Professional Documents
Culture Documents
Forex Nagandra Sir
Forex Nagandra Sir
Forex Nagandra Sir
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H
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P Foreign Exchange Risk Management
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Contents:
1. Introduction
2. Major foreign currency
3. Regulator of forex market in India
4. Types of Forex Market.
5. How transaction takes place in forex?
6. Bid, Ask and Spread
7. Exchange rate quotation (One way quote & Two way quote)
8. Interpretation of exchange rate
-Quoted in form “/€”
-Quoted in compressed form
-Few other cases
9. Types of transaction in Forex
10. Forward premium & Discount:
11. Direct quote & Indirect quote
12. Loss/gain due to Forward cover; Premium/Discount on currency
13. Swap point/Forward margin/Forward Spot differential.
14. Exchange margin
15. General concept question
16. Benefit of Early Payment
17. Cross Rates of Foreign Exchange
18. Hedging technique:
-Hedging through Forward market
-Hedging through Money (cash) Market Operation:
-Leading/Lagging
-Rupee Roll-Over-forward Contracts
-Currency option (Refer derivative)
-Currency future (Refer derivative)
19. Exchange rate determination Theory
-Interest Rate Parity (IRPT)
-Purchasing Power Parity OR Inflation rates parity
20. Nostro A/C ; Vostro A/C & LORO Account
-Maintaining Exchange position and Nostro A/C
-Transaction through demand draft (DD)
RBI FEDAI
(Reserve Bank Of India) (Foreign Exchange Dealers Association)
Forex Market
Under inter Bank Market one Bank Under retail Market Bank deal with Customer.
deal with other bank Exchange rate of retail market is known as
Exchange rate of Inter-bank Merchant rate.
market is known as Inter Bank rate. A customer can buy or sell currency only at
Only bank can deal at Inter Bank merchant rate.
rate. Merchant rate is derived from interbank rate
by adding or deducting exchange margin.
Forex Market is a world’s largest market whose average daily turnover is around $ 4 trillion.
1 million = 10 Lacs
1 billion = 1000 million
1 trillion = 1000 billion
Export to UK co.
USA Company($) 1 UK Company (£)
Inflow at 3 Month Invoice Amount: Outflow at 3 Month
Option A: $ 10,000
(Credit period 3M)
3 2B 2A
$ £
UK co. make payment at 3
month time in ‘$’ Currency UK Bank
Buy £, sell $
When invoice is in “$”: chain in steps, made in figure 12A2B3. (at end, USA co. get money in $)
Analysis for USA co: when invoice is in home currency ($) No risk on USA co. No need to hedge foreign currency
receipt and hence no need to study FOREX management.
Analysis for UK co: when invoice is in foreign currency ($) Risk lies on UK co. UK Company need to hedge
foreign currency payment.
Export to UK co.
USA Company($) 1 UK Company (£)
Inflow at 3 Month Invoice Amount: Outflow at 3 Month
Option A: £ 5,000
(Credit period 3M)
3B 3A 2
$ £
UK co. make payment at 3
USA Bank month time in ‘£’ Currency
Buy £, sell $
When invoice is in “£”: chain in steps, made in figure 123A3B. (at end, USA co. get money in $)
Analysis for USA co: when invoice is in foreign currency (£) Risk lies on USA co. Need to hedge foreign currency
receipt.
Analysis for UK co: when invoice is in home currency (£) No risk on UK co. No need to hedge home currency
payment hence no need to study FOREX management.
Export to UK co.
USA Company($) 1 UK Company (£)
Inflow at 3 Month Invoice Amount: Outflow at 3 Month
Option A: € 5,000
(Credit period 3M)
4B 4A 3 2B 2A
$ € € £
UK co. make payment at 3
USA Bank month time in ‘€’ Currency USA Bank
Buy €, sell $ Buy £, sell €
When invoice is in “€”: chain in steps, made in figure 12A2B34A4B. (at end, USA co. get money in $)
Analysis for USA co: when invoice is in foreign currency (€) Risk lies on USA co. Need to hedge foreign currency
receipt.
Analysis for UK co: when invoice is in foreign currency (£) Risk lies on UK co. also Need to hedge foreign
currency payment.
Conclusion:
From the above analysis it is clear that Hedging is done only when the invoice is being made in foreign currency.
Hedging is not required when invoice is made in home currency.
If question ask for any measures of hedging, it mean the currency payable or receivable is always foreign currency.
Hence do not get confused to recognize which currency is foreign currency and which currency is home currency.
Just identify the currency in which invoice is being made (i.e. currency in which amount payable or
receivable), and conclude that invoice currency is always foreign currency. On basis of this currency identify
the company who has to take corrective action to minimize loss.
How to apply two way quote rate, for converting one currency into other currency?
1. Identify amount payable or receivable?
For example: assume invoice amount is $ 1,00,000/- which will be payable in 3 month time.
Here amount payable is $ 1,00,000/-, means customer have to buy $ from bank. We made diagram on the
basis of our requirement but think what will do bank for ‘£’ currency and not for ‘$’ currency because left
hand currency given in rate is ‘£’ currency.
Conclusion: Apply Bid rate i.e. $ 1.5 for conversion of $1,00,000.
Example-2:
Given exchange rate is /¥ = 2.25/2.40 What does it mean?
Strength wise currency list for some important currency: (strongest to weakest currency sequence):
1. Kuwaiti Dinar-KWD 195
2. Pound –GBP (£) 85
3. Euro-EUR (€) 70
4. Swiss Franc (CHF) 58
5. US Dollar-USD ($) 55
6. Indian Rupee-INR () 1
7. Japanese Yen-JPY (¥) 0.70
Example 3:
Given Rate: ( per €): 0.0165 – 0.0175 . What does it mean?
In this case we do not need any interpretation because question specifically written per €.
It mean: € = 0.0165 – 0.0175
Solve question assuming per € even rate is illogical, because rate is specifically written as per € and we know that
specific provision overrides general.
Alternatively one can use this rate as per logic i.e. € per on the basis of strength. Both will be correct – i.e. on the
basis of strength and another, on the basis of specific information.
Example-2:
Given exchange rate is 1$ = 45.5189/12
It means rate is: 1$ = 45.5189/ 45.5212
Type of Transaction
Diagrammatic representation:
$ Payment in $
Settlement Date:
Bank Ready Transaction: Immediate
Value tom: Next Business Day
Spot Transaction: T+2 Bus. Day
Agreement Date: Today for all types of transaction Forward Transaction: Future day
Applicable rate: Ready rate, Value tom rate, Spot rate, forward
rate as the case may be.
Note:
In all transaction Exchange rate is decided today and settlement being made at different date. For different type of
transaction different rate is applicable. The exchange rate for each transaction is not same.
Normally, we use spot rate transaction for current settlement. And Forward transaction for future Settlement.
Ex-(2)
Today Future date
$ will be on Premium
$ 1 = 50 Case-I Premium amount = 5.55
1 $ = 55.55
% premium = 100 = 11.11%
Case-II
$ will be on discount
1 $ = 47.62 Discount amount = 2.38
% Discount = 100 = 4.76%
Ex-(3) All rates are same as Ex-2, but quoted in indirect form.
In case - I $ will be on premium and will be on discount. But Rate is different (i.e.11.11% & 10%)
Inc case -II$ will be on Discount and will be on Premium But Rate is different (i.e. 4.76% & 5%
How to calculate forward premium or discount when spot rate and forward rate is given:
First decide on which currency you have to calculate premium rate of discount rate.
Check the quotation, whether it is direct quote or indirect quote for the decided currency.
If calculated value is +ve Means premium If calculated value is +ve Means premium
If calculated value is –ve Means discount If calculated value is –ve Means discount
How to calculate forward rate when forward premium & Discount given?
Take spot rate. (say $1 = 45)
Multiply by (1+premium rate) to the other currency
(i.e. if premium is on $ then multiply in amount or vice versa). Or
Multiply by (1- discount rate) to other currency
(i.e. if discount is on $ then multiply in amount or vice versa).
Note: To solve practical problem, we will think direct quote/indirect quote for any one currency and not for any
country.
$1 = 48 Direct quote for $ and Indirect quote for
Indirect quote: 1 = / i.e. 1 = 0.0219 / 0.0222 (Bid rate < Ask rate)
Calculation of gain/Loss
Suppose a person has to buy 1 Kg Apple.
Today 6 month
Loss due to forward cover if 6 month rate is 47 = 2 Gain If Rate at 6 month time is given then
Loss due to forward cover if 6 month rate is 46 = 1 Gain calculate loss/gain using forward rate
and 6 month time rate.
Add to spot rate to arrive forward rate. Deduct from spot rate to arrive forward rate.
Example 1: Spot Rate $1 = 40.4800 / 4900 Example1: Spot rate $1 = 40. 4800 / 4900
Forward Premium .1100 / .1300 (increasing Forward premium .1255 / .1200 (decreasing
trend) trend)
Solution: Forward Rate: 40.4800 / 40.4900 Solution: Forward Rate: 40.4800 / 40.4900
+ .1100 + .1300 (-) .1255 (-) .1200
40.5900 40.6200 40.3545 40.3700
i.e. Forward rate: $ 1 = 40.5900 / 40.6200 i.e. Forward rate: $ 1 = 40.3545 / 40.3700
Solution: Forward Rate: 52.60 / 52.70 Solution: Forward Rate: 52.60 / 52.70
+ . 20 + . 70 (-) .30 (-) .25
52.80 53.40 52.30 52.45
i.e. Forward rate: $ 1 = 52.80 / 53.40 i.e. Forward rate: $ 1 = 52.30 / 52.45
Notes for example-2: The point “7 ” given in spot rate is not swap point because it is not the difference in
forward rate and spot rate. It is simply the quotation method as we quote telephone No 24321152/53 it means we
are quoting two telephone no. (1) 24321152 and (2) 24321153. However point given in 3 month forward is not
quotation method like telephone no. it is difference in forward rate and spot rate.
Exchange margin
Exchange margin is the extra amount or percentage charged by the bank over and above the rate quoted by bank.
How to calculate Exchange rate (for both spot rate and forward rate) using exchange margin?
When we are given the Spot rate / forward rate with margin for buying rate and margin for selling rate then effective
rate will be calculated as:
Deduct margin from buying rate to get desired Add margin to selling rate to get desired exchange
exchange rate. Hence, rate. Hence,
Actual buying rate = Bid rate (1-exchange margin) Actual selling rate = Ask rate (1+exchange margin)
Example:
Example: Given rate $1 = . 40.4800 / 40.4900 Example: Given rate $1 = . 40.8300 / 40.8650
Margin 0.08% for Buying rate Margin .25% for selling rate
Solution: Solution:
Desired buying rate $1=40.4800 (1-0.0008) Desired selling rate $1 = 40.8650 (1+0.0025)
= . 40.4476 = . 40.9672
Logic behind addition or deduction: Everyone wants to buy at low rate and wants to sell at high rate. Hence deduct
margin from buying rate to arrive at low rate and add margin to selling rate to arrive at high rate.
Question No. - 3D
A firm is contemplating import of a consignment from the USA for a value of US dollars 10,000. The firm requires
90 days to make payment. The supplier has offered 60 days interest free credit and is willing to offer additional
30 days credit at an interest rate of 6% p.a. The bankers of the firm offer a short loan for 30 days at 9% p.a. The
bankers quotation for foreign exchange is:
Spot USD 1 = 46.00
60 days forward 1 USD = 46.20
90 days forward 1 USD = 46.35
You are required to advice the firm as to whether it should pay the supplier in 60 days or avail the supplier’s
offer of 90 days credit. Show your calculations.
Ans: pay in 60 days = 465,465; pay in 90 days = 465,818
Export to USA
1 Invoice for
$ 10,000/-
Indian Company Credit period 3M USA Company
Inflow at 3 Month Outflow at 3 Month
4 3 $ 5
2
3M
today $
2 Borrow less amount today from the USA bank for 3 month at borrowing rate of USA.
= $ 10,000 / (1+0.06 X 3/12) = $ 9,852
Borrowing amount with interest will become Invoice amount at 3 month time which will pay by USA
5
Company to USA Bank.
Hence, Amount receivable under money market operation at 3 month time is equal to 4,03,932/-
Concept:
Why borrowed money from foreign bank to be deposit in home country bank? Why not keep with him
today?
We know comparison cannot be done between rickshaw wale and chartered accountant. Similarly, today
payment cannot be comparable with Future payment.
If we do not deposit money in home country bank today, then the inflow become today’s time and it is not
comparable with forward contract or with other hedging option. Hence deposit today in home country bank
by taking loan in foreign currency.
1 Invoice for
$ 10,000/-
Indian Company Credit period 3M USA Company
Inflow at 3 Month Outflow at 3 Month
2 3 $
5
4
3M
today $
2 Borrow money from home country. (How much money we will borrow?)
We cannot calculate the required amount if we follow above sequence. Hence do back calculation.
Deposit less amount today in the USA bank for 3 month at deposit rate of USA.
4
= $ 10,000/ (1 + 0.05 X 3/12) = $ 9,876
Convert $ 9,876 into ‘Rupee’ @ spot rate.
3
$ 9,876 = 9,876 X 41 = 4,04,916
Deposit amount with interest will become Invoice amount at 3 month time which will receive by USA
5
company from USA Bank.
Hence, Amount payable under money market operation at 3 month time is equal to 4,17,063/-
Concept: Why borrowed money from home country bank to be deposit in foreign bank? Why not from own pocket
at today time?
If we not borrow money from home country bank, then the outflow become today’s time and it is not
comparable with forward contract or with other hedging option. Hence deposit today by taking loan.
Question No. - 5C
F Ltd. is a medium-sized UK company with export and import trade with the USA. The following transaction are
due within the next six months.
Sale of finished goods, cash receipt due in three months $1,97,000
Purchase of finished goods cash payment due in six months $2,93,000
Exchange rates (London Market)
$/£
Spot £ 1 = $ 1.7106-1.7140
Calculate the net sterling pounds receipts and payments that F Ltd. might expect for both its three and six
months transactions if the company hedges foreign exchange risk on (1) forward foreign exchange market (2) on
money market operation basis. You may assume following interest rates:
Borrowing Lending
Pound 12.50%p.a. 9.50% p.a.
$ 9%p.a. 6% p.a.
Ans: Receipt Forward =£ 1,15,454.49; Receipt money market = £ 1,15,076.33;
Payment Forward = £ 1,72,688.16; Payment money market = £ 1,76,689.55
Question No. - 5F
Best of Luck Ltd., London will have make a payment of $ 3,64,897 in six month’s time. It is currently st October.
The company is considering the various choice it has in order to hedge its transaction exposure.
Exchange rates
Spot rate $1.5617-1.5773
six-month forward rate $1.5455-1.5609
By making the appropriate calculations decide which of the following hedging alternatives is the most attractive
to Best of Luck Ltd. (a) Forward market, (b) Cash (Money) market.
Ans: (a) Pmt. under Forward Mkt. = £ 236102.88; Pmt. under Money Mkt. = £ 2,36,510.11;
Question No. - 5H
Expo is an importer/exporter of textile machinery. It is based in the UK but trades extensively with countries
throughout Europe. It has a small subsidiary based in Germany. The company is about to invoice a customer in
Germany DM 7, 5 , payable in three month’s time. Expo’s treasurer is considering two me thods of hedging
the exchange risk;
Method 1: Borrow DM 7, 50,000 for three months, convert the loan into sterling and repay the loan out of
eventual receipts.
Method 2: enter into a three month forward exchange contract with the company’s bank to sell DM 7,5 , .
The spot rate of exchange is DM 2.3834 to the £ 1.
The three month forward rate of exchange is DM 2.3688 to the £ 1.
Annual interest rates for three months borrowing are: Germany 3%, UK 6%.
Which of the two methods are the most financially advantageous for Expo?
Ans: Rcpt. Under method 1 = £ 317022.04; under Method 2 = £ 316,616.
[In absence of deposit rate we use borrowing rate as deposit rate.]
Question No. - 5J
LMN exports its products throughout the world. It has today received from a new customer in Uganda an order
worth £ , 5 , at today’s spot rate. The order is to be paid in the importer’s currency. Terms of trade are 6
days’ credit. No discount is offered for early payment.
Foreign exchange rates (mid rates)
You are required: to calculate the expected sterling receipts from the Ugandan customer, assuming its offer of
payment in US$ is accepted. Assume LMN hedges its risk using
(1) The forward market, or
(2) The money market,
and advise LMN on which method is most advantageous; to advise LMN on whether the Ugandan customer’s
offer of payment in US$ should be accepted.
Ans: Receipt under1 = £ 1,51,281; Receipt under 2 = £ 1,50,433
Leading/Lagging
Leading:
Lead payment is a payment as on today for a transaction forgetting the credit period given by supplier.
Importer makes the lead payment when he feels that the loss due to currency fluctuation will become higher
than that of the benefit which he will get due to time value of money.
Notes: We know comparison can never be done between rickshaw wale and chartered accountant. Similarly,
Lead payment can never be comparable with Forward cover because under lead payment outflow become
today and under forward cover outflow become at some future date.
Hence, for making lead payment comparable with forward cover we make payment today taking loan (for the
period equal to forward cover) so that the outflow become at the time of repayment of loan.
Lagging:
Lagging means delaying the payment beyond the due date allowed by supplier.
Example: Indian importer has to make payment for $ 5,000 at 3 month time to US supplier. If payment is
delayed, supplier charges interest @ 6% p.a.
3 month forward rate: 1$ = 45.30- 45.36
6 month forward rate: 1$ = 43.20-43.50
Indian company is considering the lagging if it is beneficial. Cost of capital of Indian company is 12%.
2,20,762.5
= 2,14,332
Outflow under lagging will be 214332 and under normal credit period will be 2,26,800. Hence lagging is
beneficial for importer.
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 net amount. No interest for delaying the
receivables is earned.
Evaluate both the options if the cost of Rupee Fund is 12% .Which option is preferable.
Interest rate Parity theory Purchasing power parity International Fishers effect
(IRTP) theory (PPPT) (IFE)
Notes:
1. If SR, FR and two countries interest rates are based on IRPT, then Arbitrage gain is not possible.
2. The currency having high interest rate would be at discount and currency having low interest rate would be
at premium in future.
3. The premium/discount on one currency would be approximately equal to the interest rate differential.
Relationship:
(1 + Real rate) (1+ Inflation rate) = (1+ Risk free rate)
Question No. - 7C
The spot Danish Krone rate is $ 0.15986 and the three month forward rate is $ 0.1590. The three month treasury
bill rate in the United States is 6.25% p.a. and in Denmark 7.50% p.a.
(a) Calculate forward premium or discount on Danish Krone
(b) Are the forward rates and interest rate in equilibrium?
(c) Work out the forward rate if the forward premium or discount are in equilibrium.
Ans: (a) Annualized Discount = 2.152%; (b) Given DK 1 = $ 0.1590; Calculated, DK 1
= $ 0.15937; Hence not in equilibrium. (c) DK 1 = $ 0.15937.
Question No. - 7D
Spot 1$ = 52.50
Interest Rate ($) = 8% p.a
Interest Rate () = 10% p.a.
Question No. - 7E
The financial press recently listed the following information about two currencies, the Westland dollar ($W) and
the Eastland mark (EM).
Spot rates: 2.0725 EM / $W
0.4825 $W / EM
90 day rates: 2.0687 EM / $W
0.4834 $W / EM
Westland prime interest rate on the same day was 9.5%. (Note: - Use a 365 day year.)
Requirements:
(i) Explain what is implied about the Eastland interest rate.
(ii) Calculate and comment on the Eastland interest rate if the forward exchange rate was 0.4795 $W/EM.
(iii) Calculate and comment on the 90 day forward rate on EM / $W if the Eastland interest rate was 8%.
Ans: (i) Eastland interest rate = 8.72%; (ii) Eastland interest rate = 12.09%; (iii) $W 1 = EM 2.065
Ans: 3 Month: FR = 7.17; FD = 6.7%; 6 Month: Franc IR = 19.8%; FR = 7.28; 1 Year: Dollar IR = 12.5%, FD = 6.25%
Question No. - 7H
You are given the following interest rates.
$
3-month 15% 6%
6-month 14.5% 5.5%
9-month 14.0% 5.0%
The 3-month forward rate is 36/$. Calculate the 3-month forward rate 6-months from now.
Ans: Forward rate = 37.51
Question No. - 8C
An American based FII is looking to invest US$ 10 million in an emerging market. After a careful analysis of
future prospects, India and Malaysia are shortlisted. For the next year, which is also the holding period for the
FII, expected rates of return are 20% and 16% in India and Malaysian markets respectively. Withholding tax
rates applicable on the returns earned are 20% in India and 10% in Malaysia. Other information available with
the FII includes
Exchange rates:
/$ spot 43.50/43.60
MS/$ spot 3.80/3.82
Expected inflation for the next year:
India 4.0%
Malaysia 6.0%
US 2.0%
Assuming that the PPP holds good, where should the FII invest?
Ans: If invest in India, Net gain = $ 1.352; If invest in Malaysia, Net gain = .95 mill.
Arbitrage
Arbitrage is an act to earn risk free profit. The act may be:
(i) Sale at high rate & purchase at low rate; (ii) borrowing at low rate & investing at high rate
Arbitrage is not possible in Forex market if ‘Exchange rates’ and ‘interest rates’ are based on IRPT.
Arbitrage
Assume arbitrageur has cash in any currency (Say arbitrageur has $1,000)
Here two Routes are possible:
Route-1:
$ ¥ £ $
Gain
$ 1,000 Mkt-1: Mkt-2: Mkt-3: Mkt-4: If > $ 1,000
Sale $ & Sale & Sale ¥ & Sale £ &
If < $ 1,000 Loss
Buy Buy ¥ Buy £ Buy $
Route-2:
$ £ ¥ $
Gain
$ 1,000 Mkt-4: Mkt-3: Mkt-2: Mkt-1: If > $ 1,000
Sale $ & Sale & Sale ¥ & Sale £ &
If < $ 1,000 Loss
Buy Buy ¥ Buy £ Buy $
Short cut for finding the countries to be invested or to be borrowed when one way quote is given (For Cover
interest arbitrage)
Interest rate differential > Premium/Discount Borrow at low rate and deposit at high rate
Interest rate differencial <Premium/Discount Borrow at high rate and deposit at low rate
Example:
Case-I Case-II
Interest rate (India) 10% 7%
Interest rate (USA) 5% 4%
Case-I Case-II
Interest rate differential = 10%-5% = 5% Interest rate differential = 7%-4% = 3%
Premium = 4% Premium = 4%
Here benefit is due to Interest rate. Hence borrow at Here benefit is due to Exchange rate. Hence borrow
low rate (i.e. 5%) from USA and deposit at high rate at High rate (i.e. 7%) from Indian and deposit at Low
(i.e. 10%) from India for Arbitrage. rate (i.e.4%) from USA for Arbitrage.
Geographical Arbitrage
Question No. -9A [Same as Q-14B]
Assuming no transaction costs, suppose £1 = $2.4110 in New York, $1 = FF 3.997 in Paris, and FF 1 = £0.1088 in
London. How would you take profitable advantage if you had £ 50,000?
Ans: Profit = £ 2,424.01
Question No. - 9C
Frank furt Spot 1$ = 1.3689 – 1.4150DM
Mumbai Spot 1 DM = 37.5051 – 37.6050
London Spot 1$ = 50.5020 - 50.6525
Can you make profit through arbitrage? Assuming Arbitrageur has $1,000
Ans: Arbitrage gain = $ 13.587
Question No. - 9D
Spot rate (Frank furt) 1$ =1.3579-1.3585DM
Spot rate (New York) 1 DM = 0.7149-0.7295$
You have 1,00,000 DM what amount of profit you can make from arbitrage?
Ans: Arbitrage gain = DM 905.55 [if sell DM in frank furt & Purchase back in new York]
The company invoice in Indian Rupee when it exports to guard itself against the fluctuation in exchange rate. As the
company is enjoying monopoly position, the buyer normally never objected to such invoices. However, recently, an
order has been received from a whole-seller of France for FFr 80,00,000. The other conditions of the order are as
follows:
Since, company is not interested in losing this contract only because of practice of invoicing in Indian Rupee. The
Export Manger Mr. E approached the banker of Company seeking their guidance and further course of action.
The banker provided following information to Mr. E.
Mr. E entered in forward contract with banker for 90 days to sell FFr at above mentioned rate.
When the matter comes for consideration before Mr. A, Accounts Manager of company, he approaches you.
You as a Forex consultant are required to comment on:
(i) Whether there is an arbitrage opportunity exists or not.
(ii) Whether the action taken by Mr. E is correct and if bank agrees for negotiation of rate, then at what forward
Rate Company should sell FFr to bank.
1 2 3 4 5
3. At 1Y, cancel forward contract by entering opposite contract (because payment not receivable/payable at 1Y) @ SR on 1 Year.
- Calculate amount receivable/payable due to cancelation.
- Again enter 6m forward contract @ 6m FR on 1 Y to sell/Buy $ 1,00,000/-
4. At 1.5Y, cancel forward contract by entering opposite contract (because payment not receivable/payable at 1.5Y) @ SR on 1.5
Year.
- Calculate amount receivable/payable due to cancelation.
- Again enter 6m forward contract @ 6m FR on 1.5 Y to sell/Buy $ 1,00,000/-
Option – 1:
Total amount receivable/payable under Rupee roll over at future’s money term i.e. after 2Y:
Amt at 6m Amt at 1Y Amt at 1.5Y Amt at 2Y
Future value of receivable/payable = + + +
(1+PIR)3 (1+PIR)2 (1+PIR)1 (1+PIR)0
Option – 2:
Total amount receivable/payable under Rupee roll over at today’s money term:
Amt at 6m Amt at 1Y Amt at 1.5Y Amt at 2Y
Present value of receivable/payable = + + +
(1+PIR) 1 (1+PIR) 2 (1+PIR) 3 (1+PIR) 4
OR
Amt at 6m Amt at 1Y Amt at 1.5Y Amt at 2Y
+ + +
PVIF(R, 1) PVIF(R, 2) PVIF(R, 3) PVIF(R, 4)
The following are the spot rates ( /$) and six-month forward rates (,/$) prevailing at the end of each roll over
period. Determine the cash flows and compare the result with a situation when the corporate leaves the
exposure uncovered. Cost of capital for the company is 20%.
India Switzerland
India Switzerland
India Switzerland
SBI Bank opened a Current Account
with Swiss Bank in CHF currency.
Indian Bank (SBI) Swiss Bank
Nostro Account of
Indian bank
Exchange position: Exchange position (for CHF currency) of an Indian bank/dealer will affect by:
- Purchase/sale of foreign currency, (the purchase/sale of currency may be spot or forward)
- Issue/cancellation of demand draft,
- Purchase/sale of Bills receivable,
- Remittance of foreign currency [Remember that Indian bank do not remit foreign currency (say CHF) in Nostro account from India. All receipt in
Swiss franc (CHF) and all payment/remittances in CHF will be made through Nostro account maintained with Switzer land bank]
Cash Position (Nostro A/C): Nostro A/C of an Indian bank/dealer maintained with Switzerland bank will affect by:
- Spot Purchase/Sale of foreign currency (CHF) (Forward Purchase/Sale of CHF do not affect Nostro A/C because there is no delivery of
currency as on today)
- Receipt/payment in CHF.
Note: Spot purchase/Sales of CHF affects both exchange position as well as Nostro A/C (Cash Position). However, forward
purchase/sale affects only the exchange position.
Nostro A/C will decrease only after presenting DD by Mr. S to his banker
If before presenting DD it will cancel, then Indian Bank will increase its exchange position.
India Switzerland
Think all transaction
for Indian Bank and
Indian Bank not for Mr. S and Mr. B Swiss Bank
Nostro Account of
3 Indian bank
2
DD in CHF 6 5
1 CHF
Import DD
Mr. Buyer Mr. Seller
4
Pay by way of DD
India Switzerland
Nostro Account of
3 4 Indian bank
2
Received by way of B/R
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?
Ans: Buy Spot TT for CHF 5000 and also Buy Forward TT for CHF 10,000
Today before due date Due date after due date (Due date + 15 days)
1 3 4
Alternative-2
- Purchase $96000 at committed rate and sell $46,000 at spot rate prevailing on due date
Situation-II:
Some time customer enters forward contract to buy/sale the foreign currency but due to some reason (like defective goods)
later on customer want to extend contract for some further period. What he will do.
Solution:
- Cancel earlier forward contract by entering opposite contract.
- Make fresh forward contract for the desired period.
Parallel Loan
When multinational corporations operating in various countries could not transfer funds among their subsidiaries
due to restriction in capital flows exercised by various governments, they came out with innovations of back-to-back
or parallel loans among themselves.
Parallel loan involve four parties, two multinational corporations and two subsidiaries in two different countries.
India USA
Indian Subsidiary of
US Company US Company
US company willing to fund its
Indian subsidiary in currency
which is equivalent to $ 1,00,000
Question No. -17B [May-2007-old-8 Marks] [CWA-June-2008-9 Marks] [RTP-May-2011] [Same as Q-19A]
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
$/ £/
(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?
Ans: (i) (a) cash balance = 475,323; (b) 484,080; (ii) Immediate cash pooling is preferable.
(i) Determine the net exposure of each foreign currency in terms of Rupees.
(ii) Are any of the exposure positions offsetting to some extent
Ans: (i)Net exposure: $ = 16.2 Mill; FFr = 8.04 mill; £ = 4.10mill; Yen = 8 mill.
(iii) The exposure of Japanese yen position is being offset by a better forward rate
(iv) Future spot rate in 180 days as estimated by the consultant is 47.75$.
(v) A call option on the dollar, which expires in 180 days has an exercise price of 47/$ and premium 0.52/$
(vi) A put option on the dollar, which expires in 180 days has an exercise price of 47.50 and premium 0.40/$.
Required:
Carry out a comparative analysis of various outcomes (rupee cost of import)/Alternatives and decide which of the alternatives is the most
attractive to zenith Ltd.
Ans: Price to be paid under various options: (i) 95 lakhs (ii) 96,31,511 (iii) 95,04,000;