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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
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
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
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
1+ Iq
1+ Ib
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
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:
1.004
1.027
1+ Iq
1+ Ib
= 111.4469
1.004
1.027
= 108.9510
1.004
1.027
= 106.5110
Class example: 16
Spot rate = / $: 0.9450/0.9470
3 months swap points = 80 / 70
6 months swap points = 120 /110
Calculate 3 months and 6 months forward rates.
SOLUTION:
(a) Calculation of 3 months forward rate:
Spot rate
Less: 3 months swap points
3 months forward rate
Bid
0.9450
0.0080
0.9370
Ask
0.9470
0.0070
0.9400
Bid
0.9450
0.0120
0.9330
Ask
0.9470
0.0110
0.9360
Class example: 17
Spot rate: `/$ = 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
SOLUTION:
Nov. 04: 1 $ = 0.0913 Peso
Dec. 04: 1 $ = 0.1086 peso
Quote is: peso / $
Hence for peso:
0.09130.1086
0.1086
0.0173
0.1086
X 100
X 100
X 100 = - 15.93 %
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 %
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: 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
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.
1,00,000
0.52
52,000 $
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
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
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
4,40,30,000
7,10,400
4,47,40,400
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.
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
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
5,90,000
1.9510
11,51,090 $
5,90,000
16
1+ x 4
12
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
6
100
6
12
16,48,000
1.56
= $ 10,56,410.256
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
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
1
2
4
5.375
CHF
0
1
3
1
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
= 40 x
1.04
1.025
1 $ = `40
1 $ = `40.50
8%
5%
1+ Rate of quotecurrency
Rate of base currency
= 40.59
8
100
6
12
4,16,000
40.50
= $ 10,271.605
5
100
6
12
1.02
1.0145
= 1.5081
15,00,000
= 10,00,000
1.50
5.80
100
3
x 12
8
100
3
12
(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
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
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
FRSR
x 100 x
SR
365
n
45.2045.60
365
x 100 x 60
45.60
= 5.336 %
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
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
Bid
43.25
0.35
42.90
Ask
43.55
0.25
43.30
43,55,000
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
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:
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
spot rate
48.9325 / 48.9650
Due date
30th April
st
1 Jan.
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
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
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
20,32,50,000
40.65
= 50,00,000 $
13
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
FC. Receivables
1,97,000 $
FC payables:
= = 1,92,665 $
3M
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
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
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
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
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
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
9.50
9.50
L
L+2
2
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
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
8.20
1.20
0.60
0.60
0.40
0.20
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
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
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
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
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
Celina Ltd.
8.60
(0.0)
8.30
Priyanka Ltd.
5.50
(0.30)
5.20
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?
(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
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]