Question Paper

International Finance Trade – I (221) : July 2004

Section A : Basic Concepts (30 Marks)
• • This section consists of questions with serial number 1 - 30.
• • Answer all questions.
• • Each question carries one mark.
• • Maximum time for answering Section A is 30 Minutes.
< Answer
1. A quote is called as European quote, if the exchange rate is expressed >

(a) In terms of US dollars per unit of any other currency

(b) In terms of number of units of any other currency per unit of US dollar
(c) In terms of number of units of any other currency per unit of British pound
(d) In terms of number of units of any other currency per unit of any other currency excluding US
dollar
(e) Both (a) and (c) above.
< Answer
2. Short-term portfolio investments are recorded in which of the following accounts of Balance Of >
Payments (BOP) statement?
(a) Investment income (b) Unilateral transfers
(c) Current account (d) Capital account
(e) Official reserves account.
< Answer
3. In which of the following cases of international commercial terms, the seller has to make payment of >
freight charges for transportation of goods to buyer
(a) Free Alongside Ship (b) Free on Board
(c) Free Carrier (d) Ex-works (e) Delivered Ex-Ship.
< Answer
4. Where the goods are to be carried by two or more ships or partly by ship and partly by rail, the bill of >
lading providing for the continuous responsibility of all the carriers is called a
(a) Liner bill of lading (b) Third party bill of lading
(c) Through bill of lading (d) House bill of lading
(e) Charter party bill of lading.
< Answer
5. According to UCPDC if the expiry date of the documentary credit for presentation of documents falls >
on a day on which the bank to which presentation has to be made is closed for riots and civil
commotion, then the expiry date stands
(a) Extended to the first following day
(b) Unchanged
(c) Extended to the first two days of the following day of riots and civil commotion
(d) Extended to the first three days of the following day of riots and civil commotion
(e) Extended to the first five days of the following day of riots and civil commotion.
< Answer
6. Which of the following is an example of commercial documents as per Uniform Rules for Collection >

(a) Cheque (b) Bill of exchange

(c) Promissory note (d) Documents of title
(e) All of the above.
< Answer
7. The rights of authors of literary and artistic works are protected by Copy right and Related Rights under >
the agreement on trade related aspects of intellectual property rights (TRIPs) of WTO for a minimum
period of ––––––––– after the death of the author
(a) 10 years (b) 20 years (c) 30 years (d) 40 years (e) 50 years.
< Answer
8. Items which are freely importable and do not require import licenses fall under the category of >

(a) Regular licenses (b) Advance licenses

(c) Special import licenses (d) Open general licenses
(e) Canalized items.
 < Answer
9. A transaction whereby two currencies are exchanged by the parties involved, only to be exchanged back >
later is termed as
(a) Forward contract (b) Option contract
(c) Currency swap (d) Futures contract
(e) Outright forward contract.
< Answer
10. State Bank of India is having an account with Citi Bank Newyork. When ICICI Bank refers to this >
account of SBI, while corresponding with Citi Bank Newyork, it would refer to this as
(a) Nostro account (b) Vostro account
(c) Loro account (d) Mirror account
(e) Shadow account.
< Answer
11. Which of the following transactions is/are recorded as debit(s) in the current account of the Balance of >
Payments statement
(a) Export of goods (b) Export of services
(c) Gifts to foreigners (d) Gifts from foreigners
(e) Both (c) and (d) above.
< Answer
12. Under the gold standard, the loss of gold and reduction in the money supply in the deficit country may >
lead to
(a) An increase in its interest rate and a capital inflow
(b) An increase in its interest rate and a capital outflow
(c) A decrease in its interest rate and a capital inflow
(d) A decrease in its interest rate and a capital outflow
(e) None of the above.
< Answer
13. The monetary base of a country is equal to >

(a) The domestic credit created by the Central Bank

(b) The official reserves of the Central Bank
(c) The money supply in the country
(d) Both (a) and (b) above
(e) All (a), (b) and (c) above.
< Answer
14. The Bretton Woods system was a >

(a) Gold standard (b) Gold-exchange standard

(c) Flexible exchange rate system (d) Crawling peg system
(e) Currency Board system.
< Answer
15. Trade in differentiated products is called >

(a) Trade based on economies of scale (b) Inter-Industry trade

(c) Intra-Industry trade (d) Trade based on imitation gaps
(e) Trade based on product cycles.
< Answer
16. Assume that euro-sterling rate is 5% and the eurodollar rate is 3%. According to interest rate parity, >

(a) Forward premium on dollar is 1.94%

(b) Forward premium on dollar is 2.00%
(c) Forward discount on dollar is 1.94%
(d) Forward discount on dollar is 2.00%
(e) Forward premium on dollar is 3.00%.
< Answer
17. The inflation rate in UK is 3% and inflation in Germany is 2%. If the current spot rate of £1 = Euro >
1.4650, what is the expected spot rate of £1 after one year?
(a) Euro 1.4508 (b) Euro 1.4794 (c) Euro 1.4577 (d) Euro 1.4722 (e) Euro
1.4662.
< Answer
18. Which of the following strategies is classified as production strategies to manage the economic >
exposure?
(a) Market selection (b) Plant location
(c) Product strategy (d) Promotional strategy
(e) Pricing strategy.
 < Answer
19. Sridhar approached an authorized dealer (AD) for purchase of draft for £100 to subscribe for a >
magazine. Which of the following rates is applied by the banker to issue the draft?
(a) TT buying rate (b) Bill buying rate
(c) TT selling rate (d) Bill selling rate
(e) Inter bank buying rate.
< Answer
20. Which of the following is not an assumption of Heckscher-Ohlin model? >

(a) There are no obstructions to trade

(b) There are increasing returns to scale
(c) There are two factors of production namely: labor and capital
(d) Both commodity and factor markets are perfectly competitive
(e) Both the countries involved operate at the same level of efficiency.
< Answer
21. Terms of trade for a country are the ratio of ________ to _________ >

(a) Its currency, other currencies

(b) Export prices, import prices
(c) Its opportunity costs, world opportunity costs
(d) Savings, investment
(e) Foreign exchange earnings, foreign currency borrowings.
< Answer
22. Which of the following statements is/are false under the monetary approach model of exchange rate >
forecasting?
(a) An increase in the money supply causes the currency to depreciate
(b) An increase in the real money demand makes the currency to appreciate
(c) An increase in the nominal interest rates causes the currency to appreciate
(d) An increase in the real GNP of a country causes its currency to appreciate
(e) All of the above.
< Answer
23. Which of the following guarantees issued by ECGC protects a bank that added confirmation to a foreign >
LC, against losses arising out of the failure of LC issuing bank?
(a) Export performance guarantee
(b) Transfer guarantee
(c) Export production finance guarantee
(d) Export finance (overseas lending) guarantee
(e) Export finance guarantee.
< Answer
24. A dealer has taken long position in Euro against dollar when the market rates for $/Euro are 1.2145/47. >
Later the rates moved to 1.2148/49. If the dealer liquidates his long position, it results into a
(a) Profit of $ 0.0001 per Euro (b) Profit of $ 0.0002 per Euro
(c) Profit of $ 0.0003 per Euro (d) Loss of $ 0.0004 per Euro
(e) Profit of $ 0.0005 per Euro.
< Answer
25. The following are the exchange rates quoted in Singapore >

S$/Euro : 2.0118/21
S$/US$ : 1.7384/86
The synthetic rates of US $/Euro are

(a) 1.1572/73 (b) 1.1571/74 (c) 0.8640/41 (d) 0.8639/42

(e) 3.4977/79.
< Answer
26. An exporter requested his banker to quote a rate for his receivable of $ 100,000. The banker agrees to >
quote the rate relying on the inter bank rate for dollar that is Rs.44.44/45 by loading a margin of 0.15%
on the rate. The rate quoted by the banker is
(a) Rs.44.51 (b) Rs.44.52 (c) Rs.44.37 (d) Rs.44.40 (e) Rs.44.44.
< Answer
27. According to UCPDC, the issuing bank the confirming bank or a nominated bank acting on their behalf >
shall each have reasonable time for examination of documents under L/C, which shall not exceed
(a) One day (b) Two days (c) Five days (d) Seven days (e) Ten days.
< Answer
28. The settlement date for a spot transaction done on June 25, 2004, a Friday, is >
 (a) June 25, 2004 (b) June 26, 2004 (c) June 27, 2004(d) June 28, 2004 (e) June 29,
2004.
< Answer
29. On 21 June 2004 the 1 month forward rates for $ are Rs./$ 44.64/68 and the 1 month annualized >
forward premium is 2% then the spot rates as on 21 June 2004 are (Assume that the bid-offer spread is
maintained at the same level)
(a) Rs./$ 43.76/80 (b) Rs./$ 44.57/61
(c) Rs./$ 44.75/79 (d) Rs./$ 44.85/89
(e) Rs./$ 43.72/76.
< Answer
30. Which of the following is true under a currency board system? >
(a) The interest rates are automatically set by the market mechanism
(b) When there is a higher demand for the anchor currency, the reserves with the currency board gets
enhanced
(c) Lending to either the government or the domestic banks by the currency board is allowed
(d) The board can act as the lender of the last resort
(e) Exchange rates are unstable.

END OF SECTION A
 Section B : Problems (50 Marks)
• This section consists of questions with serial number 1 – 6.
• Answer all questions.
• Marks are indicated against each question.
• Detailed workings should form part of your answer.
• Do not spend more than 110 - 120 minutes on Section B.

1. Vandana International exported ready-made garments to Switzerland under an irrevocable letter of credit and
negotiated at sight bill for CHF 200000 with his banker on Jan 01, 2004. Exchange rates in the inter-bank market
of Mumbai and Singapore are quoted as under on
January 01, 2004.
Mumbai : Rs. / $ Spot 45.84 / 85
1 month forward 10 / 9 paise
2 month forward 18 / 17 paise
3 months forward 26 / 25 paise
Singapore : CHF / $ Spot 1.2800 / 05
1 month forward 0.0030 / 0.0035
2 month forward 0.0060 / 0.0065
3 months forward 0.0080 / 0.0085
As there were some discrepancies in the documents, the bill remained unpaid till February 19, 2004. The foreign
currency amount was reversed from the export bills purchased portfolio on the 30 th day from the due date that was
on February 19, 2004 by the exporter’s bank as per FEDAI rules. The following exchange rates prevailed in the
market on February 19, 2004.
Mumbai: Rs. / $ Spot 45.45 / 46
1 month forward 4/5 paise
Singapore: CHF/$ Spot 1.2750/55
1 month forward 0.0020 / 0.0025
Note: Transit period is 20 days
Exchange margin required is 0.10% for buying as well as selling rates
The exporter pays interest on post shipment credit at 8% pa
The exporter pays interest on overdue export credit at 12% pa
Exchange rate is to be rounded off to the four decimal places.
You are required to compute
a. The exchange rate quoted to the exporter.
b. The interest amount recovered from the exporter.
c. The overdue interest amount recovered from the exporter.
d. The amount outstanding in the books of accounts of the exporters bank.
(4 + 1 + 1 + 4 = 10 marks) < Answer >
2. An oil exploration company in New Zealand proposes to invest its surplus funds of
NZ$3 million for three months. The treasury manager has collected the following information from his banker to
invest in currencies other than that of home currency to earn more interest on the funds without exposing the
investment to exchange risk by covering the amounts under forward rates.
Spot NZ $/$ 1.5522/24
 Euro/£ 1.4650/52
$/£ 1.7960/62
3 months forward NZ $/$ 1.5663/65
Euro/£ 1.4570/72
$/£ 1.7885/87
3 month interest rates (P.a.)
NZ $: 3.2% – 3.6%
$ : 2.4% – 2.8%
Euro : 3.0% – 3.4%
£ : 2.8% – 3.2%
You are required to determine the currency in which the company should invest to have more returns.
(10 marks) < Answer >
3. The following quotes are available for euro, dollar and pound:
Euro / $ spot 0.8160 / 61
£/$ spot 0.5566 / 67
The 3 month interest rates (pa) are as follows:
Euro 3.2% – 3.6%
£ 3.6% – 4.00%
You are required to calculate the 3 month limits for Euro/£ forward rates to prevent arbitrage.
(8 marks) < Answer >
4. An industrial Unit in Mumbai exports diesel engines to Hongkong at a price of US$200 per unit. The company
imports components for the diesel engine from Singapore and the cost of components for each diesel engine is S $
250. The company executed an order for the supply 2000 units on January 01, 2004. The company’s variable
costs per unit are Rs.1500 and the allocable fixed costs of the company are Rs.15,00,000. The exchange rates as
on 01.01.04 are as follows.
Spot Rs./$ 45.90 / 91
Rs./S$ 25.49/50
The treasury manager who is observing the movement of exchange rates on a day today basis, has estimated that
the rupee would appreciate against USdollar and depreciate against Singapore dollar. He has estimated the
following rates for March 31, 2004.
Spot Rs./$ 44.80/81
Rs./S$ 26.35/36
You are required to find out (a) the change in profitability at the revised exchange rates for the supply of 2000
units, (b) by how much % in units should the company increase its sales so as to maintain the current profit level
for the proposed shipment in the last week of March, 04.
(5 + 3 = 8 marks) < Answer >
5. Continental Banking Corporation can borrow Euro 10 million at 3% annualized. The treasury manager wants to
use the loan amount to invest in dollars at 4% annualized over a fortnight period, considering the following
information:
Euro / $ 0.8158 / 60
Expected rates after a fortnight
Euro / $ 0.8180 / 81
You are required to compute the loss or gain if the treasury manager decides to implement his decision for
covered interest arbitrage. Show your working up to the last unit.
(8 marks) < Answer >
6. An Indian investor purchased securities on the New York stock exchange when the exchange rate was Rs.46.50.
 The exchange at the end of one year was Rs.45.75.
If the percentage returns on American securities is
(a) –20% (b) 50%, compute the net return to the Indian investor
(6 marks) < Answer >

END OF SECTION B

Section C : Applied Theory (20 Marks)

• This section consists of questions with serial number 7 - 8.
• Answer all questions.
• Marks are indicated against each question.
• Do not spend more than 25 -30 minutes on section C.

7. Multinational corporations use various techniques like technical, fundamental, mixed etc. to forecast exchange
rates. Many of the decisions by MNCs are influenced by exchange rate projections made by them. Discuss why
MNCs forecast exchange rates.
(10 marks) < Answer >
8. Quality Lace Products, a new entrant to the export business received a letter of credit for export of lace products to
Australia involving an amount of Rs.100 lacs. The Finance Manager wants to familiarize himself about the rights
and responsibilities of every party associated with an LC. Explain in brief.
(10 marks) < Answer >
END OF SECTION C

END OF QUESTION PAPER

 Suggested Answers
International Finance Trade – I (221) : July 2004
Section A : Basic Concepts
1. Answer : (b) < TOP >

Reason : (a) A quote in terms of U.S. dollars per unit of any other currency is called an American quote.
(b) A quote in terms of number of units of any other currency per U.S. dollar is called an European
quote.
(c) & (d) are examples of currencies quoted in American terms.
2. Answer : (d) < TOP >

Reason : Short-term portfolio investments are recorded in capital account of the Balance of Payments statement.
3. Answer : (e) < TOP >

Reason : In the case of delivered ex-ship contract, the seller has to make payment of freight changes for
transportation of goods to buyer. In all other cases of options a, b, c, and d the buyer has to bean the
freight changes.
4. Answer : (c) < TOP >

Reason : Where the goods are to be carried by two or more ships or partly by ship and partly by rail, the bill of
lading providing for the continuous responsibility of all the carriers is called a through bill of lading.
5. Answer : (b) < TOP >

Reason : According to UCPDC if the expiry date of the documentary credit for presentation of documents falls
on a day on which the bank to which presentation has to be made is closed for riots and civil
commotion, then the expiry date stands unchanged.
6. Answer : (d) < TOP >

Reason : The documents of title is an example of commercial documents as per uniform rules for collection.
7. Answer : (e) < TOP >

Reason : The rights of authors of literary and artistic works are protected by copy right under the agreement on
trade related aspects of intellectual property rights (TRIPs) of WTO for a minimum period of 50 years
after the death of the author.
8. Answer : (d) < TOP >

Reason : Items which are freely importable and do not require import licenses fall under the category of open
general licenses.
9. Answer : (c) < TOP >

Reason : A transaction whereby two currencies are exchanged by the parties involved, only to be exchanged back
later is termed as currency swap.
10. Answer : (c) < TOP >

Reason : State Bank of India is having an account with Citi Bank Newyork. When ICICI Bank refers to this
account of SBI, while corresponding with Citi Bank Newyork, it would refer to this as Loro account.
Loro account means “their account with you”.
11. Answer : (c) < TOP >

Reason : Entries involving gifts to foreigners are recorded as debits in the current account of Balance of Payment
(BOP) statement.
12. Answer : (a) < TOP >

Reason : Under the gold standard, the loss of gold and reduction in the money supply in the deficit country may
lead to an increase in its interest rate and a capital inflow.
13. Answer : (d) < TOP >

Reason : The monetary base of a country is equal to the domestic credit created by the Central Bank and the
official reserves of the Central Bank.

14. Answer : (b) < TOP >

 Reason : The Bretton Woods system was a gold-exchange standard.
15. Answer : (c) < TOP >

Reason : Trade in differentiated products is called Intra-Industry trade.

16. Answer : (a) < TOP >

Reason : According to interest rate parity if ‘P’ is the forward premium on the dollar,
then (1.03) (1+P) = (1.05)
P = 1.94%
17. Answer : (a) < TOP >

1.02
1.4650 x
1.03
Reason : Expected spot rate after one year =
= Euro 1.4508.
18. Answer : (b) < TOP >

Reason : Options in a, c, d and e are marketing strategies for management of economic exposure. Option in b is
the production strategy for management of economic exposure.
19. Answer : (c) < TOP >

Reason : T.T. selling rate is applied by the banker to issue the draft to Sridhar. Option in a, b and e are buying
rates, option (d), that is bill selling rate is applied by the banker for import transactions involving import
of goods.
20. Answer : (b) < TOP >

Reason : Options in a, c, d and e are the assumptions of Heckscher – Ohlin model. Option (b) is not the
assumption of Heckscher – Ohlin model.
21. Answer : (b) < TOP >

Reason : Terms of trade for a country are the ratio of export prices to import prices.
< TOP >
22. Answer : (c)
Reason : Options (a), (b) and (d) are true. It is false that an increase in the nominal interest rates causes the
currency to appreciate. It causes the currency to depreciate.
< TOP >
23. Answer : (b)
Reason : Transfer guarantee issued by ECGC protects a bank that added confirmation to a foreign LC against
losses arising out of the failure of LC issuing bank.
Options in (a), (c), (d) and (e) are not correct.
24. Answer : (a) < TOP >

Reason : The dealer will book profit as his long position is created at 1.2147 and it is liquidated
at 1.2148.
Profit = 1.2148 – 1.2147 = 0.0001 per Euro.
25. Answer : (b) < TOP >

Reason : The synthetic rates of US $/Euro are

(US $/Euro)bid = (US$/S$)bid × (S$/Euro)bid
1
× (S$ / Euro) bid
(S$ / US$)ask
=
1
× 2.0118
1.7386
= = 1.1571.
1
× 2.0121
1.7384
Similarly (US$/Euro)ask = = 1.1574.
US$/Euro = 1.1571/74.
26. Answer : (c) < TOP >

Reason : The banker who considers the bid rate of Rs.44.44, loads a margin of 0.15% on the rate. The margin of
0.15% is deducted from the bid rate.
 44.44
Less: Margin at 0.15% 0.07
Rs.44.37 The rate quoted by the banker is Rs.44.37.
27. Answer : (d) < TOP >

Reason : According to UCPDC, the issuing bank the confirming bank or a nominated bank acting on their behalf
shall each have reasonable time for examination of documents under LIC, which shall not exceed seven
days.
28. Answer : (e) < TOP >

Reason : The settlement date for a spot transaction will be the second working day from the date of the spot
transaction. Since June 05, 2004 is a Friday, the second working day will be June 29, 2004.
29. Answer : (b) < TOP >

Reason : 1 month forward rates : Rs./$ 44.64/68

1 month forward premium = 2%
F( A / B) −S( A / B)
×12 ×100
S( A / B)
Annualized forward premium =
44.64 −Spot (Rs. / $)
×12 ×100
Spot (Rs. / $)
2.00 =
Spot Rs./$ = Rs.44.57
Similarly spot ask rate is Rs.44.61.
30. Answer : (a) < TOP >

Reason : In the currency board system, the board does not have any discretionary powers over the monetary
policy; the interest rates are automatically set by the market mechanism. Options (b), (c), (d) and (e) are
not true.
 Section B : Problems

1. (a) The bank has to quote bill buying rate to the exporter
Dollar is at discount against rupee. Since this is a buying rate, the transit period will be rounded off to the
higher month and one month forward Rs. / $ buying rate is to be taken
Rs. / $ – One month forward buying rate (45.84 – 0.10) : 45.74000
Less exchange margin at 0.10% : 0.04574
––––––––
45.69426
(round off to 45.6943).
––––––––
Dollar is at premium against Swiss Franc. Since this is a selling rate, the transit period will be rounded off to
the higher month and one month forward CHF/$ selling rate is to be taken
CHF / $ Spot selling rate : 1.2805
Add premium for one month : 0.0035
––––––
1.2840
––––––
45.6943
1.2840
Bill buying rate for Rs. / CHF =
= Rs. 35.5874
Rounded off to Rs.35.5875.
(b) Interest amount recovered from the exporter
200000 x 35.5875 x 20 x 8
36500
=
= Rs. 31,200
(c) Overdue interest amount recovered from the exporter
200000 x 35.5875 x 30x 12
36500
=
= Rs.70,200
(d) Export bills remaining unpaid for a period of 30 days after the transit period in case of demand bills (drawn at
sight basis), the foreign currency amount shall be reversed from the export bills purchased portfolio on the
30th day. In case, 30th happens to be a holiday or Saturday, it shall be reversed/crystallized on the next
working day. The rate applicable to such reversal shall be the ready TT selling rate. In the given problem, the
bill amount in foreign currency is crystallized into rupees by computing the TT selling rate of February 19,
2004 and exchange margin of 0.1% is to be added (as required in the problem).
1
(CHF / $)bid
Rs/CHF selling rate = (Rs/$) ask ×
1
1.2750
= 45.46 ×
= 35.6549
Add exchange margin at 0.1% = 0.03565
On 35.6549 –––––––
35.69055 (round off to 35.6906)
Amount paid to the exporter at 35.5875 (200000 × 35.5875) = 7117500
Add the difference in rates (35.6906 – 35.5875) = 20620
 ––––––––
Amount out standing in the books of accounts 7138120
of the exporter’s bank ––––––––

< TOP >

2. The company can invest in home currency (NZ $) at 3.2%, US $ at 2.4%, £ at 2.8% and Euro at 3.0% for 3
months.
 1 + 0.032 
 
 4 
I. Investment in NZ $ 3000000 × = 3024000
Return after 3 months = 3024000 – 3000000
= NZ$24000
II. Investment in US $
Surplus of NZ$3 million is to be converted into US dollars and is invested in US dollars at 2.4%. The amount
in US $ is coverted into NZ $ by covering at 3 month forward rate.
NZ $ 3000000 converted into US$ at the NZ $/$
3000000
1.5524
Spot selling rate =
Amount received in US$ = 1932491.63
Says $1932492
 1 + 0.024 
 
 4 
Invest at 2.4% for 3 months = 1932492 ×
= $1944086.95
Says $1944087
Convert into NZ$ at 3 months forward buying rate of 1.5663
= 1944087 × 1.5663
= $3045023.47 says $3045023
Return after 3 months = 3045023 – 3000000 = NZ $45023
III. Investment in £
NZ $/£ spot bid rate = 1.5522 × 1.7960 = 2.7878
NZ $/£ spot ask rate = 1.5524 × 1.7962 = 2.7884
NZ $/£ 3 months forward bid rate = 1.5663 × 1.7885 = 2.8013
NZ $/£ 3 months forward ask rate = 1.5665 × 1.7887 = 2.8020
Surplus of NZ $ 3 million is to be converted into pounds and the amount is invested at 2.8% for 3 months by
covering at 3 month forward rate. NZ$3000000 converted into pounds at NZ$/£ spot selling rate
3000000
2.7884
=
Amount received in pounds = 1075885.81 says £1075886
 1 + 0.028 
 
 4 
Invest at 2.8% for 3 months = 1075886 ×
= £1083417.20 says £1083417
Convert into NZ$ at 3 months forward buying rate of 2.8013
= 1083417 × 2.8013
= 3034976.04 says NZ$ 3034976
Return after 3 months = 3034976 – 3000000 = NZ$ 34976
 IV. Investment in Euro
NZ$ / Euro spot bid rate = 1.5522 × 1.7960 × = 1.9026
NZ$ / Euro spot ask rate = 1.5524 × 1.7962 × = 1.9034
NZ$ / Euro 3 months forward bid rate = 1.5663 × 1.7885 × = 1.9224
NZ$ / Euro 3 months forward ask rate = 1.5665 × 1.7887 × = 1.9231
Surplus of NZ$ 3 million is to be converted into Euro and the amount is invested in Euro at 3% for 3 months
by covering at 3 months forward rate.
NZ$ 3000000 converted into euro at NZ$ / Euro spot selling rate =
Amount received in Euro = 1576126.93 say 1576127
 1 + 0.03 
 
 4 
Invest at 3% for 3 months = 1576127 ×
= 1587947.95 says 1587948
Convert into NZ$ at 3 months forward buying rate of 1.9224
= 1587948 × 1.9224
= 3052671.24 says NZ$ 3052671
Return after 3 months = 3052671 – 3000000
= NZ$ 52671
The company should invest in Euro, since the return in investment is more when compared to the others.
< TOP >
3. We have to work out the Euro / £ cross rates
( $ / £ ) bid
(Euro / £)bid = (Euro / $)bid ×
1
( £/$ ) ask
= (Euro / $)bid ×
1
0.5567
= 0.8160 × = 1.4658
(Euro / £)ask = (Euro / $)ask × ($ / £)ask
1
( £ / $ ) bid
= (Euro / $)ask ×
1
0.5566
= 0.8161 ×
= 1.4662
From the above spot rates the 6 month forward quotes using interest parity are calculatesd.
Suppose, the bank borrows Euro 100
 1 + 0.036 
 
 4 
After 3 months, it will have to repay = 100 × = Euro 100.90
Euro 100 is converted into pounds and invested in pounds at 3.6%
100 / 1.4662 = £68.2035
 1 + 0.036 
 
 4 
With interest after 3 months = 68.2035 × = £68.8173
Converting the pounds into Euro at Fb = 68.8173 × Fb
To avoid arbitrage 68.8173 × Fb ≤ Euro 100.90
So Fb ≤ 1.4662
Assume the bank borrows pounds 100
  1 + 0.04 
 
 4 
After 3 months it has to pay 100 × = £101
If we convet £100 into euro and invest euro at 3.2%, then after 3 months, the inflow of euro
 1 + 0.032 
 
 4 
= 100 × 1.4658 × = Euro 147.7526
If Fa is the forward ask rate, to avoid arbitrage
£101 ≥ 147.7526 / Fa
or Fa ≥ 1.4629
Thus Fb ≤ 1.4662 and Fa ≥ 1.4629
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4. The company’s existing profits can be calculated as follows :

Sales : 2000 × 200 × 45.90 = 18,360,000

Less variable costs 2000 × 250 × 25.50 = 12,750,000

2000 × 1500 = 3,000,000

Fixed Costs = 1,500,000 17,250,000

Profit 11,10,000
After the rupee appreciation
against US dollar and depreciation against Singapore dollar, the Company’s profitability for 2000 units will be

Sales : 2000 x 200 x 44.80 17,920,000

Less variable costs 2000x250x26.36 = 13,180,000

2000 x 1500 = 3,000,000

Fixed Costs = 1,500,000 17,680,000

Profit 240,000
Decrease in profit = 11,10,000 – 2,40,000 = 8,70,000
Let the number of units that need to be sold for keeping the profits at pre appreciation level be ‘X’.
Then 11,10,000 = [200 × 44.80 × X] – [(1500 × X)] + (250 × 26.36 × X) + 1500,000]
11,10,000 = 8960 X – 8090 X –1500000
X = 26,10,000 / 870 = 3000 units
The company should increase by 50% of the existing supply of 2000 units to maintain the current profit level of
Rs. 11,10,000.
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5. If the treasury manager borrows euro 10 million, amount to the period after a fortnight with interest at 3% Pa.
0.03
1+
24
= 10000000 × = 12275326.8
= Euro 10012500
Convert euro 10 million into dollars at Euro 0.8160 / $ and invest at 4% pa for a fortnight
10000000 
x 1 +
0.04 

0.8160  24 
Inflow of dollars with interest =
= 12275326.8 says $ 12275327
Convert US $ into euro at 12275327 × 0.8180
 = Euro 10041217.49 say Euro 10041217
Repay the loan with interest
Gain = 10041217 – 10012500
= Euro 28717
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6. To invest $100, the Indian investor needs 4650. The net return can be worked out for each case separately.

(1.0 − 0.20) (45.75) − 46.50

46.50
(a) Net return = = – 21.29%

(1.0 + 0.50) (45.75) − 46.50

46.50
(b) Net return = = 47.58%
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Section C: Applied Theory

7. Virtually every operation of an MNC can be influenced by changes in exchange rates. Several corporate functions
for which exchange rate forecasts are necessary follow:
1. Hedging decision: MNCs are constantly confronted with the decision of whether to hedge future payables
and receivables in foreign currencies. Whether a firm hedges may be determined by its forecasts of foreign
currency values. As a simple example, consider an Indian firm that plans to pay for imports from Mexico in
90 days. If the forecasted value of the peso in 90 days is sufficiently below the 90-day forward rate, the MNC
may decide not to hedge.
2. Short-term financing decision: When large corporations borrow, they have access to several different
currencies. The currency they borrow will ideally (1) exhibit a low interest rate and (2) weaken in value over
the financing period. If, for example, a U.S. firm borrowed Japanese yen, and the yen depreciated against the
U.S. dollar over the financing period, the firm could pay back the loan with fewer dollars (when converting
those dollars in exchange for the amount owed in yen). This financing decision should therefore, be
influenced by exchange rate forecasts of any currencies available for financing.
3. Short-term investment decision:. Corporations sometimes have a substantial amount of excess cash available
for a short time period. Large deposits can be established in several currencies. The ideal currency for
deposits would (1) exhibit a high interest rate and (2) strengthen in value over the investment period.
Consider, for example, a Japanese corporation that has excess cash deposited into a British bank account, and
assume the British pound has appreciated against the yen by the end of the deposit period. As the British
pound are withdrawn and exchanged for yen, more yens will be received, due to the pound’s appreciation
against the yen. Exchange rate forecasts of the currencies denominating available deposit accounts should
therefore be considered when determining where to invest the short-term cash.
4. Capital budgeting decision: When an MNC attempts to determine whether to establish a subsidiary in a given
country, a capital budgeting analysis is conducted. Forecasts of the future cash flows used within the capital
budgeting process will be dependent on future currency values. Accurate forecasts of currency values will
improve the estimates of the cash flows and therefore enhance the MNC’s decision-making abilities.
5. Long-term financing decision: Corporations that issue bonds to secure long-term funds may consider
denominating the bonds in foreign currencies. As with short-term financing, corporations would prefer the
currency borrowed (denominating the debt) to depreciate over time against the currency they are receiving
from sale. To estimate the cost of issuing bonds denominated in a foreign currency, forecasts of exchange
rates are required.
6. Earnings assessment: When earnings of an MNC are reported, subsidiary earnings are consolidated and
translated into the currency representing the parent firm’s home country. Forecasts of exchange rates play an
important role in the overall forecast of an MNCs consolidated earnings.
 < TOP >

8. The rights and responsibilities of every party associated with an LC have been defined in the UCPDC 500. It is
necessary that every party dealing with an LC keep himself informed about these responsibilities. These rights are
briefly discussed below.
• All parties dealing with an LC are dealing only with documents and not with goods/services, or performances
to which the documents may relate.
• Exporter/Beneficiary of LC has a right to receive payment against submission of prescribed documents under
the LC. It is the exporter’s duty to ship the goods as per the LC and submit the documents within the
stipulated time for negotiation.
• Negotiating bank: Once documents under the LC are submitted, the negotiating bank has to ascertain that
they appear on their face to be in accordance with the terms and conditions of the credit and if found
agreeable should effect payment as per the LC terms and dispatch documents to the opening bank as
instructed. Once the amount under the LC is paid to the beneficiary, the negotiating bank is entitled to get
reimbursement from the opening bank for the payment, provided documents are in conformity with LC
terms.
• Opening bank: Once documents under the LC are received from the negotiating bank, it should scrutinize
them, within 7 days from the date of receipt. If it finds any discrepancy in the documents, it must convey the
same to the negotiating bank through the fastest means available advising that it is holding documents in
want of disposal instructions.
• Advising bank: Once LC opening instructions are received from the opening bank, the advising bank should,
if it so desires to act as advising bank, verify the veracity of the LC and advise the beneficiary about the LC
and its terms. It is entitled to receive advising charges for having advised the LC from the LC opening bank.
• Confirming bank: If, at the request of the issuing bank, the advising bank chooses to add its conformity to the
LC, it is taking upon itself, the responsibility of paying the beneficiary against presentation of stipulated
documents. Upon payment, it is entitled to receive, reimbursement from the issuing bank. It is also entitled to
receive confirmation charges.
• Applicant to the LC: The importer is responsible for making payment under the LC, against release of
stipulated documents, to the opening bank.
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