Class work 02 – Practice Questions on Unit 01 and Unit 02

Unit 01 – Introduction to Forex markets

1) Discuss the various types of instruments through which a FDI can happen in an Indian
company and state the most common route through which the FDI is done in Indian
companies.
2) Inflation differential between two countries is an important macroeconomic variable
that will have an impact on exchange rates between two currencies. Explain
3) How can purchasing power parity be used to explain the exchange rates prevailing
between two pair of currencies? Give an example.
4) Explain the broad structure of players in the foreign exchange market and their
importance in the functioning of the foreign exchange market.
5) Workout the annualized premium, if the USD / INR spot rates are quoted as 67.50 /65
and the one month forward rate for the same pair is quoted at 38 / 40.
6) Presently all the nations are at cross roads and are facing macroeconomic parameter
such as prevalence of hardening yields on bonds, monetary tightening by US Federal
reserve after a decade long time, increasing oil prices, hyperinflation etc. Elaborate
the role the exchange rate of a country plays in tackling this situation and their
implication for their economic activity.
7) For 12th August 2016, Friday, provide the cash, spot and tom dates and days.
8) Assume that the 1-year U.S. interest rate is 11 percent, while the 1-year interest rate in
Malaysia is 40 percent. Assume that a U.S. bank is willing to purchase the currency of
that country from you 1 year from now at a discount of 13 percent. Would covered
interest arbitrage be worth considering?
9) Show the 3 month & 4 month forward quotes in the OTC markets for the swap points
of 40/30 & 30/40 respectively. Assume the ongoing spot rate of USD / INR to be
67.50/70.
10) If the annualized premium for USD / INR for 6 months is 6% p.a and the USD
interest rate for a corresponding period is 0.25% p.a., under what conditions would an
arbitrage be possible in the money market swaps in USD / INR?
11) An exchange rate between two currencies has increased to 1.45. If the base currency
has appreciated by 8% against the price currency, what was the initial exchange rate
between the two currencies?
12) “Spreads are liquidity indicators”. Justify with appropriate arguments.
13) "Swap points may be used as an indicator for assessing the future movement of a
currency". Do you agree? Substantiate.
14) Consider the following interbank quotes for EUR against INR and explain the
arbitrage possibility: HDFC Bank 82.50/65 and ICICI Bank 82.60/75
15) Does inflation have an impact on the currency valuation? If yes, then can it be used as
an indicator while selecting the country for borrowing funds by a company?
Interest rate arbitrage
16) Wander burg Inc., a US based company has $5 million in excess cash available for 90
days. It is considering the use of covered interest arbitrage since 90-day interest rate
 in India is higher than the US interest rate. What will determine whether this strategy
is feasible?
17) A recent Bloomberg report (27th July 2018) states that an economic crisis awaits
Pakistan’s new Prime Minister Imran Khan as the country struggles with foreign-
reserves crunch in the global backdrop of higher oil prices, trade war tensions and an
emerging-market sell-off. For many Pakistan watchers, a bailout from the
International Monetary Fund may be an inevitable next step. State some of the major
objectives of IMF in the context of currency crisis that occurs in economies from time
to time.
International Monetary System and Exchange rate Regimes
18) SDR is not a traded currency but still is part of external reserves of countries. Explain
the nature and use of SDRs.
19) From India’s perspective, freedom of international capital movement in and out of the
country is only sustainable if the central bank sacrifices either exchange rate stability
or an activist monetary policy. Comment.
20) Rapidly changing global prospects has revived the debate on the evolving
international monetary system and the international reserve currency that will
underpin it. Since the 1940s, the US dollar remains the world's dominant reserve
currency. Developments since 2008 have challenged the pre-eminence of the US
dollar. The euro appeared to have provided an alternative during 2000-08, but has
come under fire since early 2010. Prospects for internationalisation of emerging
economy currencies like Yuan are still limited. The recent events have resurrected
interest in the special drawing right (SDR) as an international reserve currency.
Discuss suitability of SDR as reserve currency in the light of essential required
attributes of an international reserve currency.
21) Rupee has depreciated against USD in the recent months. Having experienced an
attack on the rupee towards the end of his term (2008-13) as Governor of Reserve
Bank of India, D. Subbarao has provided three point prescription to country's central
bankers: be less interventionist, define excess volatility and admit building of reserves
is a prime aim. Why do you think these three points are important and critically
analyse their connectedness.
22) "Fixed Exchange rate system fixes the exchange rate volatility, but snatches the
freedom of the government in terms of monetary policy decisions". Express your
views on the issue, mentioning the alternate system of exchange rate determination
available to a country.
23) Tariff and non-tariff trade barriers help a nation decide the extent to which it would
want to trade internationally? Evaluate the statement.
24) Explain the necessity of devaluation of a currency, citing an example.
25) Mention any two features of “Currency Board System” and mention the difference
between a "No separate legal tender" and "Currency Board" systems with one
example of a country that has adopted each of these systems.
26) As an investor, state the factors that you would consider before investing in the
emerging stock market of a developing country from an exchange rate perspective?
 27) When the European region got into serious problems, a potential challenger for USD
as international reserve currency got weakened. Do you agree? China is pushing for
Yuan as having such a potential. Discuss the internationalisation of the Chinese
currency and assess how it is shaping up to be a reserve currency.
28) 'Free float' is more suitable to developed nations whereas 'float' is more of a
developing nation’s phenomenon. Evaluate this statement.
29) What is the difference between devaluation and depreciation of a currency?
30) “Monetary Union is an advanced form of Target Zone arrangement”. Express your
views giving appropriate example.
31) “Fixed Exchange rate system fixes the exchange rate volatility, but snatches the
freedom of the government in terms of monetary policy decisions”. Express your
views on the issue, mentioning the alternate system of exchange rate determination
available to a country.
32) “Dollarization is generally taken as a pill for prolonged period of hyperinflation”.
Explain and state the limitations it brings to the Central Bank and the Government of
the country which chooses this system of exchange rate management.
33) “Currency Board” exchange rate system imparts stability of exchange rate but takes
away the economic freedom? Express your views.
Balance of Payments and Exchange rate regimes
34) Is running a deficit in current account of a nation a problem? State your understanding
and comment on current account deficit situation in India.
35) How would a relatively high home inflation rate affect the home country’s current
account, other things being equal? Is a negative current account harmful to a country?
Discuss.
36) Classify the following transactions into Current A/c and Capital A/c:
a. A tourist from India spends USD 2000 for hotel stay in US.
b. Wipro exports software worth USD 5 million.
c. Tata Steel raised USD 5 million through ECB route to fund its expansion of
projects in UK.
37) Explain the item ‘Portfolio Investment’ in 'Balance of Payment' accounts of a nation.
38) What are the components of the current account and capital account in a Balance of
payment statement of a country?
39) “Full Currency convertibility is a necessary pre-condition for globalization”.
Substantiate.
40) “Trade deficit, Budget deficit, current account deficit and fiscal deficit” – all
communicate different aspects. Evaluate this statement.
41) Assess the impact on BOP accounts of India, if an Authorized Dealer sells 1million
USD to the Reserve Bank of India.
Unit 02 – Forex risk exposure of a firm
42) Mention two transactions that would lead to transaction exposure of a firm.
43) Discuss the determinants of operating exposure.
44) Describe the different types of foreign exchange exposure that an MNC is exposed to
and what are the different financial and non-financial tools that firms adopt for forex
exposure management?
45) Currency swaps can be used to convert assets/liabilities from one currency to another.
Explain with a suitable example
46) General Motors exports cars to Spain, but the strong dollar against the euro hurts sales
of GM cars in Spain. In the Spanish market, GM faces competition from Italian and
French car makers, such as Fiat and Renault, whose operating currencies are the euro.
What kind of measures would you recommend so that GM can maintain its market
share in Spain?
47) Flagstaff Corp. is a U.S.–based firm with a subsidiary in Mexico. It plans to reinvest
its earnings in Mexican government securities for the next 10 years since the interest
rate earned on these securities is so high. Then, after 10 years, it will remit all
accumulated earnings to the United States. What is a drawback of using this
approach? (Assume the securities have no default or interest rate risk.)
48) A US company enters into a currency swap in which it pays a fixed rate of 5.5% p.a in
euros and the counter-party pays a fixed rate of 6.75% p.a in dollars. The notional
principals are $ 100 million and Euros 116.5 million. The period of swap is 2 years.
Calculate the initial exchange of payments that takes place at the beginning of the
swap and the four semi-annual payments. Also calculate the final exchange of
payments that takes place at the end of the swap.
49) A U.S firm holds an asset in France and is trying to work out the operating exposure
faced by them. The annual economic survey report in France reveals that, there are
30% chances that the economic conditions in France will improve and the expected
exchange rate then will be 1.15$/€ & the asset price will be €1800. There are 50%
chances of things maintaining status quo, the exchange rate in that case will hover
around 1.10 $/€ with asset price of €1540. However, if economic conditions
deteriorate further, the possibility being 20%, the exchange rate will be .80$/€ & the
asset price will come down to €1100.
a. Estimate the operating exposure faced by the firm.
b. Compute the variance of the dollar value of the asset that is attributable to the
exchange rate uncertainty.
c. Offer your advice on the hedging strategies that the firm could adopt.
50) "Translation gains / losses are just book adjustments". Do you agree? Substantiate
your understanding.
51) Rupee needs to remain strong to fight import-led inflation, say experts in the article
that appeared in the Business Standard dated 19th July 2016, which extensively
discussed the role of REER and NEER as an important metric to the levels of an
exchange rate. Explain the impact of this for exporting and importing companies from
the point of view of managing multinational operations.