
Spot ` 65.22/65.27
One Month Premium 10/15
If bank agrees to take early delivery then what will be net inflow to Mr. X assuming
that the prevailing prime lending rate is 18%.
SOLUTION :-
Bank will buy from customer at the agreed rate of ` 65.40. In addition to the same if
bank will charge/ pay swap difference and interest on outlay funds.
a. Swap Difference
Bank Sells at Spot Rate on 28 November 2015 ` 65.22

Bank Buys at Forward Rate of 31 December 2015 (65.27 + 0.15) ` 65.42
Swap Loss per US$ ` 00.20
Swap loss for US$ 1,00,000 ` 20,000
b. Interest on Outlay Funds
On 28th November Bank sells at ` 65.22

It buys from customer at ` 65.40
Outlay of Funds per US$ ` 00.18
Interest on Outlay fund for US$ 1,00,000 for 31 days
(US$100000 x 00.18 x 31/365 x 18%) ` 275.00

Forex
c. Charges for early delivery
Swap loss ` 20,000.00

Interest on Outlay fund for US$ 1,00,000 for 31 days ` 275.00
` 20,275.00
d. Net Inflow to Mr. X
Amount received on sale (` 65.40 x 1,00,000) ` 65,40,000

Less: Charges for early delivery payable to bank (` 20,275)
` 65,19,725

ADR/GDR
PROBLEM - 12
X Ltd. is interested in expanding its operation and planning to install
manufacturing plant at US. For the proposed project it requires a fund of $ 10
million (net of issue expenses/ floatation cost). The estimated floatation cost is 2%.
To finance this project it proposes to issue GDRs.
You as financial consultant is required to compute the number of GDRs to be issued

and cost of the GDR with the help of following additional information.
i. Expected market price of share at the time of issue of GDR is ` 200 (Face Value
` 100)
ii. 2 Shares shall underly each GDR and shall be priced at 10% discount to market
price.
iii. Expected exchange rate ` 60/$.
iv. Dividend expected to be paid is 20% with growth rate 12%.
SOLUTION :-
$10 million
Gross Issue =  $ 10.204 million
0.98
Issue Price per GDR in ` (200 x 2 x 90%) ` 450
Issue Price per GDR in $ (` 450/ ` 60) $ 7.50
Dividend Per GDR (D1) (` 20 x 2) ` 40
Net Proceeds Per GDR (` 450 x 0.98) ` 441.00
$10.204 million
 1.3605 million
$7.50
ii. Cost of GDR to X Ltd.
60.00
ke  + 0.12= 21.07%
441.00
Forex
INTERNATIONAL WORKING CAPITAL MANAGEMENT
PROBLEM - 13
India Imports co., purchased USD 100,000 worth of machines from a firm in New
York, USA. The value of the rupee in terms of the Dollar has been decreasing. The
firm in New York offers 2/10, net 90 terms. The spot rate for the USD is ` 55; the 90
days forward rate is ` 56.
i. Compute the Rupee cost of paying the account within the 10 days.
ii. Compute the Rupee cost of buying a forward contract to liquidate the account in
10 days.
iii. 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.
SOLUTION :-
i. (98,000) (`55) = `53,90,000
ii. (100,000) (`56) = `56,00,000

Differences = `56,00,000 – `53,90,000 = `2,10,000
iii. Time value of money = (100,000 – 98,000) (` 56) = `1,12,000

Protection from devaluation = (98,000) (`56 – `55) = `9,80,000
PROBLEM - 14
A Company’s international transfer of funds amounts to about $2 million monthly.
Presently the average transfer time is ten days. It has been proposed that the
transfer of funds be turned over to one of the larger international banks, which can
reduce the transfer time to an average of two days. A charge of one-half of 1
percent of the volume of transfer has been proposed for this service. In view of the
fact that the firm’s opportunity cost of funds is 12 percent, should this offer be
accepted?

SOLUTION :-
$2,000,000 per month = $24,000,000 per year.
Time saved = 10-2 = 8 days funds are freed for other uses.
Investing $24,000,000 at 12% for 8 days: Yield = 24,000,000 (0.12) (8/360) = $64,000
% yield = 64,000/24,000,000 = 0.00267 or 0.267%
Since the firm saves less than 0.3% and the proposed charges is 0.5%, the services
would not produce commensurate savings. However, the new transfer time
would shorten the exposure of the funds to various risks by an average of 8
days. The firm must decide whether or not this reduction in risk is worth the
difference between the proposed fee and the savings due to the shorter transfer
time, 0.5% - 0.267% = 0.233%.

Forex
CROSS RATE
PROBLEM - 15
A Bank sold Hong Kong Dollars 40,00,000 value spot to its customer at ` 7.15
and covered itself in London Market on the same day, when the exchange rates
were:
US$ = HK$ 7.9250 7.9290
Local interbank market rates for US$ were
Spot US$ 1 = ` 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.
SOLUTION :-
The bank (Dealer) covered itself by buying from the London market at market selling
rate.
Rupee – US Dollar selling rate = ` 55.20
US Dollar – Hong Kong Dollar = HK $ 7.9250
Rupee – Hong Kong cross rate (` 55.20 / 7.9250) = ` 6.9653
Gain / Loss to the Bank
Amount received from customer (HK$ 40,00,000)  ` 7.15 ` 2,86,00,000

Amount paid on cover deal (HK$ 40,00,000  ` 6.9653) ` 2,78,61,200
Gain to Bank ` 7,38,800
Alternative Calculation
Gain to bank = 40,00,000 (` 7.15 – ` 6.9653) = ` 7,38,800

PROBLEM - 16
Edelweiss Bank Ltd. sold Hong Kong dollar 2 crores value spot to its
customer at ` 8.025 and covered itself in the London market on the same day,
when the exchange rates were
US$ 1 = HK $ 7.5880 - 7.5920
Local interbank market rates for US $ were
Spot US $ 1 – ` 60.70-61.00
Calculate the cover rate and ascertain the profit or loss on the transaction. Ignore
brokerage.
SOLUTION :-
The bank (Dealer) covers itself by buying from the market at market selling rate.
Rupee – Dollar selling rate = `61.00
Dollar – Hong Kong Dollar = HK $ 7.5880
Rupee – Hong Kong cross rate = `61.00 / 7.5880 = `8.039
Profit / Loss to the Bank
Amount received from customer (2 crore  8.025) `16,05,00,000

Amount paid on cover deal (2 crore  8.039) `16,07,80,000
Loss to Bank ` 2,80,000

MIND MAP
&
SUMMARY
TABLE C
Normal probability distribution table
NUMBER OF STANDARD AREA TO THE LEFT OR NUMBER OF STANDARD AREA TO THE LEFT OR
DEVIATIONS FROM MEAN RIGHT (ONE TAIL) DEVIATIONS FROM MEAN RIGHT (ONE TAIL)
(Z) (Z)
0.00 0.5000 1.55 0.0606
0.05 0.4801 1.60 0.0548
0.10 0.4602 1.65 0.0495
0.15 0.4404 1.70 0.0446
0.20 0.4207 1.75 0.0401
0.25 0.4013 1.80 0.0359
0.30 0.3821 1.85 0.0322
0.35 0.3632 1.90 0.0287
0.40 0.3446 1.95 0.0256
0.45 0.3264 2.00 0.0228
0.50 0.3085 2.05 0.0202
0.55 0.2912 2.10 0.0179
0.60 0.2743 2.15 0.0158
0.65 0.2578 2.20 0.0139
0.70 0.2420 2.25 0.0122
0.75 0.2264 2.30 0.0107
0.80 0.2119 2.35 0.0094
0.85 0.1977 2.40 0.0082
0.90 0.1841 2.45 0.0071
0.85 0.1711 2.50 0.0062
1.00 0.1557 2.55 0.0054
1.05 0.1469 2.60 0.0047
1.10 0.1357 2.65 0.0040
1.15 0.1251 2.70 0.0035
1.20 0.1151 2.75 0.0030
1.25 0.1056 2.80 0.0026
1.30 0.0986 2.85 0.0022
1.35 0.0885 2.90 0.0019
1.40 0.0808 2.95 0.0016
1.45 0.0735 3.00 0.0013
1.50 0.0668
Student’s T-Distribution
Level of Signiﬁcance for One-Tailed Test
df 0.100 0.050 0.025 0.01 0.005 0.0005
Level of Signiﬁcance for Two-Tailed Test
df 0.20 0.10 0.05 0.02 0.01 0.001
1 3.078 6.314 12.706 31.821 63.657 636.619
2 1.886 2.920 4.303 6.965 9.925 31.599
3 1.638 2.353 3.182 4.541 5.841 12.294
4 1.533 2.132 2.776 3.747 4.604 8.610
5 1.476 2.015 2.571 3.365 4.032 6.869
6 1.440 1.943 2.447 3.143 3.707 5.959

7 1.415 1.895 2.365 2.998 3.499 5.408
8 1.397 1.860 2.306 2.896 3.355 5.041
9 1.383 1.833 2.262 2.821 3.250 4.781
10 1.372 1.812 2.228 2.764 3.169 4.587
11 1.363 1.796 2.201 2.718 3.106 4.437

12 1.356 1.782 2.179 2.681 3.055 4.318
13 1.350 1.771 2.160 2.650 3.012 4.221
14 1.345 1.761 2.145 2.624 2.977 4.140
15 1.341 1.753 2.131 2.602 2.947 4.073
16 1.337 1.746 2.120 2.583 2.921 4.015

17 1.333 1.740 2.110 2.567 2.898 3.965
18 1.330 1.734 2.101 2.552 2.878 3.922
19 1.328 1.729 2.093 2.539 2.861 3.883
20 1.325 1.725 2.086 2.528 2.845 3.850
21 1.323 1.721 2.080 2.518 2.831 3.819

22 1.321 1.717 2.074 2.508 2.819 3.792
23 1.319 1.714 2.069 2.500 2.807 3.768
24 1.318 1.711 2.064 2.492 2.797 3.745
25 1.316 1.708 2.060 2.485 2.787 3.725
26 1.315 1.706 2.056 2.479 2.779 3.707

27 1.314 1.703 2.052 2.473 2.771 3.690
28 1.313 1.701 2.048 2.467 2.763 3.674
29 1.311 1.699 2.045 2.462 2.756 3.659
30 1.310 1.697 2.042 2.457 2.750 3.646
40 1.303 1.684 2.021 2.423 2.704 3.551

60 1.296 1.671 2.000 2.390 2.660 3.460
120 1.289 1.658 1.980 2.358 2.617 3.373
00 1.282 1.645 1.960 2.326 2.576 3.291

Sanjay Saraf SFM Volume 1 Forex

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Sanjay Saraf SFM Volume 1 Forex

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CONTENTS

Mind Map ..................................................................................................135

INTERNATIONAL PROJECT APPRAISAL

Year Cash inflow

Year Cash flow (Million) PV Factor at P.V.

Therefore, Rupee NPV of the project is = ` (48 x 1.013) Million

Estimated projected cash flows, in real terms, in India as well as African

Year – 0 Year – 1 Year – 2 Year - 3

Year - 1 Year - 2 Year - 3

2 Sanjay Saraf Sir

NPV of 3 years = -59320 (` ‘000)

Sanjay Saraf Sir 3

i. Variable operating cost will be US $ 20 per unit of production;

vii. Applicable Corporate Income Tax rate is 35%, and

viii. Required rate of return for such project is 12%.

4 Sanjay Saraf Sir

i. Incremental Cash Outflows

ii. Incremental Cash Inflow after Tax (CFAT)

a. Generated by investment in India for 5 years

Sanjay Saraf Sir 5

b. Cash generation by exports (Opportunity Cost)

c. Additional CFAT attributable to Foreign Investment

iii. Determination of NPV

Year CFAT ($ Million) PVF@12% PV($ Million)

Since NPV is positive the proposal should be accepted.

6 Sanjay Saraf Sir

Year Cash inflow

Calculate the NPV of the project using

i. Home Currency Approach

Required rate of return on this project is 7%.

End of Year ` `/€

Cash Flow Expected PV Factor

Therefore, Rupee NPV of the project is = ` 429.06

ii. (1 + 0.06) (1 + Risk Premium) = (1 + 0.07)

Or, 1 + Risk Premium = 1.07/1.06 = 1.00943

Therefore, Risk adjusted dollar rate is = 1.00943 x 1.04 = 1.0498 – 1 = 0.0498

Year Cash flow (Million) € PV Factor at 4.98% P.V.

Therefore, Rupee NPV of the project is = ` (72 x 5.955) Million

8 Sanjay Saraf Sir

i. The expected domestic market price of the share is ` 300

Issue Price per GDR in ` (300 x 3 x 90%) = ` 810

Net Proceeds Per GDR = ` 810 x 0.98 = ` 793.80

i. Number of GDR to be issued

ii. Cost of GDR to Odessa Ltd.

As a financial consultant, you are requested to compute the number of GDRs to be

i. Expected market price of share at the time of issue of GDR is ` 250

i. Number of GDR to be issued

ii. Cost of GDR to Omega Ltd.

10 Sanjay Saraf Sir

(Price at end - Price at begining) + Interest

(5250 - 5000) + 350

ii. If $ appreciate by 2% then return for non-US investor shall be:

Return x 1.02 = 0.12 x 1.02=0.1224 i.e. 12.24%

Alternatively, it can also be considered that $ appreciation will be applicable to

(1+0.12)(1+0.02) -1 =1.12X1.02 - 1 = 0.1424 i.e. 14.24%

Sanjay Saraf Sir 11

Equivalent of US$ for ` 15 million at this rate will be

or, = 15,000,000 x $ 0.01947 = US$ 2,92,050

i. US $ required to get ` 25 lakhs after 2 months at the Rate of ` 47/$

ii. ` required to get US$ 2,00,000 now at the rate of ` 46.25/$

iii. Encashing US $ 69000 Now Vs 2 month later

Proceeds if we can encash by forward rate :

Sanjay Saraf Sir 13

FORWARD COVER VS NO COVER