BBA F&A Year) (3 rd

International Financial Management

COC642B – SEMESTER 6

International Financial Management COC642B – BBA F&A Jan to May 2023

Market Participants
Hedgers:
➢ Primary participants in the market.
➢ Main objective to safeguard their investment
➢ Is any individual, firm that buy and sell physical commodity.
➢ They can be producers, wholesalers, retailers etc.
➢ Motive is not to make profit but to minimize the risk.
➢ Hedging strategy is to minimize the price risk that is impacted by the
market force on the underlying asset.

International Financial Management COC642B – BBA F&A Jan to May 2023

Market Participants
Speculators:
➢ Main objective is to make profit.
➢ They take on risk.
➢ With respect to anticipation of future price.
➢ In hope of making gain that are large enough to offset the risk
➢ They do not have any business interest

International Financial Management COC642B – BBA F&A Jan to May 2023

Market Participants
Arbitrageurs:
➢ A person which simultaneously buy and sell the asset or group of
asset from different market in order to make profit (At the moment)
➢ They are risk free because they seeks to make profit due to variation
in the prices in market.
➢ These persons gain from the mis-pricing of the instrument / market
mistakes.
➢ They turn the markets level.

International Financial Management COC642B – BBA F&A Jan to May 2023

Hedging
➢ It is a financial strategy used by the investors to mitigate the risk

➢ Recognizing the dangers that come with every investment and

choosing to be protected from any untoward event that can impact
one’s finances.

➢ It does not mean that the loss can be evaded but the loss can be
mitigated with a gain from alternative or can be minimized.

International Financial Management COC642B – BBA F&A Jan to May 2023

Hedging Currency Risk
Internal Techniques:
➢ Invoicing in domestic currency
➢ Leading and lagging – adjustment to time of payment (e.g. early
payment)
➢ Netting – within group companies (e.g. receivable / payable)
➢ Matching – payment and receipt. (match two sides of cashflow)
➢ Price variation – increase in price (last option)
➢ Asset Liability management

International Financial Management COC642B – BBA F&A Jan to May 2023

Hedging Currency Risk
External Techniques:
➢ Money market hedging
Is an agreement to exchange a certain amount of one currency for a fixed amount of another
currency.
Advantages
(a) Fixes the future rate, thus eliminating downside risk exposure.
(b) Flexibility with regard to the amount to be covered.
(c ) Money market hedges may be feasible as a way of hedging for currencies where
forward contracts are not available.
Disadvantages include:
(a) More complicated to organise than a forward contract.
(b) Fixes the future rate - no opportunity to benefit from favourable movements in exchange rates

International Financial Management COC642B – BBA F&A Jan to May 2023

Hedging Currency Risk
External Techniques:

➢ Derivative instrument
Forwards / Futures / Options and Swaps

International Financial Management COC642B – BBA F&A Jan to May 2023

Forwards
➢ An agreement to buy something on a future date at a specified price
➢ It is an OTC derivatives
➢ The party with an obligation to buy is known as “long party” and
holds “long position”
➢ The party with an obligation to Sell is known as “Short party” and
holds “Short position”
➢ The guaranteed price is the “Delivery price” or “Contract price”
➢ The date on which the sale will transpire is the “settlement date”
➢ Examples – interest rate / forex…

International Financial Management COC642B – BBA F&A Jan to May 2023

Futures
➢ An agreement to buy something on a future date at a specified price
➢ It is traded in an exchange
➢ The party with an obligation to buy is known as “long party” and
holds “long position”
➢ The party with an obligation to Sell is known as “Short party” and
holds “Short position”
➢ The guaranteed price is the “Delivery price” or “Contract price”
➢ The date on which the sale will transpire is the “settlement date”
➢ Examples – interest rate / forex…

International Financial Management COC642B – BBA F&A Jan to May 2023

Forwards Vs Futures
Forwards Futures
OTC derivatives Traded in exchanges
Counterparties are known to each other Anonymous counterparty
Customised contract Standard contract
Settlement on delivery Daily settlement
High credit risk Low credit risk
No collateral Margin money required
Low liquidity High liquidity

International Financial Management COC642B – BBA F&A Jan to May 2023

 Example on Currency futures and Forwards.

International Financial Management COC642B – BBA F&A Jan to May 2023

Swaps
➢ An agreement to exchange future cash flows
➢ The cash flow can be interest or currency.
➢ Combination of buying and selling of currencies

International Financial Management COC642B – BBA F&A Jan to May 2023

Options
➢ Grants its holder, a right but NOT an obligation to buy or sell
something
➢ “long party” or “holder” is the buyer of the instrument
➢ “Short party” or “writer” is the seller of the instrument
➢ Holder pays “Premium” to writer
➢ In return for the premium holder has right but not the obligation to
execute the contract.
➢ When “holder” buys the underlier then it is called “Call option”
➢ When “holder” sells the underlier then it is called “Put Option”

International Financial Management COC642B – BBA F&A Jan to May 2023

American Vs European option
➢ European option can be exercised only at the expiry of the contract
➢ American option can be exercised anytime during the contract.
➢ These are nothing to do with geography. These options are used in
various markets across the world.
➢ “In the money” concepts are not relevant in European option until
expiry, however for American option “In the money” concept is
relevant at any point of time during the contract period.

International Financial Management COC642B – BBA F&A Jan to May 2023

Options
Options

Call Put

Long call Short call Long put Short put

Right to buy the Obligation to sell
underlying asset the underlying asset

Call – Buy
Long position have Right
Put - Sell
Short position have obligation

International Financial Management COC642B – BBA F&A Jan to May 2023

Payoff diagram
Long forward payoff: Pcall,long = S - K
40
Strike (K) Spot (S) P / (L)
30
40 0 -40
20 40 10 -30
40 20 -20
P/ 10

(L) 40 30 -10
0
0 10 20 30 40 50 60 70 80
S 40 40 0
-10
40 50 10
-20 40 60 20
-30
40 70 30
40 80 40
-40

International Financial Management COC642B – BBA F&A Jan to May 2023

Payoff diagram
Long Call option payoff: Pcall,long = Max(0,S–K)
40

30
Strike (K) Spot (S) P / (L)
40 0 0
20
40 10 0
P/ 10
40 20 0
(L) 0
0 10 20 30 40 50 60 70 80
S 40 30 0
-10 40 40 0
-20 40 50 10
-30
40 60 20
40 70 30
-40
40 80 40

International Financial Management COC642B – BBA F&A Jan to May 2023

Payoff diagram
Short Call option payoff: Pcall,short = Min(0,K–S)
40
Strike (K) Spot (S) P / (L)
30
40 0 0
20 40 10 0
P/ 10 40 20 0
(L) 40 30 0
0
S
0 10 20 30 40 50 60 70 80
40 40 0
-10
40 50 -10
-20 40 60 -20
-30 40 70 -30
40 80 -40
-40

International Financial Management COC642B – BBA F&A Jan to May 2023

Payoff diagram
long put option payoff: Pput,long = Max(0,K–S)
40

Strike (K) Spot (S) P / (L)

30
40 0 40
20
40 10 30
P/ 10
40 20 20
(L) 40 30 10
0
0 10 20 30 40 50 60 70 80
S
-10
40 40 0
-20
40 50 0
40 60 0
-30
40 70 0
-40
40 80 0

International Financial Management COC642B – BBA F&A Jan to May 2023

Payoff diagram
Short put option payoff: Pput,Short = Min(0,S–K)
40

Strike (K) Spot (S) P / (L)

30
40 0 -40
20
40 10 -30
P/ 10 40 20 -20
(L) 40 30 -10
0
0 10 20 30 40 50 60 70 80
S
-10
40 40 0
40 50 0
-20
40 60 0
-30
40 70 0
-40 40 80 0

International Financial Management COC642B – BBA F&A Jan to May 2023

Profit/ loss diagram (with margin) 40
40
30
30
20
Long put
20 Long Call
10
10

0 0
0 10 20 30 40 50 60 70 80 0 10 20 30 40 50 60 70 80
-10 -10

-20 -20
-30
-30
-40
-40

40 40

30
Short Call 30
Short put
20
20
10
10
0
0 10 20 30 40 50 60 70 80 0
-10 0 10 20 30 40 50 60 70 80
-10
-20
-20
-30
-30
-40
-40

International Financial Management COC642B – BBA F&A Jan to May 2023

 Example on Options.

International Financial Management COC642B – BBA F&A Jan to May 2023

Example 2:
India Imports from US – Payable USD 1,00,000 in 3 Months
Forward Rate Currency Option
SR $1 = INR 60 – 61 Contract Size - $ 9,000
3M FR $1 = INR 62 – 63 Call 3 Mth EP – INR 61.50
Call Premium – INR 0.70 / $
Put Premium – INR 0.15 / $

International Financial Management COC642B – BBA F&A Jan to May 2023

Example 3:
India Export to US – Receivable USD 1,00,000 in 3 Months
Forward Rate Currency Option
SR INR 1 = $ 0.0165 – 0.0167 Contract Size – INR 5,20,000
3M FR INR 1 = $ 0.0172 – 0.0175 Call 3 Mth EP – INR 1 = $ 0.0170
Call Premium – $ 0.0005 / INR
Put Premium – $ 0.0002 / INR

International Financial Management COC642B – BBA F&A Jan to May 2023

Initial margin and maintenance margin
Initial Margin:
➢ Initial margin is taken when the position is created. This is generally a %
of the contract value. The initial margins vary from one product to
another.
➢ Initial margins are calculated by most exchanges across the world using
the methodology called SPAN (Standard Portfolio Analysis of Risk).
➢ Initial margins are generally taken in cash. However certain exchanges
accept collaterals like bank guarantees, Govt bonds, T Bills, Certificate
of deposits etc also in lieu of cash margins.
➢ Exchanges however apply a haircut in accepting these securities to
provide for a change in their prices
International Financial Management COC642B – BBA F&A Jan to May 2023
Initial margin and maintenance margin
Maintenance Margin:
Futures contract follow a practice called as daily Mark to Market. It means that at
the end of each trading day, the exchange credits or debits your account by
comparing your positions to the daily settlement price. This is a key difference
between the forwards and futures contracts as well.
Once Margin falls below Maintenance Margin then margin call is initiated to top up
the margin to initial margin.

International Financial Management COC642B – BBA F&A Jan to May 2023

Numerics – Margin Money
Mr A imports goods from Mr. B and agreed to pay US$ 1,000 after 2 Months.
Mr. A enters into currency futures on US$
Initial Margin Money is 20% : Maintenance Margin Money is 10%
Calculate Margin requirements for the following days assuming the spot rate are as below:
Day Rate (INR) Assuming contract size is US$1,000
0 50
1 52
2 49
3 47
4 44
5 51

International Financial Management COC642B – BBA F&A Jan to May 2023

Moneyness
If S (Market Price) is the stock price and K is the strike price then

International Financial Management COC642B – BBA F&A Jan to May 2023

Currency forward
➢ Financial assets: loans, shares, bonds, foreign currency etc.
➢ Fluctuating prices of financial assets and risk
➢ Risk faced by importers of goods
➢ Risk faced by exporters of goods
➢ Forward contracts are commitments entered into by two parties to exchange a
specified amount of money for a particular good or service at a specified future
time
➢ Price, delivery date and quantity are decided at the time of initiating the
contract, but the actual payments and delivery of the assets take place later.

International Financial Management COC642B – BBA F&A Jan to May 2023

Currency futures
➢ Also known as FX, a contract to exchange one currency to other at a
specified date in future at an agreed price
➢ On NSE the price of future is quoted INR to 1 unit of other currency.
➢ Allows investors to hedge against exchange risk
➢ Currency derivatives are available in four currencies, USD / GBP /
EUR / JPY
➢ Currency options are available in USD

International Financial Management COC642B – BBA F&A Jan to May 2023

Currency Swap
Consider an example that a US parent Co want to invest in
infrastructure in its subsidiary in France.
Three options:
1. Borrow USD convert to EUR – Exposes Company to exchange Risk
2. Borrow in France – Rate may be high
3. Finds a counterparty and setup a swap

International Financial Management COC642B – BBA F&A Jan to May 2023

Currency Swap
US MNC need EUR 40 M to fund its plants expansion at France. If US
MNC can find a counterparty in french who needs USD equivalent to
the above amount assuming the SR is 1 EUR = US 1.5.
Assuming the French company need USD 60 M
The borrowing rates are as follows:
$ EUR
US MNC 8% 7%
French MNC 9% 6%

International Financial Management COC642B – BBA F&A Jan to May 2023

Currency Swap

Swap Bank

US MNC French MNC

Borrow USD @ 8% Borrow EUR @ 6%

International Financial Management COC642B – BBA F&A Jan to May 2023

Swap Illustration
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 INR 500 crore. The oil field along
with equipments will be sold to Indian Government for INR 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:
(a) Construct a swap that will help the Drilldip to reduce the exchange rate risk.
(b) Assuming that Indian Government offers a swap at spot rate which is 1US$ =
INR50 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$ = INR 54.
Further you may also assume that the Drilldip can also take a US$ loan at 8% p.a.

International Financial Management COC642B – BBA F&A Jan to May 2023

Practical questions
Illustration 1:
ABN-Amro Bank, Amsterdam, wants to purchase INR 15 million against US$ for
funding their Vostro account with Canara Bank, New Delhi. Assuming the inter-
bank, rates of US$ is INR 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.

International Financial Management COC642B – BBA F&A Jan to May 2023

Practical questions
Illustration 2:
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.

International Financial Management COC642B – BBA F&A Jan to May 2023

Practical questions
Illustration 3:
XYZ Bank, Amsterdam, wants to purchase INR 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 $, INR
61.3625/3700 & per £, $ 1.5260/70.

International Financial Management COC642B – BBA F&A Jan to May 2023

Practical questions
Illustration 4:
JKL Ltd., an Indian company has an export exposure of JPY 10,000,000 payable August 31, 2014. Japanese Yen
(JPY) is not directly quoted against Indian Rupee.
The current spot rates are:
INR/US $ = INR 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
INR 65.
Forward rates for August 2014 are
INR/US $ = INR 66.50 JPY/US$ = JPY 110.35
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 $= INR 66.25
JPY/US$ = JPY 110.85
Is the decision to take forward cover justified?

International Financial Management COC642B – BBA F&A Jan to May 2023

Practical questions
Illustration 5:
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 =
INR 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 INR 74.3000 INR 74.3200
Mumbai-New York INR 49.2500 INR 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.

International Financial Management COC642B – BBA F&A Jan to May 2023

Practical questions
Illustration 6:
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 INR 225 INR 395 INR 510
Export sales per unit Yen 650 US$ 10.23 Eur 11.99
Receipt from sale due in 90 days Yen 78,00,000 US$ 1,02,300 Eur 95,920
Foreign Exchange rate information:
Yen / INR US$ / INR Eur / INR
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

International Financial Management COC642B – BBA F&A Jan to May 2023