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INTERNATIONAL FINANCE

FOREIGN EXCHANGE AND RISK MANAGEMENT (FOREX)


S.NO.
TOPICS
1.
INRODUCION / REGULATOR OF FOREIGN EXCHANGE MARKET IN
INDIA
2.
TYPES OF FOREX MARKET
3.
TYPES OF TRANSACTIONS
4.
EXCHANGE RATE QUATATIONS (ONE WAY AND TWO WAY QUOTE)
5.
DIRECT QUOTE AND INDIRECT QUOTE
6.
ASK RATE, BID RATE AND SPREAD
7.
FORWARD PREMIUM OR DISCOUNT/ APPRECIATION OR
DEPRECIATION OF CURRENCY
8.
CONCEPT OF SPOT RATE AND FORWARD RATE
9.
COMPUTATION OF FORWARD RATES
WITH THE HELP OF SWAP POINTS / MARGIN POINTS
WITH THE HELP OF IRP (INTEREST RATE PARITY)
WITH THE HELP OF PPP (PURCHASING POWER PARITY)
10.
CONCEPT OF EXCHANGE MARGIN
11.
HOW TO COMPUTE CROSS RATE
12.
FORWARD HEDGING VS NO HEDGING TECHNIQUE
13.
CANCELLATION OF FORWARD CONTRACT
CANCELLATION ON DUE DATE
CANCELLATION BEFORE DUE DATE
CANCELLATION AFTER DUE DATE BUT WITHIN 15 DAYS
AUTOMATIC CANCELLATION AFTER 15 DAYS
14.
EXTENSION OF FORWARD CONTRACT
15.
EARLY DELIVERY OF FORWARD CONTRACT
16.
RUPEE ROLL OVER OF FORWARD CONTRACT
17.
OPTION FORWARD CONTRACTS
18.
CALCULATION OF FORWARD RATE FOR BROKEN PERIOD
19.
MMH (MONEY MARKET HEDGING)/ HEDGING THROUGH CASH
MARKET OPERATION
20.
NETTING
21.
INTEREST RATE PARITY
22.
PURCHASING POWER PARITY THEORY
23.
ARBITRAGE / COVERED INTEREST ARBITRAG
24.
FISHERS EFFECT
25.
LEADING VS. LAGGING TECHNIQUE
26.
COVER DEAL
27.
INTERNATIONAL CAPITAL BUDGETING
28.
INTERNATIONAL JOINT VENTURE
29.
INTERNATIONAL CASH MANAGEMENT
30.
NOSTRO, VESTRO AND LORO ACCOUNT
31.
INTEREST RATE SWAP
32.
CONCEPT OF WITH HOLDING TAX
33.
VARIOUS EXPOSURES IN FOREX MARKET

LIST OF IMPORTANT CURRENCIES

Country
Argentina
Australia
Brazil
Canada
China
Czech Republic
Denmark
Hong Kong
India
Japan
Malaysia
Mexico
New Zealand
Russia
Singapore
South Africa
Switzerland
Taiwan
United Kingdom
United States of
America (USA)

Unit name
Peso
Dollar
Real
Dollar
Yuan
Koruna
Krone
Dollar
Rupee
Yen
Ringgit
Peso
Dollar
Rouble
Dollar
Rand
Franc
Dollar
Pound
Dollar

Symbol
ARS
AUD
BRL
CAD
CNY
CZK
DKK
HKD
`
JPY
MYR
MXN
NZD
RUB
SGD
ZAR
CHF
TWD
GBP
USD

Currency name
Argentine Peso
Australian Dollar
Brazilian Real
Canadian Dollar
Chinese Yuan
Czech Koruna
Danish Krone
Hong Kong Dollar
Indian Rupee
Japanese Yen
Malaysian Ringgit
Mexican Peso
New Zealand Dollar
Russian Rouble
Singapore Dollar
South African Rand
Swiss Franc
New Taiwan Dollar
British Pound
American Dollar

Topic: 1 Introduction / Regulator of forex market in India


(a) If any transaction involves foreign currency, then such transaction is known as foreign exchange
transaction.
(b) If any transaction involves foreign currency, then this transaction is regulated by
RBI
FEDAI (Foreign exchange dealers association of India)
(c) RBI established in accordance with the provisions of RBI Act, 1934. RBI manage FEMA act and
maintain foreign exchange market.
(d) FEDAI is established under section 25 of the company act. FEDAI regulate inter bank foreign
currency business.
(e) The foreign exchange market is divided in 3 tiers as shown below:

Foreign banks
Bank
Customer

Notes:
(1) Foreign banks are banks which are licenced by the RBI to deal in foreign exchange.
(2) Only bank can enter into transactions of foreign currency with foreign bank.
(3) The rate at which transaction between foreign bank and bank taken place is known as Inter bank rate.
(4) The rate at which transaction between bank and customer has taken place is known as Merchant rate.
(5) For any foreign exchange transaction always think from view point of bank.
(6) Think always view point of base currency / Commodity currency / Currency with 1 attached.
(7) Since bank is always in win win position, hence bank always purchase foreign currency at lower rate
and sell foreign currency at higher rate.
Topic: 2 Types of forex market

(1) Wholesale market / Inter bank market


Under inter bank market one bank can deal with another bank.
Exchange rate of inter bank market is known as inter bank rate.
Only bank can deal at inter bank rate.
(2) Retail market
Under retail market bank deal with customer.
Exchange rate of retail market is known as merchant rate.
A customer can buy or sale currency only at merchant rate.
Merchant rate is derived from inter bank rate by adding or deducting exchange margin.
Topic: 3 Types of transactions under forex market
(1) Cash transaction / Ready transaction Transactions entered today for immediate settlement is known as
ready transaction. Ready rate is applicable for this transaction. This transaction can be entered by one bank
with another bank. In other words, we can say that this is a inter bank market transaction.
(2) Value tom transaction Transactions entered today for T + 1 business day settlement (i.e. next business
day settlement) is known as value tom transaction. Applicable rate for this transaction is value tom rate.
This transaction is possible in inter bank market only.
(3) Spot transaction Transactions entered today for T + 2 business day settlement is known as spot
transaction. Applicable rate for this transaction is spot rate.
(4) Forward transaction Transactions entered today for settlement at a future date is known as forward
transaction. Applicable rate for this transaction is forward rate.
Topic: 4 Exchange rate quotations

One way quote


When buying rate (Bid rate) and
selling rate (Ask rate) are same,
quotation is known as one way
quote.
Example: Exchange rate = 1$ = `50
It means that 1 $ can be purchased
or sold at `50 only.

Two way quote


When bid rate and ask rate are different then
this is known as two way quote. Bid rate is
always less than ask rate because bank always
purchase foreign currency at lower rate and
sale foreign currency at higher rate.
Example: Exchange rate = 1$ = `50 / 50.50
It means that bank will purchase 1 $ at `50
and sale 1 $ at `50.50.

HOW TO APPLY TWO WAY QUOTE FOR CONVERTING ONE CURRENCY INTO ANOTHER
CURRENCY.
Following steps will be applied for conversion:
Step: 1 Identify amount payable / receivable.
Step: 2 Select applicable bid rate or ask rate by assuming that what will do bank for left hand currency i.e.
commodity currency.
Note: If bank has to purchase base currency then applicable rate is bid rate and if bank has to sell base
currency than applicable rate is ask rate. In other words we can say that bank always purchase foreign
currency at lower rate and sale foreign currency at higher rate.
Step: 3 Convert one currency into another currency by using selected rate.

Class example: 1Calculate how many rupees Shri Ras Bihari Ji Ltd., a New Delhi basedfirm, will receive
or pay for its following four foreign currency transactions:
(i) The firm receives dividend amounting to Euro 1,12,000 from its French Associate Company.
(ii) The firm pays interest amounting to 2,00,000 Yens for its borrowings from a Japanese Bank.
(iii) The firm exported goods to USA and has just received USD 3,00,000.
(iv) The firm has imported goods from Singapore amounting to Singapore Dollars (SGD) 4,00,000.
Given: 1$ = Rs.40.00/40.05
1 Euro = Rs.56.00/56.04
1 SGD = Rs.24.98/25.00
100 Yens = Rs.44.00/44.10
Solution:
(i) Firm receive Euro = 1,12,000
Applicable exchange rate = 1 Euro = `56.00 / 56.04
Since bank purchase Euro hence applicable rate is bid rate i.e. `56
Hence firm will receive = 1,12,000 * 56 = `62,72,000
(ii) Payment by firm = 2,00,000
Exchange rate: 100 = `44.00/ 44.10
Since bank sell hence applicable rate is ask rate i.e. `44.10
Payment by firm = 2,00,000 / 100 * 44.10 = `88,200
(iii) Firm receive = 3,00,000 $
Exchange rate: 1 $ = 40.00 / 40.05
Since bank purchase $ and hence applicable rate is bid rate i.e. `40.00
Hence firm receive = 3,00,000 * 40 = `1,20,00,000
(iv) Payment by firm = 4,00,000 SGD
Exchange rate: 1 SGD = `24.98 / 25.00
Since bank sell SGD hence applicable rate is ask rate i.e 1 SGD = `25
Hence firm pays = 4,00,000 * 25 = `1,00,00,000

Class example: 2Calculate how many British pounds a London based firm will receive orpay for its
following four foreign currency transactions:
(i) The firm receives dividend amounting to Euro 1,20,000 from its French Associate Company.
(ii) The firm pays interest amounting to 2,00,000 Yens for its borrowings from a Japanese Bank.
(iii) The firm exported goods to USA and has just received USD 3,00,000.
(iv) The firm has imported goods from Singapore amounting to Singapore Dollars (SGD) 4,00,000.
Given: 1$ = 0.50/0.51
1 Euro = 0.60/0.61
1 SGD = 0.39 /0.40
1 Yen = 0.0049 / 0.0050
Answer:
(i) Firm receive = 72,000
(i) Firm pays = 1,000
(iii) Firm receive = 1,50,000
(iv) Firm pays = 1,60,000
Class example: 3 Calculate how many US$ a New York based firm will receive or pay forits following
four foreign currency transactions:
(i) The firm receives dividend amounting to Euro 1,20,000 from its French Associate Company.
(ii) The firm pays interest amounting to 3,00,000 Yens for its borrowings from a Japanese Bank.
(iii) The firm exported goods to UK and has just received 3,00,000.
(iv) The firm has imported goods from Singapore amounting to Singapore Dollars (SGD) 4,00,000.
Given: 1 = $ 2.00/2.01
1 Euro = $ 1.20/1.21
1 SGD = $ 0.49/0.50
100 Yens = $ 0.89/0.90

Answer:
(i) Firm received = 1,44,000 $
(ii) Firm pays = 2,700 $
(iii) Firm received = 6,00,000 $
(iv) Firm pays = 2,00,000 $
Class example: 4 Calculate how many rupees a New Delhi based firm will receive or payfor its following
four foreign currency transactions:
(i) The firm receives dividend amounting to Euro 90,000 from its French Associate Company.
(ii) The firm pays interest amounting to 2,00,000 Yens for its borrowings from a Japanese Bank.
(iii) The firm exported goods to USA and has just received USD 3,00,000.
(iv) The firm has imported goods from Singapore amounting to Singapore Dollars (SGD) 4,00,000.
Given:
1 Re = Euro 0.0178/0.0180
1 Re = Yens 2.50/2.51
1 Re. = $ 0.0249/0.0250
1 Re = SGD 0.040 / 0.041
Solution:
(i) Receive dividend = Euro 90,000
Applicable rate: Bank sell` at 0.0180
Firm receive = 90,000 / 0.0180 = `50,00,000
(ii) Payment of interest = 2,00,000
Applicable rate = Bank is buying ` at 2.50
Payment = 2,00,000 / 2.50 = `80,000
(iii) Firm received = 3,00,000 $
Applicable rate = Bank selling ` at 0.0250
Firm receives = 3,00,000 / 0.0250 = `1,20,00,000
(iv) Payment by firm = 4,00,000 SGD
Applicable rate = Bank by ` at 0.040
Hence payment = 4,00,000 / 0.040 = `1,00,00,000
Topic: 5 Exchange rate interpretation Exchange rate would be defined as the price of currency in
terms of another. Thus JPY 130.0250 per EUR means that 1 EUR = JPY 130.0250. Here Euro is known as
base currency and JPY is known as the price currency.
In general terms A/B, where
A = Price currency
B = Base currency
`/$implies that 1 $ = `
$/ implies that 1 = $
Topic: 6Direct quote and Indirect quote
(a) Direct quote is the home currency price for 1 unit of foreign currency. Means,
Direct quote: 1 unit of foreign currency = How many units of home currency
(b) Indirect quote is the foreign currency price for 1 unit of home currency. Means,
Indirect quote: 1 unit of home currency = How many units of foreign currency.
How to convert direct quote into indirect quote or vice versa Direct quote and indirect quote are
reciprocal of each other. Hence,
Direct quote =

1
Indirect quote

OR

Indirect quote =

1
Direct quote

Note: In two way quote, when we calculate reciprocal then bid rate becomes ask rate and ask rate
becomes bid rate.
Class example: 5Identify whether the following is a direct quote in USA. If not, find it.
(i) `46 = 1 $
(ii) 1 $ = S$ 1.60
(iii) 1 GBP = $ 0.639
Answer:
(i) No; 1 ` = 0.0217 $
(ii) No; 1 S$ = 0.6250
(iii) Yes
Class example: 6A Mumbai banker has given the following quotes. Identify whether they are direct or
indirect. For each direct quote give the corresponding indirect quote and vice versa.
Currency
Rate
Quote
SEK
6.16
`per Kroner
Euro
0.0148
per `
SGD
0.0299
SGD per `
AED
13.85
` per UAE Dirham
Solution:
Given quote
` per Kroner
per `
SGD per `
` per UAE Dirhan

Nature
Direct
Indirect
Indirect
Direct

Other quote
Korner per `
` per
` per SED
AED per `

New rate
0.1623
67.5676
33.4448
0.0722

Class example: 7 Convert the direct quotes into indirect quotes:


(a) 1$ = Rs.40.00 / 40.05
(b) 1 = Rs.82.00/82.07
(c) 1Euro = Rs.56.00/ 56.18
Topic: 7 Bid rate, Ask rate and spread
Bid rate is the rate at which bank buys base currency / left hand side currency.
Ask rate is the rate at which bank sell base currency / left hand side currency.
Ask rate will always be greater than bid rate.
Spread is the difference between ask rate and bid rate.
Spread = Ask rate Bid rate
% of Spread =

Ask rateBid rate


Bid rate

X 100

Note: Sometimes, the ask rate may be given in incomplete fashion, and then it should be interpreted as
under:
`/$ = 47.30 / 70 implies 47.30 / 47.70
`/$ = 47.40 / 10 implies 47.40 / 48.10
$/ = 1.3520 / 70 implies 1.3520 / 1.3570
$ / = 1.3260 / 10 implies 1.3260 / 1.3310
Class example: 8Consider the following quotes.
Spot (Euro/Pound) = 1.6543/1.6557

Spot (Pound/NZ$) = 0.2786/0.2800


1. Calculate the % spread on the Euro/Pound Rate
2. Calculate the % spread on the Pound 1 NZ $ Rate
3. The maximum possible % spread on the cross rate between the Euro and the NZ $.
Topic: 8 Concept of exchange margin
Exchange margin is the extra amount or % charged by the bank over and above the rate quoted in inter
bank market. With the help of exchange margin we can calculate merchant rate applicable for customers.
How to calculate exchange rate using exchange margin:
Rule: 1 Deduct margin from buying rate to get desired exchange rate.
Rule: 2 Add margin to selling rate to get desired exchange rate.
Class example: 9 Mr. A imported goods worth $ 1,00,000. Exchange rate on that date was 1$ = `40.80 /
40.90. If bank wants to earn margin of 0.8 %, then what rate should be quoted by the bank to customer.
SOLUTION:
Bank sell $ at ask rate
Add: Margin @ 0.80 %
Applicable rate for customer

40.90
0.3272
41.2272

Class example: 10In the inter bank market, we have the following quote:
` /$ = 59.20 / 59.40
TT buying commission = 0.8 %
TT selling commission = 0.90 %.
Calculate merchant / retail rates for customer.
SOLUTION:
Statement of retail rates for customer:
Inter bank rate
Adjustment of margin:
0.80 %
0.90 %
Applicable rate

Bid
59.20

Ask
59.40

(0.4736)

0.5346
59.9346

58.7264

Class example: 11In the inter-bank market, the DM is quoting Rs.21.50. If the bank charges
0.125%commission for IT selling and 0.15% for TT buying, what rate should it quote?
Answer: Applicable rate: 1 DM = `21.46775 / 21.52688
Topic: 9 Concept of spot rate and forward rate
Spot rate Spot rate is the exchange rate at which we can buy or sell currency now. In other words spot
rate is the rate which prevails today.
Forward rate Forward rate is the rate agreed today but settlement takes place at future date.
How to determine forward rate Forward rate may be given in question directly or information is provided
for calculating it. If forward rate is directly given in question, then it is known as outright forward rate. If
forward rate is not given directly, then we should calculate forward rate as per the following method as
provided.
Method: 1 With the help of swap points / Margin points / Forward points
Forward rate = Spot rate Swap points
Rules for determining forward rate with the help of swap points
Rule: 1 If swap points / forward points are in increasing order then add to spot rate to arrive forward rate.

Rule: 2 If swap points / forward points are in decreasing order then should be deducted from spot rate to
arrive forward rate.
Method: 2 With the application of IRPT (Interest rate parity theory):
Forward rate = Spot rate X

1+ Rq
1+ Rb

Rq = Rate of quote / price currency


Rb = Rate of base currency
Method: 3 with the application of PPPT (Purchasing power parity theory)
Forward rate / Expected spot rate = Spot rate X

1+ Iq
1+ Ib

Iq = Inflation rate of quote / price currency


Ib= Inflation rate of base currency
Class example: 12The following quotes are available
Spot (DM/$): 1.5105/1.5120
Three-month swap points: 25/20
Six-month swap points: 30/25
Calculate the three-month and six-month forward rates.

Class example: 13The 90 day interest rate is quoted at 5 % in the US and 6% in UK. Current spot
rate is $ 2.02 / . What will be the 90 days forward rate. Assume 360 days in a year.
SOLUTION:
Spot rate = 1 = 2.02 $
Interest rate in US = 5 % p.a. or 1.25 % for 90 days
Interest rate in UK = 6 % p.a. or 1.50 % for 90 days
Hence, Forward rate = Spot rate X
Forward rate = 2.02 X

1.0125
1.0150

1+ Rq
1+ Rb

= 2.0150

Class example: 14The current spot rate for the British pound is `81. The expected inflation rate is 4
% in India and 2.7 % in UK. What is the expected spot rate of British pound a year hence?
SOLUTION:
Forward rate / Expected spot rate = Spot rate X

Forward rate / Expected spot rate = 81 X

1.04
1.027

1+ Iq
1+ Ib

= 82.025

Class example: 15The inflation rate in US is expected to be 2.7 % per year and the inflation rate in
Japan is expected to be 0.40 % per year. If the current spot rate is 114 Yen/$ , what will be the
expected spot rate in year 3?
SOLUTION:

Forward rate / Expected spot rate = Spot rate X

For year 1 = 114 X

1.004
1.027

1+ Iq
1+ Ib

= 111.4469

For year 2 = 111.4469 X

1.004
1.027

= 108.9510

For year 3 = 108.9510 X

1.004
1.027

= 106.5110

Class example: 16
Spot rate = / $: 0.9450/0.9470
3 months swap points = 80 / 70
6 months swap points = 120 /110
Calculate 3 months and 6 months forward rates.
SOLUTION:
(a) Calculation of 3 months forward rate:
Spot rate
Less: 3 months swap points
3 months forward rate

Bid
0.9450
0.0080
0.9370

Ask
0.9470
0.0070
0.9400

Bid
0.9450
0.0120
0.9330

Ask
0.9470
0.0110
0.9360

(b) Calculation of 6 months forward rate:


Spot rate
Less: 6 months swap points
6 months forward rate

Class example: 17
Spot rate: `/$ = 58.60/ 58.90
1 month swap point = 50/60
3 months swap point = 90 /110
Calculate 1 month and 3 months forward rate.
Answer:
(a) 1 Month forward rate = 59.10 / 59.50
(b) 3 Month forward rate = 59.50 / 60.00
Topic: 10 Forward premium or discount/ Appreciation or depreciation in currency
Forward premium If currency is costlier in future as compared to spot it is said to be at premium.
Forward discount If currency is cheaper in future as compared to spot it is said to be at discount.
Calculation of Annualized forward premium / Discount on currency:
Currency terms = A/B
A = Price currency
B = Base currency

Annualized forward premium on currency B =

Forward rateSpot rate


12
100 X
X
Spot rate
Period

Annualized forward premium on currency A =

Spot rateForward rate


12
100 X
X
Forward rate
Period

Note: A negative answer would imply annualized discount rate.


Class example: 18The exchange rate for Mexican peso was 0.1086 in December 2004, and 0.0913
inNovember 2004, against dollar. Which currency has depreciated and by how much?

SOLUTION:
Nov. 04: 1 $ = 0.0913 Peso
Dec. 04: 1 $ = 0.1086 peso
Quote is: peso / $
Hence for peso:

Spot rateForward rate


Forward rate

0.09130.1086
0.1086
0.0173
0.1086

X 100

X 100

X 100 = - 15.93 %

Hence, Mexican Peso depreciated 15.93 % against $


Class example: 19The dollar is currently trading at `40. If Rupee depreciates by 10%, what will be
thespot rate? If dollar appreciates by 10% what will be the spot rate?
SOLUTION:
Spot rate: 1 $ = `40
To find depreciation of `, we need to have a quote of `. Since, given quote is in $ and hence we need to
convert it. So, 1` = 1 / 40 = 0.025 $
If ` depreciate by 10 %, then new rate would be
0.025 0.0025 = 0.0225
Hence, 1 $ = 1 / 0.0225 = `44.44
(b) If $ appreciates by 10 %, then we can apply 10 % directly to $ quote.
Hence, new rate would be: 40 + 10 % = 44
Hence, 1 $ = `44

Class example: 20
Spot rate: $ / = 1.3650
3 months forward rate $ / = 1.3710
Calculate annualized forward premium / discount on pound and dollar.
SOLUTION:
Quote: (A/B) = ($ / )
(a) Annualized forward premium on pound =

FS
S

12
X 100 X n

1.37101.3650
1.3650
0.006
1.3650

X 100 X

12
3

X 100 X

12
3

= 1.7582 %

(b) Annualized forward premium on $ (Currency A)

SF
F

12
n

X 100 X

1.36501.3710
1.3710
0.006
1.3710

X 100 X

12
3

X 100 X

12
3

= - 1.7505 % (Discount)

Class example: 21
Spot rate: `/ = 70.20
6 months forward rate = 68.10
Compute the annualized forward premium / discount on and `.
Answer: Forward premium on = - 5.9829 %
Forward premium on ` = 6.1674 %
Class example: 22
3 months forward rate (`/$) = 60
Based on 3 months forward rate, annualized forward discount on $ against ` = 5 %
Based on 6 months forward rate, annualized forward premium on ` against $ = 7 %
Compute 6 month forward rate (`/$).
Solution:
Calculation of spot rate using 3 months forward rate

FS
S

X 100 X

12
n

60S
S

X 100 X

12
3

60S
S

X 400 = - 5

=-5

=-5

24,000 400 S = - 5 S
395 S = 24,000
S = 60.7595
Calculation of 6 months forward rate (Currency A)

SF
F

X 100 X

12
n

=7

60.7595F
F

X 100 X

60.7595F
F

X 200 = 7

12
6

=7

12,151.90 200 F = 7 F
207 F = 12,151.90
F = 58.7048
Class example: 23
6 months forward rate = $0.9750/
Based on 6 months forward rate, the annualized forward premium on $ = 8 %
Based on 3 months forward rate, the annualized forward discount on = 6 %
Calculate 3 months forward rate.
Topic: 11 Concept of cross rate
Cross rate is the exchange rate between two currencies where neither of the currencies are of the country in
which the exchange rate is quoted. In other words, whenever desired exchange rate will calculate with the
help of two or more another exchange rates then such rate is known as cross rate.
Class example: 24Following exchange rates are quoted by bank:
Dollar Euro exchange rate ($/) = 1.5968
Dollar Yen exchange rate ( / $) = 108.0030
Calculate Euro Yen ( / ) cross rate.
Answer: 1 = 0.0058
SOLUTION:
1 = 1.5968 $
So, 1 $ = 1/1.5968 or 1 $ = 0.6263
1 $ = 0.6263
1 $ = 108.0030
So, 108.0030 = 0.6263
1 = 0.6263 / 108.0030
1 = 0.0058

Class example: 25Following exchange rates are quoted by bank:


Dollar Euro exchange rate: 1 = 1.5451 $
Dollar Pound exchange rate: 1 = 2.0975 $
Calculate Euro pound ( / ) cross rate.
Answer: 1 = 1.3575
Class example: 26Following exchange rates are quoted by bank:
1 $ = 1.1641 / 1.1646 CAD
1 $ = 1.2948 / 1.2956 AUD
Calculate cross rate between AUD / CAD.

Answer: 1 CAD = 1.1118 / 1.1130 AUD


SOLUTION:
Interpretation of quotes:
(i) Bank buy 1 $ and sell 1.1641 CAD
Bank sell 1 $ and buy 1.1646 CAD
(ii) Bank buy 1 $ and sell 1.2948 AUD
Bank sell 1 $ and buy 1.2956 AUD
If bank buy I CAD against AUD
Bank must sell AUD and purchase $ and
simultaneously sell $ and buy CAD
Hence, applicable rates:
1 $ = 1.2948 AUD
1 $ = 1.1646 CAD
So, 1.1646CAD = 1.2948 AUD
1 CAD = 1.2948 / 1.1646 = 1.1118 AUD

If bank sell 1 CAD against AUD


Bank sell $ and buy AUD and buy $ and sell CAD
1 $ = 1.2956 AUD
1 $ = 1.1641 CAD
1.1641 CAD = 1.2956 AUD
1 CAD = 1.2956 / 1.1641
1 CAD = 1.1130 AUD

Class example: 27Following rates are quoted by bank:


Rate between and $ ( / $) = 119.05 121.95
Rate between and $ ( / $) = 0.7920 0.7932
Calculate cross rate between and ( / )
Answer: 1 = 150.0883 / 153.9773
Class example: 28You are given the following exchange rates:
1 $ = 1.6000 / 1.6035 SF
1 = 1.9810 / 1.9850 $
Find out cross rate between 1 = SF.
Answer: 1 = 3.1696 / 3.1829 SF
SOLUTION:
Interpretation of quotes:
(i) Bank buy $ and sell SF at 1.6000
Bank sell $ and buy SF at 1.6035
(ii) Bank buy and sell $ at 1.9810
Bank sell and buy $ at 1.9850
Bank buy against SF
Buy and sell $ and Buy $ and sell SF
1 = 1.9810 $ or 1 $ = 1 / 1.9810
1 $ = 1.6000 SF
1 / 1.9810 = 1.6000 SF
1 = 1.6000 * 1.9810 = 3.1696 SF

Bank sell against SF


Sell and buy $ and sell and SF
1 = 1.9850 $ or 1 $ = 1/1.9850
1 $ = 1.6035 SF
1 / 1.9850 = 1.6035 SF
1 = 1.6035 * 1.9850 = 3.1829

Class example: 29 A bank is quoting the following exchange rate against the dollar for the Swiss franc and
the AUD:
SF/$ = 1.5960 / 70
AUD / $ = 1.7225 / 35
An Australian firm asks the bank for an AUD / SF quote. What cross rate would the bank quote?
Answer: 1 SF = 1.0786 / 1.0799 AUD
Class example: 30Assume a French trader who imports from London. He would like to buy Pound against
euro. The following market rates prevail:
EURO / $ = 1.18 / 1.19

Pound / $ = 0.69 / 0.70


At what rate the French would book his Pound?
Answer: 1 = 1.7246
Class example: 31Consider the following rates:
Spot `/$ 42.17/42.59
`/DM 24.61/25.10

3-m forward `/$ 43.15/43.60


`/DM 25.36/25.90
From these rates calculate the spot and forward DM/$ rates.
Answer: Spot rate 1 $ = 1.6801 / 1.7306 DM
3 months forward rate 1 $ = 1.6660 / 1.7192 DM
Class example: 32You are given the following information
Spot DM/$: 1.5105/1.5130
Three-month swap: 25/35
Spot $/: 1.6105/1.6120
Three-month swap: 35/25
Calculate the three-month DM/ rate.
Answer: 1 = 2.4314 / 2.4408 DM
Class example: 33A bank has to submit a quote to a customer for buying DM against Rupees. The
customerhave the option of taking delivery of `at the end of the second month. Given the following
spot and forward rates what rate should it quote?
`/$ Spot: 35.20/35.30
One-month forward: 15/25
Two-month forward: 20/30
DM/$ Spot: 1.51/1.52
One-month forward: 15/10
Two-month forward: 20/15.
Answer: 1 DM = `25.84
Topic: 12 Forward hedging Vs No hedging
Hedging means protect himself due to risk arise from exchange fluctuation. For hedging importer or
exporter has following alternatives:
(a) Forward cover or forward hedging
(b) Money market hedging / Cash market hedging
(c) Option hedging
(d) Future hedging

Forward hedging means take an appropriate action to reduce risk against exchange fluctuation which
will arise in future in respect of payables or receivables.
No hedging means no protection against future payables or receivables. Under this approach importer
or exporter wait till settlement date and settle transaction at applicable rate.
Under forward cover Vs no cover following steps would be followed:
Step: 1 Book a forward contract today at applicable forward rate.
Step: 2 Calculate cash flows due to such forward cover.
Cash flow = Contract size * Forward rate
Step: 3 Calculate cash flow at spot rate prevails on due date (i.e. No cover)
Step: 4 Compare both cash flows and take decision.
Note: Sometimes in the question various spot rates and their probabilities are given then we have to
calculate spot rate on due date (Expected spot rate) with the help of probability.

Expected spot rate = [Spot rate1* Probability1 + Spot rate2 * Probability2 + .]


Class example: 34Lorascorporation imported goods from New Zealand and needs 100,000 New Zealand
dollars 180 days from now. It is trying to determine whether to hedge this position. Loras has developed
the following probability distribution for the New Zealand dollar:
Possible value of New Zealand Dollar
Probability
$ 0.40
5%
0.45
10 %
0.48
30 %
0.50
30 %
0.53
20 %
0.55
5%
The 180-day forward rate of the New Zealand dollar is $.52. The spot rate of the New Zealand
dollar is $.49. Decide that whether Loras Corporation go for forward hedging or not.
Answer: Benefit due to no hedging = $ 2,750
SOLUTION:
Alternative 1: Forward hedging
Amount payable
Applicable forward rate
Amount payable
Alternative 2:
Calculation of expected spot rate
Spot rate
Probability
0.40
0.05
0.45
0.10
0.48
0.30
0.50
0.30
0.53
0.20
0.55
0.05

1,00,000
0.52
52,000 $

Expected spot rate


0.02
0.045
0.144
0.15
0.106
0.0275
0.4925

Amount payable = 1,00,000 * 0.4925 = $ 49,250


Hence, Benefit due to no hedging = 52,000 49,250 = 2,70 $
Class example: 35Suffolk Co. negotiated a forward contract to purchase 200,000 British pounds in 90
days. The 90-day forward rate was $1.40 per British pound. The pounds to be purchased were to be used to
purchase British supplies. On the day the pounds were delivered in accordance with the forward contract,
the spot rate of the British pound was $1.44. What was the real cost of hedging the payables for this U.S.
firm?
Answer: Cost of hedging: $ 8,000
SOLUTION:
Cost of forward market hedging (2,00,000 * 1.40)
2,80,000
Cost of remaining unhedged (2,00,000 * 1.44)
2,88,000
Cost of hedging
8,000
Class example: 36You believe that IRP presently exists. The nominal annual interest rate in Mexico is
14%. The nominal annual interest rate in the U.S. is 3%. You expect that annual inflation will be about 4%
in Mexico and 5% in the U.S. The spot rate of the Mexican peso is $.10. You will receive 1 million pesos
in one year.
(a) Determine the amount of dollars that you will receive if you use a forward hedge.
(b) Determine the expected amount of dollars that you will receive if you do not hedge and believe in
purchasing power parity (PPP).
Answer: (i) $ 90,400
(ii) $ 1,00,960

Class example: 37 JKL Ltd, an Indian company has an export exposure of JPY 1,00,00,000 payable
August 31, 2014. Japanese Yen (JPY) is not directly quoted against Indian Rupee.
The current spot rates are:
INR / US $
`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 `65.
Forward rates for August 2014 are:
INR / US $
`66.50
JPY / US $
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 $
`66.25
JPY / US $
JPY 110.85
Is the decision to take forward cover justified?
[CA May, 2014]
Answer:
(i) Loss Without hedging - `8,38,000
Loss due to forward cover - `54,000
(ii) Loss Without hedging - `1,03,000
SOLUTION:
Calculation of spot rate between `/ =
1 $ = `62.22
1 $ = 102.34
So, 102.34 = `62.22
1 = 62.22 / 102.34 = 0.6080
Expected rate between `/
1 $ = `65
1 $ = 124
So, 124 = `65
1 = 65 / 124 = `0.5242
Forward rate between `/
1 $ = `66.50
1 $ = 110.35
110.35 = 66.50
1 = 66.50 / 110.35 = 0.6026
(i)
Calculation of expected loss, if no hedging:
Value of export at the time of export (1,00,00,000 * 0.6080)
Estimated payment to be received (1,00,00,000 * 0.5242)
Loss
Calculation of loss under forward cover:
Value of export at the time of export (1,00,00,000 * 0.6080)
Payment to be received under forward cover (1,00,00,000 * 0.6026)
Loss
Decision: Hence, by taking forward cover loss is reduced to `54,000.
(ii) Calculation of expected spot rate on August 31, 2014:
1 $ = `66.25
1 $ = 110.85
110.85 = 66.25

60,80,000
52,42,000
8,38,000
60,80,000
60,26,000
54,000

1 = 66.25 / 110.85 = 0.5977


Value of export at the time of export (1,00,00,000 * 0.6080)
Estimated payment to be received (1,00,00,000 * 0.5977)
Loss
The decision to take forward cover is still justified.

60,80,000
59,77,000
1,03,000

Topic: 13 Cancellation of forward contract Whenever customer requested bank for not fulfilling his
obligation then it is known as cancellation of forward contract.
(a) Cancellation on due date whenever bank book a forward contract with any customer then at the
same time bank also book counter contract with the market. If on the due date customer requests to bank
for cancellation of his forward contract even then bank also has to fulfil his counter obligation. For
fulfilling his counter obligation bank have to go in the market on the date of cancellation and purchase /
sale of foreign currency. Bank has to pay an additional amount for this new contract can be recovered from
customer and if there is any gain to bank then bank has to refund this gain to customer. Gain / loss to
customer can be calculated as under:
Spot rate for the new contract on the date cancellation
xxx
Add/ Less: Margin
xxx
xxx
Less: Original contract rate
xxx
Loss or gain to customer
xxx
(b) Cancellation before due date Whenever bank book a forward contract with any customer then at the
same time bank also book counter contract with the market. If before the due date customer requests to
bank for cancellation of his forward contract even then bank also has to fulfil his counter contract on due
date. For this purpose, bank has to book a new contract with market for the remaining period of the
original contract. Gain / loss to customer can be calculated as under:
Forward rate of new contract
xxx
Add/ Less: Margin
xxx
xxx
Less: Original contract rate
xxx
Gain / loss to customer
xxx
(c) Cancellation of forward contract after due date but within 14 days Whenever customer cancel his
contract after due date but within 14 days then bank will recover loss arising from cancellation of forward
contract from the customer.
If there is any gain on cancellation then such gain will not be given to customer.
(d) Automatic cancellation on 15th Day In this situation bank does opposite action on spot basis.
Exchange loss if any is recovered from the customer but if there is any gain due to such cancellation the
entire gain will be retain by the bank itself.
Topic: 14 Extension of forward contract Whenever customer approaches to bank for increasing the
time limit of contract, it is known as extension of forward contract.
(a) Extension on due date - An exporter finds that he is not able to export on the due date but expects to
do so in about two months. An importer is unable to pay on the due date but is confident of making
payment a month later. In both these cases, they may approach their bank with which they have entered
into forward contracts to postpone the due date of the contract. Such postponement of the date of delivery
under a forward contract is known as the extension of forward contract. When a forward contract is sought
to be extended. It shall be cancelled and rebooked for the new delivery period at the prevailing exchange
rates. FEDAI has clarified that it would not be necessary to load exchange margins when both the
cancellation and re-booking of forward contracts are undertaken simultaneously. However, it is observed
that banks do include margin for cancellation and rebooking as in any other case.
Flow chart for extension of forward contract

For extension of contract first we have


to cancel the original contract. At the
time of cancellation bank has to fulfil
his counter contract by purchasing /
selling foreign currency in market.

Extension charges = Spot rate on the date of extension


(with margin, if any) original contract rate

Bank has to rebook a new contract


with customer for the extended period.

Same contract with customer


for extended period. In other
words, bank again booked a
new forward contract with
customer. New forward rate
should be calculated.

Early extension - When the request for extension is received earlier to the due date, it is known as early
extension. Due to such early extension, bank has to make a new forward contract for the remaining period
of original contract with the market. The difference between new forward rate and original contract rate is
known as extension charges which should be either recovered from customer or paid to customer. Bank
also decides a new forward rate for extended period.
Class example: 38 A customer with whom the bank had entered into 3 months forward purchase contract
for 50,000 $ at the rate of `50.25 comes to the bank on due date and requests cancellation of the contract.
Spot rate on the date of cancellation are:
1 $ = `50.85 / 51.00. What are the loss/ gain to the customer on cancellation?
Class example: 39An exporter requests his bank to extend the forward contract for US $20,000 which is
due for maturity on 31st October, 2014 for a further period of 3 months. He agrees to pay the required
margin money for such extension of the contract.
Contracted rate US $1= `62.32
The US $quoted on 31.10.2014:
Spot rate: - 61.5000/ 61.5200
3 months discount 0.93 % / 0.87 %
Margin money from banks point of view for buying and selling rate is 0.45 % and 0.20 % respectively.
Compute:
(a) The cost of importer in respect of the extension of the forward contract, and
(b) The rate of new forward contract.
[RTP May, 2015]
SOLUTION:
Statement showing extension charges:
Applicable spot rate (Selling rate)
Add: Margin @ 0.20 %
Adjusted rate
Less: original rate
Gain per $
Exposure amount
Total gain
Calculation of new forward rate:
Applicable spot rate
Less: Discount rate @ 0.93 %
Less: Margin @ 0.45 %
New rate

61.5200
0.1230
61.64
62.32
0.68
20,000
13,600
61.50
0.5720
60.9280
0.2742
60.65

Class example: 40On 1.4.2007, Sangeet International (SI) concluded a contract for purchase of 10,00,000
blue ray discs from an American company at $ 1.48 per Disc, to be supplied over the next 3 months. SI is
required to make the payment immediately upon receipt of all the discs. To meet the obligation, SI had
booked a forward contract with its bankers to buy $ 3 months hence. The following are the exchange rates
on 1.4.2007
Spot rate:
`41.30 70
3 months forward rate:
`42.00 50
On 1.7.2007, the American company expressed its inability to supply the last installment of 3,00,000 Blue
Ray discs due to export restrictions in US and required SI to settle for the quantity supplied. Spot rate on
1.7.2007 was `40.90 41.20.
(a) Ascertain the total cash outgo for SI for purchase of 7,00,000 discs.
(b) Would total cash outgo undergo any change if the American company had informed on 1.6.2007, when
the following exchange rates were available
Spot rate:
`41.70 42.20
1 months forward:
`42.10 42.50
[CWA Study Material]
Solution:
(a) Bank booked forward sale
14,80,000 $ @ 42.50
Spot rate: 41.30 / 41.70

Bank booked forward purchase


Due date of contract
4,44,000 $ contract will be cancelled
Spot rate: 40.90 / 41.20

Statement showing calculation of cash outflow:


(a) Amount paid for honored contract (i.e. for 7,00,000 discs) (10,36,000 *
42.50)
(7,00,000 * 1.48 * 42.50)
(b) Amount paid due to cancellation of contract (40.90 42.50) * 4,44,000
Total cash outflow
(b)
Bank booked forward sale
14,80,000 $ @ 42.50
Spot rate: 41.30 / 41.70

4,40,30,000
7,10,400
4,47,40,400

Bank booked forward purchase


1.7.2007
Due date of contract
Cancellation
Spot rate: 41.70 / 42.20
1 months forward = 42.10 / 42.50

Customer cancel its contract before due date. Bank has booked 1 month forward sale contract with market.
Since market purchases $, Lower rate will (i.e. 42.10) apply. Hence cash outflow will be as under:
Statement showing calculation of cash outflow:
(a) Amount paid for honored contract (i.e. for 7,00,000 discs) (10,36,000 *
42.50)
(7,00,000 * 1.48 * 42.50)
4,40,30,000
(b) Amount paid due to cancellation of contract (42.10 42.50) * 4,44,000
1,77,600
Total cash outflow
4,42,07,600
Class example: 41Ankita Papers Ltd (APL), on 1st July 2007 entered into a 3 Month forward contract for
buying GBP 1,00,000 for meeting an import obligation. The relevant rates on various dates are
Date
Nature of quote
Quote
1.7.2007
Spot
`81.50 81.85
3 months forward
`81.90 82.30
1.8.2007
Spot
`82.10 82.40
2 months forward
`82.25 82.60
1.9.2007
Spot
`81.70 82.05

1 month forward
`82.00 82.30
2 months forward
`82.40 82.70
1.10.2007
Spot
`82.50 82.75
1 month forward
`82.60 82.90
Explain the further course of action if APL
(a) Honours the contract on
01.10.2007
01.09.2007; and meets the import obligation on the same date.
(b) Cancels the contract on
01.08.2007
01.09.2007
01.10.2007; as the import obligation does not materialize.
(c) Rolls over the contract for - 2 Months on 01.09.2007
1 Month on 01.10.2007; as the import obligation gets postponed to 01.11.2007. Also determine the
cost / gain of that action. Ignore transaction costs.
[CWA Study Material]
Topic: 15 Early delivery of forward contract When a customer requests early delivery of a forward
contract, i.e., delivery before its due date, the bank may accede to the request provided the customer agrees
to bear the loss, if any, that may accrue to the bank. At the time of early delivery, following procedure will
be adopted by bank:

In case of exporter
1. Take delivery from customer and sale
the foreign currency in the market
immediately. Hence calculate inflow from
sale in market.
2. Rebook a new forward purchase contract
with market for the remaining period of
original contract. Hence calculate outflow.
3. Difference between inflow and outflow
either recovered from customer or paid to
customer.

In case of Importer
1. Purchase foreign currency from market
immediately and sale to importer at contract rate.
Hence calculate outflow due to purchase from
market.
2. Rebook a new forward sale contract with
market for the remaining period of original
contract. Hence, calculate inflow from this
contract.
3. Difference between inflow and outflow either
recovered from customer or paid to customer.

ADDITIONAL QUESTIONS RELATED TO CANCELLATION, EXTENSION, EARLY


DELIVERY OF FORWARD CONTRACTS
Q.1 On 15th November, ICICI bank booked a 3 months forward purchase contract of $ 20,000 for its export
customer. On that date exchange rate was as follows:
Spot rate: 1 $ = `49.3200 / 3325
3 months swap points = 1,000 / 1500
Margin = 0.10 % / 0.125 %
On the due date customer requests for cancellation of this contract. Exchange rate prevailing on that date is
as follows:
Spot rate: 1 $ = `47.5300 / 5400
3 months swap point = 500 / 1000
Margin = 0.10 % / 0.125 %

Calculate the amount recoverable from or payable to customer.


Answer: Amount payable to customer: `35,424
Q.2 On 1st April, the bank entered into a forward purchase contract of $ 1,00,000 at `44 due on 1st June. On
the same day bank covered its position by a forward sale at `45. On the due date the customer requested
for cancellation of the contract. The prevailing exchange rate on 1st June were as under:
Spot inter bank rate: 1 $ = `44.5500 / 6000
Margin = 0.15 %
Spot merchant rate = 1 $ = `44.43 / 44.67
Calculate the amount recoverable from or payable to the customer.
Answer: Amount recoverable from customer: `67,000
Q.3 In the previous question assumes that the customer made the request for cancellation of the contract on
1st May. The prevailing prices on 1st May are as under:
Spot inter bank rate: 1 $ = `44.2000 / 3000
Forward June = 2,000 / 2500
Margin = 0.15 %
Forward June (Merchant rate): 1 $ = `44.34 / 44.62
Calculate the amount recoverable from the customer.
Answer: Amount recoverable from customer = `62,000
Q.4 On 15th January you booked a forward sale contract for French Francs 2,50,000 for your import
customer delivery 15th February at `6.95. on the due date the customer requests cancellation of the
contract. Assuming French Francs were quoted in the London foreign exchange market as under:
Spot rate: 1 $ = FF 5.0200 / 0300
And the US $ were quoted in the local inter bank exchange market as under on the date of cancellation:
Spot rate: 1 $ = `34.7900 / 7975
Exchange margin required by you is 0.15 %. What will be the cancellation charges payable by the
customer, if any?
Answer: Cancellation charges = `10,000
Q.5 The bank entered into an agreement with its customer on 10th July for a forward purchase contract for
$ 4,000 to be delivered 10th September at the rate of `28.14 per $ covering itself by a forward sale at
`28.16. on 10th August, the customer requests the bank to settle the contract. Calculate the amount that
would be paid to the customer assuming the following rates in the inter bank market on 10th August:
Spot rate: 1 $ = `28.1025 / 1075
Delivery September: 1 $ = `28.6475 / 6550
Interest on outlay of funds at 12 % and inflow of funds at 8 %.
Answer: Total recovery from customer = `2,212
Q.6 Bank entered into an agreement with its customer on 1st January, 2014 for a forward purchase contract
for $ 10,000 delivery 31st May, 2014.
Spot rate on 1st January, 2014: 1 $ = `62.00
Forward premium (May end): `2.00 / `2.03
On 31st March, 2014, customer requests the bank for settlement of its forward transaction. Following rates
are prevail in market on 31st March, 2014:
Spot rate: 1 $ = `61
Forward premium (May end): `0.85 / 0.87
Interest on outlay of funds at 18 % and inflow of funds at 15 %. Calculate amount payable to customer /
recoverable from customer.
Answer:
Q.7 The bank entered into an agreement with Mr. A on 31st July for a forward purchase contract for GBP
8,000 to be delivered on 30th September at the rate of `56.28 per pound covering itself by a forward sale at
`56.32. On 31st August, the customer requests the bank to settle the contract of 8,000 GBP. Calculate the
amount that would be paid to the customer assuming the following rates in the inter bank market on 31 st
August:
Spot rate: 1 GBP = `56.2050 / 2150
Delivery September: 1 GBP = `55.2950 / 3100
Interest on outlay of funds at 12 % and inflow of funds at 9 %.

Answer: Net amount payable to customer = `7,154


Q.8 The bank had agreed on 1st January that it will sell on 1st April to customer Dirham 10,000 at `17.29.
on the same day bank covered its position by buying forward from the market due 1 st April at the rate of
`17.2775. On 1st March, the customer approaches the bank to sell Dirham 10,000 under the forward
contract earlier entered into. The rates prevailing in the inter bank market on this date are:
Spot rate: 1 Dirham = `17.2350 / 2400
April: 1 Dirham = `17.1275 / 1300
Interest on outlay of funds at 18 % and inflow of funds at 12 %. What is the amount that would be
recovered from the customer on the transaction?
Answer: Net amount recovered from customer = `1,120
Q.9 A bank enters into a forward purchase TT covering an export bill for Swiss francs 1,00,000 at
32.4000 due on 25th April and covered itself for same delivery in the local inter-bank market at 32.4200.
However on 25th March, exporter sought for cancellation of contract as the tenor of the bill is changed
In Singapore market, Swiss Francs were quoted against US dollars as under:
Spot: 1 $ = Sw. Fcs 1.5076 / 1.5120
One month forward: 1.5150 / 1.5160
Two month forward: 1.5250 / 1.5270
Three month forward: 1.5415 / 1.5445
And the inter bank market US $ were quoted as under:
Spot rate: 1 $ = `49.4302 / 0.4455
Spot / April: 0.4100 / 0.4200
Spot / May: 0.4300 / 0.4400
Spot / June: 0.4500 / 0.4600
Calculate the cancellation charges payable by the customer if exchange margin required by the bank is
0.10% on buying and selling
[CA Nov. 2015]
Answer: Cancellation charges: `55,000
Q.10 A bank had booked a forward purchase contract with a customer for $ 2,50,000 at the rate of 1$ =
`33.50 delivery due on October 30. On September 30 customer approaches bank with a request to cancel
the forward purchase contract. What will be the cancellation charges of the bank, if following are the rates
in the interbank market on September, 30?
Spot rate: 1$ = `34.7400 / 35.0800
1 month forward: 8 -15 paise per US $
2 months forward: 31 41 paise per US $
3 months forward: 60 70 paise per US $
The bank is to load an exchange margin of 0.15 %.
Answer:
Q.11 Date of maturity of forward sale contract:
September 30th 2002
Amount:
$ 2,50,000
Contract rate:
1$ = `49.4500
On August 10, 02 the customer requests to extend the forward contract for October 31 st 2002. Interbank
market rates on August 10, 02:
Spot:
1$ = `48.1325 / 48.1675
Forward spot/ August
2200 / 2100
Spot / September
4700 / 4500
Spot / October
6900 / 6300
Compute extension charges payable / receivable. You are allowed to load an exchange margin of 0.08 % on
TT buying and 0.15 % on TT selling rate.
Answer:
Q.12 On 20th November, 2002 you booked a forward purchase contract for DEM 50,000 from your export
customer delivery 20th Feb. At `28.2500. On the due date the customer requests cancellation of the
contract. The rates prevailing on that day are:
Spot USD 1 = DEM 1.5150 / 1.5170
Spot USD 1 = `42.6125 / 2975
Exchange margin is 0.10%. Calculate gain or loss to customer, if any?
Answer:

Q.13 The company had agreed on 20th February that it will buy on 20th April from the banker USD 10,000
at `44.57. On 20th March, the company approaches the bank to buy USD 10,000 under the forward contract
earlier entered into. The rates prevailing in the market on this date are:
Spot rate: 1$ = `44.4725/ 4800
April: 1 $ = `44.2550/ 2625
Ignoring interest and fine out the amount that would be paid / received by the company on early delivery.
Answer:
Q.14 An Importer booked a Forward Contract with his Bank on 10th April forUSD 2,00,000 due on 10th
June @ `64.4000. The Bank covered its position in the market at `64.2800. The Exchange Rates for Dollar
in the InterBank Market on 10th June and 20th June were:
10th June
20th June
Spot USD 1
`63.8000 / 8200
`63.6800 / 7200
Spot / June

`63.9200 / 9500

`63.8000/8500

July

`64.0500 / 0900

`63.9300 / 9900

August

`64.3000 / 3500

`64.1800 / 2500

September

`64.6000 / 6600

`64.4800 / 5600

Exchange Margin 0.10% and interest on Outlay of Funds @12%. TheImporter requested on 20th June for
extension of contract with due date on 10th August. Rates rounded to 4 decimal in multiples of 0.0025.
On 10th June, Bank Swaps by selling spot and buying one month forward.
Calculate the following:
(i) Cancellation Rate (iv) Interest on Outlay of Funds, if any
(ii) Amount Payable on $ 2,00,000(v) New Contract Rate
(iii) Swap Loss (vi) Total Cost
[CA May, 2015]
Answer: (i) Cancellation rate 63.6175 (ii) Amount payable - `1,56,740 (iii) Swap loss 30,000 (iv)
Interest cost 320 (v) New contract rate 64.3150 (vi) Total cost 1,87,060
Q.15 On 1st January, the bank enters into a forward purchase contract with an export customer for $ 10,000
due on 1st March at an exchange rate of `35.60 and covers its position in the market at `35.65. The
customer defaults to execute the contract on the due date. On 15th March the cancels the contract. The
following were the exchange rate prevalent:
On 1st March:
Inter bank rate: 1 $ = `33.75 / 80
1 month forward (can be used for 15 days forward also) = 1 $ = 35.90 / 95
Merchant rate: 1 $ = `35.67 / 90
On 15th March:
Inter bank rate: 1 $ = `36.10 / 15
Merchant rate: 1 $ = `36.05 / 20
Interest rate applicable = 12 % per annum.
Calculate amount recoverable from customer.
Q.16 An Import customer booked a forward contract with the bank on 10 th April for $ 20,000 due 10th June
at `36.40. The bank covered its position in the market on 10th June and 25th June were:
10th June
25th June
Spot 1 $
`35.80 / 82
`35.68 / 72
June
`35.92 / 95
`35.80 / 85
July
`36.05 / 09
`35.93 / 99
August
`36.30 / 35
`36.18 / 25
September
`36.60 / 66
`36.48 / 56
Exchange margin = 0.15 %
Interest on outlay of funds = 12 %
How will the bank react if the customer requests on 25th June:
(a) To cancel the contract
(b) To execute the contract

(c) To execute the contract with due date to fall in August.


Topic: 16 Option forward contract
Option forward contracts are contracts which allow option (choice) about date of settlement during last
month of the contract.
12 Months

11 months

1 month

T=0
T = 1 Option period T = 2
(Customer can settle the transaction during the period t= 1 to t =2)
When to use option forward contract When the customer is not certain about settlement date, then
customer must use option forward contract. In India, maximum period is 1 month.
How to price option forward contract:
It is a simple forward rate, which will be used in normal forward contract.
For calculation of forward rate we need spot rate, forward points and exchange margin.
Option forward contract is priced considering the uncertainty involved in settlement from t= 1 to t
= 2.
Bank follows worst case scenario approach.
Summary rule: Bank will quote such rate which is beneficial for bank. Either start of option period or end
of option period. The burden of uncertainty is on customer.
Class example: 42
1 USD = 49.8825 / 49.8975
Spot / May = 2500 / 2700
Spot / June = 5200 / 7700
Spot / July = 7700 / 8200
An exporter is likely to receive USD in July. What rate authorised dealer should quote for option forward
contract?
Solution:
Statement of applicable rate:
2 months
3 months
Spot rate
49.8825
49.8825
Add: Swap points
0.5200
0.7700
Forward rate
50.4025
50.6525
Hence, Forward rate for option contract = 50.4025.
Class example: 42
A Bank is quoting the following rates:
DM / $
Saudi riyal / $
Spot rate
1.5975 / 1.5980
Spot rate
3.7550 / 3.7560
2 month
20/10
2 month
20/40
3 month
25/15
3 month
30 /50
A firm wishes to buy Riyals against DM 3 month forward with an option over 3 rd month. What rate will the
bank quote?
Answer: Bank should sell riyals at 0.4251 DM
Topic No. 17: Money market hedging / Cash market hedging (MMH) Whenever our exposure is for
foreign currency receivables or payables for a short period then we can hedge our receivables or payables
through money market hedging.

Case: A: Money market hedging for exporter For an exporter under MMH we should apply following
steps:
Step: 1 Create foreign currency loan amount which is the discounted value of receivables. For this purpose
discount rate should be foreign currency borrowing rate.
Step: 2 Convert foreign currency loan into home currency amount by using spot rate.
Step: 3 Investment home currency amount at deposit rate.
Step: 4 On maturity amount realized from foreign currency debtors and repay foreign currency loan from
such value.
Step: 5 Realize from investment with interest
Hence, Inflow under MMH = Investment amount + Interest on investment.
Case: B Money market hedging for Importer For an Importer under MMH we should apply following
steps:
Step: 1 Take home currency loan at spot rate for amount of investment.
Step: 2 Create foreign currency deposit / investment which is the discounted value of foreign currency
payable. The discount rate should be the deposit rate.
Step: 3 On maturity realized from investment and pay for foreign currency payables.
Step: 4 Repay home foreign currency loan with interest.
Hence, outflow = Loan amount + Interest on loan
Note:
(1) Interest rates given in the question is always quoted on per annum basis.
(2) if deposit and borrowing rates are not specifically mentioned then assume lower rate as deposit rate and
higher rate as borrowing rate.
Class example:43 Assume the following information:
US interest rate = 16 %
British interest rate = 18 %
Spot rate of British pound = $ 1.50
180 days forward rate of British pound = $1.48
Assume that Riverside Corp. from the United States will receive 400,000 pounds in 180 days. Would it be
better off using a forward hedge or a money market hedge? Substantiate your answer with estimated
revenue for each type of hedge. Assume 360 days in a year.
Answer: Alternative 1: Forward cover - $ 5,92,000; Alternative 2: MMH 5,94,495.416 $
Class example: 44Assume the following information:
U.S. interest rate = 16 % p.a.
Malaysian interest rate = 12 %
Spot rate of Malaysian ringgit = $.404
90-day forward rate of Malaysian ringgit = $.400
Assume that the Santa Barbara Co. in the United States will need 300,000 ringgit in 90 days. It wishes to
hedge this payables position. Would it be better off using a forward hedge or a money market hedge?
Substantiate your answer with estimated costs for each type of hedge.
Answer: Alternative: 1 Forward cover 1,20,000; Alternative: 2 MMH 1,22,376.70 $

Class example: 45Assume that Carbondale Co. expects to receive S$500,000 in one year. The
existing spot rate of the Singapore dollar is $.60. The one-year forward rate of the Singapore dollar is
$.62. Carbondale created a probability distribution for the future spot rate in one year as follows:
Future spot rate
Probability

$ 0.61
20 %
$ 0.63
50 %
$ 0.67
30 %
Assume the following money market rates:
US
Singapore
Deposit rate
8%
5%
Borrowing rate
9%
6%
Decide that which of the following hedging strategy is most appropriate for Carbondale Co.
(i) Forward hedging
(ii) Money market hedging
(iii) No hedging
Answer: Alternative: 1 Forward cover 3,10,000; Alternative: 2 MMH 3,05,660.38; Alternative: 3
No hedging 3,19,000
Class example: 46Columbus Surgical Inc. is based in US, has recently imported surgical raw material
from the UK and has been invoiced for 4,80,000, payable in 3 months. It has also exported surgical
goods to India and France.
The Indian customer has been invoiced for 1,38,000 payable in 3 months and the France customer
has been invoiced for 5,90,000 payable in 4 months.
Current spot rate and forward rates are as follows:
/ US $
Spot rate: 0.9830 0.9850
Three months forward: 0.9520 0.9545

US $ /
Spot rate: 1.8890 1.8920
Four months forward: 1.9510 1.9540
Current money market rates are as follows:
UK: 10.0 % - 12.0 % p.a.
France: 14.0 % - 16.0 % p.a.
USA: 11.50 % - 13.0 % p.a.
You as treasury manager are required to show how the company can hedge its foreign exchange
exposure using forward market and money market hedge and suggest and suggest which the best
hedging technique is.
Solution: Since Columbus has receipts and payments maturing at same time so net liability of
3,42,000 (4,80,000 1,38,000) to be hedged.
(a) Forward hedging
Amount payable after 3 months
Applicable forward rate
Total payment (3,42,000 / 0.9520)
(b) Money Market hedging:
Foreign
currency liability
3months
3,42,000

3,42,000
0.9520
3,59,244 $
Foreign currency receivables

3,42,000
10
1+ x 3
12

Borrow in $
Borrowings:

3,33,658
0.9830

Steps for MMH:


Step: 1Borrow $ 3,39,428 for 3 months @ 13 % p.a.
Step:2 Convert $ into at spot rate i.e. 0.9830
Hence = 3,39,428 * 0.9830 = 3,33,658
Step: 3 Invest 3,33,658 @ 10 % for 3 months.
Step: 4 Realize investment in Foreign currency and paid FC liabilities.
Step: 5 Repay $ loan with interest
Cash outflow = 3,39,428 + 3,39,428 *13 % * 3/12
= 3,39,428 + 11,031 = $ 3,50,459
For receivable after 4 months:
Option 1: Forward hedging
Amount receivable after 4 months
Applicable forward rate
Total receipt (5,90,000 * 1.9510)

5,90,000
1.9510
11,51,090 $

Option 2: Money Market hedging:


Foreign
currency receivable
3months
5,90,000

Foreign currency loan

5,90,000
16
1+ x 4
12

Convert at spot rate and invest


5,60,144 * 1.8890
= 10,58,112 $

Step: 1 Borrow 5,60,144 @ 16 % for 4 months


Step: 2 Convert loan amount in $ at spot rate
Hence, $ = 5,60,144 * 1.8890 = $ 10,58,112
Step: 3 Invest $ 10,58,112 for 4 months @ 11.50 %.
Step: 5 realize from foreign currency debtors and repay foreign currency loan.
Step: 6 Realize from investment
10,58,112 + 10,58,112 * 11.5 % * 4/12
= 10,58,112 + 40,561 = 10,98,673 $.
Decision: Go for forward hedging.
Topic: 18 Choice of short term borrowings or investment / investing excess cash to get
maximum return or profit
If a firm has surplus funds, it may invest in its home currency without currency risk. Instead, it may
invest in some foreign currency. This creates foreign currency receivables. Depending upon the sums
it may be required to cover the receivable forward or leave it uncovered. Finally, we should that
currency of investment for which home currency inflow is the highest.

Similarly, we should choose that currency of borrowing for which home currency outflow or
maturity is least.
On the other hand sometimes question requires investing in such currency in which we can get highest
return.
PART A: SHORT TERM INVESTMENTS:
Class example: 47Suppose that the treasurer of IBM has an extra cash reserve of $1,000,000 to invest for
six months. The six-month interest rate is 8% per annum in the U.S. and 6% per annum in Germany.
Currently, the spot exchange rate is DM1.60 per dollar and the six-month forward exchange rate is
DM1.56 per dollar. The treasurer of IBM does not wish to bear any exchange risk. Where should he/she
invest to maximize the return?
Solution:
Alternative: 1 Invest in US
If treasurer invest $ 10,00,000 in US for 6 months, then maturity value in 6 months will be:
10,00,000 + 10,00,000 x

8
100

6
12

10,00,000 + 40,000 = 10,40,000$


Alternative: 2 Invest in Germany
(i) Convert $ 10,00,000 in DM by using spot rate
1 $ = 1.60 DM
10,00,000 $ = 10,00,000 * 1.60 = 16,00,000 DM
(ii) Invest 16,00,000 DM in Germany for 6 months, then maturity value in 6 months will be:
DM 16,00,000 + 16,00,000 x

6
100

6
12

DM 16,00,000 + 48,000 = DM 16,48,000


(iii) Convert 16,48,000 DM in $ by using forward rate
So, $ value =

16,48,000
1.56

= $ 10,56,410.256

Decision: It is better to invest in Germany.

Class example: 48Your banks London office has surplus funds to the extent of USD 5,00,000/- for a
period of 3 months. The cost of the funds to the bank is 4% p.a. It proposes to invest these funds in
London, New York or Frankfurt and obtain the best yield, without any exchange risk to the bank. The
following rates of interest are available at the three centres for investment of domestic funds there at
for a period of 3 months.
London 5 % p.a.
New York 8 % p.a.
Frankfurt 3 % p.a.
The market rates in London for US dollars and Euro are as under:
London on New York
Spot rate
1.5350 / 90
1 month
15/ 18
2 month
30 /35
3 month
80 / 85
London on Frankfurt
Spot rate
1.8260 / 90
1 month
60/55
2 month
95 / 90

3 month
145 /140
At which centre, will be investment be made & what will be the net gain (to the nearest pound) to the
bank on the invested funds?
[CA Nov. 2013]
Solution:
Alternative 1: Invest in $
Step:1 Invest $ 5,00,000 at 8 % p.a. i.e. 2 % for 3 months. $ receivable after 3months.
= 5,00,000 (1.02) = $ 5,10,000.
Step: 2 Sell $ 3 month forward at 1.5390 + 0.0085 = 1.5475, so inflow after 3 months =

5,10,000
1.5475

= 3,29,563.81
Step: 3 Initially the bank has surplus fund of $ 5,00,000. At the current spot rate of 1.5390, it is
equivalent to

5,00,000
1.5390

= 3,24,886.29

Given cost of fund i.e. 4 % p.a. or 1 % for 3 months


Outflow after 3 months = 3,24,886.29 * 1.01 = 3,28,135.15
So net gain = 3,29,563.81 3,28,135.15 = 1,428.66
Alternative 2: Invest in London
Step: 1 Convert $ 5,00,000 into spot getting 3,24,886.29.
Step: 2 Invest at 5 % p.a. i.e. 1.25 % for 3 months. So inflow after 3 months
= 3,24,886.29 3,28,135.15 = 812.22
Alternative: 3 Invest in
Step: 1 Convert 3,24,886.29 into spot getting
3,24,886.29 * 1.8260 = 5,93,242.37
Step: 2 Invest 3 % p.a. i.e 0.75 % for 3 months. So inflow after 3 months
5,93,242.37 * 1.0075 = 5,97,691.69
Step: 3Sell 3 months future getting at 1.8290 0.140 = 1.8150, getting
5,97,691.69 / 1.8150 = 3,29,306.72
Net gain = 3,29,306.72 3,28,135.15 = 1,171.57
Conclusion: The firm should invest in NY i.e.$.
Class example: 49 An Indian firm has surplus fund of `500 lakhs for 6 months. Following interest
rates are given:
` = 10 % / 11 %
$=6%/7%
= 1.10 % / 1.50 %
Following exchange rates are provided:
Spot rate (` / $) = 57.20 / 57.90
6 months swap point = 90/110
Spot rate (` / ) = 0.4325 / 0.4380
6 months swap point = 140 / 170
Also the following currency forecast for the exchange rate likely to prevail after 6 months are
available.
Expected spot rate (`/$) = 58.30 / 58.95
Expected spot rate (` / ) = 0.4425 / 0.4480

Advise the firm as to which currency is to be choose for the currency and on what basis (i.e. forward
cover or uncovered)
Class example: 50Suppose you are a treasurer of XYZ Plc in the UK. XYZ have two overseas
subsidiaries, one based in Amsterdam and one in Switzerland. The Dutch subsidiary has surplus Euros in
the amount of 7,25,000 which it does not need for the next three months but which will be needed at the
end of that period (91 days). The Swiss subsidiary has a surplus of Swiss Francs in the amount of 9,98,077
that again it will need on day 91. The XYZ Plc. In UK has a net balance of 75,000 that is not needed for
the foreseeable future. Given the rates below, what is the advantage of swapping Euros and Swiss Francs
into Sterling?
Spot rate:
/ :
0.6858 / 0.6869
91 day Pts.
0.0037 / 0.0040
Spot rate:
CHF / :
91 day Pts.

2.3295 / 2.3326
0.0242 / 0.0228

Interest rates for deposits:


Amount of currency
0 1,00,000
1,00,001 5,00,000
5,00,001 10,00,000
Over 10,00,000

1
2
4
5.375

91 days interest rates (% per annum)

CHF

0
1

3
1

PART B: SHORT TERM BORROWINGS


Class example: 51The treasure at an Indian company requires `10 million for 6 months. He is exploring
various options of financing and has collected the following information:
`/$
`/
Spot
46.90 / 95
65.35 / 40
6 months forward
70 / 90 paise
90 / 100 Paise
Expected spot rate after 6 months
47.50 / 55
66.90 / 95
Interest rates Per annum:
` = 12.00 %
$ = 4.00 %
= 5.00 %
You are required to advise the treasure in which currency to borrow, if he
(i) Covers the exchange risk in forward market
(ii) Keep the position open.
Class example: 52An Indian company based at Mumbai needs short term funds of `50 million for a period
of 3 months. The company collected the following information from its banker:
`/$
`/
Spot rate
48.50 / 55
74.05 / 10
3 months forward
45 / 50
85 / 90
3 months interest rates (p.a.)
`
9%
$
4%

6%
You are required to calculate the annualized effective cost of borrowing:
(a) If the company borrows in USD and
(i) Covers the exchange rate risk through forward market
(ii) Keeps the position open and spot rate after 3 months turns out to be `/ $ - 48.90 / 95.
(b) If the company borrows in pound and
(i) Covers the exchange rate risk through forward market
(ii) Keeps the position open and spot rate after 3 months turns out to be `/ - 74.75 / 80.

Topic: 19 Netting
Netting means net position between parties. Whenever, one party has receivables as well as payables
then netting technique will apply to reduce the transaction cost. Netting is of two types:
(a) Bilateral netting Netting between two parties only is known as bilateral netting.
(b) Multilateral netting Netting between all parties are known as multilateral netting.
Note: If question is silent always use multilateral netting.
Note: For netting process if more than one currency is given then convert all other currencies into one
identified (selected) currency. This could be the currency of parent company or any other currency.
Topic: 20 Cover deal / cover rate / Profit or loss of dealer due to contract
Whenever, dealer (i.e. bank) booked a contract with customer, at the same time dealer also booked a
counter contract with the market. This counter contract is known as cover deal. The rate applicable for
the counter contract with the market is known as cover rate.
How to find out profit or loss of dealer due to cover = Cover rate Contract rate with customer
Topic: 21 Leading and Lagging technique
Under leading technique settlement will be done before due date whereas under lagging technique
there is delay in settlement. Generally name of technique is given in the question but if not given then
apply following rules:
Foreign currency at premium Foreign currency at discount
Importer
Lead
Lag
Exporter
Lag
Lead
Topic: 21 Concept of Interest rate parity (IRP) and arbitrage process
As per IRP, interest rates across the world on a covered basis must be equal. Thus, whichever
currency has a lower interest rate, the currency of that country should be at a forward premium.
(A) Concept understanding:
Person of USA have two possible alternatives for investment:
A1 (Invest in USA)
t=0
t=1
100 $
$ 105
5%
8%
A2 (Invest in India)
t = 0 (exchange rate = 40)
t=1
`4,000 (100 * 40)
`4,320 (assume exchange rate = `40)
4,320 /40 = $ 108
In the above situation it is better for investor to invest in India for a year as it gives more $ in return in
comparison to invest in USA. However as per IRP theory the exchange rate will adjust in such a way that
there is no benefit to investor. In other words we can say that investor is indifferent between alternative 1
and alternative 2.
Hence, as per IRP exchange rate should be = 4,320 / 105 = `41.1429.
Summary:
(i) If IRP theory hold good = There is no arbitrage
(ii) If IRP theory does not hold good = Investor can earn arbitrage.
(B) How to compute forward rate with the help of interest rate parity theory (IRP)
Forward rate = Spot rate X

1+ Rq
1+ Rb

Rq = Rate of quote / price currency


Rb = Rate of base currency
(C) How to check arbitrage
Arbitrage means risk less profit.
Ideally buy low and sale high.
While carrying out arbitrage equal amount is bought or sold.
If money market interest differential is equal to forex market differential then IRP is valid and
hence arbitrage is not possible. In other words, if money market differential is not equal to forex
differential then arbitrage is possible and this is called covered interest arbitrage.
If interest rate differential is higher than forex differential, then investor should go for deposit in
country where interest rate is higher.
If interest rate differential is lower than forex differential, then investor should go for deposit in
country where interest rate is lower.
(D) Locational arbitrage Locational arbitrage can occur when the spot rate of a given currency varies
among locations. Specifically, the ask rate at one location must be lower than the bid rate at another
location. The disparity in rates can occur since information is not always immediately available to all
banks. If a disparity does exist, locational arbitrage is possible.
Class example: 53Assume the following information:
Beal bank
Yardely bank
Bid price of New Zealand $
$ 0.401
$ 0.398
Ask rate
$ 0.404
$ 0.400
Given this information, is locational arbitrage possible? If so, explain the steps involved in locational
arbitrage and compute the profit from this arbitrage if you has $ 10,00,000 to use.
Class example: 54
Assume the following information:
SBI bank
BOB bank
Bid rate
1 $ = 45.05
1 $ = 45.08
Ask rate
1 $ = 45.07
1 $ = 45.09
Given this information is locational arbitrage possible? If so, explain the steps involved in locational
arbitrage and compute the profit from this arbitrage if you has `1,00,000 to use.
(E) Covered interest arbitrage
Class example: 55 Check arbitrage opportunity from the following information:
Spot rate
6 months forward rate
Indian interest rate
USA interest rate
Solution:
Step: 1 Calculate theoretical forward rate: SR x

= 40 x

1.04
1.025

1 $ = `40
1 $ = `40.50
8%
5%

1+ Rate of quotecurrency
Rate of base currency

= 40.59

Quoted forward rate = 40.50


Since theoretical forward rate Quoted forward rate, so arbitrage is possible. For arbitrage, arbitrager
should borrow $ and invest in `.
Step: 2 Following is the process of arbitrage
(i) Borrow 10,000 $ @ 5 % per annum for 6 months.

(ii) Convert into ` by using spot rate


10,000 x 40 = `4,00,000
(iii) Invest `4,00,000 @ 8 % per annum for 6 months.
(iv) Buy forward purchase contract of $ at `40.50
(v) Realize from investment with interest
4,00,000 + 4,00,000 x

8
100

6
12

4,00,000 + 16,000 = 4,16,000


(vi) Buy $ at agreed forward rate
$ Inflow =

4,16,000
40.50

= $ 10,271.605

(vii) Repay loan with interest


$ Outflow = 10,000 + 10,000 x

5
100

6
12

10,000 + 250 = $ 10,250


(viii) Arbitrage profit = 10,271.605 10,250 = 21.605 $
Class example: 56Currently, the spot exchange rate is $1.50/ and the three-month forward exchange rate
is $1.52/. The three-month interest rate is 8.0% per annum in the U.S. and 5.8% per annum in the U.K.
Assume that you can borrow as much as $1,500,000 or 1,000,000.
(i) Determine whether the interest rate parity is currently holding.
(ii) If the IRP is not holding, how would you carry out covered interest arbitrage? Show all the steps and
determine the arbitrage profit.
Solution: SR = 1 = 1.50 $
Theoretical forward rate = 1.50 x

1.02
1.0145

= 1.5081

Quoted forward rate = 1.52


Since, TFR quoted forward rate, thus IRP is not holding exactly.
For arbitrage borrow $ and invest in pound. Process of arbitrage is as under:
(i) Borrow 15,00,000 $ for 3 months @ 8 % per annum.
(ii) Purchase / Convert into by using spot rate
15,00,000 $ =

15,00,000
= 10,00,000
1.50

(iii) Invest 10,00,000 for 3 months @ 5.80 % per annum.


(iv) Book forward sell contract of pound at 1.52
(v) Realize from investment with interest
Inflow = 10,00,000 + 10,00,000 x

5.80
100

= 10,00,000 + 14,500 = 10,14,500


(vi) Sell at applicable forward rate
$ Inflow = 10,14,500 x 1.52 = 15,42,040 $

3
x 12

(vii) Repay loan with interest


$ Outflow = 15,00,000 + 15,00,000 x

8
100

3
12

= 15,00,000 + 30,000 = $ 15,30,000


(viii) Arbitrage profit = 15,42,040 15,30,000 = 12,040 $

(F) Triangular arbitrage - As the name suggest triangular arbitrage involve 3 currencies. Under
triangular arbitrage start with currency A; then go to currency B (means sell currency A and buy
currency B); then go to currency C and finally come back to currency A.
In the process, if you end up with more A then you start with, triangular arbitrage is possible.
Class example: 57Consider the following quotations:
Bank A: $ / = 1.4680 / 10
Bank B: / = 1.3150 / 90
Bank C: $ / = 0.6810 / 50
Show the process of arbitrage using $ 6,000.
Class example: 58Consider the following quotations:
Bank A: CHF / AUD = 0.8210 / 50
Bank B: CHF / CAD = 0.7650 / 90
Bank C: AUD / CAD = 0.9650 / 0.9710
Show the arbitrage process of triangular arbitrage using CHF 80,000.
Class example: 59 The Dollar to Swiss Franc spot exchange rate is $0.8918/SF1.00, the Dollar to Pound
spot exchange rate is $1.6302/1.00, and the SF to Pound spot exchange rate is SF1.7914/1.00. Determine
the triangular arbitrage profit that is possible if you have $8,000,000.
Topic: 22 Purchasing power parity theory
As per the purchasing power parity theory goods market prices are used to determine the exchange rates
between two currencies. The exchange rate of 2 countries would be affected due to inflation rates in 2
countries. So we have to adjust inflation rate to find out expected spot rate. In other words, the expected
spot rate can be estimated using todays spot rate and inflation differential of 2 countries.
Expected spot rate = Spot rate X

1+ Iq
1+ Ib

Iq = Inflation rate of quote / price currency


Ib= Inflation rate of base currency
Topic: 23 International capital budgeting
Whenever an entity of any one country wants to establish a project or business unit in another country then
entity has to decide whether project should be establish or not with the help of capital budgeting process. If
NPV of the project is positive then project should establish otherwise not. For calculation NPV we should
apply either of the following approach:
Approach 1: Home currency approach
Step: 1 Calculate foreign currency cash flows of each year.
Step: 2 Convert foreign currency cash flows into home currency cash flows by using exchange rates.
Step: 3 Compute home currency discount rate
Step: 4 Compute home currency NPV in its usual manner

Decision: If NPV of the project is positive, then accept the project.


Approach 2: Foreign currency approach
Step: 1 Calculate foreign currency cash flows of each year
Step: 2 Calculate foreign currency discount rate
Step: 3 Calculate foreign currency NPV of the project
Step: 4 Convert foreign currency NPV into home currency NPV by using spot rate.
Notes:
(i) Discount rate under both approach are different.
(ii) Discount rate should always be risk adjusted discount rate.
(iii) How to find out risk adjusted discount rate.
Risk adjusted discount rate = RF + Risk premium
OR
Risk adjusted discount rate = (1 + RADR) = (1 + RF) (1 + Risk premium)
(iv) Risk premium under both approaches are assumed to be same if question is silent.
(v) If exchange rates are missing use IRP theory or PPP theory to find out exchange rates.
Topic: 24 Concept of withholding tax
Whenever a foreign company invest in a home country then home country charges an additional tax over
and above the normal tax. Such tax is known as withholding tax. Withholding tax is applicable on surplus
profits or profits which are taken back by foreign company in his own country.
Topic: 25 International cash management
Cash management means manage surplus cash in such a manner that entity can get maximum return by
investing such surplus fund. Under cash management parent company may follow either decentralised cash
management system or centralised cash management system.
Decentralised cash management If decentralised cash management system is followed then no set off
of cash deficit is possible from any surplus cash available with another subsidiary. In other words, we
should calculate cash requirement for each subsidiary separately.
Centralised cash management Under this system we can set off deficit of a company with surplus of
any other company under the same management and cash requirement will calculate on net basis.
Topic: 26 International joint venture
Whenever any business is in form of joint venture then we should compute NPV of the project as per share
of joint venture. Each joint venture is liable to contribute in cash outflow and receive his share of inflow
from the project.
Topic: 27 Nostro, Vestro and Loro account
(a) Nostro account Nostro account is also called ours account with you. Nostro account is a current
account maintained by a domestic bank / dealer with a foreign bank in foreign currency.

SBI

Switzerland
bank
Current account in CHF currency called Nostro account

(b) Vostro account Vostro account is called yours account with us. Vostro account is a current account
maintained by a foreign bank with domestic bank in ` currency.

SBI

Switzerland
bank

Current account in ` currency called Vostro account


(c) Loro account Loro account is called our account with their money with you. Loro account is a current
account maintained by one domestic bank on behalf of other domestic bank in foreign bank in foreign
currency.

SBI

Switzerland
Current account in CHF currency called Nostro account

PNB

Loro account

Maintaining forex position Vs. Fund position Whenever we buy or sell foreign currency either on cash
basis, tom basis, spot basis or forward basis then forex position is created. The total of buy or sell is
counted and net amount is arrived at the end of every day. Position will be either over bought position or
oversold position. The bank has risk of adverse exchange rate movement in forex position. For avoiding
this risk bank has to create square up position on the same day with net amount.
Fund position (Nostro account) - This account will be affected due to forex transaction on cash basis only.
Topic: 28 Foreign exchange exposures
(a) Transaction exposure / Contractual exposure under such type of exposure we have to show impact of
settling outstanding obligations entered into before change in exchange rate but to be settled after changing
exchange rate. Such exposure arises due to (i) Sale or purchase transaction
(ii) Receivable or payable transaction
(iii) Expenses or income transaction
(b) Operating exposure Operating exposure denotes expected future cash flows arising from an
unexpected change in exchange rates. Such exposure can be affected by change in sales volume, sales
price, operating cost etc.

QUESTION BANK
Q.1 Assume you have a German customer who experts to London and would like to sell
pounds against Euros. The following market rates prevail:
Euro/$ 1.1875/1.1890
Pound/$ 0.6957/0.7008
If your customer wants a Cross Rate for Pound/Euro in Euro terms from you, what rate will you quote
assuming you want a spread of 0.0020 points.
Q.2 An Indian bank sells FF 1,000,000 spot to a customer at Rs.6.40. At that point of time,the following
rates were being quoted.
FF/$ : 5.5880/5.5920
Rs./$ : 35.50/35.60
How much profit do you think the bank has made in the transaction?
Q. 3 As a dealer in the bank, you observed the following quotes in the market.
Rs./$ 42.18
42.60
Rs./ 68.59
69.96
Rs./46.25
47.17
Compute the cross rates for $/ and $/.
Q.4 From the following quotes of a bank, determine the rate at which Yen can be purchasedwith Rupees.
Rs./Pd. Sterling 75.31-33
Pd.Sterling/Doliar 1.563-65
Dollar/Yen 1.048/52 [Per 100 Yen]
Q.5 Q.14 Spot rate: 1 $ = 25.45 / 25.60
6 months forward swap points: 0.12/ .07
Find out forward rate.
Answer: Forward rate: 1 $ = 25.33 / 25.53
Q. 6 The following quotes are available:
Spot (DM/$) = 1.5105 / 1.5120
Three months swap points = 25/20
Six months swap points = 30/25
Calculate the three months and six months outright forward rates.
Answer: 1 = 2.4314 / 2.4408 DM
Q.7 An Indian customer who has imported equipment from Germany has approached its bank for booking
a forward DM contract. The delivery is expected at the end of the 6th month from now. The following rates
are being quoted.
Spot (DM/$) = 1.584 / 1.585

Three months forward = 0.030 / 0.029


Six months forward = 0.059 / 0.058
Spot (Rs. / $) = 35.60 / 35.70
Three months forward = 15/25
Six months forward = 20/30
What rate will the bank quote if it needs a margin of 0.5 %?
Answer: 1 DM = `23.73
Q.8 On January 28, 2007 an importer customer requested a bank to remit SGD 25,00,000 under an
irrevocable LC. However, due to bank strike, the bank could effect the remittance only on February 4,
2007. The inter bank market rates were as follows:
January 28
February 4
USD 1
INR 45.85/90
INR 45.91 / 97
GBP 1
USD 1.7840 / 50
USD 1.7765 / 75
GBP 1
SGD 3.1575 / 90
SGD 3.1380 / 90
The bank wishes to retain an exchange margin of 0.125 %. How much does the customer stand to gain or
loss due to the delay?
[CA May, 05]
QUESTIONS RELATED TO FORWARD COVER AND NO COVER AND BENEFITS FROM EARLY
PAYMENT
Q. 9 Excel exporters are holding an export bill in united states dollar (USD) 1,00,000 due 60 days, hence
they are worried about the falling USD value which is currently at Rs. 45.60 per USD. The concerned
export consignment has been priced on an exchange rate of Rs. 45.50 per USD. The firms bankers have
quoted a 60 days forward rate of Rs. 45.20.
Calculate:
(a) Rate of discount quoted by bank.
(b) The probable loss of operating profit if the forward sale is agreed to.
[CA Nov. 04]
SOLUTION:
Spot rate: 1 $ = `45.60
60 days forward rate: 1 $ = 45.20
(i) Rate of discount quoted by bank

FRSR
x 100 x
SR

365
n

45.2045.60
365
x 100 x 60
45.60

= 5.336 %

(ii) Probable loss of operating profit if forward sale is agreed:


Spot rate
Forward rate
Loss per $
Contract size
Total loss

45.50
45.20
0.30
1,00,000
30,000

Q.10 An importer has to settle a bill for $ 1,35,000. The exporter has given the Indian company two option:
(i) Pay immediately without any interest charge.
(ii) Pay after 3 months, with interest 6 % p.a.
The importers bank charges 16 % p.a. on overdrafts. If the exchange rates are as follows, what should the
company do?
Spot rate (RS. / $) = 48.35/ 48.36 3 months forward rate (Rs. /$) = 48.81 / 48.83
[CWA Dec. 02]

SOLUTION:
Option: 1 Pay immediately without any interest
Invoice value (1,35,000 * 48.36)
Add: Interest on overdraft facility (65,28,600 * 16 % * 3/12)
Total amount payable

65,28,600
2,61,144
67,89,744

Option: 2 Pay after 3 months with 6 % interest:


Invoice value
$1,35,000
Add: Interest @ 6 % for 3 months (1,35,000 * 6 % * 3/12)
$2,025
Total amount
$1,37,025
Applicable rate
48.83
Total amount payable
66,90,931
Decision: It is advisable to settle the payable after 3 months. It will provide saving of `98,813.

Q.11 The following rates are appears in the foreign exchange market:
Spot rate: (Rs./ $) = Rs. 45.80 / 46.05
2 months forward rate (Rs. / $) = Rs. 46.50 / 47.00
(i) How many dollars should a firm sell to get Rs. 5 crores after 2 months?
(ii) How many rupees is the firm required to pay to obtain $ 2,00,000 in the spot market.
(iii) Assume the firm has $ 50,000. How many rupees does the firm obtain in exchange of $.
[CS Dec. 03]
SOLUTION:
(i) 5,00,00,000 / 46.50 = 10,75,268.82 $
(ii) 2,00,000 * 46.05 = 92,10,000
(iii) 50,000 * 45.80 = 22,90,000
Q.12 Dishita Ltd. your customer has imported 5,000 cartridges at landed cost in Mumbai, of US $ 20 each.
The company has the choice for paying for the goods immediately or in 3 months time. It has a clean
overdraft limit with you where 14 % p.a. rate of interest is charged. Calculate which of the following
methods would be cheaper to your customer,
(i) Pay in 3 months time with interest @ 10 % and cover risk forward for 3 months.
(ii) Settle now at a current spot rate and pay interest of the overdraft for 3 months.
The rates are as follows:
Mumbai Rs. / $ spot rate: 43.25 / 43.55
3 months swap: 35 / 25
[CWA June, 06]
SOLUTION:
Alternative: 1 Pay in 3 month time with interest @ 10 %
Amount payable (5,000 * 20)
Add: Interest @ 10 % for 3 months
Total exposure
Applicable forward rate
Cash outflow

$ 1,00,000
$2,500
$1,02,500
43.30
`44,38,250

Working note: Calculation of 3 months forward rate:


Spot rate
Less: Swap point
Forward rate
Alternative: 2 Settle now at current spot rate and pay interest
Cash outflow at spot rate (1,00,000 * 43.55)

Bid
43.25
0.35
42.90

Ask
43.55
0.25
43.30
43,55,000

Add: Overdraft interest (43,55,000 * 14 % * 3/12)


Total cash outflow

1,52,425
45,07,425

Decision: Since the cash outflow is lowest in alternative 1, hence it is suggested to pay in 3 months time.
Q.13 Management of Indian company is contemplating to import a machine from USA at a cost of $
15,000 at todays spot rate of $ 0.0227272 per rupee. Finance manager opines that in the present foreign
exchange market scenario, the exchange rate may shoot up by 10 % after two months and accordingly he
proposes to defer import of machine. Management thinks that deferring import of machine will cause a
loss of Rs. 50,000 to the company in the coming two months. As the company secretary, you are asked to
express your views, giving reasons, as to whether the company should go in for purchase of machine right
now or defer purchase for two months.
[CS Dec. 06]
SOLUTION:
Spot rate: 1` = 0.0227272 $
Current cost of machine = $ 15,000
Current cost of machine in ` terms = 15,000 / 0.0227272 = 6,60,000
2 months forward rate = 0.0227272 * 1.10 = 0.02499992
Cost of machine after 2 months = 15,000 / 0.02499992 = 6,00,000
Saving due to foreign exchange fluctuations: 6,60,000 6,00,000 = 60,000
Loss due to deferring the import = 50,000
Net saving = 60,000 50,000 = 10,000
Q.14 In March, 2007 Yati Ltd. makes the following assessment of USD rates per GBP to prevail in June
2007.
USD / GBP
1.60
1.70
1.80
1.90
2.00
Probability
0.15
0.20
0.25
0.20
0.20
(a) What is the expected spot rate in June 2007?
(b) If, as of March 2007, the 3 month forward rate is USD 1.80, should the firm sell forward its GBP
receivables due in March, 2007?
[CWA June, 08]
Q.15 ABC Co. has taken a 6 month loan from their foreign collaborator for US Dollors 2 millions. Interest
payable on maturity is at LIBOR plus 1 %. Current 6 month LIBOR is 2 %. Enquiries regarding
exchange rates with their bank elicit the following information:
Spot USD 1 = Rs. 48.5275
6 months forward = Rs. 48.4575
(i) What would be their commitment in rupees, if they enter into a forward contract?
(ii) Will you advise them to do so? Explain giving reasons?
[CA Nov. 03]
Q. 16 Fleur du lac, a French company, has shipped goods to an American importer under a letter of credit
arrangement, which calls for payment at the end of 90 days. The invoice is for 1,24,000 $. Presently the
exchange rate is 5.70 French francs to the $ if the French franc were to strengthen by 5 % by the end of 90
days, what would be the transactions gain or loss to exporter in French francs? If it were to weaken by 5 %,
what would happen?
[Study material]
Q. 17 A company operating in Japan has today effected sales to an Indian company, the payment being due
3 months from the date of invoice. The invoice amount is 108 lakhs yen. At todays spot price, it is
equivalent to Rs. 30 lakhs. It is anticipated that the exchange rate will decline by 10 % over the 3 months
period and in order to protect the yen payments, the importer proposes to take appropriate action in the
foreign exchange market. The 3 months forward rate is presently quoted as 3.3 yen per rupee. You are
required to calculate the expected loss and to show how it can by hedged by a forward contract.
[CA Nov. 03]
Q.18 A UK company, is due to receive 5,00,000 Northland dollars in six months time for goods supplied.
The company secedes to hedge its currency exposure by using the forward market. The spot rate of
exchange is 2.5 Northland dollars to the pound. The forward rate of exchange is 2.5354 Northland dollars

to the pound. Calculate how much UK company actually gains or losses as a result of the hedging
transaction if at the end of the six months, the pound in relation to the Northland dollar, has (i) gained 4 %,
(ii) lost 2 % or (iii) remained stable.
[Study material]
Q.19 A company is considering hedging its foreign exchange risk. It has made a purchase on 1st January,
2008 for which it has to make a payment of US $ 50,000 on September 30, 2008. The present exchange
rate is 1 US $ = Rs. 40. It can purchase forward 1 US $ at Rs. 39. The company will have to make a
upfront premium of 2 % of the forward amount purchased. The cost of fund to the company is 10 % per
annum and the rate of corporate tax is 50 %. Ignore taxation. Consider the following situations and
compute the profit / loss the company will make, if it hedges its foreign exchange risk:
(i) If the exchange rate on September 30, 2008 is Rs. 42 per US $.
(ii) If the exchange rate on September 30, 2008 is Rs. 38 per US $.
[CA May, 2008]
Q. 20 A operating a garment store in US has imported garments from Indian exporter of invoice amount of
Rs. 1,38,00,000 (equivalent to 3,00,000 $). The amount is payable in 3 months. It is expected that the
exchange rate will decline by 5 % over 3 months period. A is interested to take appropriate action in
foreign exchange market. The three month forward rate is quoted at Rs. 44.50. you are required to
calculate expected loss which A would suffer due to this decline if risk is not hedged. If there is loss, then
how he can hedge this risk.
[RTP May, 2011]
SOLUTION:
Invoice amount in ` = 1,38,00,000
$ equivalent value = $ 3,00,000
Spot rate: 1 $ = 1,38,00,000 / 3,00,000
1 $ = `46
Expected spot rate: 1 $ = 46 (1 0.05)
1 $ = 46 * 0.95 = 43.70
Statement of profit / loss without hedging:
Cost of `1,38,00,000 at present (1,38,00,000 / 46)
Cost of `1,38,00,000 if no cover (1,38,00,000 / 43.70)
Loss
Statement of profit / loss due to hedging
Present cost
Cost if forward cover is taken at 44.50 (1,38,00,000 / 44.50)
Loss

$ 3,00,000
$ 3,15,789
$ 15,789
$ 3,00,000
$ 3,10,112
10,112

Q. 21 At the end of the of July, 2007, an Indian company has an export exposure of EUR 50,000 due at the
end of August 2007. EUR is not directly quoted against INR. The current spot rates are INR 46 / USD and
EUR 2.30 / USD. It is estimated that EUR will depreciate to EUR 2.5 level against USD and that INR will
depreciate against USD to INR 47. One month forward rate at the end of July 2007 are EUR 2.45 / USD
and INR 47.04 / USD.
(a) Calculate expected loss if hedging is not done. How the position will change with the company taking a
forward cover?
(b) If spot rate on 31st August 2007 are eventually EUR 2.52 / USD and INR 47.88 / USD is the decision to
take forward cover justified?
QUESTIONS RELATED TO EXTENSION/ CANCELLATION/ EARLY DELIVERY OF FORWARD
CONTRACT
Q. 22A customer with whom the bank had entered into 3 months forward purchase contract for Swiss
Francs 10,000 at the rate of Rs. 27.25 comes to the bank after 2 months and requests cancellation of the
contract. On the date, the rates prevailing are:
Spot: CHF 1 = Rs. 27.30 / 27.35
One month forward: CHF 1 = Rs. 27.45 / 27.52
What is the loss / gain to the customer on cancellation?
[CA May, 02]

Q. 23 A customer with whom the bank had entered into 3 months forward purchase contract for Swiss
Francs 1,00,000 at the rate of Rs. 36.25 comes to the bank after 2 months and requests cancellation of the
contract. On this date, the rates are:
Spot: CHF 1 = Rs. 36.30 / 36.35
One month forward: CHF 1 = Rs. 36.45 / 36.52
Determine the amount of profit or loss to the customer due to cancellation of the contract.
[CA May, 04]
Q.24 NBA bank Ltd. transacted on August 19, 2010 the following:
(i) Sold $ 1,00,000 two months forward to Alpha Manufacturing Co. Ltd. at Rs. 44.50.
(ii) Purchase EURO 10,00,000 two months forward from Beta Trading Co. Ltd. at Rs. 47.20.
On October 19, 2010 both the customers approached the bank. Alpha Manufacturing Co. wants the
forward contract to be cancelled while Beta Trading Co. wants the contract to be extended by one month.
The following exchange rates prevailed on that day:
Rs. / $
Rs. / EURO
Spot
44.60 / 65
47.75 / 85
One month forward
44.75 / 85
48.00 / 48.20
Based on the above information (ignore interest etc.), you are required to:
(i) Calculate the amount to be paid to or received from Alpha Manufacturing Co. due to the cancellation of
the forward contract.
(ii) Calculate the amount to be paid to or recovered from Beta Trading Co. due to the extension of the
forward contract.
[CWA Dec. 06]
Q.25 A bank entered into a forward sale contract with a customer for US $ 5,00,000 due September 15 at
the rate of 1 $ = Rs. 34.60. On September 15, customer requests the bank to cancel the contract. What will
be the cancellation charges if the following is the spot rate in the interbank market:
1 $ = Rs. 34.5000 / 34.5225. Exchange margin to be loaded by the bank is 0.080 %.
Q.26 A bank booked a forward purchase contract for $ 2,50,000 with a customer at the rate of 1$ = Rs.
34.50 due October 30th 2005. On the due date customer requests the bank to cancel the contract. The rates
ruling in the interbank market on October 30, 2005 are as under:
Spot rate: 1$ = 34.9025 / 35.2050. What will be the cancellation charges of the bank if bank load 0.150%
for their exchange margin.
Q.27 A customer with whom the bank had booked a forward purchase contract for $ 2,00,000 at Rs. 43.52.
however, on the maturity date your customer requested you to extend contract by one month. Assuming the
interbank market rates for US $ are as under:
Spot rate:
1$ = 43.6925 / 7075
1 month forward:
600 / 700
2 months forward:
900 / 1,000
3 months forward:
1200 / 1300
What will be the extension charges payable by your customer bearing in mind that you require an
exchange margin of 0.08 % for TT buying and 0.10 % for TT selling? Also determine the new forward
rate.
SOLUTION
Forward sale contract

Forward purchase contract


$ 2,00,000 @ 43.52

Due date
Spot rate: 43.6925 / 43.7075

Since customer approaches for extension of contract by 1 month, so original contract is cancelled and bank
has to go in spot market for purchase of $ 2,00,000 at higher rate i.e. 43.7075.
Calculation of extension charges:

(A) Rate applicable due to extension:


Market selling rate
Add: Margin @ 0.10 %
(B) Original contract rate
Loss due to extension
Exposure amount
Total loss / extension charges
Calculation of new forward rate:
Forward purchase contract at bid rate:
Spot bid rate
Add: Swap point
Less: Margin @ 0.08 %
New forward rate

43.7075
0.0437

43.75
43.52
0.23
2,00,000
46,000

43.6925
0.0600

43.7525
0.0350
43.7175

Q.28 Date of maturity of forward purchase contract:


April 30th 2002
Amount:
$ 2,50,000
Contract rate:
1$ = Rs. 49.4500
Date of booking:
1 January, 2002
On March 1, 02 the customer requests to extend the forward contract for May 31st 2002. Interbank market
rates on March 1, 02:
Spot:
1$ = 48.9325 / 48.9650
Forward spot/ March
2000 / 2100
Spot / April
4200 / 4500
Spot / May
6300 / 6700
Compute extension charges payable / receivable. You are allowed to load an exchange margin of 0.08 % on
TT buying and 0.15 % on TT selling rate.
SOLUTION:
1st March

Forward sale contract

spot rate
48.9325 / 48.9650

Due date
30th April

st

1 Jan.

Forward purchase contract


$ 2,50,000 @ 49.4500

Since customer requests for extension up to 31st May but bank has to fulfil contract on 30th April. Bank has
to book a forward contract with market due on 30th April at ask rate.
Statement showing extension charges:
(A) Spot rate on date of extension
Add: Swap points
Add: Margin @ 0.15 %
Less: Original contract rate
Loss per $
Contract size
Total loss / extension charges
Calculation of new forward rate:
Spot rate on extension (bid rate since bank purchase)
Add: Swap points

48.9650
0.4500
49.4150
0.0741

49.4891
49.4500
0.0391
2,50,000
9,775
48.9325
0.6300
49.5625

Less: Margin @ 0.08 %


New forward rate

0.0397
49.5228

Q.29 On 30th June 2009 when a forward contract matured for execution you are asked by an importer
customer to extend the validity of the forward sale contract for US $ 10,000 for a further period of three
months.
Contracted rate:
1$ = Rs.41.87
The US$ quoted on 30.6.2009:
Spot rate:
1$ = Rs. 40.4800 / 40.4900
Premium July:
0.1100 / 0.1300
Premium August:
0.2300 / 0.2500
Premium September:
0.3500 / 0.3750
Calculate the cost for your customer in respect of the extension of the forward contract. Rupee values to be
rounded off to the nearest rupee. Margin 0.080 % for buying and 0.25 % for selling rate.
[RTP May, 2010]
Q.30 Your import customer requested you to him Danish Kroners (DKR) 12,50,000 six months forward at
Rs. 7.0200. However, after two months, customer requests cancellation of the contract. The rates prevailing
on that day are:
Spot:
USD 1 = DKR 6.2800 / 2900
4 months forward
900 / 850
Spot
USD 1 = Rs. 42.6125 / 6200
4 months forward
42.6800 / 6925
Exchange margin is 0.10%. Calculate gain or loss to customer, if any?
Q.31 A company entered into an agreement with its banker on 15th March, for a forward sale contract for
DEM 4,000 delivered on 1st July at the rate of 28.14 per mark. On 15th April, the company requested the
bank to sell the bill for DEM 4,000 under this contract. Calculate the amount payable/ receivable to the
company assuming the following rates on 15th April:
Spot rate: 1 DEM = Rs. 28.1025 / 1075
Delivery July: 28.6475/6550
Ignore interest and the penal provisions under FEDAI rules.
Q. 32 A person has to make payment of USD 3,00,000. Payment is to be done in three equal yearly
instalments. Assuming the following rates are available:
A Today
1 year forward rate: 42 / 42.50
.
B. At the end of 1st year
Spot rate: 43 / 43.10
1 year forward rate: 43.4/ 43.50
C. At the end of 2nd year
Spot rate: 44 / 44.10
1 year forward rate: 44.50 / 44.60
D At the end of 3rd year
Spot rate: 45/ 45.10
.
Find the amount he has to pay in rupees in the following three cases:
(i) No hedging
(ii) Rupee roll over forward
(iii) Three separate forward contracts, one today, 1 year and 2 years from today.
Q. 33 A Ltd. Exports edible oils to Middle East and African countries. In June the company exported an
assignment worth $ 5 million to Jambia. The payment for the same is expected to realize during the month
of September. For the company has entered into an option forward contract for delivery of $ 5 million over
the month of September. The market quotes on June 30 at the time of entering into the contract were as
follows:
June 30 Spot
Rs. / $
47.05 / 08
1 month
23/25
Forward rate
2 month
47/49
3 month
70/72

On September 1, the company approached the bank for extension of the contract by another two months,
that is for delivery during the month of November. The market quotes on September 01 were as follows:
Spot rate
Rs. / $
47.58/ 60
1 month
18/20
Forward rate
2 month
37/39
3 month
55/57
On November 01, the company approached the bank to cancel the forward contract. The exchange rates as
on November 01, were as follow:
Spot
Rs. / $
47.97 / 99
Forward
1 month
16/18
2 month
33/35
You are required to calculate:
(a) The forward rate to be quoted to A Ltd.
(b) The exchange rate to be quoted be the bank on September 01 for the extension of the contract.
(c) The amount of cash flows due to extension of the contract.
(d) The exchange rate at which the forward contract to be cancelled on November 01.
(e) The amount of cash flows due to cancellation of the contract.
[CWA June, 2010]
QUESTIONS RELATED TO MONEY MARKET HEDGE AND FORWARD COVER:
Q. 34 MN a UK company, has a substantial portfolio of its trade with American and German companies. It
has recently invoiced a US customer the sum of $ 50,00,000, receivable in one years time. MN finance
director is considering two methods of hedging the exchange risk:
Method: 1- Borrowing present value of $ 5 million now for one year, converting the amount into sterling
and repaying the loan out of eventual receipts.
Method: 2- Entering into a 12 month forward exchange contract with the companys bank to sell the $ 5
million.
The spot rate of exchange is 1= US $ 1.6355. The 12 month forward rate of exchange is 1= US $
1.6125. Interest rate for 12 months are USA 3.5 % and UK 4 %. You are required to calculate the net
proceeds in sterling under both methods and advise the company.
[CWA June. 04]
SOLUTION:
Method 1:
Borrow P.V. of 50,00,000 $
Convert into sterling at spot rate
Deposit @ 4% for 1 year

= 50,00,000 /1.035 = 48,30,918$


= 48,30,918 / 1.6355 = 29,53,787

Total inflow after 1 year = 29,53,787 + (29,53,787


Method 2: Forward Hedging
Total Inflows
= 50,00,000/1.6125
Decision: Go for forward hedging

4
100 ) = 29,53,787 + 1,18,151 = 30,71,938

= 31,00,775

Q. 35The finance director of M Ltd. has been studying exchange rates and interest rates relevant in India
and USA. M Ltd. has purchased goods from the US Co. at a cost of $ 40.50 lakhs payable in $ in 3 months
time. In order to maintain profit margins the finance director wishes to adopt, if possible a risk free
strategy that will ensure that the cost of goods to M Ltd. is no more than Rs. 18 crores:
Rs. / $ spot:
Rs. 41 / 43
Rs. / $ (1 month forward)
Rs. 42 / 44
Rs. / $ (3 months forward)
Rs. 43 / 46
Interest rate available of M Ltd.:
India (rates in %)
USA (rates in %)
Deposit
Borrowing
Deposit
Borrowing
1 month
9.00
12.0
4.0
7.0
3 months
9.00
13.0
5.0
8.0

Calculate whether is it possible for M Ltd. to achieve a cost directly associated with transaction not more
than Rs. 18 crore, by means of a forward market hedge or money market hedge. Ignore transaction costs.
[CWA June, 06]
SOLUTION:
Option 1: MMH

FC. Liability
40,50,000 $

3M

FC Receivables:
Discounted value of liability
= = 40,00,000 $

Loan amount:
40,00,000 $ 43
= 17,20,00,000
Step 1: Borrow `17,20,00.000 for 3 months @ 13% p.a.
Step 2: Purchase $ at spot rate i.e. 1$ = 43
Hence $ = 17,20,00,000 /43 = 40,00,000 $
Step 3: Invest 40,00,000$ @ 5% p.a. for 3 months
Step 4: Realize investment in FC and paid FC liability
Step 5: Reply home currency loan with interest
Cash outflow after 3 months : 17,20,00,000 + (17,20,00,000 13% 3/12) = 17,75,90,000 `
Option 2: Forward hedging
Amount payable in 3 month time = 40,50,000$
3 month forward rate: 1 $ = 46`
Total Cash outflow after 3 months = 40,50,000 46 = 18,63,00,000
Decision: Since cash outflow is less in close of MMH, Hence it is suggested to choose MMH
Q. 36The Chief Finance Officer (CFO) of Yati Ltd. hass been studying the exchange rates and interest rates
relevant to India and USA. Yati Ltd. purchased materials from an American company at a cost of US $
5.05 millions, payable in US $ in 3 months time. In order to maintain profits margins, the CFO wishes to
adopt, if possible, a risk free strategy that will ensure that the cost of the goods to Yati Ltd. does not exceed
Rs. 21 crores.
Exchange rates
Bid rate (Rs. / US $ 1)
Ask rate (Rs. / US $ 1)
Spot rate
40.35
40.65
1 month forward
41.20
41.50
3 months forward
42.15
42.50
Interest rates (available to Yati Ltd.):
India (rates in %)
USA (rates in %)
Deposit
Borrowing
Deposit
Borrowing
1 month
5.0
12.0
3.0
8.0
3 months
6.0
13.0
4.0
9.0
Calculate whether it is possible for Yati Ltd. to achieve a cost directly associated with this transaction of no
more than Rs. 21 crores, by means of a forward hedge or money market hedge. Transaction costs may be
ignored.
[CA - RTP]
SOLUTION:
Option 1: MMH

FC. Liability
50,50,000 $

3M

FC Receivables:
= = 50,00,000

Borrow in HC:
50,00,000 40.65= 20,32,50,000

Step 1: Borrow `20,32,50,000 for 3 months @ 13% p.a.


Step 2: Convert borrowed amount in $ at spot rate to be invested
In FC

20,32,50,000
40.65

= 50,00,000 $

Step 3: Invest 50,00,000$ for 3 months at 4% rate


Step 4: Realize investment after 3 months and paid FC liability
Step 5: Reply home currency loan with interest

13

Hence, Total cash outflow under, MMH = 20,32,50,000 + 20,32,50,000 100 12


= 20,32,50,000 + 66,05,625 = 20,98,55,625
Option 2: Forward hedging
Payment in $ after 3 month period
= 50,50,000$
Forward rate: 1 $ = 42.50 `
Cash outflow = 50,50,000 42.50 = 21,46,25,000
Decision: GO for MMH.
Q. 37An exporter is a UK based company. Invoice amount is $ 3,50,000. Credit period is three months.
Exchange rates in London
Rate of interest in money market
Particulars
Exchange rates
Currency
Deposit
Loan
Spot rate ($ / )
1.5865 1.5905
$
7%
9%
3 month forward rate ($ / )
1.6100 1.6140

5%
8%
Compute and show how a money market hedge can be put in place. Compare and contrast the outcome
with a forward contract.
[CA Nov. 08]
SOLUTION:
Option 1: MMH

FC. Receivables
3,50,000 $

3M

FC payables:
= = 3,42,298.29 $

Deposit 2,15,214.27Convert
for 3 months
at 5%
3,42,298.28
$ in at Spot rate = 3,42,298.29/1.5905 = 2,15,214.27

Step 1: Borrow P.V. of 3,50,000 $


= 3,50,000/1.0225 = 3,42,298.29 $
Step 2: Convert in to at spot rate
= 3,42,298.29/1.5905 = 2,15,214.27
Step 3: Deposit 2,15,214.27. for 3 months at 5%
Step 4: on maturity realize from debtors and paid FC loan.
Step 5: Amount received from deposit with interest
Hence, inflow = 2,14,215.27 + 2,690.18 = 2,17,904.45

Option 2: Forward hedging


Invoice amount = 3,50,000 $
3 month forward rate
1 = 1.6100/1.6140
Hence, inflow = 3,50,000 /1.6140 = 2,16,852.54 $
Decision: Go for money market hedge.
Q.38 F Ltd. is a medium size UK company with export and import trade with the USA. The following
transactions are due within next 6 months.
Sale of finished goods, cash receipt due in three months $ 1,97,000
Purchase of finished goods, cash payment due in 6 months $ 2,93,000
Exchange rates (London market):
$/
Spot
1 = $ 1.7106 / 1.7140
Three months forward
1 = $ 1.7024 / 1.7063
Six months forward
1 = $ 1.6967 / 1.7006
Calculate the net sterling pound 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 interests rates:
Borrowing
Lending
Pound
12.50 %
9.50 %
$
9%
6%
SOLUTION:
(A) 3 Months receivables
Alternative: 1 Forward cover
Amount receivable in 3 months
$ 1,97000
Applicable forward rate (Per )
1.7063 $
Amount received due to forward cover (1,97,000 / 1.7063)
1,15,454
Alternative: 2 Money market hedge

FC. Receivables
1,97,000 $

FC payables:
= = 1,92,665 $

3M

Deposit 1,12,407 for 3


months1,92,665
at 9.5% $ in at Spot rate = 1,92,665 / 1.7140 = 1,12,407
Convert

Hence, Inflow = 1,12,407 + [1,12,407 * 9.50 % * 3/12]


1,12,407 +2,670 = 1,15,077
Decision: Go for forward hedging.
(B) 6 Months receivables:
Alternative: 1 Forward cover
Amount receivable in 6 months
Applicable rate (Per )
Amount payable (2,93,000 / 1.6967)
MMH FC. Liability
2,93,000 $

2,93,000
1.6967
1,72,688.16

FC Receivables:
= = 2,84,466.02

Borrow in HC:
2,84,466.02 / 1.7106 = 1,66,296.05

Hence, cash outflow = 1,66,296.05 + 10,393.50 = 1,76,689.55


Q. 39 An Indian company has availed the services of two London based interior decorators and are
required to pay GBP 50,000 in 3 months. From the following information, advice the course of action to
minimize rupee outflow
Foreign exchange rates (Rs. / GBP)
Money market rates (p.a.)
Bid
Ask
Deposit
Borrowings
Spot
Rs. 81.60
Rs. 81.90
GBP
6%
9%
3 month forward Rs. 82.70
Rs. 83.00
Rs
8%
12 %
Q.40 An Indian exporting firm, Rohit and Bros. would be cover itself against a likely depreciation of
pound sterling. The following data is given:
Receivables of Rohit Bros.
5,00,000
Spot rate
1 = Rs. 56
Payment date
3 months
3 months interest rate
India: 12 % per annum
UK: 5 % per annum
What should the exporter do?
[CA Nov. 2008]
Q.41 Wenden Co. is a Dutch based company which has the following expected transactions.
One month:
Expected receipt of 2,40,000
One month:
Expected payment of 1,40,000
Three months:
Expected receipts of 3,00,000
The finance manager has collected the following information:
Spot rate (1 = )
: 1.7820 0.0002
One month forward rate (1 = )
: 1.7829 0.0003
Three months forward rate (1 = )
: 1.7846 0.0004
Borrowing
Deposit
One year euro interest rate
4.9 %
4.6 %
One year sterling interest rate
5.4 %
5.1 %
Assume it is now 1st April.
Required:
(a) Calculate the expected Euro receipts in one month and in three months using the forward market.
(b) Calculate the expected Euro receipts in three months using money market hedge and recommend
whether a forward market hedge or a money market hedge should be used.
[CA RTP, May, 2010]
QUESTIONS RELATED TO NEETING
Q. 42The following payments and receipts are to be settled between a parent company in USA and its three
subsidiaries located in Canada, Germany and UK. All amounts are is $:
USA
CANADA
GERMANY
UK
Pay
Receipt
Pay
Receipt Pay
Receip Pay
Receipt
t
USA
30
20
35
10
60
40
CANADA
20
30
10
25
40
30
GERMANY
10
35
25
10
30
20
UK
40
60
30
40
20
30
Case1: How bilateral netting would be carried out?

Case 2: How multilateral netting would be carried out?


Q.43The following payments and receipts (in million) are to be settled between a parent and its two
subsidiaries:
Payment
Receipts
Amount to whom
Amount from whom
UK Parent
USD 75
USA
STG 200
USA
EURO 60
GERMANY
STG 100
GERMANY
GERMANY
EURO 150
USA
USD 125
USA
STG 100
UK
EURO 60
UK
USA
STG 200
UK
EURO 150 GERMANY
USD 125
GERMANY
USD 75
UK
Exchange rate:
1STG = EURO 1.5; 1 STG = 1.25 USD; 1 EURO = 8.333 USD
Q.44 Trueview Plc., a group of companies controlled from the United Kingdom includes subsidiaries in
India, Malaysia and United States. As per the CFOs forecast that, at the end of the June 2010 the position
of inter company indebtedness will be as follws:
(i) The Indian subsidiary will be owed Rs. 1,44,38,100 by the Malaysian subsidiary and will to owe the US
subsidiary $ 1,06,007.
(ii) The Malaysian subsidiary will be owed MYR 14,43,800 by the US subsidiary and will owe it $ 80,000.
Suppose you are head of central treasury department of the group and you are required to net off inter
company balances as far as possible and to issue instructions for settlement of the net balances. For this
purpose, the relevant exchanges rates may be assumed in terms of 1 are $ 1.415; MYR 10.215; Rs. 68.10.
What are the net payments to be made in respect of the above balances?
[RTP Nov. 2010]
QUESTIONS RELATED TO LEADING AND LAGGING
Q.45 An Indian importer has to make payment of $ 1,00,000 import bill to US party 3 months from now.
Spot rate 1 $ = Rs. 45.40 / 45.80. 3 months forward rate: 1 $ = Rs. 46.10 / 46.75.
The US party is willing to offer a cash discount of 2 % for immediate payment. The INR loan borrowing
rate is 14 %. Advise the importer whether he should enter into a forward contract or make lead payment
today?
Q.46 An Indian importer has to settle a bill for $ 1,35,000. The exporter has given the Indian company two
options:
(i) Pay immediately without any interest charge,
(ii) Pay after 3 months, with interest 6 % p.a.
The importers bank charges 16 % p.a. on overdrafts. If the exchange rates are as follows, what should the
company do?
Spot rate: 1$ = Rs. 48.35 / 48.36
3 months forward rate: 1$ = Rs. 48.81 / 48.83
Q.47 An Indian firm has imported a machine from USA, the invoice is $ 1,00,000/-. The payment is to be
made in 2 months time. The USD rates are quoted in the market as follows:
2 month forward 1$ = Rs.45.30/ 45.36
3 month forward 1$ = Rs.44.80/ 44.85
The importer firm is considering the lagging. The exporter firm will charge interest at the rate of 9% p.a.
if the payment is delayed after it becomes due. Your cost of capital is 12%. Opine.
Q. 48 CQS plc is a UK company that sells goods solely within UK. CQS plc has recently tried a foreign
supplier in Netherland for the first time and need to pay 2,50,000 to the supplier in six months time. You
as financial manager are concerned that the cost of these supplies may rise in Pound Sterling terms and has
decided to hedge the currency risk of this account payable. The following information has been provided
by the companys bank:
Spot rate ( per ):
1.998 0.002
Six months forward rate ( per ):
1.979 0.004

Money market rates available to CQS plc:


Borrowing
Deposit
One year pound sterling interest rates
6.1 %
5.4 %
One year Euro interest rates
4.0 %
3.5 %
Assuming CQS plc has no surplus cash at the present time. You are required to evaluate whether a money
market hedge, a forward hedge or a lead payment should be used to hedge the foreign account payable.
[CA RTP May, 2010]
Q. 49 NP and Co. has imported goods for US $ 7,00,000. The amount is payable after three months. The
company has also exported goods for US $ 4,50,000 and this amount is receivable in two month. For
receivable amount a forward contract is already taken at Rs. 48.90.
The market rates for Rs. and Dollar areas under:
Spot
Rs. 48.50 / 70
Two month
25 / 30 point
Three month
40/45 point
The company wants to cover the risk and it has two options as under:
(a) To cover payables in the forward market and
(b) 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?
[CA - May, 2012]

QUESTIONS RELATED TO COVER RATE / COVER DEAL/ PROFIT OR LOSS OF DEALERS


Q. 50A dealer sold 1 lakh Hong Kong Dollar @ Rs. 6.37 and cover himself in London market on the same
day when the existing rate were:
US$ 1 = HK $ 7.5780 / 7.5810
Local bank rate for US $ were:
Spot rate US $ 1 = Rs. 47.20 / Rs. 47.40
Calculate cover rate and ascertain profit or loss in the deal.
[CA June, 09]
Q.51 You sold HK $ 10 million value spot to your customer at Rs. 5.70 and covered in London market on
the same day, when the exchange rates were 1 $ = HK $ 7.5880 / 7.5920. Local interbank market rates for
US $ were spot: 1 $ = Rs. 42.70 / 42.85.
Calculate cover rate and ascertain profit or loss in the transaction. Ignore brokerage.
Q. 52 A bank sold Hong Kong Dollars 40,00,000 value spot to its customer at Rs. 7.15 and covered itself in
London Market on the same day, when the exchange rates were:
1 $ = HK $ = 7.9250 / 7.9290
Local interbank market rates for US $ were:
Spot rate: 1 $ = Rs. 55.00 / 55.20.
You are required to calculate rate and ascertain the gain or loss in the transaction. Ignore brokerage. You
have to show the calculations for exchange rate up to four decimal points.
[CA- May, 2013]
QUESTIONS RELATED TO INTEREST RATE SWAP
Q. 53 Company ABC and XYZ have been offered the following rates per annum on a Rs. 200 lakhs five
year loan:
Company
Floating rate
Fixed rate
ABC
Libor + .1 %
12 %
XYZ
Libor + 0.6 %
13.4 %
Company ABC requires a floating rate loan; Company XYZ requires a fixed rate loan. Design a swap that
will net a bank acting as intermediary 0.1 % per annum and be equally attractive the both companies. Find
out the advantageous interest rate for the two companies.

SOLUTION:
Step: 1 Identify absolute advantage party.
Company ABCs benefit in fixed market = 1.40
Company ABCs benefit in floating market = 0.50
Hence company ABC is the absolute advantage party.
Step: 2 Decide the market for both parties. First decide market of absolute advantage party and the other
partys market get automatically decided.
ABC Company should go in fixed market and XYZ Company should go in floating market.
Step: 3 Structure of IRS can be shown as under:
L + 0.60
12 %

Company XYZ

Company ABC
Fixed @ 12 %

Floating @ L + 0.60
12 %
Swap dealer

Bank

Bank

L + 0.60
Step: 4 Statement of gain / loss due to interest rate swap and allocation of swap gain:
ABC
XYZ
(A) Cost due to IRS:
ABC pays
L + 0.60
XYZ Pays
12
(B) Cost without IRS
L + 0.10
13.40
Gain / (loss due to IRS)
(0.50)
1.40
Net gain
0.90
Less: Dealers margin
0.10
Net gain
0.80
Share of each party
0.40

0.40

Step: 5 Statement of effective rate:


Cost without IRS
Less: Share in gain due to IRS
Effective rate

ABC
L + 0.10
(0.40)
L 0.30

XYZ
13.40
(0.40)
13.00

Q. 54 ABC Ltd. is a financial institution which enjoys very good credit rating. It lends at floating rates and
borrows at fixed and it has risk of floating rates fall. XYZ is a manufacturing company enters into a fixed
price contract to purchase machinery. It has higher funding costs, whether fixed or floating. It has risk of
losses if funded on a floating rate basis. The relative borrowing costs of ABC Ltd. and XYZ Ltd. are as
follows:
Company
Floating rate
Fixed rate
ABC Ltd. (Financial institution)
Libor
8%
XYZ Ltd. (Manufacturing company)
Libor + 1 %
10%
Differential borrowing cost
1
2
What is the saving for both the companies?
SOLUTION:
Step: 1 Identify the absolute advantage party
Advantage of ABC in fixed market = 2

Advantage of ABC in floating market = 1


Step: 2 Decide the market for both parties. First decide market of absolute advantage party and the other
partys market get automatically decided.
ABC Company should go in fixed market and XYZ Company should go in floating market.
Step: 3 Structure of IRS can be shown as under:
L + 1.00

Company XYZ

Company ABC
8%
Fixed
@8%

Floating @ L + 1.00
Bank

Bank

Step: 4 Statement of gain / loss due to interest rate swap and allocation of swap gain:
ABC
XYZ
(A) Cost due to IRS:
ABC pays
L + 1.00
XYZ Pays
8
(B) Cost without IRS
L
10
Gain / (loss due to IRS)
(1)
2
Net gain
1.00
Less: Dealers margin
Net gain
1.00
Share of each party
0.50

0.50

Step: 5 Statement of effective rate:


Cost without IRS
Less: Share in gain due to IRS
Effective rate

ABC
L
(0.50)
L 0.50

XYZ
10
(0.50)
9.50

Q. 55 Company A has outstanding debt on which it currently pays fixed rate of interest at 9.5 %. The
company intends to refinance the debt with a floating rate of interest. The best floating rate it can obtain is
Libor + 2 %. However, it does not want to pay more than Libor. Another company B is looking for a loan
at a fixed rate of interest to finance its exports. The best rate it can obtain is 13.5 % bit it cannot afford to
pay more than 12 %. However, one bank has agreed to offer finance at a floating rate of Libor + 2 %. Citi
bank is in the process of arranging an interest rate swap between these two companies.
(i) With a schematic diagram, show how the swap deal can be structured.
(ii) What are the interest saving by each company?
(iii) How much would Citi bank receive?
[CWA Dec. 05]
SOLUTION:
(i) Structure of interest rate swap
L + 2.00
9.50 %
Company A

Company XYZ

Fixed @
9.50 %

Floating @ L + 2
12 %
Swap dealer

Bank

Bank

L
(ii) Calculation of interest saving by each party:
Company A
(A) Cost due to swap:
Paid to swap dealer
L
Received from swap dealer
9.50
Paid to bank
9.50
Net cost due to swap
L
(B) Cost without swap
L+2
Saving of party
2

Company B
12
L+2
L+2
12
13.50
1.50

Statement of gain earned by city bank:


Received from A
Paid to A
Received from B
Paid to B
Gain of city bank

L
(9.50)
12
L+2%
0.50

Q. 56 Yorkshire Industries a British industries firm with a US Subsidiary seeks to refinance some of its
existing British pound debt to include floating rate obligations. The best floating rate if can obtain in
London is LIBOR + 2.0%, but cannot afford more than L. Its current debts are as follows:
(i.) $ 10 Million owed to Citibank at 9.5% (fixed annually); and
(ii) 5 Million owed to Midland Bank at 9.5% (fixed) annually.
Huron River Salt Company wishes to Finance exports to Britain with 3 million of pound rate in London
for less than 13.5% interest because of its lack of credit history in the U.K. however, Lloyds Bank is
willing to extend a floating rate British pound Loan at LIBOR + 2%. Huron, however, cannot afford to pay
more than 12%. How can Yorkshire and Huron help one another via an interest rate swap? Assume that
Yorkshire is in a strong bargaining position and can negotiable the best deal possible, but Huron will not
pay over 12%, Assume further that transaction costs are 0.5% and exchange rates do not change. Illustrate
the effective post-swap interest rates of each party with boxes and arrows. What are the interest savings by
each party over the six months period of the swap?
[CWA June, 07]
SOLUTION:
(i) Structure of interest rate swap
L + 2.00
9.50 %

Huron

Yorkshire
Fixed @
9.50 %

Floating @ L + 2
12 %
Swap dealer

Bank

Bank

L
(ii) Calculation of interest saving by each party:
Yorkshire
(A) Cost due to swap:
Paid to swap dealer
L

Huron
12

Received from swap dealer


Paid to bank
Net cost due to swap
(B) Cost without swap
Saving of party

9.50
9.50
L
L+2
2

Statement of gain earned by swap dealer:


Received from A
Paid to A
Received from B
Paid to B
Gain of city bank

L+2
L+2
12
13.50
1.50
L
(9.50)
12
L+2%
0.50

Q. 57 MUMBAI LTD. is an Indian Company; they are in the process of raising a US dollar loan and are
negotiating the rates with City Bank. The Company has been offered a fixed rate of 7% p. a. with a proviso
that should they opt for a floating rate, the interest rate is likely to be linked to the Bench mark rate of 60
basis points over the 10 years US T Bill rate, with interest re fixation on a three monthly basis. The
expectations of Mumbai Ltd are that the dollar interest rates with fall, and are inclined to have a flexible
mechanism built into their interest rates. On enquiry they find that they could go for a swap arrangement
with Chennai India Ltd. Who have been offered a floating rate of 120 basis points over 10-year US T Bill
Rate, as against a fixed rate of 8.20% Describe the swap on the assumption that the swap differential is
shared between Mumbai Ltd and Chennai India Ltd. in the preparation of 2:1.
[CWA June, 08]

SOLUTION:
Available interest rates are as follows:
Mumbai Ltd.
7%
Bench mark + 60 BP

Fixed rate
Floating rate

Chennai Ltd.
8.20 %
Bench mark + 120 BP

Step: 1 Identify absolute advantage party


Advantage of Mumbai Ltd. in fixed market = 1.20
Advantage of Mumbai Ltd. in floating market = 60 BP or 0.60
Hence absolute advantage party = Mumbai Ltd.
Step: 2 Decide market for both party.
Mumbai Ltd. should go in fixed market and Chennai Ltd. should go in floating market.
Step: 3 Structure of IRS can be shown as under:
Bench mark + 1.20
Mumbai Ltd.

Chennai Ltd.

7%
Fixed
@7%

Floating @
Bench mark + 1.20
Bank

Bank

Step: 4 Statement of gain / loss due to interest rate swap and allocation of swap gain:
Mumbai Ltd.
Chennai Ltd.
(A) Cost due to IRS:
Mumbai Ltd. pays
Bench mark + 1.20
Chennai Ltd. Pays
7

(B) Cost without IRS


Gain / (loss) due to IRS
Net gain
Less: Dealers margin
Net gain
Share of each party

Bench mark + 0.60


(0.60)

8.20
1.20
0.60
0.60

0.40

0.20

Step: 5 Statement of effective rate:


Mumbai Ltd.
Bench mark + 0.60
(0.40)
Bench mark + 0.20

Cost without IRS


Less: Share in gain due to IRS
Effective rate

Chennai Ltd.
8.20
(0.20)
8.00

Q.58 X Company Ltd. And Y Company Ltd. Both wish to raise US 40 M Dollars Loan for five years, X
Company Ltd. has the choice of issuing fixed rate debt at 7.50% or floating rate debt at LIBOR+25 basis
point. On the other, Y Company Ltd. which has a lower credit rating can issue fixed rate debt of the same
maturity at 8.45% or floating rate at LIBOR + 37 basis points. X Company Ltd. prefers to issue floating
rate debt and Y Company Ltd. prefers fixed rate debt with a lower coupon. City Bank is in the process of
arranging an interest rate swap between these two companies.
X Company Ltd. negotiates to pay the Bank a fixed a floating rate of LIBOR flat while the Bank agrees to
pay X Company Ltd. a fixed rate of 7.60%. Y Company Ltd. agrees to pay Bank a fixed rate of 7.75%
while the Bank pays Y Company Ltd a floating rate of LIBOR flat.
Required:
(i) With a schematic diagram, show how the swap deal can be structured.
(ii) What are interests saving by each company?
(iii) How much would City bank receive?
[CWA June, 09]
SOLUTION:
Available interest rates are as follows:
Company X
7.50 %
L + 0.25

Fixed rate
Floating rate

Company Y
8.45 %
L + 0.37

Step: 1 Identify absolute advantage party


Advantage of company X in fixed market = 0.95
Advantage of company X in floating market = 0.12
Hence, absolute advantage party = Company X
Step: 2 Identify the market of loan for both party and then enter into swap contract.
Company X should go in fixed market whereas company Y should go in floating market.
Step: 3Structure of interest rate swap
L
7.60 %

Company Y

Company X
Fixed @
7.50 %

Floating @ L + 0.37
7.75 %
City bank

Bank

Bank

L
Calculation of interest saving by each party:
Company X
(A) Cost due to swap:

Company Y

Paid to swap dealer


Received from swap dealer
Paid to bank
Net cost due to swap
(B) Cost without swap
Saving of party

L
7.60
7.50
L 0.10
L + 0.25
0.35

7.75
L
L + 0.37
8.12
8.45
0.33

Statement of gain earned by swap dealer:


Received from X
Paid to X
Received from Y
Paid to Y
Gain of city bank

L
(7.60)
7.75
(L)
0.15

Q.59 Soni Ltd. and Tony Ltd. face the following interest rate:
Particulars
Soni Ltd.
Tony Ltd.
US Dollar (Floating rate)
Libor + 0.25 %
Libor + 2.25 %
Japanese Yen (Fixed rate)
1.75 %
2%
Toni Ltd. Wants to borrow US Dollar at a floating rate of interest and Soni Ltd. wants to borrow Japanese
Yen at a fixed rate of interest. A financial institution is planning to arrange a swap and requires a 100 basis
points spread. If the swap is equally attractive to Soni Ltd. Toni Ltd. What rate of interest will they end up
paying?
[CS June, 06]

SOLUTION:
Step: 1 Identify the absolute advantage party
Advantage of Soni Ltd. in fixed rate loan = 0.25
Advantage of Soni Ltd. in floating rate loan = 2.00
Hence, absolute advantage party is Soni Ltd.
Step: 2 Decide market for each party. Decide market for the absolute advantage party and other partys
market will automatically decide.
Soni Ltd. borrow floating rate loan and Tony Ltd. borrow fixed rate loan.
Step: 3 Structure of interest rate swap
2%
L + 0.25

Tony Ltd.

Soni Ltd.
Fixed @
L + 0.25 %

Borrow @ 2 %
L + 0.25

Bank
2%

Financial
institution

Bank

Step: 4 Statement of gain / loss due to interest rate swap and allocation of swap gain:
Sony Ltd.
Tony Ltd.
(A) Cost due to IRS:
Soni Ltd. pays
2%
Tony Ltd. Pays
L + 0.25
(B) Cost without IRS
1.75 %
L + 2.25
Gain / (loss) due to IRS
(0.25)
2.00
Net gain
1.75
Less: Dealers margin
1.00

Net gain
Share of each party

0.75
0.375

0.375

Step: 5 Statement of effective rate:


Sony Ltd.
1.75
(0.375)
1.375

Cost without IRS


Less: Share in gain due to IRS
Effective rate

Tony Ltd.
L + 2.25
(0.375)
L + 1.875

Q.60 Celina Ltd. wishes to borrow US Dollars at a fixed rate of interest. Priyanka Ltd. wishes to borrow
Japanese Yen at a fixed rate of interest. The amounts required by the two companies are roughly the same
at current exchange rate. The companies have been quoted the following interest rates:
Name of company
Yen
Dollar
Celina Ltd.
4.0 %
8.6 %
Priyanka Ltd.
5.5 %
9%
Design a swap that will net a bank, acting as intermediary, 50 basis points per annum. Make the swap
equally attractive to the two companies and ensure that all foreign exchange risk is assumed by the bank.
[CS June, 05]
SOLUTION:
Step: 1 Identify the absolute advantage party
Advantage of Celina Ltd. in Yen loan = 1.50
Advantage of Celina Ltd. in $ loan = 0.40
Step: 2 Decide market for each party. Decide market for the absolute advantage party and other partys
market will automatically decide.
Celina Ltd. borrow Yen loan and Priyanka Ltd. borrow $ loan.
Step: 3 Structure of interest rate swap
9%
4%

Priyanka Ltd.

Celina Ltd.
Yen loan
4%

$ loan @ 9 %
4%
Bank
9%

Financial
institution

Bank

Step: 4 Statement of gain / loss due to interest rate swap and allocation of swap gain:
Tony Ltd.
(A) Cost due to IRS:
Celina Ltd. pays
9%
Priyanka Ltd. Pays
4%
(B) Cost without IRS
8.60
5.50
Gain / (loss) due to IRS
(0.40)
1.50
Net gain
1.10
Less: Dealers margin
0.50
Net gain
0.60
Share of each party
0.30

0.30

Step: 5 Statement of effective rate:


Cost without IRS
Less: Share in gain due to IRS
Effective rate

Celina Ltd.
8.60
(0.0)
8.30

Priyanka Ltd.
5.50
(0.30)
5.20

INTEREST RATE PARITY / PURCHASING POWER PARITY / INTEREST COVERED ARBRITRAGE

Q.61 It is given that Dollar 6 month T-Bills rate = 7 % and Risk Free 6-month Japanese bonds = 5.5%;
Spot exchange rate is 1 Yen = $ 0.009. What is the 6-months forward exchange rate?
[Nov. 2008]
Q.62 The united State Dollar is selling in India at `45.50. if the interest rate of a 6 months borrowing in
India is 8% per annum and the corresponding rate in USA is 2%.
(a) Do you accept United State Dollar to be at a premium or at discount in the Indian forward market;
(b) What is the expected 6-months forward rate for United State Dollar in India; and
(c) What is the rate of forward premium or discount?
[CA FINAL]
Q.63 The rate of inflation in USA is likely to be 3% per annum and in India it is likely to be 6.5 %. The
current spot rate of US $ in India in`43.40. Find the expected rate of US $ in India after one year and 3
years from now using purchasing power parity theory.
[CA - Nov 2008]
Q.64 The rate of inflation in India is 8 % per annum and in USA it is 4 %. The current spot rate of USD in
India is `46. What will be the expected rate after 1 year and after 4 years applying purchasing power parity
theory?
[CA May, 2010]
Q.65 On April,1, 3 months interest rate in UK and US $ are 7.5 % and 3.5 % per annum respectively. The
/$ spot rate is 0.7570. What would be the forward rate for $ for delivery on 30th June?
[CA Nov. 2008]
Q.66 The expected annual inflation in Mexico is 5 %. The expected inflation for the US is 1.5 %. If the
spot rate for the peso is 3.4 peso/$, estimate the expected 1 year future spot rate.
Q.67 On 1st April, 3 months interest rate in the US and Germany are 6.5 % and 4.5 % per annum
respectively. The $/ DM spot rate is 0.6560. What would be the forward for DM for delivery on 30 th June?
[CA Nov. 2002]
Q.68 An Indian company is planning to invest in US. The US inflation rate is expected to be 3 % and that
of India is expected to be 8 % annually. If the spot rate currently is `45 per $, what spot rate can you
expect after 5 years.
[CWA June, 2005]
Q.69 Spot rate: $ .02090/ `
6 months forward rate: $ 0.02105/ `
6 months T bill rate in India = 5.50 % p.a.
US 6 months T bill rate will be =?
Q.70 Exchange rates:
Spot rate: 1 DM = 0.665 Can. $
3 months forward rate: 1 DM = 0.670 Can $
Interest rate: DM = 7 %; Can $ = 9 %.
What operations would be carried out to take the possible arbitrage gain?

[CA May, 2006]

Q.71 Spot rate: 1 $ = `47.7123


180 days forward rate: 1 $ = 48.6690
Interest rate in India = 12 % p.a.
Interest rate in US = 8 % p.a.
An arbitrageur takes loan of `40,00,000 from Indian bank for 6 months and goes for arbitrage. What is his
gain or loss? (Take 1 year = 360 days).
[RTP Nov. 2008]
Q. 72 Consider the following:
Spot rate: $ 0.75 / DM
1 year forward rate: $ 0.77 / DM
Interest rate (DM) = 7 % p.a.
Interest rate ($) = 9 % p.a.

(i) Assuming no transaction cost or taxes exist, do covered arbitrage profits exist in the above situation?
Explain
(ii) Suppose now that transaction costs in the foreign exchange market equal 0.25 % per transaction. Do
unexploited covered arbitrage profit opportunities still exist?
[CWA Dec. 2005/ CA Nov. 2010]
Q. 73 The annual interest rate is 5 % in the US and 8 % in UK. The spot exchange rate is STG / USD =
1.50 and forward exchange rate, with one year maturity is STG / USD = 1.48. In view of the fact that the
arbitrager can borrow $ 10,00,000 at current spot rate, what would be the arbitrager profit or loss?
[CWA Dec. 2004]
Q.74 Following are the rates quoted at Mumbai for British Pound
Spot rate: 1 BP = `52.60 / 70
3 months forward rate: 20 /30
6 months forward rate: 50 /75
Interest rates are as under:
`

3 months
8%
5%
6 months
10 %
8%
Verify whether there is any scope of covered interest arbitrage if you borrow rupees.
[CA Study Material]
Q. 75 Spot rate 1 $ = `48.0123
180 days forward rate for 1 $ = `48.8190
Annualized interest rate for 6 months (`) = 12 %
Annualized interest rate for 6 months ($) = 8 %
Is there any arbitrage possibility? If yes how an arbitrageur can take advantage of the situation, if he is
willing to borrow `40,00,000 or $ 83,312.
[CA Nov. 2006]
Q.76 Given Spot Exchange rate $ = FF 7.05. Complete missing entries.
3 months
6 months
$ int. Rate (Annuity)
11.5%
12.25%
FF Int. Rate (Annuity)
19.5%
C
Forward Franc per $
A
D
Forward Dollar Premium %
B
6.3%

1 years
E
20%
7.52
F
[CA Nov. 2000]

Q.77 Syntex Ltd. has to make a US $ 5 million payment in three months time. The required amount in
dollars in available with Syntex Ltd. The management of the company decides to invest them for three
months and following information is available in this context:
The US $ deposit rate is 9% per annum.
The Sterling pound deposit rate is 11% per annum.
The Spot exchange rate is $ 1.82/pound.
The three month forward rate is $1.80 /pound
Answer the following Questions
(a) Where should the company invest for better returns?
(b) Assuming that the interest rates and the spot exchange rate remain as above, what forward rate would
yield an equilibrium situation?
(c) Assuming that the US interest rate and the spot and forward rates remain as above, where should the
company invest if the sterling pound deposit rate were 15% per annum?
(d) With the originally stated spot and forward rates and the same dollars deposit rate, what is the
equilibrium sterling pound deposit rate?
[RTP CA, May, 2005]
Q.78 Decide whether on opportunity for currency arbitrage exists for the following quotes in each case:
JPY / USD:
110.25 / 111.10
NLG / USD:
1.6520 / 1.6530
JPY / NLG:
68.30 / 69.00
Q.79 In London, a dealer quotes:
1 GBP = 3.5250 / 55 CHF

1 GBP = 180.80 / 181.30 JPY


(i) What do you expect the 1 CHF = JPY rate to be in Geneva?
(ii) Suppose that in Geneva you get 1 CHF = 51.1530 / 51.2550 JPY. Is there an arbitrage opportunity?
Q.80 Following are the spot exchange rates quoted at three different forex markets:
1 $ = `48.30 in Mumbai
1 GBP = `77.52 in London
1 GBP = 1.6231 in New York
The arbitrageur has $ 1,00,00,000. Assuming that there are no transaction costs, explain whether there is
any arbitrage gain possible from the quoted spot exchange rates.
[CA Nov. 2008]
QUESTIONS RELATED TO INTERNATIONAL CAPITAL BUDGETING / CASH
MANAGEMENT / TREATMENT OF WITHHOLDING TAX / JOINT VENTURE
Q.81 ABC Ltd. is considering a project in US, which will involve an initial investment of US $
1,10,00,000. The project will have 5 years of life. Current spot exchange rate is Rs. 48 per US $. The risk
free rate in US is 8 % and the same in India is 12 %. Cash inflows from the project are as follows:
Year
Cash inflows
1
US $ 20,00,000
2
US $ 25,00,000
3
US $ 30,00,000
4
US $ 40,00,000
5
US $ 50,00,000
Calculate the NPV of the project using foreign currency approach. Required rate of return on this project is
14 %.
[CA Nov. 06]
Q.82 XYZ Inc. currently exports 500 calculators per month to UAE @ $ 60 per piece. The variable cost
per unit is $ 40. There is a proposal to establish a manufacturing plant in UAE, for which the company
decided to make an equity investment of $ 1 million, half of which would represent working capital and
the balance is fixed assets. The company would sell the plant to a local entrepreneur for a sum of $ 1
million at the end of 5th year and the Government of UAE would repay the company $ 5,00,000 for
working capital. XYZ Inc. will sell its calculators at $ 50 per unit in the UAE. The total cost of local
managers and material would be $ 15 per calculator. Other materials would be purchased from parent
company at $ 10 per unit and the parent company would receive a direct contribution to overhead variable
costs $ 5 per unit sold. The company expects to sell 12,000 calculators per annum. The fixed assets are to
be depreciated on a straight line basis over a 5 year period. The company will have to pay income tax at 50
% on profits. The current exchange rate is 10 UAE dinars per $ and is expected to stay the same for the
next five years. There is no restriction on cash flow repatriation.
(i) Determine the NPV of the project at 10 %.
(ii) XYZ Inc. has been informed that if it decides to reject the project, it would lose its entire export sales
to UAE. How does this affect decision of XYZ?
[CWA Study Material]
Q.83 A Ltd. an India based MNC is evaluating an overseas investment proposal. It is considering a project
building a plant in United Kingdom. The proposal would initially cost 50 million pound and is expected to
generate the following cash flows, over its 4 years life:
Years
Cash flows in million ()
1
20
2
30
3
20
4
10
The current spot rate = 1 = Rs. 70. Risk free rate in India = 10 % in United Kingdom is 6 %. The
companies cost of capital is 20 %. Will the project be undertaken?
Q. 84 An American firm is evaluating an investment proposal in Holland. The project cost is 1.3 million
NLG (Netherlands guilders). The interest rate in Holland and USA are respectively 6 % and 5 %. The spot
rate in NLG = 0.5 $. Cost of capital in USA = 16 % and the NLG discount rate is 17.1 %. The cash flows
for 5 years project are as follows:

Years
Cash flow (in000 NLG)
1
400
2
450
3
510
4
575
5
650
Evaluate under both approaches and advise whether the project should be taken up.
Q.85 XY Limited is engaged in large retail business in India. It is contemplating for the expansion into a
country of Africa by acquiring a group of stores having the same line of operation as that of India. The
exchange rate for the currency of the proposed African country is extremely volatile. Rate of inflation is
presently 40 % in a year. Inflation in India is currently 10 % a year. Management of XY Limited expects
these rates likely to continue for the foreseeable future. Estimated projected cash flows, in real terms, in
India as well as African country for the first three years of the project are as follows
Particulars
Year 0
Year 1
Year 2
Year 3
Cash flow in India (` 000)
- 50,000
- 1,500
- 2,000
- 2,500
Cash flows in African Rands (000) - 2,00,000 50,000
70,000
90,000
XY Ltd. assumes the year 3 nominal cash flows will continue to be earned each year indefinitely. It
evaluates all investments using normal cash flows and a nominal discount rate. The present exchange rate
is African Rand 6 to `1.
You are required to calculate the Net present value of the proposed investment considering the following
(i) African Rand cash flows are converted into ` and discounted at a risk adjusted rate.
(ii) All cash flows for these projects will be discounted at a rate of 20 % to reflect its high risk.
[CA May, 2013]
Q.86 A USA based company is planning to set up a software development unit in India. Software
development at the Indian unit will be bought back by the US parent at a transfer price of US $ 10
millions. The unit will remain in existence in India for one year; the software is expected to get developed
within this time frame. The US based company will be subject to corporate tax of 30 % and a with
holding tax of 10 % in India and will not be eligible for tax credit in the US.
The software developed will be sold in the US market for US $ 12.0 millions. Other estimates are as
follows
Rent for fully furnished unit with necessary hard ware in india
`15,00,000
Man power cost (80 software professional will be working for 10 hours each day)
`400 per man
hour
Administrative and other costs
`12,00,000
Advise the US company on financial viability of the project. The ` - $ rate is `48 / $.
[CA Nov. 2007]
Q.87 A US based plastic manufacturer is considering a proposal to produce of high quality plastic glasses
in India. The necessary equipment to manufacture the glasses would cost `1,00,000 in India and it would
last 5 years. The tax relevant rate of depreciation is 25 % on written down value method. The expected
salvage value is `10,000. The glasses will be sold at 4 each. Fixed cost will be `25,000 each year and
variable cost `2 per glass. The manufacturer estimates it will sell 75,000 glasses per year; tax rate in India
is 35 %. The US manufacturer assumes 20 % cost of capital for such a project. Additional working capital
requirement will be `50,000.
The US manufacturer will be allowed 100 % repatriation each year with a withholding tax rate of 10 %.
Should the proposal of setting up a manufacturing unit in India be accepted by the US manufacturer? Spot
and expected exchange rates are as follows:
Spot rate
`50 / $
Year end 1
`50
Year end 2
`50
Year end 3
`52
Year end 4
`52
Year end 5
`52

Q. 88 OJ Ltd. is a supplier of leather goods to retailers in the UK and other Western European countries.
The company is considering entering into a Joint venture with a manufacturer in South America. The two
companies will each own 50 % of the limited liability company JV (SA) and will share profits equally.
4,50,000 of the initial capital is being provided by OJ Ltd. and the equivalent in South America dollars
(SA$) is being provided by the foreign partner. Manager of the joint venture expects the following net
operating cash flows, which are in nominal terms:
Year
SA $ (000)
Forward rate of exchange to the sterling
1
4,250
10
2
6,500
15
3
8,350
21
For tax reasons JV (SA) the company to be formed specifically for the joint venture, will be registered in
South America. Ignore taxation in your calculation.
Requirements:
Assume you are financial adviser retained by OJ Limited to advice on the proposed joint venture. Calculate
the NPV of the project under the two assumptions explained below. Use a discount rate of 16 % for both
assumptions.
Assumption: 1 The South America country has exchange control which prohibit the payment of dividends
above 50 % of the annual cash flows for the first three years of the project. The accumulated balance can
be repatriated at the end of the third year.
Assumption: 2 The government of South America country is considering removing exchange controls and
restriction on repatriation of profits. If this happens all cash flows will be distributed as dividends to the
partner companies at the end of each year.
[Supplement study material]
Q. 89 AMK Ltd. an Indian based company has subsidiaries in US and UK. Forecasts of surplus funds for
the next 30 days from two subsidiaries are as below:
U.S.
$ 12.5 millions
U.K.
6 millions
Following exchange rate information are obtained:
$/`
/`
Spot
0.0215
0.0149
30 days forward
0.0217
0.0150
Annual borrowing / deposit rates (Simple) are available.
`
6.4 % / 6.2 %
$
1.6 % / 1.5 %

3.9 % / 3.7 %
The Indian operation is forecasting a cash deficit of `500 million. It is assumed that interest rates are based
on a year of 360 days.
(i) Calculate the cash balance at the end of 30 days period in ` for each company under each of the
following scenarios ignoring transaction costs and taxes:
(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 companys point of view?
[CA May, 2007]
Q. 90 An American multinational corporation has subsidies whose cash positions for the month of
September, 2002 are given below:
Swiss subsidiary:
Cash surplus of SF 1,50,00,000
Canadian subsidiary:
Cash deficit of Can $ 2,50,00,000
UK subsidiary:
Cash deficit of 30,00,000 (UK pound)
What are the cash requirements, if
(i) Decentralized cash management is adopted?
(ii) Centralized cash management is adopted?
[Exchange rate: SF 1.48 / $; Can $ 1.58 / $; $ 1.50 / ]
[CWA Dec. 2002]

Q.91 An American small car manufacturing company wants to established a project in China, after
surveying the country for demand for small cars. Initial outlay is $ 120 millions. Annual cash flows (in
Chinese yuan) for next 5 years are 200 millions, 350 millions, 300 millions, 250 millions, 150millions.
At the end of five years, the project would be wound up. Considering Chinas stringent exchange
restrictions and its average cost of capital, the desired return is 15 % in USD terms. In respect of project
investment by foreign companies, the Chinese laws restrict repatriation to 10 % of the project investment
for each of the first 3 years. The foreign companys share in the cash flows in excess of 10 % of the project
investment should be invested in 6 % tax free Government of China bonds. The bonds will mature at the
end of the 3rd year.
The spot rate is USD 0.1250 per yuan. The Yuan is expected to appreciated by 10 % every year for
the next 2 years and depreciates 3 % every year thereafter. Evaluate the project from the American
companys perspective, would there be any change, if the 50 % of the project is financed by a Chinese
engineering firm?
[CWA Study Material]
Q.92 D Ltd. an Indian company is evaluating an investment in Hong Kong. The project costs 300 million
Hong Kong Dollars. It is expected to generate an income of 100 million HKD a year in real terms for the
next 4 years (project duration). Expected inflation rate in Honk Kong is 6 % p.a. interest rate in India is 7
% p.a. while in Hong Kong is 10 % p.a. The risk premium for the project is 6 % in absolute terms, over the
risk free rate. The project beta is 1.25. Spot rate per HKD is `5.75. Evaluate the project in `, if the
investment in the project is out of retained earnings.
[CWA Study material]
Q. 93 XYZ Ltd. is considering a project in Luxemburg, which will involve an initial investment of
1,30,00,000. The project will have 5 years of life. Current spot exchange rate is `58 per . The risk free
rate in Germany is 8 % and the same in India is 12 %. Cash inflow from the project are as follows:
Year
Cash inflow
1
30,00,000
2
25,00,000
3
35,00,000
4
40,00,000
5
60,00,000
Calculate the NPV of the project using foreign currency approach. Required rate of return on this project is
14 %.
[CA RTP Nov. 2008]
Q.94 An Indian company is planning to set up a subsidiary in US. The initial project cost is estimated to be
US $ 40 million; working capital required is estimated to be $ 4 milion. The finance manager of company
estimated the data as follows:
Variable cost of production (per unit sold)
$ 2.50
Fixed cost per annum
$ 3 million
Selling price
$ 10
Production capacity
5 million units
Expected life of plant
5 years
Method of depreciation
SLM
Salvage value at the end of 5 years
Nil
The subsidiary of the Indian company is subject to 40 % corporate tax rate in the US and the required rate
of return if such type of project is 12 %. The current exchange rate is `48 / $ and the rupee is expected to
depreciate by 3 % per annum for next 5 years. The subsidiary company shall be allowed to repatriate 70 %
of the CFAT every year along with the accumulated arrears of blocked funds at the end of 5 years, the
withholding taxes are 10 %. The blocked fund will be invested in the USA money market by the
subsidiary, earning 4 % (free of taxes) per year. Determine the feasibility of having a subsidiary company
in the USA, assuming no tax liability in India on earnings received by the parent company from the US
subsidiary.
[CA RTP Nov. 2008]
Q. 95 An MNC company in USA has surplus funds to the tune of $ 10 million for six months. The finance
director of the company is interested in investing in DM for higher returns. There is a Double tax

avoidance agreement (DTAA) in force between USA and Germany. The company received the following
information from London:
/ $ spot rate
0.4040 / 41
6 months forward
67 / 65
Rate of interest for 6 months (p.a.)
5.95 % - 6.15 %
Withholding tax applicable for interest income
22 %
Tax as per DTAA
10 %
If the company invests in , what is the gain for the company?
[CA RTP June, 2009]
QUESTIONS RELATED TO NOSTRO ACCOUNTS
Q. 96 You as a dealer in foreign exchange have the following position in Swiss France on 31 st October,
2007:
Particulars
Swiss Francs in thousand
Balance in Nostro account credit
100
Opening position overbought
50
Purchased a bill on Zurich
80
Sold forward
60
Forward purchases cancelled
30
Remitted by TT
75
Draft on Zurich cancelled
30
Expected closing balance in Nostro credit
30
Expected closing overbought
10
[CA Nov. 2005]
Q. 97 A dealer has the following position in Frankfurt. What must he do to make it square?
His account in Frankfurt is overdrawn DEM 3,75,000. He has purchased cheques which are in course of
post and not yet credited to his account totalling DEM 3,28,000. He has forward contracts outstanding as
follows:
Sales
DEM 1,63,86,000
Purchases
DEM 1,46,06,250
He has issued draft not yet presented for payment for DEM 12,20,080. He has long bills purchased in hand
not due for DEM 28,85,640.
Q. 98 You as a dealer have the following position in pound sterling:
Opening balance in Barclays bank international London
GBP 20,000 O/D
Opening currency position overbought
5,000
Purchased a telegraphic transfer
50,000
Issued a draft on London
20,000
TT remittance outward
25,000
Purchased bills on London
75,000
Forward sales
75,000
Export bills realized
45,000
What steps would you take if you are required to maintain a credit balance of GBP 10,000 in Nostro
account and square your exchange position?
Q.99 XYZ Bank, Amsterdam, wants to purchase ` 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 $, 61.3625/3700 & per , $ 1.5260/70.
TRANSACTION EXPOSURE / NET EXPOSURE / OPERATING EXPOSURE
Q.100 An automobile company in Gujarat exports its goods to Singapore at a price of SG $ 500 per unit.
The company also imports components from Italy and the cost of components for each unit is 200. The
companys CEO executed an agreement for the supply of 20,000 units on January 1, 2010 and on the same
date paid for the imported components. The companys variable cost of production per unit is Rs. 1,250

and the allocable fixed costs of the company are Rs. 1,00,00,000. The exchange rates as on 1 st January,
2010 were as follows:
Spot Rs. /SG $ = 33.00 / 33.04
Rs. / = 56.49 / 56.56
Mr. A, the treasury manager of company is observing the movement of exchange rates on a day to day
basis and has expected that the rupee would appreciate against SG $ and would depreciate against . As per
his estimates the following are expected rates for 30th June, 2010.
Spot: Rs. / SG $
32.15 / 32.21
Rs. /
57.27 / 57.32
Required: find out
(i) The change in profitability due to transaction exposure for the contract entered into.
(ii) How many units should the company increases its sales in order to maintain the current profit level for
the proposed contract in the end of June, 2010.
[CA Nov. 2010]
Q.101 Following are the details of cash inflows and outflows in foreign currency denominations of MNP
Co. an Indian export firm, which have no foreign subsidiaries:
Currency
Inflow
Outflow
Spot rate
Forward rate
US $
4,00,00,000 2,00,00,000
48.01
48.82
French Franc (FFr)
2,00,00,000 80,00,000
7.45
8.12
UK
3,00,00,000 2,00,00,000
75.57
75.98
Japanese Yen
1,50,00,000 2,50,00,000
3.20
2.40
(i) Determine the net exposure of each foreign currency in terms of Rupees.
(ii) Are any of the exposure position offsetting to some extent?
[CA Nov. 06]
Q.102 M/s Omega Electronics Ltd exports air-conditioners to Germany by importing the components from
Singapore. The company is exporting 2400 units at a price of Euro 500 per unit. The cost of imported
components is S$ 800 per unit, The fixed cost and other variable cost per unit are Rs. 1000 and Rs. 1500
respectively. The cash-flows in foreign currencies are due in six months. The current exchange rates are as
follows:
Rs./Euro 51.50/55
Rs./S$ 27.20/25
After six months the exchange rates turn out as follows:
Rs./Euro 52.00/05
Rs./S$ 27.70/75
(1) You are to calculate the gain/loss due to transaction exposure.
(2) Based on the following additional information calculate the loss/gain due to transaction and operating
exposure if the contracted price of the air conditioner is Rs.25000:
(i) The current exchange rate is :
Rs./Euro 51.75/80
Rs./S$ 27.10/15
(ii) Price elasticity of demand is estimated to be 1.5.
(iii) Payments and receipts are to be settled in six-months.
[CA Nov. 09]
OTHERS
Q.103 A firm is contemplating import of a consignment from the USA for a value of US $ 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 % per annum. The bankers of the firm offer
a short loan for 30 days at 9 % per annum. The bankers quotation for foreign exchange is:
Spot rate: 1 $ = Rs. 46
60 days forward 1 $ = Rs. 46.20
90 days forward 1 $ = Rs. 46.35
You are required to advise the firm as to whether it should:
(i) Pay the supplier in 60 days, or
(ii) Avail the suppliers offer of 90 days credit. Show your calculations.
[RTP May, 06]

Q.104 On 1st March, 2008 A, Inc. a US company bought certain products from Tapland. The currency of
Tapland is Tapa. The price agreed was Tapa 9,00,000 payable on 31st May, 2008. The spot price on 1st
March, 2008 was 10 Tapa per $. The expected future spot rate was 8 Tapa per $ and the 3 months forward
rate is 9 Tapa per $. The US and Tapland annual interest rate are 12 % and 8 % respectively. The tax rate
for both countries is 40 %. A Inc. is considering three alternatives to deal with the risk of exchange rate
fluctuations.
(i) To enter the forward market to buy Tapa 9,00,000 at 3 months forward rate.
(ii) To borrow appropriate amount in $ to buy Tapa at current spot rate and to invest the Tapa purchased for
3 months.
(iii) To wait until May, 2008 and buy Tapas at whatever spot rate prevailing at that time.
Which alternative the A Inc. should follow in order to minimize its cost of future payment of Tapas.
[RTP Nov. 08]
Q.105 Yati Ltd. is planning to import a multi purpose machine from Japan at a cost of 3,400lakhs Yen.
The company can avail loans at 18 % per annum with quarterly rests with which it can import the machine.
However, there is an offer from Tokyo branch of an India based bank extending credit of 180 days at 2 %
p.a. against opening of an irrevocable letter of credit.
Other information:
Present exchange rate: Rs. 100 = 340 Yen
180 days forward rate: Rs. 100 = 345 Yen.
Commission charges for letter of credit at 2 % per 12 months. Advise whether the offer from the foreign
branch should be accepted?
[CA Nov. 96]
Q.106 A company operating in a country having dollar as its unit of currency has today invoiced sales to an
Indian company, the payment being due three months from the date of invoice. The invoice amount is $
13,750 and at todays spot rate of $ 0.0275 per Re.1, is equivalent to Rs. 5,00,000. It is anticipated that the
exchange rate will decline by 5 % over the three months period and in order to protect the dollar proceeds,
the importer proposes to take appropriate action through foreign exchange market. The three month
forward rate is quoted as $ 0.0273 per Re.1. You are required to calculate the expected loss and to show,
how it can be hedged by forward contract.
[CA May, 98]
Q.107 Your forex dealer had entered into a cross currency deal and had sold US $ 10,00,000 against EURO
at US $ 1 = EURO 1.4400 for spot delivery. However, later during the day, the market became volatile and
the dealer in compliance with his managements guidelines had to square up the position when
quotations were:
Spot US $ 1
INR 31.4300/ 4500
1 month margin
25 /20
2 months margin
45/35
Spot US $ 1
EURO 1.4400/ 4450
1 month forward
1.4425 / 4490
2 months forward
1.4460 / 4530
What will be the gain or loss in the transaction?
[CA June, 2009]
Q.108 An Indian importer has to settle an import bill for $ 1,30,000. The exporter has given the Indian
exporter two options:
(i) Pay immediately without any interest charges.
(ii) Pay after three months with interest at 5 % per annum.
The importers bank charges 15 % per annum on overdrafts. The exchange rates in the market are as
follows:
Spot rate (Rs. /$): 48.35 / 48.36
3 months forward rate (Rs. /$): 48.81 / 48.83
The importer seeks your advice. Give your advice.
[CA Nov. 2011]