FOREX MARKET

• EXCHANGE RATE • AMERICAN TERM

• DOMESTIC • EUROPEAN TERM
CURRENCY • BID
• DIRECT QUOTE • ASK
• INDIRECT QUOTE • TWO WAY QUOTE
• LINK BETWEEN • SPREAD
DIRECT&INDIRECT • CONVERTING
QUOTE TWOWAY QUOTE
• Arbitrage
 FOREX MARKET
• CROSS RATE • SWAP POINTS
• SPOT RATE • FORWARD RATE,
• FORWARD RATE PREMIUM AND
• DISCOUNT
APPRECIATION
• DEPRECIATON
• COMPUTATION OF
APPRECIATION AND
DEPRECIATION
 EXCHANGE RATE
• THE PRICE OF ONE CURRENCY
VIEWED IN RELATION TO ANOTHER
CURRENCY IS CALLED EXCHANGE
RATE.
• EXAMPLE- Re/$ 44.76 means
44.76=1USD
 3. DIRECT QUOTE
• X UNITS OF DOMESTIC CURRENCY
EQUAL ONE UNIT OF FOREIGN
CURRENCY.
• EXAMPLE- Rs44.20 per USD IS A
DIRECT QUOTE FOR USD IN INDIA
 4. INDIRECT QUOTE
• THE DOMESTIC CURRENCY IS THE
COMMODITY WHICH IS BEING
BOUGHT AND SOLD.
• COMMODITY COMES FIRST AND
PRICE NEXT.
• EXAMPLE- Re1=.02 USD
 5.CONVERTION (D TO I)
• RUPEES Rs44.20=1$- DIRECT QUOTE
• INDIRECT QUOTE Re1= 1/44.20=.0227
• ? KRONER 0.1481 –KRONERS PER
RUPEE
• ?SAUDI RIYAL(SAR) .08 –RIYAL PER
RUPEE
• ? GBP 83.27 RUPEES PER POUND.
 6. AMERICAN AND
EUROPEAN TERMS
• AMERICAN TERM IS DIRECT.
• EUROPEAN TERM INDIRECT.
• EXAMPLE-THE RATE $ 1.5 PER POUND IS AN
AMERICAN TERM.
• THE QUOTE $1= INR 45 IN EUROPEAN TERM.
• ? AMERICA OR EUROPE.
• (a) 3.419$ PER QUWAITI DINAR- IN USA IT IS
A DIRECT MODE- AMERICAN TERMS.
• EUROPEAN TERM- 1/AMRICAN TERM : .2925
KWD PER USD.
 7. SOLVE
• (a) 7.760 HKD PER $
• (b) 7.57 PER DANISH KRONER
• Direct quote
• American term
• 1HKD=.128$ European term
• .128Rs=1HKD Indirect quote
 ANSWERS
• (a) PERSON IN AMERICA THE QUOTE IS
FOREIGN CURRENCY PER UNIT OF HOME
CURRENCY. HENSE IT IS INDIRECT MODE-
EUROPEAN TERM
• THE AMERICAN TERM: 1/EUROPEAN TERM
IS 1/7.760= .13 $ PER HKD(HONG-KONG)
DOLLAR.
• (b)THE QUOTE IS NEITHER EUROPEAN NOR
IN AMERICAN TERM SINCE DOLLAR IS NOT
ONE OF THE PAIR OF CURRENCIES.
 BID AND ASK
• THE BANK’S QUOTE OF BID AND ASK IS
FROM THE BANKER’S PERSPECTIVE.
• BID= BUY
• ASK=SELL
• IF THE BID RATE FOR USD IS 40 IT MEANS
THAT THE BANK IS READY TO BUY 1$ FOR
Rs.40
• IF THE ASK RATE IS FOR USD IS 41, IT
MEANS THAT THE BANK IS (ASKING IF
SOMEONE WILL BUY) SELLING 1$ FOR Rs.41.
 Three tier architecture
• A) bottom tire- Money changers licenced
by RBI
• B) Second tire-cooperative and
Commercial Bank licenced to maintain
accounts for NRI
• C) TOP TIER- Authoried dealers-
Scheduled Banks-full-fledged foreign
exchange business.
 Two way quote
• BID QUOTE AND ASK QUOTE
• Ex: Re/$- 40.42 – 41.63
• Rs.40.42-bid(buying)-( Bank point of view)
• Rs.41.63-ask(selling)
• Rs.40.42=1$ means the quote is in india
• Yen33= Re.1 means the quote is in Japan
• If you want to buy, if you have $, you will get
Rs.40.42
• If you want to sell Rs. and buy $ you part with
Rs.41.63.
 Spread
• ASK MINUS BID=SPREAD
• EX. 40-41
SPREAD=
Rs.41-40=Rs.1
Factors:a) Stability of the exchange rate
b) depth of the market-volume of
transaction
High volume(deep market)-narrow spread
Low volume (thin market)-wider spread
 Problem

• Indian would like to have travelers cheques:

GBP-STERLING 72.70-73.25
• A) explain the quote
• B) compute the spread
• C) how much would you pay for purchasing 250
pounds in TCS?
• D) If you have a balance of pounds 23 in
travellers cheques , how many rupees would you
receive if the bank in india quotes 73.65-73.92?
 Answer
• A)Bank buys at 72.70and Ask rate is 73.25
• B)Spread=.55
• C) 250*73.25=Rs.18312.50
• D)Rs.23*73.65=Rs.1693.95
• Note: in practice all forex transactions are
rounded off to a rupee ie Rs.1694
 Converting two way quotes

• Formula
• Bid(Rs/$)=1/Ask($/Rs)or
• Ask(Rs/$)=1/Bid ($/Rs)or
• Take the inverse of each rate (bid and
ask) and switch them around.
• Ex:INR/USD 40.25-41.35
• 1/40.25 1/41.35
• USD/INR =0.0248 =.02418
 PROBLEM
• CONSIDER THE FOLLOWING
QUOTATIONS IN MUMBAI
• Rupee/UAE Dirham(AED)=12.69
• Rupee/Swedish kroner(SEK)=5.49
• Rupee/New Zealand Dollar(NZD)=25.35
• Euro/INR=0.0198
• Compute a)The quote for SEK/AED
• b) Euro/NZD
 Solutions
• A)SEK/AED=SEK/INR*INR/AED=.18*12.6
9
• =1 AED
• B)
EURO/NZD=EURO/Re*Re/NZD=.0198*25
.35=.50
 SPOT RATE
• RATE OF EXCHANGE FOR IMMEDIATE
SETTLEMENT
• IT IS SETTLED ON THE SECOND WORKING
DAY
• SATURDAY AND SUNDAY ARE HOLIDAYS
• EX:SPOT RATE:Rs./$40.35-41.36 SUPPOSING
YOU HAVE 124000 DOLLAR RECEIVED ON
THURSDAY THE BANK WILL SETTLE
124000*40.35=50,03,400 ON THE FOLLOWING
MONDAY.
 FORWARD RATE
• RATE CONTRACTED TODAY FOR
EXCHANGE OF CURRENCIES AT A
SPECIFIED FUTURE DATE
• THERE IS A FORWARD BID AND
FORWARED ASK
• CASH DELIVERY-ON THE SAME DAY
• TOM DELIVERY-ON WORKING DAY ON
THE FOLLOWING DAY
 APPRICIATION AND
DEPRECIATION
• IF F>S IN A DIRECT QUOTE THE FOREIGN
CURRENCY IS APPRECIATING
• Home depreciate
• Indirect quote: Foreign depreciates and HOME
APPRECIATES
• Ex: 1. SPOT: SGD .O370=Re 1
• IN SINGAPORE ; FORWARD RATE THREE MONTHS
HENCE 0.0360
• SGD APPRECIATES OR DEPRECIATES?
• SPOT USD 1.5865= 1 POUND IN UK. FORWARD 1
MONTH 1.5833 .
• ?DEPRECIATE OR APPRICIATE
 SWAP POINTS
• DIFFRENCE BETWEEN SPOT BID AND
FORWARD BID OR SPOT ASK AND
FORWARD ASK
• ?DIFFRENCE BETWEEN SPREAD AND
SWAP POINTS
 FORWARD RATE, PREMIUM
AND DISCOUNT
• IF SWAP ASK> SWAP BID-FOREIGN
CURRENCY IS APPRECIATING HENCE
ADD SWAP POINTS
• IF SWAP ASK <SWAP BID FOREIGN
CURRENCY IS DEPRECIATING. HENCE
DEDUCT THE SWAP POINTS.
 Arbitrage
• Act of buying currency in one market at
lower prices and selling it in another at
higher price.
• It helps the arbitrageurs in the market to
earn profit without risk
• It is a balancing operations that do not
allow the same currency to have varying
rates in different forex markets.
 Types of arbitrage
• Geographical
• Triangular arbitrage
 Geographical arbitrage
• Different prices quoted in two geographical
markets for the same currency
• Tokyo and London
• 1.Observe the following:
• Rs/US $
• London Rs.: 42.5730--42.61
• Tokyo $: 42.6750 -- 42.6675
• Can make money out of it?
• Buy at London market at 42.6100 and sell the
same at Tokyo market for Rs.42.6350.
• Suppose you buy from London for 100 million
Rupees you can get 100 million
/42.61=$2,346,866.932
• Sell $ 2,346,866.932 in Tokyo market at Rs.
42.6350 gives Rs.100,058,671.16
• There are transaction costs involved.
• Note: selling price of one market should be
higher than buying price of another market.
 Exercise-2
• The following are three quotes in three
forex markets
1$=Rs.48.3011 in Mumboi
1pound=Rs.77.1125 in London
1Pound=$1.6231 in Newyork.
Are there any arbitrage gains possible?
Assume there are no transaction costs
and the arbitrageaur has $1,000,000.
 Answer-2
• The cross rate between Mumboi and London
with respect to$/pound=77.1125/48.3011
• =$1.5965/pound
• But in newyork the price is quoted $1.6231
• There is an opportunity to earn by buing indian
rupee in in Mumboi market and convert them
into pounds in London Market
• Then convert pounds into dollors in NewYork
market.
 Answer-2 continues
• Rs.48.3011X 1 million
dollor=Rs.48,301,100
• Pounds=48,301,100/77.1125=626,371.85
92
• Dollors=626,371.8592X1.6231
=$1,016,664.164.
The gain=$16,664.164.
Exercise-3: arbitrage in forward
market
• Determine arbitrage gain from the
following data:
• Spot rate Rs.78.10/pound
• 3 month forward rate Rs.78.60/pound
• 3 month interest rates:
Rupees: 5%; British pound :9%
Assume Rs10 million borrowings or pound
200,000 as the case may be.
 Answer-3
• Since forward rate is higher than the spot
rate pound is at a premium.
• Percentage premium = (78.60-
78.10)X12X100/(78.10X3)=2.56%
• Interest rate differential =9%-5%=4%
• This helps to borrow from Indian market
and invest today in pounds in the spot
market
 Method -2
• 1.Borrow in Uk and invest such pounds
after converting them into rupees in India
• 2.After three months re convert the rupees
including the interest into pounds at forward
rate
• 3.Deduct the loan including interest from
step –2
• If step-2 is more than step-3 there is a gain.
 Exercise-4
• Spot rate=78.10; interest rates India-5%;
interest rate in UK-9% (pounds); At what
forward rate the arbitrage is not possible?
 Answer-4
• Spot rate =78.10
• Add: 4% premium for three month
period(78.10 X 4/100) X3/12=0.781
• Forward rate= 78.10-0.781=77.319
• What is the principle used?
 Principle
• The arbitrageur earns 4% extra interest to
pay 4% forward premium yielding him no
gain.
 Exercise-5
• Spot rate-78.10; forward rate for three
months-Rs.77.50; rate of interest for
pounds-6% for three months.Rate of
interest in India-5%. Is there any
arbitrage ?
 Answer-5
• The British pound is at a forward discount of
3.073% ie.(78.10-77.50)x 100/78.10x (12/3)100
• Interest rate differential is 6%-5%=1%
• There are arbitrage gain possibilities.
• Borrow in UK 2,00,000 pounds at 6% and
convert them into Indian currency and invest
them in India at rate of 5%
• The total amount is converted into pounds at
the forward rate
• Net gain =1067.7419 pounds.
 Exercise-6
• A Ltd is planning to import a multipurpose machine
from Japan at a cost of 3400 lakh Yen.The company
can borrow at the rate of 18% per annum with
quarterly rests.However there is an offer from Tokyo
bran of Indian Bank extending credit of 180 days at
2% per annum against the opening of an irrevocable
letter of credit. Other information is as follows:
• Spot rate for Rs.100=340 yen; 180 days forward rate
for Rs.100=345 yen; commission charges for letters
of credit are at 2% for 12 months.
• Advise the company which mode of purchase is
better?
 Answer-6
• Borrowing 3400 lakhs yen
• Borrowing in Indian rupee=Rs.1000 lakhs
• Interest for the first 3 months= 45
• Interest for the second quarter=47.025
• Total cash outflow at the end of 6 months equals
to Rs.1092.025 lakhs.
• If letter of credit is followed:
Borrowings 3400 lakhs yen
Interest for 6 months 34 yen
Commission charges 3400 x .02 x6/12=34
 Answer-6 continues
• Total payments =3468 lakhs yen
• Conversion into indian rupees=1005.217
• Conclusion:- Avail overseas offer
 Exercise-7
• Spot Rs.48/$ ;6 month interest rate: India-
7.5%Per annum; US interest rate-2% per
annum.what forward rate will no arbitrage
gain be possible?
 Answer-7
• Difference in rate-7.5%- 2%=5.5%p.a.
• Spot rate $48
• Add: 5.5% premium for three months
(48x (5.5/100) x 3/12) =0.66
Forward rate = 48.66/$
 Exercise-8
• Spot rate- Rs.48.5/$ ; 6 month forward
rate-Rs.48.90/$ ; Annualised interest on
US 6 month treasury bill –2.5%;
annualised interest on Indian 6-month
treasury bill-6.0%; what are the
transactions the trader will execute to
receive arbitrage gain?
 Answer-8
• Interest rate differential=6%-2.5%=3.5%pa
• Premium of forward rate=(48.90-
48.5)/48.5x100 x(12/6)=1.65%
• Since interest diferential is more than
premium forward arbitrage gain is
possible.
 Exercise-9
• Calculate cross currency rate between
Euro/pound(bid as well as ask)
Rs/Us $ Rs 48.35-48.90
Rs/Euro Rs.51.90-52.30
$/ Pound $ 1.49-1.50
 Answer-9
• Euro/Pound(bid)=Rs/Us $ x $/Pound x
Euro/Rs=48.35 x1.49 x 1/51.90
• Euro/Pound(ask)=48.90 x 1.50 x1/52.30
 Exercise-10
• You are required to fill in the missing
figures and complete the table
US Poun Cana Yen Euro
dolla d dian
r
1USD 1.0 o.616 1.525 ------ 0.928
1 - 1 9 - 7
pound - 1.0 - - -
1Cana - - 1.0 1.0 -
di - - - - -
 Answer-10

US Poun Canadi Yen Euro

dollar d an
1USD 1.0 o.616 1.5259 118.08 0.9287
1 pound 1.623 1 2.4767 191.655 1.5074
1Canadi 0.655 1.0 1.0 77.3838 0.6086
1 Yen 30.00 .4037 0.0129 1.0 0.0078
1 Euro 85 .0052 1.6430 127.145 1.0
1.076 .6634
 Exercise-11
• The following quotations are available to
you:
by a bank in New York $ 1.6012/Pound
By a bank in Paris FFr4.9800/$
By a a bank in London Pound 0.1350/FFr
Is any triangular arbitrage possible?
 Answer-11
• From a direct quote of New York and
Paris, the cross rate for Pound/FFr is
Pound/FFr= Pound/$ x $/FFr= 1/1.6012
x1/4.9800
• Or Pound/FFr =0.1254
• Since in the direct quote the FFr in London
is pound 0.1350/FFr(different from
0.1254), triangular arbitrage is possible.
 Answer-11
• 1/1.6012 x 1/ 4.9800=0.1254=Pound/FFr
• Since in the direct quote the FFr in London
is 0.1350/FFr different from 0.1254,
triangular arbitrage is possible.
• Borrow in the country where the rate of
interest is low and invest in the country
where interest rate is high.
 Exercise-12
• On 1st April 3 months interest rate in the
US $ and Germany are 6.5% and 4.5%
per annum respectively.The USD/DM spot
rate is 0.6560. What would be the forward
rate for DM, for delivery on 30th June?
 Answer-12
• Spot rate is US $ 0.6560/DM
• Interest rate parity relationship
S0=[1+imA]/[1+inB
• S0= Spot rate; S1= Future exchange rate
• inA=Nominal interest in country A(USA)
• inB= Nominal interest in country
B(Germany)
• S1=0.6560{1+(0.065 x3/12)/1 +(0.045 x 3/12)}
= 0.6560 x (1.01625/1.01125) = USD 0.6592
$/DM
 Exercise-13
• Spot rate 47.88/$
• 3 month forward rate 48.28/$
• 3 month interest rates Re.7%
$ 11%
Is there any arbitrage gain?
 Answer-13
3 month forward rate of dollar is higher than spot rate
implies that the dollar is at premium.

• Premium(percentage)= (48.28-47.88) /
47.88x(12/3) x 100=3.34% per annum.
• Interest rate differential=11%-7%=4%
• Since interest rate differential is more than
premium percentage there are arbitrage
gain possible.
 Exercise-14
• On 1st April, 3 months interest rate in the
US and Germany are 4.5% and 6.5 % per
annum respectively. The $/DM spot rate is
0.6560. What would be the forward rate for
DM for delivery on 30th June?
• S1=0.6560{1+(0.045 x3/12)/1 +(0.065 x
3/12)}
= 0.6560 x ( 1.01125/1.01625)
= USD 0.652772 $/DM
 Exercise-15
• In International Monetary Market an
international forward bid for December, 15
on pound sterling is $ 1.2816 at the same
time that the price of IMM sterling future
for delivery on December,15 is $1.2806.
The contract size of pound sterling is
62,500. How could the dealer use
arbitrage in profit from this situation and
how much profit is earned?
 Exercise-16
• ABC Co. have taken 6-month loan from their foreign
collaborators for US Dollars 2 millions. Interest payable
on maturity is at LIBOR plus 1.0%. 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 forwardRs.48.4575
1.What would be their total commitment in rupees, if they
enter into a forward contract?
2. Will you advise them to do so? Explain giving reasons.
 Exercise-17
• The United States Dollar is selling in India at
Rs.45.50. If the interest rate for 6 month
borrowing in India is 8% per annum and the
corresponding rate in USA is 2%.
1.Do you expect US dollar to be at premium or at
discount in the Indian forward market?
2.What is expected 6 month forward rate for United
States Dollar in India?
3. What is the rate of forward premium or discount?
 Answer
• Borrow in US at 2% and invest in India
• Differential interest rate =8%-2%=6%
• Since US interest rate is low dollar is at
premium.
• Forward rate=45.50(1+[.04
x6/12)]=Rs.46.41
 Exercise-18
• A company operation 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 today’s spot rate, it is
equivalent to $30 lakhs. It is anticipated that the
exchange will decline by 10% over 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 be hedged by a forward contract.
 Exercise-19
• The following table shows interest rates for
the United States dollar and French
francs. The spot exchange rate is 7.05
franks per dollar. Complete the missing
entries:
3 months 6 months 1 year

Dollar interest rate

(annually compounded
11 ½% 12 ¼% ?
Frank interest rate 19 ½% ? 20%
(annually compounded)
Forward franc per dollar ? ? 7.5200
Forward discount on franc
per cent per year ? 6.3% ?
 Exercise-20
• In march 2008, the multinational Industries makes the
following assessment of dollar rates per British pound to
prevail as on 1.9.08.
1) What is the expected spot rate for 1.9.2008?
2) If , as of March,2003, the 6 month forward rate is $1.80,
should the firm sell forward its pound receivables due in
$/pound Probability
September, 2008?
1.6 0.15
1.7 0.20
1.8 0.25
1.9 0.20
2.0 0.20
 Exercise-21
• X Ltd. an Indian company has an export exposure of 10 million(100 lacs)
Yen, value September end. Yen is not directly quoted against Rupee.
The current spot rates are-USD/INR=41.79 and USD/JPY=129.75.
• It is estimated that Yen will depreciate to 144 level and rupee to
depreciate against dollar to 43
• Forward rate for September, 2008 USD/Yen =137.35 and
USD/INR=42.89.
You are required
i) To calculate the expected loss if hedging is not done. How the position
will change with company taking forward cover?
ii) If the spot rate on 30th September, 1998 was eventually
USD/Yen=137.85 and USD/INR=42.78, is the decision to take forward
cover justified?
 Exercise-22
• A company operating in a country having the 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
today 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
month 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.
 Exercise-23
• Shoe Company sells to a wholesaler in Germany. The purchases price of
a shipment is 50,000 deutsche marks with term of 90 days. Upon
payment, Shoe Company will convert the DM to dollars. The present spot
rate for DM per dollar is 1.71, whereas the 90-day forward rate is 1.70.
• You are required to calculate and explain:
1) If Shoe Company were to hedge its foreign –exchange risk, what would it
do? What transactions are necessary?
2) Is the deutsche mark at a forward premium or at a forward discont?
3) What is implied differential in interest rates between the two countries?
(Use interest rate parity assumption)
 Answer-23
• Spot rate DM/US $ =1.71
• If company receive payment then
• 50,000 x 1.71=
 Exercise-24
• A 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 this date, the rates prevailing are:
• Spot CHF 1=27.30 27.35
• One month forward Rs.27.45 27.52
• What is the loss/gain to the customer on
cancellation?
• (loss to the customer $2700 due to exchange
difference)