IFM Unit 3

International
Financial Management
Foreign Exchange Markets – I

Introduction to Forex Markets
Krishna Kumar S
Department of Management Studies
Objectives
- Understanding the meaning of Foreign Exchange, Foreign Exchange markets.,
- Structure and functions of Foreign Exchange markets.
- Market participants,
- Types of foreign exchange transactions Cash/Tom/Spot and Forward contracts
- Exchange rate quotations

Foreign Exchange Markets – Part I – Introduction
- International transactions, like domestic transactions, require money flows at

some point.
- In international transactions, however, money flows often require the use of
currencies other than the national currencies of the parties to the
transactions.
- The foreign Exchange Market is the market which accommodates the Currency
preferences of the parties involved and helps convert one Currency into the
other Currency.
- It encompasses all transactions involving the exchange of different monetary
units for each other.
Foreign Exchange Markets – Part I – Introduction
- Because of time zone differences between countries across the globe, most
global transactions takes place in a few select currencies viz., the USD, EUR,
GBP, JPY, CHF, AUD, CAD, etc.
- because of the time zone differences, it’s a 24-hour market.
- Five day week & market players take advantage of the time zone differences.
- plays the role of a clearing house for settlement of global transactions., TARGET,
RTGS, CLS, CCIL, etc.
- network of players ., buyers and sellers spread over the world.
- Australia-Japan-Hongkong - Singapore-India-Europe-USA
Foreign Exchange Markets – I – functions of foreign exchange markets
Transfer Function:
- The basic function of the foreign exchange market is to facilitate the conversion
of one currency into another, i.e., to accomplish transfers of purchasing power
between two countries.
- This transfer of purchasing power is effected through a variety of credit

instruments, such as telegraphic transfers, bank draft and foreign bills.
Credit Function:
- A second function of foreign exchange market is that it provides credit for foreign
trade.
- Bills of exchange, with maturity period of three months, are generally used for
international payments.
- Credit is required for this period in order to enable the importer to take
possession of goods, sell them and obtain money to pay off the bill.
Hedging Function:
- A third function of the foreign exchange market is to hedge foreign exchange

risks. Hedging means the avoidance of a foreign exchange risk.
- In a free exchange market when exchange rate, i.e., the price of one currency in
terms of another currency, change, there may be a gain or loss to the party
concerned.
Liquidity Function:
- A fourth function of the foreign exchange market is that liquidity is created in

each of the global markets by the market participants who aggressively deal in
the market to hedge foreign exchange risks.
- In a free exchange market, in view of the various monetary instruments available

globally, market participants take advantage of the flow of liquidity and bring
depth into the market.
Arbitrage Function:
- A fifth function of the foreign exchange market is that it provides opportunities

for arbitrage. In view of the time zone differences and the interest rates differing
across the markets, participants take advantage by taking positions advantageous
to them.
- Added to this, the markets across the globe are liberalized by the respective
home countries inducing the traders/speculators to take advantage of the
arbitrage opportunities available.
Foreign Exchange Markets – I – Participants
The participants in this market are −

Central Banks
Major commercial banks
Investment banks
Corporations for international business transactions
Hedge funds
Speculators
Pension and mutual funds
Insurance companies
Forex brokers
Foreign Exchange Markets – Types of transactions – Cash/Tom/Spot transactions
- Cash transaction – where delivery and settlement of the foreign currency against
the home currency or the intervening currency, takes place the same day.
(Merchant transactions)
- Tom Transaction - where delivery and settlement of the foreign currency against
the home currency or the intervening currency, takes place the next working day.
(time zone currencies)
- Spot transaction is the settlement of the foreign currency against the home
currency or the intervening currency, normally, taking place, on the second
following business day. (Inter-Bank transactions)
Foreign Exchange Markets – Types of transactions – Forward transactions
- Forward transaction requires delivery at a future date of a specified amount of

one currency for a specified amount of another currency. The exchange rate is
established at the time of the agreement, but payment and delivery are not
required until maturity.
- Forward exchange rates are usually quoted for value dates, beyond Spot dates
i.e., 1 month, 2 months 3 months, 6 months and up to 12 – 13 months.
- In all the above cases, the date of settlement is referred to as the value date i.e.
the date on which the respective Bank’s accounts gets debited/credited.
- Concept of Nostro, Vostro and Loro accounts
Foreign Exchange Markets – Types of transactions – futures transactions
Futures Transaction similar to forward transactions and deals with the contracts in
the same manner as that of normal forward transactions but differs from the
transaction made in the forward contract on the following grounds:
(a) Futures are standardized transactions while forwards are over the counter
transactions.
(b) Futures are on the organized exchanges whereas forwards are generally with
Banks.
(c) Futures are based on the margins deposited by the Clients as deposits while
forwards are purely based on the limits set up by the Banks based on the
turnover and relationship of the Clients with the Bank.
Foreign Exchange Markets – Types of transactions - Options
- Option Transactions: Foreign currency option is a contract giving the purchaser

the right but not the obligation to buy or sell a given amount of currency at a
fixed price per unit for a specified time period.
- In other words, Option gives an investor the right, but not the obligation to
exchange the currency in one denomination to another at an agreed exchange
rate on a pre-defined date.
- An Option to buy the currency is called as a Call Option i.e. under CALL, the buyer
has the right to purchase the currency (generally Imports).
- An Option to sell the currency is called as a Put Option i.e. under PUT, the buyer
has the right to sell the currency(generally Exports).
- The buyer of the option is the holder while the seller is the writer.
Foreign Exchange Markets – Types of transactions - Swaps
- Swap Transactions : a simultaneous borrowing and lending of two different

currencies between two investors. Example: an investor borrows the currency
and lends another currency to the second investor.
- the obligation to repay the currencies is used as collateral, and the amount is
repaid at a forward rate.
- swaps can be either Currency Swap or an Interest rate swap or a combination of
both.
- a foreign exchange rate is the price of one currency expressed in terms of
another currency.
- a foreign exchange quotation (or quote) is a statement of willingness to buy or
sell at an announced rate.
Various Forex transactions that are conducted in the forex markets?
Inflows/Inbound remittances Outflows/Outbound remittances
Resident Individuals Resident Individuals
NRIs & Foreign Nationals NRIs & Foreign Nationals
Exports (goods & services) Imports (goods & services)
Foreign Direct Investments Overseas Direct Investments
ECBs/FCCBs
Current account transactions- Retail
Current account- non retail
Capital account transactions

16
THANK YOU
Krishna Kumar S
krishnakumars@pes.edu
International
Hedging Foreign Exchange Exposure
Exchange rate quotations –
Cash/Tom/Spot/Forward – USD/INR
Krishna Kumar S
Foreign Exchange Markets – determination of exchange rates
Objectives
understanding numerical part of Foreign Exchange
- Purchase and sale in Foreign Exchange – Bid – Ask - Spread
- Determination of Exchange rates in Cash/Tom/Spot and forward

markets
- Concept of premium and discount.

Various Forex transactions that are conducted in the forex markets?
Inflows/Inbound remittances Outflows/Outbound remittances
Resident Individuals Resident Individuals
NRIs & Foreign Nationals NRIs & Foreign Nationals
Exports (goods & services) Imports (goods & services)
Foreign Direct Investments Overseas Direct Investments
ECBs/FCCBs
Current account transactions- Retail
Current account- non retail
Capital account transactions

3
Foreign Exchange Markets – Cash settlement
A cash contract * in the interbank market is the exchange of foreign
currency against intervening currency (INR) with delivery and payment,
between Banks, taking place, normally, on the same day. The date of
settlement is referred to as the value date.
Example: Deal dated 2nd Nov 2021
Bank A, Mumbai buys from Bank B, Delhi USD 1,000,000 against INR @
74.9500 value cash i.e.
- Bank A will pay INR 7,49,50,000 to Bank B through RBI account VD
2nd Nov
- Bank B will pay USD 1,000,000 to Bank A through the Nostro a/c VD
2nd Nov
* also known as short dated contract normally used for rolling over the maturity positions in foreign exchange contracts.
Foreign Exchange Markets – TOM settlement
A TOM contract * in the interbank market is the exchange of foreign
currency against intervening currency (INR) with delivery and payment,
between Banks, taking place, normally, on the next working day. The
date of settlement is referred to as the value date.
74.9600 value TOM (presuming 3rd Nov is a working day)
- Bank A will pay INR 7,49,60,000 to Bank B through RBI account VD 3rd
Nov
3rd Nov
* also known as short dated contract normally used for rolling over the maturity positions in foreign exchange contracts.
Foreign Exchange Markets – SPOT settlement
A Spot contract in the interbank market is the exchange of foreign
currency against intervening currency with the delivery and payment
between Banks, taking place, normally, on the second following
business day. The date of settlement is referred to as the Value date.
74.9700 value SPOT (presuming 3rd & 4th Nov are working days)
- Bank A will pay INR 7,49,70,000 to Bank B through RBI account VD 4th
Nov
4th Nov
- A foreign exchange rate is the price of one currency expressed in

terms of another currency.
- A foreign exchange quotation (or quote) is a statement of willingness

to buy or sell at an announced rate.
- Most foreign exchange transactions involve the US dollar.
- Most foreign currencies in the world are stated in terms of the

number of units of foreign currency needed to buy one dollar except
NZD, AUD, EUR, GBP, etc., where it is the reverse.
Foreign Exchange Markets – determination of exchange rates - Quotes
A direct quote is a home currency price of a unit of foreign currency
i.e. 1 USD = 74.9600/74.9700 where 74.9600 is the Bid (buy price of
the Bank quoting the price) and 74.9700 is the Ask (sell price of the
Bank quoting the price. Maxim: buy low sell high.
Indirect quote is a foreign currency price of a unit of home currency i.e.
Rs. 100 = USD 1.3340/1.3339 where 1.3340 is the Bid (buy price of the
Bank quoting the price) and 1.3339 is the Ask (sell price of the Bank
quoting the price. Maxim : buy high sell low.
Most of the global currencies are quoted with USD as the base
currency (1 USD = SFR 0.9114/0.9113…) except NZD, AUD, EUR, GBP
where these currencies are the base currency.
Eg: 1 GBP = USD 1.3627/28., 1 EUR = USD 1.1591/1592
- Many currency pairs are inactively traded and hence their exchange rate
is determined through their relationship to a widely traded third
currency (cross rate).
- Cross rates can be used to check on opportunities for intermarket
arbitrage.
- Two-way arbitrage / three-way arbitrage
THANK YOU
Krishna Kumar S
International
Determination of Exchange rates –
Spot & Forward
Krishna Kumar S
Objectives
understanding
- the factors affecting exchange rates
- determination of Exchange rates in Spot markets and forward markets
- concept of premium and discount
- exchange rate behavior
- cross Rates - Bid – Ask – Spread

The 3 approaches to exchange rate determination –
1. the international parity conditions integrate exchange rates with inflation and
interest rates.
2. the balance of payments approach
3. the asset market approach
It is important to remember that these three theories are not competing, but
rather are complementary to each other.
In addition to gaining an understanding of the basic theories, it is equally important
to gain a working knowledge of how the complexities of international political
economy; societal and economic infrastructures; and random political, economic,
or social events affect the exchange rate markets.
Parity Conditions
1. Relative inflation rates
2. Relative interest rates
3. Forward exchange rates
4. Interest rate parity
Is there a well-developed Is there a sound and secure

and liquid money and capital banking system in-place to support
market in that currency? Spot currency trading activities?
Exchange
Rate
Asset Approach Balance of Payments

1. Relative real interest rates
1. Current account balances
2. Prospects for economic growth
2. Portfolio investment
3. Supply & demand for assets
3. Foreign direct investment
4. Outlook for political stability
4. Exchange rate regimes
5. Speculation & liquidity
5. Official monetary reserves
6. Political risks & controls
Foreign Exchange Markets – determination of exchange rates – BOP approach
The relationship between the BOP and exchange rates can be illustrated by the use
of a simplified equation that summarizes BOP data:
(X – M) + (CI – CO) + (FI – FO) + FXB = BOP

Where X = exports of goods and services, M = imports of goods and services, CI =
capital inflows, CO = capital outflows, FI = financial inflows, FO = financial
outflows and FXB = official monetary reserves.
Fixed Exchange Rate :
- under a fixed exchange rate system, the government bears the responsibility to
ensure a BOP near zero.
- to ensure a fixed exchange rate, the government must intervene in the foreign
exchange market and buy or sell domestic currencies (or sell gold) to bring the
BOP back to near zero.
- it is very important for a government to maintain significant foreign exchange
reserve balances to allow it to intervene in the foreign exchange market
effectively.
Floating Exchange Rate
- Under a floating exchange rate system, the government of a country has no

responsibility to peg its foreign exchange rate.
- the fact that current and capital account balances do not sum to zero will
automatically (in theory) alter the exchange rate in the direction necessary to
obtain a BOP near zero.
Managed Floats:
- countries operating with managed floats, while still relying on market conditions
for day-to-day exchange rate determination, often find it necessary to take action
to maintain their desired exchange rate values.
- they seek to alter the market’s valuation of a specific exchange rate by influencing
the motivators of market activity, rather through direct intervention in the foreign
exchange markets.
- the primary action taken by such governments is to change relative interest rates.
Foreign Exchange Markets – determination of exchange rates – Asset market approach
- The asset market approach assumes that whether foreigners are willing to hold
claims in monetary form depends on an extensive set of investment
considerations or drivers
- relative real interest rates
- prospects for economic growth
- capital market liquidity
- country’s economic and social infrastructure
- political safety
- corporate governance practices
Foreign Exchange Markets – determination of exchange rates – other factors
Inflation
- Inflation in the country would increase the domestic prices of the commodities.
With increase in prices exports may dwindle because the price may not be
competitive. With the decrease in exports the demand for the currency would
also decline; this in turn would result in the decline of external value of the
currency.
- It may be noted that unit is the relative rate of inflation in the two countries that
cause changes in exchange rates.
- If, for instance, both India and the USA experience 10% inflation, the exchange
rate between rupee and dollar will remain the same.
- If inflation in India is 15% and in the USA it is 10%, the increase in prices would be
higher in India than it is in the USA.
- Therefore, the rupee will depreciate in value relative to US dollar.
11
Foreign Exchange Markets – determination of exchange rates – other factors
Interest rate differentials
- Interest rates have great influence on the short term movement of capital.
- when the interest rates, it attracts short term funds from other centres. This
would increase the demand for the currency at the centre and hence its value.
- rising of interest rate may be adopted by a country due to tight money conditions
or as a deliberate attempt to attract foreign investment.
Foreign Exchange Markets – determination of exchange rates – demand & supply
- The higher the supply of foreign exchange in the country, the prices of the
foreign exchange comes down resulting in appreciation of the home currency.
- Higher the demand for foreign exchange in the country, the prices of the
foreign exchange goes up resulting in depreciation of the home currency.
- while appreciation of the home currency makes imports cheaper, depreciation

of the home currency makes the exports competitive.
Foreign Exchange Markets – determination of exchange rates – demand & supply
Foreign Exchange Markets – determination of exchange rates – technicals
- Technical analysts, traditionally referred to as chartists, focus on price and

volume data to determine past trends that are expected to continue into the
future.
- The single most important element of technical analysis is that future exchange
rates are based on the current exchange rate.
- Exchange rate movements can be subdivided into three periods:
• Day-to-day – intra day and overnight
• Short-term (several days to several months)
• Long-term – generally beyond 6 months
Foreign Exchange Markets – determination of exchange rates – technical
… charts …BAR charts

- provides open, high, low and closing rates of a particular security or a position or a
portfolio. Also known as OHLC charts.
- helpful in spotting trends, monitoring stock/security/currency prices and helps dealers in
taking positions or exiting such positions.
USD/INR - Open/High/Low/Closing -Last week
74.70
74.60
74.50
74.40
74.30
74.20
74.10
74.00
73.90
73.80
73.70
02-08-2021 03-08-2021 04-08-2021 05-08-2021 06-08-2021
Open High Low Adj Close

Foreign Exchange Markets – determination of exchange rates – technical
…trend lines
- trend lines represent a consistent change in the prices and showing a trend in the market
movements.
- may be either a rising trend or a falling trend.
USD/INR rising trend line (INR depreciation) during the Lehmann Crisis
47.50
47.00
46.50
46.00
45.50
45.00
44.50
44.00
43.50
43.00
42.50
Open High Low Adj Close

THANK YOU
Krishna Kumar S
International
Exchange rate quotations –Forward
Krishna Kumar S
Foreign Currency Futures
Examples
• Calculate the premium for the three month future rate,
• if spot S (Re/$) = 45.6500/7000 and
• Three
• month futures rate is F (Re/$)= 45.5000/5500
-
Examples
• From the US $ based quotations for the new Zealand dollar (NZ$) and
the Indonesian rupiah, Calculate the cross rate for the NZ$ in terms of
the rupiah. Quotation are as follows.
• NZ$/US$ = 1.9552
• IR/US$ = 2054
•
Fundamental No-Arbitrage Equation
(Theoretical Futures Price)
• In the case of currencies, the return takes the form of interest on the
foreign currency.
Example
• Assume on march 10, 2018, six month annual interest rate was
9% p.a. on Indian rupees and US dollar six month rate was 1% per
annum. The spot Re/$ exchange rate was 65.3500. Using the above
information calculate the theoretical futures price on March 10, 2018,
expiring August 9, 2018.
THANK YOU
Krishna Kumar S
International Financial Management
Options
Krishna Kumar S
Foreign Exchange Markets – Options
Objectives
Understanding Options
Options - meaning
- Foreign currency option is a contract giving the purchaser the right but
not the obligation to buy or sell a given amount of currency at a fixed
price per unit for a specified time period.
- The two basic options are the call & the put options.
- Under CALL, Buyer has the right to purchase the currency (generally
Imports) and under PUT, Buyer has the right to sell currency (generally
Exports).
- The buyer of the option is the holder while the seller is the writer.
Options – elements
- Every option has 3 different price elements.
- The strike or exercise price is the exchange rate at which foreign

currency can be purchased or sold.
- The premium is the cost of the value of the option paid at the time
the option is purchased.
- The actual spot rate in the market at the time the option is
purchased.
Options - types
- American options – exercised any time during the life of the option
contract.
- European options – exercised only on the specified maturity date.
- Options may also be classified as :
(a) At the Money options where the strike price is equal to the spot
price.
(b) In the Money options where the strike price is more favorable to
the buyer of the option than the current market price.
(c) Out of Money options where the strike price is less favorable to the
buyer of the option than the current market rate.
Options - pricing
Pricing of an option combines 5 elements:
(a) present spot rate

(b) time to maturity
(c) forward rate for the underlying matching maturity
(d) interest rates for the intervening currency
(e) Volatility *
• Option volatility is defined as the standard deviation of the daily percentage changes in the
underlying exchange rates. It is the most important variable because of the exchange rates
perceived likelihood to move either in or out of the range in which the option would be exercised.
Volatility is stated on p.a. basis – the present vols factor is 7.90 %.
• Volatility is viewed in 3 ways –(a) historic volatility which is normally measured as a percentage of
movement in spot rate on daily basis.,(b) forward looking volatility - adjusting volatility for
expected market swings., and (c) implied volatility which is calculated by backing out of the market.
• The primarily problem of volatility is that it is unobservable and there is no single correct method of
calculation.
Plain Vanilla Options
Market Spot: 75.85, 1yr Forward: Rs.2.05Paise

Cost of the option: Rs. 2.95 paise
• Summary : Exporter buys put @ Rs. 77.90
• If spot at maturity is below 77.90, exporter sells USD at 77.90
• If spot at maturity is above 77.90, exporter sells USD at market
• Effective worst case rate for exporter = 74.95 (77.90 – 2.95)

• Cost of the option: Rs. 2.95 paise.
• When would the exporter want to buy option rather than a forward
?
When he feels that rupee could depreciate beyond the forward levels
And caps the downside
Payoff Matrix…
Market Spot: 75.85, 1year Forward: 77.90

Cost of the option: 2.95 paise
•Exporter buys Put @ 77.90
•Cost of the Option is 2.95 per USD
•Pay off at maturity
Spot Scenario’s 74.00 75.80 77.90 78.50 79.20
Payoff of a Forward 3.90 2.10 0.00 (0.60) (1.30)
Payoff of the Option 0.95 (0.85) (2.95) (2.35) (1.65)

ITM ITM ATM OOM OOM
Hedging – Call Options On 1st Jan, ABC buys a call option for covering its import payment at a
strike price of 1 USD = 75.50 expiring on 30th June. The premium paid is
Option pay-off 0.30 paise.
- What is the option pay-off ?

- What is the difference between forwards & options
Spot rate Exercise rate Premium Gain/loss
74.50 74.50 0.30 - 0.30(OOM)

+ 0.20 75.00 75.00 0.30 - 0.30(OOM)
75.50 75.50 0.30 - 0.30 (ATM)
0.00
76.00 75.50 0.30 +0.20 (ITM)
74.50 75.00 75.50 76.00
- 0.30 Characteristics of non-linear derivatives :
- Change in the stock to the change in the option pay-off is not linear.
Underlying - prices - The pay-off is not proportionate to the change in the underlying.
- Delta keeps changing as the value pf the underlying changes.
- In other words, the pay-off changes with time & value.
9
International
Options
Krishna Kumar S
Black-Scholes Option Pricing Model
Where C: current price of a call option

S: current market price of the underlying stock
X: exercise price
r: risk free rate
t: time until expiration
N(d1) and N (d2) : cumulative density functions for d1 and d2
Example 1
Current stock price: 50 exercise price : 55
Risk free rate: 6.25% time to expiration: 6 months
Volatility: 40% What is the call price?
Solution
N(d1) = 0.4661 N(d2) = 0.3564

Put call parity
■ Relationship between the price of a put option and
the price of a call option on the same underlying
equity.
■ Using the same values before,

Example 2
• Calculate the value of three month at the money European call option
on stock index when the index is at 250, risk free interest rate is at
10% per annum, volatility of index is 18% per annum.
Tables for N(X)
When d takes positive value
•
Tables for N(X)
When d takes Negative value
•
THANK YOU
Krishna Kumar S
International
SWAP
Krishna Kumar S
Swaps
• Swaps are derivative instruments that represent an agreement

between two parties to exchange a series of cash flows over a specific
period of time.
• Swaps offer great flexibility in designing and structuring contracts

based on mutual agreement. This flexibility generates many swap
variations, with each serving a specific purpose.
Factors influencing Usage of Swaps
• Investment objectives or repayment scenarios may have changed.
• There may be increased financial benefit in switching to newly

available or alternative cash flow streams.
• The need may arise to hedge or mitigate risk associated with a

floating rate loan repayment.
Types of Swap
1. Interest Rate Swap
2. Currency Swap
Interest Rate Swap
• Where cash flows at a fixed rate of interest are exchanged for those referenced to
a floating rate.
• An interest rate swap is a contractual agreement to exchange a series of cash
flows.
• One leg of cash flow is based on a fixed interest rate and the other leg is based on
a floating interest rate over a period of time.
• There is no exchange of principal. The size of the swap is referred to as the
notional amount and is the basis for calculating the cash flows.
Currency Swap
• Where cash flows in one currency are exchanged for cash flows in
another currency.
• A currency swap is contractually similar to an interest rate swap.
• The transactional value of capital that changes hands in currency

markets surpasses that of all other markets.
• Currency swaps offer efficient ways to hedge forex risk.

Interest rate Swap- Numerical
• Company A and company B both wish to borrow Rs. 10,00,000.
• Company A (well known company) wants to arrange floating rate loan.
• Company B (less known company) wants to arrange fixed rate loan.
• They have been offered the following terms.
Company Name Fixed rate

Company A 6% MIBOR + 0.5 %
Company B 9% MIBOR + 2 %
• Compute equal arbitrage profit share and cost of loan for each company.
•
Currency Swap
• In a currency swap, one counterparty exchanges the debt service

obligations of a bond denominated in one currency for the debt service
obligations of the other counterparty denominated in another currency.
• The basic currency swap involves the exchange of fixed-for-fixed rate debt
service. Some reasons for using currency swaps are to obtain debt
financing in the swapped denomination at a cost savings and/or to hedge
long-term foreign exchange rate risk.
Example 1
• A U.S. MNC desires to finance a capital expenditure of its German
subsidiary. The project has an economic life of five years. The cost of the
project is €40,000,000. At the current exchange rate of $1.30/€1.00, the
parent firm could raise $52,000,000 in the U.S. capital market by issuing
five-year bonds at 8 percent.
• Suppose the U.S. parent can borrow €40,000,000 for a term of five years at
a fixed rate of 7 percent. The current normal borrowing rate for a well-
known firm of equivalent creditworthiness is 6 percent.
Example 1 continued
• Assume a German MNC of equivalent creditworthiness has a mirror-image financing need. It has
a U.S. subsidiary in need of $52,000,000 to finance a capital expenditure with an economic life of
five years. The German parent could raise €40,000,000 in the German bond market at a fixed rate
of 6 percent and convert the funds to dollars to finance the expenditure.
• The German parent could issue Eurodollar bonds, but since it is not well known its borrowing cost
would be, say, a fixed rate of 9 percent.
• Design a swap agreement. it is assumed that the bid and ask swap rates charged by the swap
bank are the same; that is, there is no bid-ask spread.
THANK YOU
Krishna Kumar S
Exchange rate numerical – Cash/Spot/Forwards – Cross Currency
Krishna Kumar S
Objectives
Understanding and calculating
- EUR/INR Cash rates., EUR/INR Spot rates., EUR/INR Forward Rates
- GBP/INR Cash rates., GBP/INR Spot rates., GBP/INR Forward Rates

Numerical – EUR/USD Rates – Cash, Spot, Forward settlements.
USD/INR Rates
Spot 74.3500/74.3600
Cash/Spot 2/3 ., Swap Points 1 Month : 19/21., 3 months : 45/46., 6 months
166/169., 12 months 342/344
EUR/USD Rates
Spot 1.1432/1.1442
Cash/Spot - Global currencies are not quoted on Cash basis because of the time
zone differences., Swap Points 3 months : 31/32., 6 months 54/55.,
While SWAP points USD/INR are also known as paise., SWAP points in Cross
currencies are known as PIPS.
1.Calculate EUR/INR - value cash
2.Calculate EUR/INR - 3 months forward
3.Calculate EUR/INR - 6 months forward
To calculate EUR/INR , EUR/USD and the USD/INR route to be used.
Solution No. 1 - Calculate EUR/INR - value cash

Inter-Bank Spot Buy 74.3500 Sell 74.3600., Spot EUR/USD 1.1432/1.1442
Deduct C/S 0.0300 0.0200
(Deduct Max for Purchase/Min for Sale).
Inter-Bank Cash 74.3200 74.3400
(Cash/Spot does not arise in EUR/USD)
Inter-Bank Spot Buy 1.1432 1.1442 (EUR/USD taken on spot basis)
EUR/INR 84.9626 85.0598
Bank’s margin 0.0500 0.0500
(Deduct margin for Purchase/Add margin for sale)
Customer’s rate 84.9126 85.1098
Rounded off 84.9125 85.1100
Solution No. 2 - Calculate EUR/INR - 3 months Forward
Inter-Bank Spot Buy 74.3500 Spot Sell 74.3600
+ 3 month premium 0.4500 0.4600
(Premium is added for Purchase & for Sale).
Inter-Bank Forward 74.8000 74.8200
Inter-Bank Spot Buy 1.1432 1.1442
+ 3 month premium 0.0031 0.0032
EUR/USD 3 month 1.1463 1.1474
EUR/INR 1.1463 X 74.80 1.1474 X 74.8200
EUR/INR 85.7432 85.8484
Rounded off 85.6930 85.8985
Solution No. 3 - Calculate EUR/INR - 6 months Forward
+ 3 month premium 1.6600 1.6900
Inter-Bank Spot Buy 1.1432 1.1442
+ 3 month premium 0.0054 0.0055
EUR/USD 3 month 1.1486 1.1497
EUR/INR 1.1486 X 76.01 1.1497 X 76.05
EUR/INR 87.3050 87.4346
Rounded off 87.2550 87.4850
Calculation of Exchange rates
Basic concepts - theoretical
Cash Spot to be deducted from the Spot rates
To arrive at the Cash rate (buying) deduct maximum and in case of cash rate (Selling)
deduct minimum
Premium/Discount – if the swap points are in ascending order, the points denote
premium and if the Swap points are in descending order, the points denote discount
If the base currency is at a premium, add premium to the Spot rate to arrive at the
Forward rate.
If the base currency is at a discount, deduct discount from the Spot rate to arrive at
the Forward rate.
Calculation of Exchange rates
Exercise to the Students
On the similar lines of EUR/USD., calculate GBP/INR rates given the following details :
USD/INR 74.3500/74.3600
Swap points 3 months 45/46., 6 months 166/169
GBP/USD Spot 1.3447/1.3457
Swap Points 3 months 27/25., 6 months 35/30.,
Calculate GBP/INR Value Cash., GBP/INR Value spot., GBP/INR value 3 months.,
GBP/INR value 6 months
Exchange rate numerical – Cash/Spot/Forwards – USD/INR
Krishna Kumar S
Objectives
Understanding and calculating
- USD/INR Cash rates ., USD/INR Spot rates., USD/INR Forward Rates
- EUR/INR Cash rates., EUR/INR Spot rates., EUR/INR Forward Rates
- GBP/INR Cash rates., GBP/INR Spot rates., GBP/INR Forward Rates

Numerical - USD/INR Rates – Cash, Spot, Forward settlements.
Spot 74.3500/74.3600
Cash/Spot 2/3
Swap Points 1 Month : 19/21., 3 months : 45/46., 6 months 166/169., 12 months
342/344
Calculate purchase rate and the sale rate for the Customer assuming a margin of 5
paise for both purchase and sale transactions.
1.USD/INR Value Cash
2.USD/INR Value 1 month
3.USD/INR value 6 months
4.USD/INR value 12 months
Solution : (1) - cash rates
Deduct C/S 0.0300 Deduct C/S 0.0200
(Deduct Max for Purchase/Min for Sale).
Inter-Bank Cash 74.3200 74.3400
Solution : (2) - 1 Month forward rate
+ 1 month premium 0.1900 0.2100

+ 3 month premium 0.4500 0.4600

+ 6 month premium 1.6600 1.6900

+ 12 month premium 3.4200 3.4400

IFM Unit 3

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International

Foreign Exchange Markets – I

- Understanding the meaning of Foreign Exchange, Foreign Exchange markets.,

- Structure and functions of Foreign Exchange markets.

- Types of foreign exchange transactions Cash/Tom/Spot and Forward contracts

- Exchange rate quotations

- International transactions, like domestic transactions, require money flows at

- This transfer of purchasing power is effected through a variety of credit

- A third function of the foreign exchange market is to hedge foreign exchange

- A fourth function of the foreign exchange market is that liquidity is created in

- In a free exchange market, in view of the various monetary instruments available

- A fifth function of the foreign exchange market is that it provides opportunities

The participants in this market are −

- Forward transaction requires delivery at a future date of a specified amount of

- Option Transactions: Foreign currency option is a contract giving the purchaser

- Swap Transactions : a simultaneous borrowing and lending of two different

Resident Individuals Resident Individuals

NRIs & Foreign Nationals NRIs & Foreign Nationals

Exports (goods & services) Imports (goods & services)

Foreign Direct Investments Overseas Direct Investments

Current account transactions- Retail

Current account- non retail

Capital account transactions

understanding numerical part of Foreign Exchange

- Purchase and sale in Foreign Exchange – Bid – Ask - Spread

- Determination of Exchange rates in Cash/Tom/Spot and forward

- Concept of premium and discount.

Resident Individuals Resident Individuals

NRIs & Foreign Nationals NRIs & Foreign Nationals

Exports (goods & services) Imports (goods & services)

Foreign Direct Investments Overseas Direct Investments

Current account transactions- Retail

Current account- non retail

Capital account transactions

- A foreign exchange rate is the price of one currency expressed in

- A foreign exchange quotation (or quote) is a statement of willingness

- Most foreign exchange transactions involve the US dollar.

- Most foreign currencies in the world are stated in terms of the

- the factors affecting exchange rates

- determination of Exchange rates in Spot markets and forward markets

- concept of premium and discount

- exchange rate behavior

- cross Rates - Bid – Ask – Spread

Is there a well-developed Is there a sound and secure

Asset Approach Balance of Payments

(X – M) + (CI – CO) + (FI – FO) + FXB = BOP

Floating Exchange Rate

- Under a floating exchange rate system, the government of a country has no

- while appreciation of the home currency makes imports cheaper, depreciation

- Technical analysts, traditionally referred to as chartists, focus on price and

… charts …BAR charts

Open High Low Adj Close

Open High Low Adj Close

- The strike or exercise price is the exchange rate at which foreign

- European options – exercised only on the specified maturity date.

- Options may also be classified as :

(a) present spot rate

Market Spot: 75.85, 1yr Forward: Rs.2.05Paise

• If spot at maturity is below 77.90, exporter sells USD at 77.90

• If spot at maturity is above 77.90, exporter sells USD at market

• Effective worst case rate for exporter = 74.95 (77.90 – 2.95)

Market Spot: 75.85, 1year Forward: 77.90

Payoff of a Forward 3.90 2.10 0.00 (0.60) (1.30)