International Finance – Alaknanda Lonare

Unit - 3: Foreign Exchange Market

Q.1. You are required to fill in the missing figures and complete the table:
Currencies USD GBP CAD YEN EUR
USD 1 0.731 1.263 110.580 0.853
GBP 1
CAD 1
YEN 1
EUR 1
Sol:
Currencies USD GBP CAD YEN EUR

USD 1.000 0.731 1.263 110.580 0.853

GBP 1.368 1.000 1.728 151.272 1.167
CAD 0.792 0.579 1.000 87.553 0.675
YEN 0.009 0.007 0.011 1.000 0.008
EUR 1.172 0.857 1.481 129.637 1.000

Q.2. Convert the following rates into outright rates and indicate spreads.
Particulars Spot 1-month 3-month 6-month
Rs/$ 70.6300/25 20/25 25/35 30/40
Rs/GBP 85.2200/35 40/30 50/35 55/42
Rs/DEM 43.9000/30 30/25 40/60 45/65
Also calculate premium or discount on the rupee dollar rates given above.
Sol:
Forward premium or
Outrights rates
Bid Rate Ask Rate Mid-Rate discount =
Rs/$
(F-S)/S * 12/M * 100
Spot 70.63 70.6325 70.63125
1-month 70.632 70.6325 70.63225 0.016989647
3-month 70.6325 70.6335 70.633 0.009910627
6-month 70.633 70.634 70.6335 0.007645341

Q.3. Suppose an Indian importer is to pay to a New Zealand export firm in New Zealand dollars. Assume
further that the direct quote of Indian rupee and New Zealand dollars is not available. Therefore, the exporter is
to use the other two relevant quotes, namely, the New Zealand $/US $ and Re/US $. These rates are as follows:
New Zealand $/US $ : 1.4218 – 1. 4295
Rupee/US $ : 73.148 – 73.163
Determine the exchange rate between Indian rupee and New Zealand dollar.

Sol: In this case the direct quotation for NZD – INR is not available; therefore, we will use the cross rate for the
determination of the exchange rate.

Step 1: Importer will buy USD in India and the rate of buying would be – Rs. 73.163/$
Step 2: Now the importer will have to sell USD and buy NZD and the rate would be – NZD 1.4218/$

Therefore, the cross rate = 73.163/1.4218

International Finance – Alaknanda Lonare

And the exchange rate between INR/NZD = 51.45/NZD

Q.4. From the following rates, determine INR/CAD exchange rate:

INR/USD : 73.5642/73.8358
CAD/USD : 1.262/1.295

Sol: Here we will use the concept of Cross Rate to determine the exchange rate between INR and CAD

INR/CAD = 73.5642 / 1.295 = 56.8063 – Bid rate

INR/CAD = 73.8358 / 1.262 = 58.5070 – Ask Rate

Q.5. At two forex centers, the following Re-US $ rates are quoted:
London : Rs 71.5730 – 71.6100
Tokyo : Rs 71.6350 – 71.6675
Find out arbitrage possibilities for an arbitrageur who has Rs 100 million.

Sol: Here the Geographical Arbitrage gains are possible as the rates at both the markets are different.

Arbitrage process:
Step 1: The arbitrageur will buy USD from the London Market @ 71.6100 and the process will be
(100,000,000/71.6100 = $ 13,96,453)

Step 2: Then he will sell the USD in Tokyo Market @ 71.6350 and the proceeds will be ($ 13,96,453 * 71.6350
= 100034911)

From this arbitrageur will be able to earn Rs. 34911.

Q.6.The following are three quotes in three forex markets:

$1 = Rs 72.2133 in Mumbai
£1 = Rs 100.335 in London
£1 = $1.4020 in New York

Calculate arbitrage if there are any arbitrage gains. Assume there are no transaction costs and the arbitrageur has
US $1,000,000.

Sol:
Using the concept of Cross rate, Let us determine the exchange between the $/£
i.e. using the exchange rates
$1 = Rs 72.2133
£1 = Rs 100.335

Therefore, the Cross rate = 100.335 / 72.2133

Cross rate = 1.3894

The exchange rate available at New York is £1 = $1.4020 and exchange rate using cross rate concept is £1
1.3894 which less than the rate available, so we can say that the arbitrage opportunities are possible.

Calculation of Arbitrage is as below:

International Finance – Alaknanda Lonare

Step 1: The arbitrageur will convert US $1,000,000 into INR @ 72.2133 and proceed will be= INR 72213300 in
Mumbai

Step 2: Convert INR into GBP @ 100.335, proceeds will be £ 719722 in London

Step 3: Convert £ 719722 @ 1.4020, proceed are equals to $ 1009050 in New York

Arbitrage = $ 1,009,050 - $ 1,000,000 = $ 9,050 (Gain for the arbitrageur)

Q.7. From the data given below calculate forward premium or discount, as the case may be, of the £ in relation
to the rupee.
Spot 1 month forward 3 months forward 6 months
forward
Re/£ Rs 92.1255/92.3279 Rs 92.4291/6523 Rs 91.7134/8906 Rs 93.1900/3200
Sol:
Using Bid rate, will calculate Forward Premium or Discount

Forward Premium = [(F – S) / S] * 12/M * 100

For 1month forward – using 1 month forward bid rate

Forward Premium = [(92.4291 – 92.1255) / 92.1255] * 12/1* 100

Forward Premium = 3.954%

Q.8. Determine arbitrage gain from the following data:

Spot rate Rs 92.2/£
3 month forward rate Rs 92.7/£
3 month interest rates:
Rupees 9% p.a.
British £ 5% p.a.
Assume Rs 10 million borrowings or £200,000 (as the case may be) to explain your answer.

Sol:
Step 1: Interest rate differential = 9 – 5 = 4% and Forward premium = (92.7 – 92.2)/92.2 * 12/3 * 100 = 2.169%
as the interest rate differential and forward premium are not equal, therefore the arbitrage gains are possible.

As there is forward premium, so we can borrow in a country where the interest rates are low.

Step 2: As the interest rate on GBP is low therefore trader or investor will borrow GBP.
Borrow £200,000 @ 5% and convert £200,000 into INR @ Rs 92.2/£ and proceed will be = INR 18,440,000

Step 3: Invest INR 18,440,000 @ 9% for 3month and the Interest amount will be = (18,440,000 * 9%*3/12) =
INR 4,14,900 and amount available with the investor at the end of the three months = 18,440,000 + 4,14,900 =
INR 1,88,54,900

Step 4: Convert INR 1,88,54,900 @ forward rate Rs 92.7/£ and the proceed will be = £ 203,397
International Finance – Alaknanda Lonare

Step 5: Return the interest on GBP (2,00,000 @ 5% = 200,000* 5%*3/12) = 2,500

Therefore, the total amount that needs to returned by the investor = 2,00,000 + 2,500 = £ 2,02,500

Step 6: The investor has £ 203,397 - £ 2,02,500 = £ 897 (Arbitrage)

Q.9. Determine arbitrage gain from the following data:

Spot rate Rs 74.137/$
3 month forward rate Rs 73.182/$
3 month interest rates:
Rupees 6%
USD 7%
Assume borrowings as the case may be to explain your answer.

Sol:
Step 1: Interest rate differential = 7 - 6 = 1% and Forward Discount = (S –F) /S * 12/M * 100 = (74.137 –
73.182 / 74.137) * 12/3 * 100 = 5.15 %, as the interest rate differential and Forward discount is not equal,
therefore there is arbitrage opportunity.

If there is forward discount, then we need to borrow at the higher rate of interest.

Step 2: Let us assume the investor borrows $ 1,00,000 @ 7% and converting it into INR @ 74.137 and proceed
will be = INR 74,13,700

Step 3: Invest INR 74,13,700 @ 6% for 3 months. Proceeds of investment = (7413700 * 6% * 3/12) = 1,11,206
and total amount available with the investor = INR 75,24,906

Step 4: Convert INR 75,24,906 @ the forward rate Rs 73.182/$ and the proceeds are = $ 1,02,825.

Step 5: Investor will return the borrowed fund with interest and Interest = 1,00,000 * 7%*3/12 = 1,750 and total
amount he will have to return =$ 1,01,750

Step 6: Gain from the transaction = $ 1,02,825 - $ 1,01,750 = $ 1,075 (Arbitrage Gains)

Q.10. In 2014 a foreign institutional investor (FII) invested US$ 1 million in the Indian stock market. The rupee
returns from the Indian stock market since 2014 has been 16% as dividend income. However, stock prices have
come down by 10% since 2014. The currency rate at the time of FII purchase was Rs.48/$. If FII sells its
holding today and current currency rate is Rs.73/$, what is the profit or loss to the FII in dollar terms.

Sol:
Investment by US (FII) $ 1,000,000 in 2014 INR 48,000,000
+ 16% Dividend income INR 7,680,000
- 10% loss in capital due to decrease in prices INR 4,800,000
Total investment in today’s time INR 50,880,000

Amount of investment in term of $ as the exchange rate is Rs.73/$ = $ 6,96,986

There is a loss of $ 303013 ($1000,000 – $ 696986), if the investments are liquidated today.