FOREX REVISION

MAY - 2023

03 – FOREIGN EXCHANGE EXPOSURE

AND RISK MANAGEMENT

Foreign Exchange Risk Management

(1) Basics
(2) Spot Market Arbitrage
(3) Forward Contract
(4) Cover Deal
(5) Exchange Rate Determination
(6) Currency Exposure
(7) Cancellation of Forward Contract
(8) Foreign Currency A/C
(9) Currency of Borrowing
(10) Currency of Investment
(11) International Cash Management
(12) Currency Swap
(13) Economic Exposure
(14) Residual

(1) Basics

1. Exchange Rate
Exchange rate means price of one country’s currency is expressed in another country’s
currency.
$1 = ₹60
£1 = ₹82.50
€1 = ₹70.25

Direct Quote
Direct quote means one unit of foreign currency is worth how many units of home currency.
₹/$ = 70.25
₹/€ = 83.50
₹/£ = 92.75
USD/INR = 70.50

Indirect Quote
Indirect quote means one unit of home currency is worth how many units of foreign
currency.

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$/₹ = 0.0143
€/₹ = 0.0119
£/₹ = 0.0108
INR/USD = 0.0138

2. Conversion of Currency

Example – 01
₹/$ = 70.50
$ 100000 =₹?

Solution:

$ 1,00,000 × 70.50 = ₹ 70,50,000

Example – 03
$/£ = 1.5235
$ 40000 =£?

Solution:

$ 40,000
= £ 26255.33
1.5235

Example – 06
INR/GBP = 94.75
£ 40000 =₹?

Solution:

£ 40000 × 94.75 = ₹ 37,90,000.

3. Bid – Ask Rates

Foreign exchange is over the counter (OTC) market & regulated by RBI. RBI has appointed a
foreign exchange dealer to buy & sell currency. A dealer quote Bid & Ask rates for a currency
pair.
Suppose SBI Quotes
₹/$ = 70.25/70.75
It means
 SBI is ready to buy $ at ₹ 70.25 & it is called Bid rate.
 SBI is ready to sell $ at ₹ 70.75 & it is called Ask rate.
Difference between Ask rate & Bid rate is called Bid Ask spread i.e.
(70.75 – 70.25) = ₹0.50

Example – 07
₹/$ = 75.50/75.75

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Mr. Ram import goods from US & $1,00,000 payable to US party. How much rupees are
required to buy $1,00,000.

Solution:

$ 1,00,000 ×75.75 =₹75,75,000.

 Ratefdlcurrency dk fn;k gS ?
 Bank mlcurrency dksbuy dj jgk gS ;ksell dj jgk gSA

Example – 08
$/£ = 1.50/1.55
A UK customer import goods from US & $10,000 payable to US party. How much pounds are
required to buy $10,000.

Solution:

₹ 100,000
= £6,666.67
1.50
4. Appreciation & Depreciation In Currency

Example – 12
₹/$ = 70
If $ will appreciate by 10% what is new Exchange Rate.

Solution:

$1 = ₹ 70 × 1.10
= ₹ 77

Example – 14
₹/$ = 70
If $ will depreciate by 10% then calculate New Exchange Rate.

Solution:

$1 = ₹ 70 × 0.9
= ₹ 63.

5. Calculation of Customer Rate or Merchant Rate

If Inter Bank Rates are given, then commission or margin is added to Ask Rate &
Subtracted from bid rate to find out customer rate.

6. Cross Rates
 Exchange rates of all foreign currency against home currency may not be available. In
this situation, exchange rate is determined with the help of cross multiplication is
called “Cross Rate”

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 Cross rates are used to calculate arbitrage.

 We will discuss cross rates in two parts.
Part I – Cross Rates Without Bid-Ask
Part II – Cross Rates With Bid-Ask

Part I – Cross Rates Without Bid-Ask

Example – 16
₹/$ = 60
$/£ = 1.50
₹/£ =?

Solution:

₹ 60 × 1.50= ₹ 90.

Example – 17
₹/£ = ₹ 90
$/£ = 1.50
₹/$ =?

Solution:

1
₹ 90 × = ₹ 60
1.50

Part – II Cross Rates With Bid – Ask

Example – 24
₹/$ = 70.25/70.75
$/£ = 1.5045/1.5085
₹/£ =?

Solution:

Example – 25
₹/£ = 90.45/91.25
₹/$ = 71.25/71.75
$/£ = ?

Solution:

1
Bid Rate = × 90.45
71.75
= 1.2606
1
Ask Rate = × 91.25
71.75

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= 1.2807.
* If 1 ls divide djuk gS rks Bidfd txg Ask & Askdh txg Bid Rateysuk gSA
Example – 26
¥/$ = 145/153
¥/£ = 182/185
£/$ = ?

Solution:
1
Bid Rate = × 145
185
= 0.7838
1
Ask Rate = × 153
182
= 0.8406

Example – 27
$/₹ = 0.0165/0.0168
₹/€ = 75.45/75.85
£/€ = 0.8525/0.8605
$/£ = ?

Solution:

$/£ = $/₹×₹/€ × €/£

1
Bid Rate = 0.0165 × 75.45 ×
0.8605
= 1.4467
1
Ask Rate = 0.0168 × 75.85
0.8525
= 1.4947

Question – 02
Mr. Mammen, an Indian investor invests in a listed bond in USA. If the price of the bond at
the beginning of the year is USD 100 and it is USD 103 at the end of the year. The coupon
rate is 3% payable annually.

Find the return on investment in terms of home country currency if:

(i) USD is Flat.

(ii) USD appreciates during the year by 3%.

(iii) USD depreciates during the year by 3%.

(iv) Indian Rupee appreciates during the year by 5%.

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(v) Will your answer differ if Mr. Mammen invests in the bond just before the interest
payable.

(RTP May – 2022 & Exam July – 2021)

Solution:

(I) Calculation of the return on investment

(i) If USD is flat

$106- $100
Return on Investment = × 100 = 6% p.a.
$100

(ii) If $ appreciator by 3%

Return on Investment = [(1.06 × 1.03) − 1] × 100 = 9.18%

(iii) If $ deprecator by 3%

Return on Investment [(1.06 ×0.97)−1] × 100 = 2.82%

(iv) If ₹ appreciator by 5% (If $ depreciates by 5%)

Return on Investment = [(1.06 × 0.95) − 1] × 100 = 0.7%

Question – 03
On January 28, 2013 an importer customer requested a Bank to remit Singapore Dollar
(SGD) 2,500,000 under an irrevocable Letter of Credit (LC). However, due to unavoidable
factors, the Bank could effect the remittances only on February 4, 2013. The inter-bank
market rates were as follows:

January 28, 2013 February 4, 2013

US$ 1 = ₹ 45.85/45.90 ₹ 45.91/45.97
GBP £ 1 = US$ 1.7840/1.7850 US$ 1.7765/1.7775
GBP £ 1 = SGD 3.1575/3.1590 SGD 3. 1380/3.1390

The Bank wishes to retain an exchange margin of 0.125%

Required:

How much does the customer stand to gain or lose due to the delay?

(Note: Calculate the rate in multiples of 0.0001)

(Study Material, PM & Exam November - 2011)

Solution:

Calculation of Exchange Rate ₹/SGD

28/01/2013

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₹/$ = 45.90
$/£ = 1.7850
SGD/£ = 3.1575
₹/SGD = ₹/$ ×$/£ × SGD/£
= 45.90 × 1.7850 × 1/3.1575
= 25.9482 + 0.125%
= ₹25.9806.

04/02/2013
₹/$ = 45.90

$/£ = 1.7775

SGD/£ = 3.1380

1
₹/SGD = 45.97× 1.7775 ×
3.1380

=26.0341 + 0.125%

= ₹26.0719

Loss due to delay

= (25.9806−26.0719) × SGD25,00,000
= ₹2,28,250.

(2) Spot Market Arbitrage

Arbitrage means risk free profit. In spot market arbitrage, we buy currency where it is selling
at lower rate & we sell currency where it is selling at higher rate.

Suppose $ rate in India is ₹ 70 & in USA is ₹ 72.

In this situation we buy $ from India at ₹ 70 & sell in US at ₹ 72 arbitrage gain = ₹ 2 per $

Example – 29

₹/$ = 60.50/60.75 India

₹/$ = 60.90/61.25 USA
Calculate Arbitrage Gain

Solution:

Arbitrage
Buy $ from India at ₹ 60.75 & sell $ in USA at ₹ 60.90
Arbitrage Gain = ₹ 60.90 – 60-75
= ₹ 0.15 per $.

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Question – 06
On the same date that the DM spot rate was quoted at $0.40 in New York, the price of the
pound Sterling was quoted at $1.80:

(i) What would you expect the price of the Pound to be Germany?

(ii) If the Pound was quoted in Frankfurt at DM 4.40/Pound, what would you do to profit
from situation.

Solution:

$/DM = 0.40 NY
$/£ = 1.80 NY
DM/£ =?

(i) Price of £ in Germany

1
DM/£ = × 1.80 = DM 4.50
0.40

(ii) If price of £ in Frankfurt is DM 4.50 than buy £ from frank at DM 4.40 & sell in New
York at DM 4.50.
Arbitrage = (DM 4.50 − DM 4.40)
= DM 0.10 per £.

Triangular Arbitrage

Question – 07
Followings are the spot exchange rates quoted at three different forex markets:

USD/INR 48.30 in Mumbai

GBP/INR 77.52 in London

GBP/USD 1.6231 in New York

The arbitrageur has USD 1,00,00,000. Assuming that there are no transaction costs, explain
whether there is any arbitrage gain possible from the quoted spot exchange rates.

(Study Material & PM)

Solution:

Arbitrage process
− Sell $ in Mumbai = $1,00,00,000 × 48.30
= ₹48,30,00,000

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₹48,30,00,000
− Buy £ in London =
77.52

= £ 62,30,650.15

− Sell £ in New York = £ 62,30,650.15 × 1.6231

= $ 1,01,12,968.27

Arbitrage = $ 1,01,12,968.27− $
= $ 1,12,968.27

Question – 09
Followings are the spot exchange rates quoted at three different forex markets:

USD/INR 59.25/59.35 in Mumbai

GBP/INR 102.50/103.00 in London

GBP/USD 1.70/1.72 in New York

The arbitrageur has USD 1,00,00,000. Assuming that bank wishes to retain an exchange
margin of 0.125%, explain Whether there is any arbitrage gain possible from the quoted spot
exchange rates.

Solution:

Arbitrage process
 Sell $ in New York at (1.72 + 0.(5)) = 1.722
$ 10000000
=
1.722
= £ 5807200.93
 Sell £ in London at (102.50 – 0.125%) = 102.37
= £ 5807200.93 × 102.37
= ₹ 594483159
 Buy $ in Mumbai at (59.35 + 0.125%) = 59.42
₹ 594483159
= = $10004765
59.42
= $ 10112968.27
Arbitrage Gain = $ 10004765 - $10000000
= $ 4765

Question – 10

Citi Bank quotes JPY/ USD 105.00 - 106.50 and Honk Kong Bank quotes USD/JPY 0.0090-
0.0093.

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(a) Are these quotes identical if not then how they are different?

(b) Is there a possibility of arbitrage?

(c) If there is an arbitrage opportunity, then show how would you make profit from the
given quotation in both cases if you are having JPY 1,00,000 or US$ 1,000.

(RTP November - 2020)

Solution:

City Bank Honk Kong Bank

¥/$ 105.00/106.50 $/¥ 0.0090/0.0093

$/¥ 0.0094/0.0095 ¥/$ 107.53/111.11

i) No there Question are not identical, City Bank’s Quote direct quote for yen & Honk
Kong Bank’s quote direct quote for $.

ii) Since City Bank Rates of $/¥ 0.0094/0.0095, both rates are higher than Honk Kong
Bank’s Rate house there is a possibility of Arbitrage.

Arbitrage gain

If we hove ¥ 100000

 Buy $ from City Bank

¥ 100000
= $ 938.967
106.50
 Sell $ in Honk Kong Bank
$ 938.967 × 107.53 = ¥ 100967
Gain = ¥ 100967 - ¥100000
= ¥ 967
If we have $ 1000
 Buy ¥ from Honk Kong Bank
= $ 1000 × 107.53 = ¥ 107530
 Sell ¥ in City Bank
¥ 107530
= = $ 1009.67
106.50

Gain = $ 1009.67 - $1000

= $ 9.67

(3) Forward Contract

(I) Forward Contract for Importer

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Example – 34

Spot Rate

₹/$ = 70.50/71.25

3 Months Expected SR

₹/$ = 74.00

3 Months Forward Rate

₹/$ = 72.50

(i) Calculate expected loss.

(ii) Whether Ram should enter into forward contract?

(iii) If yes, saving in loss due to the forward contract?

Solution:

i) Calculation of Expected lose

Method I : Expected lose

= (₹ 74-71.25) × 100000

= ₹ 275000.

Method II : If Buy $ at SR

= (₹100000 -71.25) = 7125000

If buy $ at Expected SR

($ 100000 -74) = ₹ 7400000

Expected Loss ₹275000

ii) Yes, Ram should enter into forward, contract, because Expected spot rate is less than
forward rate.

iii) Calculation of loss if hedging is done

loss (72.50 – 71.25) $ 100000 = ₹ 125000

Or

If Buy $ at SR ₹ 7125000

If buy $ at FR

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($100000 × 72.50) ₹ 7250000

Loss ₹ 1250000

Saving in lose due to forward contracts

(₹ 275000 - ₹ 125000) = ₹ 150000.

(II) Forward Cover For Exporter

Example – 35

Spot Rate

₹/£ = 90.00/90.50

Expected Spot Rate

₹/£ = 87.50

3 Months Forward Rate (Bank)

₹/£ = 89.00

(i) Calculate expected loss.

(ii) Whether Ram should enter into forward contract?

(iii) If yes, saving in loss due to forward contract.

Solution:

i) Calculation of Expected lose if hedging is not done

If Sell £ at SR

(£ 50000 × 90) = ₹ 4500000

If Sell £ at Expected SR

(£ 50000 × 8750) = ₹ 4375000

Expected Loss = ₹ 125000

ii) Yes, Ram should enter into forward contract, because forward rate is more than
Expected SR.

iii) Saving in loss due to forward Cover

If Sell £ at SR = ₹ 4500000

If Sell £ at FR (£ 50000 × 89) = ₹ 4450000

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Loss ₹ 5000

Saving in Loss (125000-50000) = ₹ 75000.

Forward Premium Or Discount:-In forex, one currency may appreciate against another
currency in forward contract. If currency appreciate then it is at “Premium” & if currency
depreciates then we can say currency is at discount.

Forward premium or discount is calculated as under.

Forward Rate-Spot Rate 12

Forward premium/(Discount) = × 100 ×
Spot Rate n

Example – 38

Spot Rate ₹/$ = 70.45

3 Months FR ₹/$ = 71.25
Calculate Premium/Discount in
(i) $ (ii) ₹

Solution:

F−S 12
Forward premium/(Dist) = × 100 ×
S 3

71.25−70.45 12
= × 100 ×
70.45 3
= 4.54% p.a.

ii) Premium/(Disc) in ₹D;ksfa d Rate $ dk fn;k gS rks Formula mYVk yxkuk gSaA
S−F 12
= × 100 ×
F n

70.45−71.25 12
= × 100 ×
71.25 3

= 4.49% p.a. Disc. in ₹.

Calculation of Forward Rate With The Help of Swap Points:-Swap points are basically
premium or discount in currency. If swap points are in ascending order (10/15) then swap
point are added to spot rate & if swap points are in descending order then they are
subtracted from spot rate to find out forward rate.

Example – 40
Spot Rate ₹/$ = 60.25/45
1 Months swap = 10/15
2 Months swap = 25/15
Calculate 1 Month & 2 Months FR.

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Solution:

1 Month FR
SR 60.25/60.45
+ 1 Month Swap 00.10/00.15
60.35/60.60
2 Months FR
SR 60.25/60.45
- 2 Month FR 00.25/00.15
60.00/60.30

Question – 11
The following 2-way quotes appear in the foreign exchange market:

Spot 2-months forward

RS/US $ ₹46.00/₹46.25 ₹47.00/₹47.50

Required:

(i) How many US dollars should a firm sell to get ₹ 25 lakhs after 2 months?

(ii) How many Rupees is the firm required to pay to obtain US $ 2,00,000 in the spot
market?

(iii) Assume the firm has US $ 69,000 in current account earning no interest. ROI on
Rupee investment is 10% p.a. Should the firm encase the US $ now or 2 months later?

(Study Material & PM)

Solution:

(i) $ Sell by firm to get ₹25,00,000

₹ 25,00,000
= $ 53191.49
47

(ii) Rupees required to buy $ 2,00,000

$2,00,000 ×₹ 46.25 = ₹92,50,000

(iii) Encash Now

− Sell $ 69,000 × 46 = ₹31,74,000

− Invest ₹3174000 @ 10% P.a for 2 Months

2
CI = 31,74,000 + 31,74,000 × 10% ×
12
= ₹32,26,900

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Encash after 2 months

Sell $ 69,000 at 2 months FR $ 69,000 × 47= ₹32,43,000

Encash after 2 months is better.

Question – 12
In March, 2009, the Multinational Industries make the following assessment of dollar rates
per British pound to prevail as on 01/09/2009:

$/Pound Probability
1.60 0.15
1.70 0.20
1.80 0.25
1.90 0.20
2.00 0.20

(i) What is the expected spot rate for 01/09/2009?

(ii) If, as of March, 2009, the 6-month forward rate is $ 1.80, should the firm sell forward
its pound receivables due in September, 2009?
(Study Material & PM)
Solution:

(i) Expected Spot Rate

= ($ 1.60 ×0.15) + (1.70 × 0.20) + (1.80 ×0.25) + (1.90×0.20) + (2.00×0.20)

= $ 1.81.

(ii) Since Expected spot rate is more than forward rate, hence firm should not sell its
pound receivable.

Question – 13
JKL Ltd., an Indian company has an export exposure of JPY 10,000,000 receivable 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

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INR/US $ = ₹ 66.50

JPY/US$ = JPY 110.35

Required:

(i) Calculate the expected loss, if the hedging is not done. How the position will change, if
the firm takes forward cover?

(ii) If the spot rates on August 31, 2014 are:

INR/US $ = ₹66.25

JPY/US$ = JPY 110.85

Is the decision to take forward cover justified?

(Study Material, PM & Exam May – 2014)

Solution:

(i) Calculation of SR, Expected SR & FR of ₹/¥

Spot Rate : ₹/$ 62.22

¥/$ 102.34

1
₹/¥ 62.22 × = 0.6080
102.34
Expected SR : ₹/$ 65

¥/$ 124

1
₹/¥ 65 × = 0.5242
124
Expected Rate FR : ₹/$ 66.50

¥/$ 110.35

1
₹/¥ 66.50 × = 0.6026
110.35
Calculation of Expected Loss if hedging is not done

If sell ¥ at SR (¥ 1,00,00,000 × 0.6080) = ₹60,80,000

If Sell ¥ atExpected SR(1,00,00,000 × 0.5242) = ₹52,42,000
Expected Loss = ₹8,38,000

Calculation of loss if forward cover is done

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If Sell ¥ at SR = ₹ 6080000
If Sell ¥ at FR (¥ 1,00,00,000 × 0.6026) = ₹ 6026000
Loss = ₹ 54000
Due to the forward Contracts, Loss reduced to ₹54,000.

(ii) Spot Rate as on Aug. 31,2014

₹/$ 66.25 ¥/$ = 110.85

1
₹/¥ 66.25 × = 0.5976
110.85
Calculation of loss on the basis Actual SR

If Sell ¥ at SR = ₹ 60,80,000

If Sell ¥ at SR on 31/08/2014

(¥ 1,00,00,000 × 0.5976) = ₹59,76,000

Loss = ₹1,04,000

Least loss in forward cover, hence forward cover is justified.

Question – 14
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 today's
spot rate, it is equivalent to ₹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 be hedged by a forward contract.
(Study Material & PM)
Solution:

(i) Calculation of Spot Rate & Estimated SR

Spot Rate : ¥ 108 Lakhs = ₹ 30 Lakhs

¥ 108
¥/₹ = = 3.60
₹ 30

Expected SR : ¥/₹ = 3.60 × 0.90 = 3.24

Forward Rate ¥/₹ = 3.30

Calculation of Expected Loss if hedging is not done

¥ 108
If Buy ¥ at SR = = ₹30 Lakhs
3.60

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¥ 108 L
If Buy ¥ at Estimated SR = = ₹33.33 Lakhs
3.24

Expected Loss = ₹3.33 Lakhs

Calculation of loss if covered through forward contract

If Buy ¥ at SR = ₹30 Lakhs

¥ 108 L
If Buy ¥ at FR = = ₹32.73 Lakhs
3.30
Loss = ₹2.73 Lakhs

Loss can be reduced to ₹2.73 Lakhs due to the forward contract.

Question – 17
A company is considering hedging its foreign exchange risk. It has made a purchase on 1st
July, 2016 for which it has to make a payment of US$ 60,000 on December 31, 2016. The
present exchange rate is 1 US $ = ₹65. It can purchase forward 1 $ at ₹ 64. The company will
have to make an upfront premium @ 2% of the forward amount purchased. The cost of funds
to the company is 12% per annum.

In the following situations, compute the profit/loss the company will make if it hedges its
foreign exchange risk with the exchange rate on 31st December, 2016 as:

(i) ₹ 68 per US $.

(ii) ₹ 62 per US $.

(iii) ₹ 70 per US $.

(iv) ₹ 65 per US $.

(Study Material, PM & Exam November – 2016)

Solution:

Calculation of cost of hedging

Premium Amount = $ 60,000 × 64 × 2% = ₹ 76,800

6
(+) Opportunity Cost 76800 × 12% × = ₹ 4,608
12
Cost of Hedging ₹ 81,408

Calculation of profit /loss to the Company

(i) Exchange Rate ₹ 68 per $

Profit (68-64) × $ 60000 =₹2,40,000
(−) Hedging Cost ₹81,408
Net Profit =₹1,58,592

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(ii) If Exchange Rate ₹61 per $

Loss = (₹62 −₹64) × $60,000 =₹1,20,000
(+) Hedging Cost ₹81,408
Net Profit =₹2,01,408

(iii) If Exchange Rate ₹ 70 per $

Profit = (₹ 70 −₹ 64) × $ 60,000 =₹3,60,000
(−) Hedging Cost ₹81408
Net Profit =₹278592

(iv) If Exchange Rate is ₹ 65 per $

Profit = (₹ 65 - ₹ 64) × $ 60000 =₹60,000
(−) Hedging Cost ₹81,408
Net Profit =₹21,408

Question – 20
Digital Exporter are holding an Export bill in United States Dollar (USD) 5,00,000 due after
60 days. They are worried about the falling USD value, which is currently at ₹75.60 per USD.
The concerned Export Consignment has been priced on an Exchange rate of ₹75.50 per USD.
The Firm’s Bankers have quoted a 60-days forward rate of ₹75.20 Calculate:

(i) Rate of discount quoted by the Bank, assuming 365 days in a year.

(ii) The probable loss of operating profit if the forward sale is agreed to.

(Exam November – 2018)

Solution:

(i)Calculation of discount in $

F-S 365
Premium/discount in $ = = × 100 ×
S 60

75.20- 75.60 365

= = × 100 ×
75.60 60

= 3.22% p.a. discount in $.

(ii) Calculation of Probable loss

Probable Loss = (75.20−75.50) × $5,00,000

= ₹1,50,000

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Question – 23
Following information relates to AKC Ltd. which manufactures some parts of an electronics
device which are exported to USA, Japan and Europe on 90 days credit terms.
Cost and Sales information:

Japan USA Europe

Variable cost per unit ₹225 ₹395 ₹510
Export sale price per unit Yen 650 US$10.23 Euro 11.99
Receipts from sale due in 90 Yen 78,00,000 US$1,02,300 Euro 95,920
days

Foreign exchange rate information:

Yen/₹ US$/₹ Euro/₹

Spot market 2.417-2.437 0.0214-0.0217 0.0177-0.0180
3 months forward 2.397-2.427 0.0213-0.0216 0.0176-0.0178
3 months spot 2.423-2.459 0.02144-0.02156 0.0177-0.0179

Advise AKC Ltd. by calculating average contribution to sales ratio whether it should hedge its
foreign currency risk or not.

(Study Material, PM & Exam Nov – 2019)

Solution:

Calculation of sales & Contribution

Japan USA Europe

i) Receipt ¥ 78,00,000 $1,02,300 € 95,920
ii) Selling Price per unit ¥ 650 $ 10.23 €11.99
iii) No. of Unit λ/𝜇 12,000 Unit 10,000 Unit 8,000 Unit
iv) Variable watt per unit ₹ 225 ₹ 395 ₹ 510
V) Variable Cost (iii × iv) ₹ 27,00,000 ₹ 39,50,000 ₹ 40,80,000
vi) Forward Contract Rate 2.427 0.0216 0.0178
vii) Sale if fledging (i/vi) ₹ 32,13,844 ₹ 47,36,111 53,88,764
viii) Expected SR 2.459 0.02156 0.0179
ix) Sales if hedging not done 31,72,021 47,44,898 53,58,659

Total VC (2700000 + 3950000 + 4080000) = 1,07,30,000

Sales FC (3213844 + 4736111 + 5388764) = 1,33,38,719

Sales ESR (3172021 + 4744898 + 5358659) = 1,32,75,578

Average Contribution to sales Ratio

1,33,38,719-1,07,30,000
If hedging is done (forward Contract) × 100= 19.56%
1,33,38,719

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1,32,75,578– 1,07,30,000
If Hedging is not done × 100= 19.17%
1,32,75,578

Forward cover is better due to hedging contribution to sales ratio.

Question – 24
You have following quotes from Bank A and Bank B:

Bank A Bank B
SPOT USD/CHF 1.4650/55 USD/CHF 1.4653/60
3 Months 5/10
6 Months 10/15

SPOT GBP/USD 1.7645/60 GBP/USD 1.7640/50

3 Months 25/20
6 Months 35/25

Calculate:
(i) How much minimum CHF amount you have to pay for 1 Million GBP spot?

(ii) Considering the quotes from Bank A only, for GBP/CHF what are the Implied Swap
points for Spot over 3 months?

(Study Material & PM)

Solution:

(i) Calculation of CHF Amount to pay £ 1 Million

Buy $ from Bank A = CHF/$ 1.4655

Sell $ &Buy £ from Bank B = $/£ 1.76550

Calculation = CHF/£ = 1.4655 × 1.7650

= 2.5866

Minimum CHF required to buy £ 10,00,000

£ 10,00,000 × 2.5866 = CHF25,86,600

(ii) Calculation of 3 months Swap

SR 3 Months FR

CHF/$ 1.4650/1.4655 CHF/$ 1.4655/1.4665

$/£ 1.7645/1.7660 $/£ 1.7620/1.7640

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CHF/£ 1.4650 × 1.7645/1.4655 × 1.7660 1.4655 × 1.7620/1.4665

× 1.7640
= 2.5850/2.5881 2.5822/2.5869

3 Month FR 2.5822/2.5869

Spot 2.5850/2.5881

−0.0028/−0.0012

3 Month Swap Point = 28/12.

Question – 25
An importer customer of your bank wishes to book a forward contract with your bank on 3 rd
September for sale to him of SGD 5,00,000 to be delivered on 30 th October.
The spot rates on 3rd September are USD 49.3700/3800 and USD/SGD 1.7058/68. The
swap points are:

USD/₹ USD/SGD
Spot/September 0300/0400 1st Month Forward 48/49
Spot/October 1100/1300 2nd Month Forward 96/97
Spot/November 1900/2200 3rd Month Forward 138/140
Spot/December 2700/3100
Spot/January 3500/4000

Calculate the rate to be quoted to the importer by assuming an exchange margin of 5 paisa.

(Study Material, PM & Exam May – 2018)

Solution:

Calculation of 2 Month FR

Inter Bank Customer Rate

₹/S SGD/$

SR 49.3700/49.3800 SR 1.7058/1.7068

(+) Swap 0.1100/0.1300 (+) Swap 0.0096/0.0097

49.4800/49.5100 1.7154/1.7165

(+) Margin 0.0500

49.5600

1
₹/SGD = 49.5600 ×
1.7854

= 28.8912

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(4) Cover Deal

Question – 29
You sold Hong Kong Dollar 1,00,00,000 value spot to your customer at ₹5.70 & covered
yourself in London market on the same day, when the exchange rates were

US$ 1 = H.K.$ 7.5880 7.5920

Local inter bank market rates for US$ were

Spot US$ 1 = ₹42.70 42.85

Calculate cover rate and ascertain the profit or loss in the transaction. Ignore brokerage.

(Study Material & PM)

Solution:

Calculation of Cover Rate

Buy $ from local Inter Bank Market @ ₹/$ 42.85

Buy HK $ from London Market @ HK$/$ 7.5880

1
₹/HK$ Cover Rate = 42.85 × = 5.6471
7.5880
Calculation of Profit/loss

Amount received from customer (HK $1,00,00,000 × 5.70) = ₹5,70,00,000

Amount Paid on cover deal (HK $1,00,00,000 × 5.6471) = ₹5,64,71,000

Profit = ₹5,29,000

Question – 32
You, a foreign exchange dealer of your bank, are informed that your bank has sold a T.T. on
Copenhagen for Danish Kroner 10,00,000 at the rate of Danish Kroner 1 = ₹6.5150. You are
required to cover the transaction either in London or New York market. The rates on that
date are as under:

Mumbai – London ₹ 74.3000 ₹ 74.3200

Mumbai – New York ₹ 49.2500 ₹ 49.2625
London – Copenhagen DKK 11.4200 DKK 11.4350
New York – Copenhagen DKK 07.5670 DKK 07.5840

In which market will you cover the transaction, London or New York, and what will be the
exchange profit or loss on the transaction? Ignore brokerages.

(Study Material, PM & Exam November – 2013)

Solution:

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Calculation of Cover Rate

London Market
 Buy £ from Bank @ ₹/£ 74.3200
 Buy DKK from Bank @ DKK/£ 11.4200
1
₹/DKK =₹74.3200 ×
11.4200
= 6.5079

New York Market

 Buy $ from Bank @ ₹/$ 49.2625
 Buy DKK from Bank @ DKK/$ 7.5670
1
₹/DKK =₹49.2625 ×
7.5670
= 6.5102

Covered from London Market is better & Cover d rate ₹/DKK is 6.5079.

Calculation of profit/lose

Amount received from customer(DKK 10,00,000 × 6.5150) = ₹65,15,000

Amount Paid on Cover deal(DKK 10,00,000 × 6.5079) = ₹65,07,900

Profit to Bank = ₹7,100

(5) Exchange Rate Determination

Exchange rate of countries currency depends on following factors.

(i) Interest Rate [Interest Rate Parity]

(ii) Inflation Rate [Purchasing Power Parity]

(iii) Interest Rate & Inflation Rate [International Fisher Effect]

(i) Interest Rate Parity (IRP)

 As per IRP, exchange rate between two countries currency depends on interest rate of
their countries.
 Currency of a country having lower rate of interest will be stronger than currency of
country having higher rate of interest in future.
 IRP Equation

F$ 1+RA$
=
S$ 1+RB

F = Forward Rate
S = Spot Rate

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RA = Rate of Interest
RB = Rate of Interest

Question – 33
On April 1, 3 months interest rate in the UK £ and US $ are 7.5% and 3.5% per annum
respectively. The UK £/US $ spot rate is 0.7570. What would be the forward rate for US $ for
delivery on 30th June?
(Study Material & PM)
Solution:

£/$ = £ 0.7570

Calculation of 3 months FR using IRP

IRP Equation

F 1+rA
=
S 1+rB

F 1+ (7.5% × 3/12)
=
£ 0.7570 1+ 3.5% × 3/12

F 1.01875
=
£ 0.7570 1.00875

£ 0.7570 × 1.01875
F =
1.00875
F = £ 0.7645.

Question – 35
The following table shows interest rates for the United States Dollar and French Franc. The
spot exchange rate is 7.05 Franc per Dollar. Complete the missing entries:
3 Months 6 Months 1 Year
Dollar interest rate
(annually compounded) 11 ½ % 12 ¼ % ?
Franc interest rate
(annually compounded) 19 ½ % ? 20%
Forward Franc per Dollar ? ? 7.5200
Forward discount per Franc
percent per year ? 6.3%

(Practice Manual)
Solution:

3 Months (Using IRP)

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(i) Calculation of 3 months FR

F 1+rA
=
S 1+rB

F 1.195 3/12
=
FF 7.05 1.115

F
= 1.01747
FF 7.05

F = FF 7.17

(ii) Discount Per FF

S-F 12
Discount = × 100 ×
F 3

7.05- 7.17 12
= × 100 ×
7.17 3

= 6.69% Discount Per FF.

6 Months
(i) Calculation of 6 Months FR
S-F 12
Discount per FF = × 100 ×
F 3

7.05- F 12
−6.3 = × 100 ×
F 3

7.05- F
−6.3 × 6/12 = × 100
F

−0.0315F = 7.05-F

0.9685 F = 7.05

7.05
F = = FF 7.28
0.9685
(ii) FF Interest Rate using IRP

F 1+rA
=
S 1+rB

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FF 7.28 (1+rA)6/12
=
FF 7.05 (1+0.1225)6/12

FF 7.28 (1+rA)6/12
=
FF 7.05 1.05948

7.28 × 1.05948 12/6

1 + rA =
7.05
2
1 + rA = 1.09404
2
rA = (1.09404 −1) × 100

=19.69%

1 year

(i) Dollar Interest

F 1+rA
=
S 1+rB

FF 7.52 1.20
=
FF 7.05 1 +rB

7.05 ×1.20 -1
rB =[( ) ] × 100
7.52

= 12.5%

(ii)Discount per FF

S-F
Discount = × 100
F

7.05-7.52
= × 100
7.52

= 6.25% Discount

Covered Interest Arbitrage:-As per IRP, forward rate should be on the basis of interest rates
but actual forward rate may differ from theoretical forward rate i.e. forward rate calculated as
per IRP. In this situation there is a possibility of “ Covered Interest Arbitrage.”

Question – 39
Spot rate 1 US $ = ₹ 48.0123

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180 days Forward rate for 1 US $ = ₹ 48.8190

Annualized interest rate for 6 months – Rupee = 12%

Annualized interest rate for 6 months – US $ = 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 US $83,312.
(Study Material & PM)
Solution:

(i) Calculation of Premium is $ & Interest rate difference

F 12
Premium is $ = -1 × 100 ×
6
S

48.8190 12
= -1 × 100 × 6
48.0123

= 3.36% p.a.

1.12
Interest Rate difference= -1 × 100 = 3.70% p.a. (12%-8% = 4%)
1.08
Yes premium in $ ≠ Interest Rate Difference since premium is $ is less than interest
rate difference, hence borrow from USA and Invest is INDIA.

Arbitrage Process
Today

 Borrow $ 83,312 from USA @ 8% P.a. for 6 months.

 Sell $ at SR ($ 83,312 ×₹ 48.0123) = ₹ 4000000
 Invest ₹ 40,00,000 @ 12% P.a. for 6 Months.
 Contract to buy $ at 6 months FR.

After 6 Months

Cash Inflows
Investment Amt (₹)

₹ 4000000 × 1.06 = ₹ 42, 40, 000

₹42,40,000
Buy $ at FR = $ 86,851.43
48.8190
Cash Outflows

Repayment of loan

$ 83,312 (1.04) = $ 86,644.48

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Arbitrage Gain = ($ 86,851.43 = $ 86,644.48)

= $ 206.95

Or $ 206.95 × 48.8190 = ₹10,103

Question – 40
Given the following information:

Exchange rate – Canadian dollar 0.665 per DM (spot)

Canadian dollar 0.670 per DM (3 months)

Interest rates – DM 7% p.a.

Canadian Dollar – 9% p.a.

What operations would be carried out to take the possible arbitrage gains?
(Study Material, PM & Exam May - 2011)
Solution:

(i) Calculation of Premium in DM & Interest rate difference

F 12
Premium is DM = −1 × 100 ×
3
S

$ 0.670 12
= -1 × 100 ×
3
$ 0.665

= 3.007% p.a.

1.09
Interest Rate difference = − 1 × 100
1.07

= 1.869% p.a. (9%-7%) = 2%

Since premium in DM is more than interest rate difference, hence borrow in Can $ &
invest in DM.
Arbitrage Process
It is assumed that we borrow can $1000.
Today
 Borrow Can $ 1000 @ 9% P.a. for 3 months.
Can $ 1000
 Sell Can $ at SR = DM 1503.7594
0.665
 Invest DM 1503.7594 @ 7% P.a. for 3 Months.
After 3 Months
Cash Inflows
Investment Amt
DM = ₹1,503.7594 (1.0175)

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= DM 1,530.0752

Sell DM at FR = DM 1,530.0752 × 0.670

= Can $ 1,025.15

Cash Outflows
Repayment = Can $ 1,000 (1.0225)
= Can $ 1,022.50
Arbitrage gain = (Can $ 1,025.15 – Can $ 1022.50)
= $ 2.65.

(ii) Purchasing Power Parity (PPP)

As per purchasing power parity , there are two theorem

I. Absolute form of PPP

II. Expectation form as relative form of PPP

I. Absolute Form of PPP

(1) As per PPP, Exchange rate of two countries currency depends on demands of goods
&services of their countries. It means demand of goods creates demand of currency &
currency will become strong in future.

(2) Suppose price of 1 pen in USA is $ 10 & price of such pen in India ₹500. As per PPP,
Exchange rate between $ &₹ should be

$10 = ₹500 Or, $1 = ₹50

(3) If actual Exchange is other than $1 = ₹50 than there is a possibility of arbitrage.

Suppose Actual Exchange rate $1 = ₹40. In this situation an arbitrageur, buy pen
from US & pay ($10× ₹40) = ₹400 & sell such pen in India at ₹500. Arbitrage ₹100.

So demand of pen is USA will Increase due to Lower rate, hence demand of dollar will
Increase & $ will become strong .

Such process will continue till then $1 = ₹50.

So Exchange rate depends on demands of goods & services.

II. Expectation Form of PPP

− As per PPP, Currency of Country having Lower rate of Inflation will be stronger than
currency of country having higher rate of Inflation.

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− Suppose 1 pen in India is ₹500 & price of such pen in USA $ 10, hence as per PPP
Exchange Rate is

$ 10 = ₹500
$ 1 = ₹50

In Inflation Rate in India is 10% p.a. & USA is 8% p.a. then price of pen in India &USA
is Price of Pen

India = ₹500 × 1.10 = ₹550

USA = $10 ×1.08 = $10.80

Exchange Rate after 1 year

$10.80 = ₹550
550
$1 = = ₹50.92
10.80

Formula of PPP

Es1 (1+i)A
=
So (1+i)B

Question – 45
The rate of inflation in India is 8% per annum and in the U.S.A. it is 4%. The current
spot rate for USD in India is ₹ 46. What will be the expected rate after 1 year and
after 4 years applying the Purchasing Power Parity Theory.

(Study Material, PM & Exam May - 2010)

Solution:
Calculation of Expected Rate applying PPP

E (S) 1+i A
PPP Equation =
S 1+i B

1 year

Es 1 1.08
=
₹ 46 1.04
46 ×1.08
Es1 = = ₹47.77
1.04

2 year

Es 2 1.08
=
₹ 47.77 1.04

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₹47.77 ×1.08
Es2 = = ₹ 49.61
1.04

3 year

Es 3 1.08
=
49.61 1.04
49.61 ×1.08
Es3 = = ₹51.52
1.04

4 year

Es 4 1.08
=
51.52 1.04
51.52 ×1.08
Es4 = = ₹53.50
1.04

III. International Fisher Effect (IFE)

Domestic Fisher Effect:-

− Domestic fisher effect explains relationship between Interest rate & Inflation Rate.

− In order to understand International fisher effect, we have to discuss Nominal Rate of

Interest & Real rate of Interest.

− Real Rate of Interest means Excluding Inflation Rate.

− Nominal Rate of Interest means including inflation Rate.

Domestic Fisher Effect

Nominal Interest Rate = (1 + Real Interest Rate) (1 + i) – 1

(1+Nominal Interest Rate)

Real Interest Rate = –1
(1+i)

Question – 47
A US investor chose to invest in Sensex for a period of one year. The relevant information is
given below.

Size of investment ($) 20,00,000

Spot rate 1 year ago (₹/$) 42.50/60
Spot rate now (₹/$) 43.85/90
Sensex 1 year ago 3,256
Sensex now 3,765
Inflation in US 5%
9%

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Inflation in India

(i) Compute the nominal rate of return to the US investor.

(ii) Compute the real depreciation /appreciation of Rupee.

(iii) What should be the exchange rate if relevant purchasing power parity holds good?

(iv) What will be the real return to an Indian investor in Sensex?

(RTP May – 2022& January – 2021)

Solution:

i) Calculation of Nominal Rate of return to US Investor

Size to Investment = $ 20,00,000

Sell $ 1 year ago = $ 20,00,000 ×₹42.50 = ₹8,50,00,000

Invest ₹8,50,00,000 in Sensex

₹8,50,00,000
After 1 year Investment Value = × 3765
3256
= ₹9,82,87,776

₹9,82,87,776
Buy $ at SR =
43.90
= $22,38,901

$22,38,901-$28,00,000
Nominal Rate of return to US Investment = × 100
$20,00,000
= 11.94% P.a.

ii) Calculation of Real Application or depreciation in ₹ Real Rate of $ (without Inflation)

₹43.85 1.09
Bid Rate = =
5 1.05
43.85 ×1.05
S = = 42.24
1.09
S−F
= × 100
F

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42.50 – 42.24
= × 100 = 0.61%
42.24
₹43.90 1.09
Ask Rate = =
5 1.05
43.90 ×1.05
S = = 42.29
1.09

42.60 – 42.29
= × 100
42.29
= 0.73% premium in ₹

iii) Calculation of Estimated SR as per PPP

E (S) 1+iA
=
S 1+iB
E (S) 1.09
Bid Rate = = = ₹44.12
42.50 1.05
iv) Real rate of Return on sensex for India Investor

3765 −3256
Sensex Return = ×100
3256
= 15.63%

1.1563
Real Return = −1 ×100
1.09
= 6.08%

(6) Foreign Currency Exposures

We will discuss three types of currency exposure in forex.

1. Transaction Exposure

2. Translation Exposure or Accounting Exposure

3. Economic Exposure or Operating Exposure

(1) Transaction Exposure

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(i) It is direct exposure.

(ii) It is faced by firm having foreign currency payables or receivables.

(iii) Whenever we import or export, we know how much foreign currency, but we don’t
know how much home currency required to buy foreign currency.

(iv) Transaction exposure can be hedged.

(2) Translation Exposure or Accounting Exposure

(i) It is notional exposure.

(ii) It is faced by firm having foreign branch or foreign subsidiary.

(iii) Whenever parent company prepares financial statement with foreign subsidiary then
financial statement of foreign subsidiary shall be translated in home currency.
Exchange rate can affect the value of asset of foreign subsidiary. [Financial Statement]
due to this reason, intrinsic value of share can be affected.

(iv) Translation exposure need not to be hedged.

(3) Economic Exposure or Operating Exposure

(i) It is indirect exposure.

(ii) It is faced by all firm whether foreign currency payable/receivable or not.

(iii) Suppose, Mr. Ram exports goods USA. Invoicing in INR invoice amount
₹60,00,000[10,000 units @ ₹600 per units]. In this situation transaction exposure
hedged because invoicing in Indian Rupees, but there is a possibility of economic
exposure. Current exchange rate is $1 = ₹ 60. It means as party i.e. Mr. A has to buy ₹
60,00,000 & $ required ₹ 60,00,000/60 = $ 1,00,000. But if exchange rate change & $
₹ 60,00,000
1 = ₹50. In this situation Mr. A has to pay = $1,20,000 to buy ₹60,00,000.
50
It means cost of goods to Mr. A increase by $ 20,000 [in percentage 20%]. Suppose
price electricity of demand 1.5 means demand of goods will decrease by (20 × 1.5) =
30% Hence sales for Mr. Ram will decrease. It is an example of economic exposure.

(iv) Economic exposure can’t be hedged.

Techniques of Hedging of Translation Exposure Techniques

Internal Hedging External Hedging

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1. Leading & Laggings 1. Forward Contract

2. Invoicing 2. Money Market Cover

3. Netting 3. Currency Future

4. Outsourcing or Matching 4. Currency Option

Internal Hedging

1. Leading &Laggings:-Leading means immediate payment & Laggings means delay

payment.

(i) Lead the payable if foreign currency will appreciate.

(ii) Lag the payable if foreign currency will depreciate.

(iii) Lead the receivable if foreign currency will depreciate.

(iv) Lag the receivable if foreign currency will appreciate.

2. Invoicing:-Whenever we import or export in foreign countries then try to payment or

receive payment in home currency i.e. Invoicing should be in home currency.

If we invoicing in home currency then transaction exposures can be avoided but

economic exposure can’t be avoided.

3. Netting:- If we have to pay foreign currency in future & receivable same foreign
currency at same time then we should not settle separately. Only net amount should
be settled & reduced Bid-Ask spreads.

4. Outsourcing or Matching:-If we export to USA & receivable & then we afraid of $

falling. In this situation we should create $ payable at same time by outsourcing raw
material or borrowing from US. On maturity net balance can be hedged.

Question – 50
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 percent per annum.

The importer's bank charges 15 percent per annum on overdrafts. The exchange rates in the
market are as follows:

Spot rate (₹ /$) : 48.35 /48.36

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3-Months forward rate (₹/$) : 48.81 /48.83

The importer seeks your advice. Give your advice.

(Study Material, PM & Exam November – 2011)

Solution:

Calculation of cash outflows (₹)

(i) Pay Immediately

Rupees required to buy $ 1,30,000 at SR

($ 1,30,000 × 48.36) = ₹62,86,800

Borrow ₹6286800 @ 15% P.a. for 3 Month

cash outflows = 62,86,800 (1.0375)

= ₹65,22,555

(ii) Pay after 3 Months

$ Payable with Interest = $1,30,000 (1.0375)

= $1,31,625

Buy $ 131625 at 3 months FR

Cash outflow = $1,31,625 × 48.83 = ₹64,27,249

Pay after 3 months is better due to the lower cash outflows.

Question – 51
Z Ltd. importing goods worth USD 2 million, requires 90 days to make the payment. The
overseas supplier has offered a 60 days interest free credit period and for additional credit for
30 days an interest of 8% per annum.

The bankers of Z Ltd offer a 30 days loan at 10% per annum and their quote for foreign
exchange is as follows:

₹
Spot 1 USD 56.50
60 days forward for 1 USD 57.10
90 days forward for 1 USD 57.50

You are required to evaluate the following options:

(i) Pay the supplier in 60 days, or

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(ii) Avail the supplier's offer of 90 days credit.

(Study Material & PM)
Solution:

Calculation of cash outflows (₹)

(i) Pay the supplier in 60 days

Rupees required to buy $ 20,00,000 at 60 days

FR ($ 20,00,000 × 57.10) = ₹11,42,00,000

Borrow ₹1,14,20,000 @ 10% P.a. for 30 day cash outflows

(₹11,42,00,000 × 1.00833) = 11,51,51,667

(ii) Pay the supplier in 90 days

$ Payable with Interest = $ 20,00,000 × 1.00667

= $ 20,13,333

Buy $ 20,13,333 at 90 days FR

Cash outflow = $ 20,13,333 × 57.50

= ₹11,57,66,648

Pay the supplier in 60 days is better due to the lower cash outflows.

External Hedging or Transaction Exposure

1. Forward Contract:-In forward contract, we can buy or sell foreign currency at contracted
rate in future. It means, we are sure that how much domestic currency required to buy
foreign currency in future.

2. Money Market Cover of Money Market Hedged:-

(i) Money Market Cover For Importer

(ii) Money Market Cover for Exporter

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(II) Money Market Cover

QUESTION – 57
Columbus Surgicals Inc. is based in US, has recently imported surgical raw materials from
the UK and has been invoiced for £ 480,000, payable in 3 months. It has also exported
surgical goods to India and France.

The Indian customer has been invoiced for £ 138,000, payable in 3 months, and the French
customer has been invoiced for € 590,000, payable in 4 months.

Current spot and forward rates are as follows:

£ / US$

Spot: 0.9830 – 0.9850

Three months forward: 0.9520 – 0.9545

US$ / €

Spot: 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: 11.5% – 13.0% p.a.

You as Treasury Manager are required to show how the company can hedge its
foreign exchange exposure using Forward markets and Money markets hedge and
suggest which the best hedging technique is.

(Study Material & PM)

Solution:

Import from UK & £ 4,80,000 Payables is 3 months. Export to India & £ 1,38,000
receivable in 3 months hence nothing in possible.

Net £ payable to UK pasty = (£ 4,80,000-£1,38,000)

= ₹3,42,000

We have to hedge for £3,42,000

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i) Forward Cover

3,42,000
Buy £3,42,000 at 3 months FR = = $ 3,59,243.70
0.9520

ii) Money Market Cover

 Amount to be invested in UK money market @ 10% P.a for 3 months

£ 3,42,000
= = £3,33,658.54
1 + (0.10 ×3/12)
£3,33,658.54
 $ required to buy £ = = $ 3,39,428.83
0.9830
 Borrow $ 3,39,428.83 from US Money Market @ 13% P.a. for 3 Months.

3
Cash outflows = $ 3,39,428.83× 1 + 0.13 × 12
= $ 3,50,460.27

Money market cover is better due to lower Cash outflows.

Hedging of Receivable € 5,90,000

 Forward Cover
Sell € 5,90,000 at 3 Months FR
Cash Inflows = € 5,90,000× 1.9510
= $ 11,51,090
 Money Market Cover
 Amount to borrow from France money @ 16% P.a. for 4 months

€ 5,90,000
= = € 5,60,126.58
1+(0.16 ×4/12)

 Sell € 5,60,126.58 at SR = € 5,60,126.58× 1.8890

= $ 10,58,079.11
 Invest $ 10,58,079.11 in US money market @ 10.5% for 4 months

4
Cash Inflows = $ 10,58,079.11× 1 + 0.15 × 12
= $ 10,98,638.81

Forward cover is better due to higher cash inflows.

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Question – 58
An exporter is a UK based company. Invoice amount is $3,50,000. Credit period is three
months. Exchange rates in London are :
Spot Rate ($/£) 1.5865 – 1.5905

3-month Forward Rate ($/£) 1.6100 – 1.6140

Rates of interest in Money Market:

Deposit Loan
$ 7% 9%
£ 5% 8%

Compute and show how a money market hedge can be put in place. Compare and contrast
the outcome with a forward contract.
(Study Material & PM)
Solution:

Option 1 : Forward Cover

Sell $ 3,50,000 at 3 months FR

$ 3,50,000
Cash Inflows = = £ 2,16,852.54
1.6140

Option 2 :Money Market

− Amount to be borrowed from US money market @ 9% P.a. for 3 months

$ 350000
= = $ 3,42,298.29
1 + (0.09 × 3/12)

$ 3,42,298.29
− Sell $ 3,42,298.29 at SR = = £ 2,15,214.27
1.5905

− Invest £ 2,15,214.27 in UK Money market @ 5% for 3 months

Cash Inflows = £ 215.27 × [1 + (0.05 × 3/12)]

= £ 2,17,904.44.
Money Market cover is better due to higher cash Inflows.

3. Currency Future:-
− Currency future means future contract on currency.

− If we afraid from exchange rate rising, take long position.

− If we afraid from exchange rate falling, take short position.

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Question – 63
XYZ Ltd. is an export oriented business house based in Mumbai. The Company invoices in
customers’ currency. Its receipt of US $ 1,00,000 is due on September 1, 2009.

Market information as at June 1, 2009 is:

Exchange Rates Currency Futures

US $/₹ US $/₹ Contract size ₹4,72,000

Spot 0.02140 June 0.02126

1 Month Forward 0.02136 September 0.02118

3 Months Forward 0.02127

Initial Margin Interest Rates in India

June ₹ 10,000 7.50%

September ₹ 15,000 8.00%

On September 1, 2009 the spot rate US $Re. is 0.02133 and currency future rate is 0.02134.
Comment which of the following methods would be most advantageous for XYZ Ltd.

(a) Using forward contract

(b) Using currency futures

(c) Not hedging currency risks.

It may be assumed that variation in margin would be settled on the maturity of the futures
contract.

(Practice Manual)
Solution:

(a) Using forward Contract

Sell $ 1,00,000 at 3 month FR

$ 1,00,000
Cash Inflows = = ₹ 47,01,457
0.02127

Step 1 : Since $ is receivable, hence we afraid from $ falling but rate is given of ₹. If
means ₹ rising.

Therefore we should take long position on ₹ future at 0.02118.

Step 2 : No. of Contracts

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$1,00,000
₹ Equivalent $ 100000 = = ₹ 47,21,435
0.02118

$ 47,21,435
No. of Contracts = = 10 contract long
4,72,000

Step 3: Variation Margin

On maturity currency future rate is 0.02134, hence gain on long position on

currency future

Variation Margin = ($ 0.02134 − $ 0.02118) × 472000 × 10

= $ 755.20

₹755.20
₹ Equivalent $ 755.20 = $ 755.20 = = ₹35,405
0.02133

Step 4 : Cash : Inflows

$ 1,00,000
Sell $ 1,00,000 at 3 months SR =
0.02133

= ₹46,88,232

Opportunity cost on initial

Margin = (15,000 × 10) × 8% × 3/12 = (3000)

Variation Margin = 35,405

= ₹47,20,637

(c) No Hedging

Sell $ 1,00,000 at 3 months SR

₹1,00,000
Cash Inflows = = ₹46,88,232
0.02133

Currency future is the best due to higher cash Inflows.

Question – 68
Nitrogen Ltd, a UK company is in the process of negotiating an order amounting to €4 million
with a large German retailer on 6 months credit. If successful, this will be the first time that
Nitrogen Ltd has exported goods into the highly competitive German market. The following
three alternatives are being considered for managing the transaction risk before the order is
finalized.

(i) Invoice the German firm in Sterling using the current exchange rate to calculate the
invoice amount.

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(ii) Alternative of invoicing the German firm in € and using a forward foreign exchange
contract to hedge the transaction risk.

(iii) Invoice the German first in € and use sufficient 6 months sterling future contracts (to
the nearly whole number) to hedge the transaction risk.

Following data is available:

Spot Rate € 1.1750 - €1.1770/£

6 months forward premium 0.55-0.60 Euro Cents

6 months future contract is currently trading at €1.1760/£

6 months future contract size is £62500

Spot rate and 6 months future rate €1.1785/£

Required:

(a) Calculate to the nearest £ the receipt for Nitrogen Ltd, under each of the three
proposals.

(b) In your opinion, which alternative would you consider to be the most appropriate and
the reason thereof.

(Study Material, PM & Exam November – 2011)

Solution:

(i) Invoicing

Invoice the German firm in £ current exchange rate

€/£ = 1.1770

€40,00,000
Invoice amount in £ = = £ 33,98,471
1.1770
(ii) Forward Cover

Sell €40,00,000 at 6 months FR

FR = (1.1770 + 0.0060) = 1.1830

€40,00,000
Cash inflows = = £ 33,81,234
1.1830
(iii) Currency Future

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Step I: Since € receivable & we afraid from € falling but rate is given of £, means
afraid from £ rising hence we take long position of £ future at £
1.1760/£.

Step II: No. of Contract

€40,00,000
£ equivalent €40,00,000 =
1.1760
= €34,01,360

€34,01,360
No. of Contract =
€62,500
= 54 Contract Lag

Step III: Variation Margin

Currency future rate on settlement rate in €1.1760/£, hence gain on

long position (€1.1785 - €1.1765) × 54× €62,500 = €8,438

€8,438
£ Equivalent €8,438 = = £ 7,160
1.1785
Step IV: Cash Inflows

€40,00,000
Sell 6,40,00,000 at 6 months SR =
1.1785
= £33,94,145

Variation Margin = £7,160

= £ 34,01,305

Currency future is the best option due to highest cash inflow.

Question – 70
ABC Technologic is expecting to receive a sum of US$ 4,00,000 after 3 months. The company
decided to go for future contract to hedge against the risk. The standard size of future
contract available in the market is $1000. As on date spot and futures $ contract are quoting
at ₹44.00 &₹45.00 respectively. Suppose after 3 months the company closes out its position
futures are quoting at ₹44.50 and spot rate is also quoting at ₹44.50. You are required to
calculate effective realization for the company while selling the receivable. Also calculate how
company has been benefitted by using the future option.
(Study Material & PM)
Solution:

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Currency Future

Step 1 : Since $ is receivable, & we afraids from $ falling hence we should take short
position of $ future at ₹/$45.

Therefore we should take long position on ₹ future at 0.02118.

Step 2 : No. of Contracts

$ 4,00,000
No. of Contracts = = ₹400 Contract short
$ 1000

Step 3: Variation Margin

$ future rate on settlement date is 44.50, hence gain on short position

Variation Margin = (₹45 – 44.50) × 400 × $ 1000

= ₹2,00,000

Step 4 : Cash : Inflows

Sell $ 400000 at 3 months SR

($ 400000 ×44.50) = ₹1,78,00,000

(+) Variation Margin = ₹2,00,000

Cash Inflows = ₹1,80,00,000

Effective Realization per $ = ₹1,80,00,000

= $4,00,000

= ₹45

(IV) Currency Option

Question – 71
XYZ Ltd. a US firm will need £ 3,00,000 in 180 days. In this connection, the following
information is available:

Spot rate 1 £ = $ 2.00

180 days forward rate of £ as of today = $1.96

Interest rates are as follows:

U.K. US
180 days deposit rate 4.5% 5%
180 days borrowing rate 5% 5.5%

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A call option on £ that expires in 180 days has an exercise price of $ 1.97 and a premium of
$ 0.04.

XYZ Ltd. has forecasted the spot rates 180 days hence as below:

Future rate Probability

$ 1.91 25%
$ 1.95 60%
$ 2.05 15%

Which of the following strategies would be most preferable to XYZ Ltd.?

(a) A forward contract;

(b) A money market hedge;
(c) An option contract;
(d) No hedging.

Show calculations in each case

(Study Material, PM & Exam November - 2015)

Solution:

(a) Forward Cover

Buy £ 300000 at 180 day FR

£ 3,00,000 × 1.96 = $ 5,88,000

(b) By Money Market Cover

− Calculation of Amount to be inverted in UK money market @ 4.5% for 180 days

£ 3,00,000
= = £ 2,87,081.34
1.045

− $ required to buy £ 287081.34 at SR

£ 287081.34 × 2.00 = $ 574162.68

− Borrow $ 574162.68 @ 5.5% for 180 days from US Money marketCash outflow

= $ 574162.68 (1.055)

= $ 605741.63

(c) Option Contract

Call option E $ 1.97 Premium = $ 0.04

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Price Exercised or Cost of Premium Effective Cash Probability Expected

not $ Cost per outflows Cash
$ £ 300000 × outflows
EC
1.91 No $ 1.91 $ 0.04 $ 1.95 $ 5,85,000 25% 1,46,250
1.95 No $ 1.95 $ 0.04 $ 1.99 $ 5,97,000 60% 3,58,200
2.01 Yes $ 1.97 $ 0.04 $ 2.01 $ 603000 15% 90,450
$ 5,94,900

(+) Opportunity Cost of premium $ 660

(£ 3,00,000 × 0.04) × 5.5%
C.o $ 5,95,560
(d) No. hedging
Expected SR = (1.91 × 0.25) + (1.95 × 0.60) + (1.97 ×0.15)

= 1.943

Cash outlaws = £ 3,00,000 × 1.943

= $ 5,82,900

No hedging is the best due to lower Cash outflows.

Question – 73
A Ltd. of U.K. has imported some chemical worth of USD 3,64,897 from one of the U.S.
suppliers. The amount is payable in six months time. The relevant spot and forward rates
are:
Spot rate USD 1.5617−1.5673

6 months’ forward rate USD 1.5455 –1.5609

The borrowing rates in U.K. and U.S. are 7% and 6% respectively and the deposit rates are
5.5% and 4.5% respectively.

Currency options are available under which one option contract is for GBP 12,500. The
option premium for GBP at a strike price of USD 1.70/GBP is USD 0.037 (call option) and
USD 0.096 (put option) for 6 months period.

The company has 3 choices:

(i) Forward cover

(ii) Money market cover, and

(iii) Currency option

Which of the alternatives is preferable by the company?

(Study Material & PM)

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Solution:

Option 1: Forward Cover

Buy $ 3,64,897 at 6 months FR

$ 364897
Cash outflows = = 236103
1.5455

Option 2: Money Market Cover

− Amount to be invested in US money market @ 4.5% p.a. for 6

$ 3,64,897
month = $ 356867
1+ (0.045 ×6/12)

= £ 228512

− Borrow £ 228512 from UK money market @ 7% P.a. for 6 months

Cash outflows = £ 228512 × [1 + (0.07 × 6/12)]

= £ 236510

Option 3: Currency option

Step 1: Since $ payables & we afraid from $ rising but rare was given of £.

It means £ falling hence we should we should buy put option & we have
the right to sell £ at EP $/£ $ 1.70.

Step 2: No. of Contract

$ 3,64,897
£ Equivalent $ 364897 =
1.70

= £ 2,14,645

£ 2,14,645
No. of Contracts =
£ 12,500

= 17.17 “Means 17 Contract”

Step 3: Cash outflows

Covered through option Hedging

Put option EP = $/£ = $ 1.70

Contract singe = £ 12500, No = 17 contract

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Total contract Amt in £ = 12,500 × 17 Contract= £ 2,12,500

Covered through option hedging (£ 2,12,500 × 1.70) = $ 3,61,250

It means total £ required to buy $ 3,61,250 = £ 2,12,500.

Covered through forward contract

Uncovered portion = $ 3,64,807 − $ 3,61,250

= $ 3,647

$ 3,647
Buy $ 3,647 at 6 months FR = = £ 2,360.
1.5455

Premium Amount

Premium of put option = $ 0.0096 per £

Contract SGC = £ 12,500, No. of Contract = 17

Total premium is $ = $ 0.096 × 12,500 × 17 = $ 20,400

$ 20,400
Buy $ 20,400 at SR =
1.5617
= £ 13,063

Total Cash outflows = £ 2,12,500 + £ 2,360 + £ 13,063

= £ 2,27,923.

Currency option is best due to lower cash outflows.

Question – 74
XYZ, an Indian firm, will need to pay JAPANESE YEN (JY) 5,00,000 on 30 th June. In order to
hedge the risk involved in foreign currency transaction, the firm is considering two
alternative methods i.e. forward market cover and currency option contract.

On 1st April, following quotations (JY/INR) are made available:

Spot 3 months forward

1.9516/1.9711. 1.9726./1.9923

The prices for forex currency option on purchase are as follows:

Strike Price JY 2.125

Call option (June) JY 0.047

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Put option (June) JY 0.098

For excess or balance of JY covered, the firm would use forward rate as future spot rate. You
are required to recommend cheaper hedging alternative for XYZ.

(Study Material, PM & Exam November – 2015)

Solution:

Option 1: Forward Cover

Buy ¥ 5,00,000 at 3 months FR

¥5,00,000
Cash Outflows = = ₹ 2,53,472
1.9726
Option 2: Currency Option

Step 1: Since ¥ payable & we afraid from ¥ rising but rate was given of ₹
means ₹ falling, hence we buy put option at

EP ¥/₹ = ¥ 2.125

Step 2: Cash Outflows

Option Hedging

Exposure = ¥ 5,00,000

EP = ¥/₹ = 2.125

¥
= ₹ 2,35,294
2.125
Premium,

Premium of put option = JY 0.098 per ₹

Total premium (¥) = 0.098 × 2,35,294

= ¥ 23,059

¥23,059
Buy ¥ 23,059 at SR =
1.9516
= ₹ 11,815

Currency Option = 2,47,109

Currency option is better due to lower cash outflows.

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Question – 75
An American firm is under obligation to pay interests of Can$ 10,10,000 and Can$ 7,05,000
on 31st July and 30th September respectively. The Firm is risk averse and its policy is to
hedge the risks involved in all foreign currency transactions. The Finance Manager of thefirm
is thinking of hedging the risk considering two methods i.e. fixed forward or option contracts.

It is now June 30. Following quotations regarding rates of exchange, US$ per Can$, from the
firm’s bank were obtained:

Spot 1 Month Forward 3 Months Forward

0.9284-0.9288 0.9301 0.9356

Price for a Can$ /US$ option on a U.S. stock exchange (cents per Can$, payable on purchase
of the option, contract size Can$ 50,000) are as follows:

Strike Price Calls Puts

(USD/Can$) July Sept. July Sept.
0.93 1.56 2.56 0.88 1.75
0.94 1.02 NA NA NA
0.95 0.65 1.64 1.92 2.34

According to the suggestion of finance manager if options are to be used, one month option
should be bought at a strike price of 94 cents and three month option at a strike price of 95
cents and for the remainder uncovered by the options the firm would bear the risk itself. For
this, it would use forward rate as the best estimate of spot. Transaction costs are ignored.

Recommend, which of the above two methods would be appropriate for the American
firm to hedge its foreign exchange risk on the two interest payments.

(Study Material, PM, MTP March – 2022 & Exam Nov - 2013)
Solution:

Option 1: Forward Cover

1 month exposure

Cash outflows = Can $ 10,10,000 × 0.9301

= $ 9,39,401

3 months Exposure

Cash outflows = $ 7,05,000 × 0.9356

= $ 6,59,598

Currency option

Step 1:Since Can $ payable & we afraid from Con $ rising hence we should call option.

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For 1 month EP $ 0.94 & Premium = $ 0.0102

For 3 months EP $ 0.95 & premium = 0.0164

Step 2: No. of Contracts

Can $ 1,01,000
1 Month = = 20 Contracts
Can $ 50,000

Can $ 7,05,000
3 Month = = 14 Contracts
Can $ 50,000

Step 3: Cash Outflows

1 Month 3 Month
: Option Hedging 20 Contract × Can $ 50,000 14 contract× Can $ 50,000
Can $ 10,00,000 × 0.94 Can $ 7,00,000 × 0.95
US $ 9,40,000 US $ 6,65,000
: Uncovered Position Uncovered = Can $ Uncovered = 7,05,000 –
Using forward cover 1,01,000− Can $ 10,00,000 7,00,000
Can $ 10,000 × 0.9301 Can $ 5000 × 0.9356
US $ 9301 US $ 4678
: Premium $ 0.0102 per Can $ Can $ $ 0.0164 per Can $ Can $
10,00,000 × 0.0102 7,00,000 × 0.0164
= US $ 10,200 US $ 11,480
US $ 9,59,501 US $ 6,81,158

Forward Cover is better due to lower cash outflows.

Question – 78
XYZ Ltd. has imported goods to the extent of US$ 8 Million. The payment terms are as under:

(a) 1% discount if full amount is paid immediately; or

(b) 60 days interest free credit. However, in case of a further delay up to 30 days, interest
at the rate of 8% p.a. will be charged for additional days after 60 days. M/s XYZ Ltd.
has ₹ 25 Lakh available and for remaining it has an offer from bank for a loan up to 90
days @ 9.0% p.a.

The quotes for foreign exchange are as follows:

Spot Rate INR/ US$ (buying) ₹ 66.98

60 days Forward Rate INR/ US$ (buying) ₹ 67.16

90 days Forward Rate INR/ US$ (buying) ₹ 68.03

Advise which one of the following options would be better for XYZ Ltd.

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(i) Pay immediately after utilizing cash available and for balance amount take 90 days
loan from bank.

(ii) Pay the supplier on 60th day and avail bank’s loan (after utilizing cash) for 30 days.

(iii) Avail supplier offer of 90 days credit and utilize cash available.

Further presume that the cash available with XYZ Ltd. will fetch a return of 4% p.a. in India
till it is utilized.

Assume year has 360 days. Ignore Taxation.

Compute your working upto four decimals and cash flows in Crore.

(RTP November - 2021)

Solution:

Option 1: Pay Immediately $ Payables after discount ($ 8M − $ 0.08) = $ 7.92M

Rupees required

Rupees required to buy $ 7.92 M at SR

$ 7.92 M × 66.98 = ₹ 530. 486 M = ₹ 53.04816 Cr.

(−) Cash Available = ₹ 0.25 Cr.

Fund required = ₹ 52.7982 Cr.

Borrow ₹ 52.7982 Cr @ 9% P.a. for 90 days

90
Cash outflows = ₹ 52.7982 × 1+ 0.09 ×
360

= ₹53.9862 Cr.

Option 2: Pay in 60 days

$ payable = $ 8 M

₹ required to buy $ 8 M at 60 days RR

$ 8 M × 67.16 = ₹ 53.728 Cr

(−) Available Amt

60
0.25 × 1+ 0.04 × = ₹ 0.2517 Cr.
360

= ₹ 53.4763 Cr.

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Borrow ₹ 53.4763 or @ 8% P.a. for 30 day cash outflows

30
= ₹ 53.4763 × 1+ 0.09 ×
360

= ₹ 53.8774 Cr.

Option 3: Pay in 90 days

$ payable with Interest

30
=$8× 1+ 0.08 × 360

= $ 8.0533 Cr.

Rupees required to buy $ 8.0533 at 90 days FR

$ 8.0533 × 68.03 = ₹ 54.7866 Cr

(−) Available Cash

90
0.25 Cr. × 1+ 0.04 ×
360
= ₹ 0.2525 Cr.

Cash outflows = ₹ 54.5341

Pay immediately is the best due to lower cash Inflows.

(7) Cancellation of Forward Contract

(1) Cancellation & Extension of Forward Contract.

(2) Provision of Overdue Forward Contract.

(3) Early Delivery.

(1) Cancellation &Extension of Forward Contract.

Example – 77
Ram had entered into forward to contract buy $1,00,000 on due date 01/04/2022 at ₹75.00.
On maturity date 01/04/2022 contract cancelled.

Inter-bank (SR) ₹/$ = ₹ 72.00/72.25

Margin = 0.10%

Calculate cancellation charges.

Solution:

Calculation of Cancellation Charges

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Selling rate of Bank = ₹ 75.00

Buying Rate of Bank = ₹ 71.93

(72-0.10%)

Gain to Bank = ₹ 3.07

(×) Contract size = $ 1,00,000

Amount recoverable from customer ₹ 3,07,000 Cancellation charges

Example – 78
Ram had entered into forward contract to sell $1,00,000 at ₹75.50 after 3 months on
maturity, Contract cancelled.

Inter-bank rates (SR) ₹/$ = 72.50/72.25

Margin = 0.08%

Calculate amount payable to or recoverable from customer.

Solution:

Calculation of Amount payable to or recoverable from customer

Selling rate of Bank = ₹ 75.50

Buying Rate of Bank = ₹ 72.56

(72.50-0.08%)

Gain to customer = ₹2.94

(×) Contract size = $ 1,00,000

Amount payable from customer ₹ 2,94,000

(I) Cancellation on Maturity

Selling Contract of Bank:-Bank sells currency at FR & buys currency at SR of due date.

Buying Contract of Bank:-Banks buys currency at FR & sells at SR of due date.

Any difference between forward rate & spot rate is recoverable from customer or
payable to customer. If amount recoverable from customer then, it is called cancellation
charges.

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(i) Cancellation & Extension of Forward Contract

Example – 79
Selling contract of bank for $1,00,000 after 3 months @ 72.50 on 31/03/2022

Exchange rate on cancellation date: 31/01/2022

Inter-bank SR = ₹70.25/45

1 month swap = 20/25

2 months swap = 35/40 (31/03/2022)

3 months swap = 65/80

Margin = 0.10%

Calculate amount payable are recoverable from customer.

Solution:

Calculation of Amount payable/recoverable from customer

Selling rate of Bank = ₹ 75.50

(-)Buying Rate of Bank = ₹ 70.53

(70.60-0.1%)

Gain to Bank = ₹ 1.97

(×) Contract size = $ 1,00,000

Amount recoverable from customer ₹ 1,97,000

(II) Cancellation Before Maturity

Selling Contract Bank:-Banks sell currency at original FR & Buy currency at FR of due
date, available on cancellation date.

Buying Contract of Bank:-Banks buy currency at original FR & Sells currency at FR of due
date available on cancellation date.

Any difference between above rates is payable to or receivables from customers.

(III) Extension of Forward Contract

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In extension of forward contract, original forward contract shall be cancelled & New forward
contract shall be made for new due date.

Question – 87
Suppose you are a banker and one of your export customer has booked a US$ 1,00,000
forward sale contract for 2 months with you at the rate of ₹ 62.5200 and simultaneously you
covered yourself in the interbank market at 62.5900. However on due date, after 2
monthsyou customer comes to you and requests for cancellation of the contract and also
requests for extension of the contract by one month. On this date quotation for US$ in the
market was as follows:
Spot ₹ 62.7200/62.6800

1 month forward ₹ 62.6400/62.7400

Determine the extension charges payable by the customer assuming exchange margin of
0.10% on buying as well as selling.

Solution:

Calculation of Extension Charges

Buying rate of Bank ₹ 62.5200

(−) Selling Rate of Bank (62.7200 + 0.10%) ₹ 62.7825

= ₹ 62.7827

Gain to Bank ₹ 0.2625

(×) Contract size $ 1,00,000

Extension charger = ₹ 26,250

New forward Rate

Buying Rate (1 Month) ₹ 62.6400

(−) Margin 0.10%

62.5774

New FR 62.5775

Question – 89
NP and Co. has imported goods for US $ 7,00,000. The amount is payable after three
months. The company has also exported goods for US $ 4,50,000 and this amount is
receivable in two months. For receivable amount a forward contract is already taken at ₹
48.90.

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The market rates for Rupee and Dollar are as under:

Spot ₹ 48.50/70

Two months 25/30 points

Three months 40/45 points

The company wants to cover the risk and it has two options as under :

(A) To cover payables in the forward market and

(B) To lag the receivables by one month and cover the risk only for the net amount. No
interest for delaying the receivables is earned. Evaluate both the options if the cost of
Rupee Funds is 12%. Which option is preferable?

(Study Material, PM & Exam May – 2012)

Solution:

(A) Cover payable in forward Market

(i) Payable

Buy $ 700000 at 3 months FR = ₹ 3,44,05,000

(48.70 + 0.45) 49.15

(700000 × 49.15) C.O. (A) = ₹ 3,44,05,000

(ii) Receivable

Sell $ 4,50,000 at 48.90

(4,50,000 × 48.90) = ₹ 2,20,05,000

Interest (2,20,05,000 × 12% × 1/12) = ₹ 2,20,050

CI (B) ₹ 2,22,25,050

Net Cash outflows = ₹ 12179950

(A.B)

(B) Leg the receivables by one month forward contract cancelled

Buying rate of Bank ₹ 48.90

(−) Selling rate of Bank ₹ 49.00

(48.70 + 0.30) = 49.00

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Gain to Bank ₹ 0.10

(×) Contract size $ 4,50,000

Cancellation charge ₹ 45,000

Net $ payable after 3 months

$ payable = $ 7,00,000

(-) $ receivables = $ 4,50,000

Net $ payable = $ 2,50,000

Cash Outflows

Buy $ 2,50,000 at 3 months FR

($ 2,50,000 × 49.15) = ₹ 1,22,87,500

(+) Cancellation charges = ₹ 45,000

Cash Outflow = 1,23,32,500

Option A is better due to lower Cash outflows.

Example – 80
− Selling contract of bank @ ₹75.50 on maturity customer request to bank for extension of
forward contract for 1 month.

− Exchange rate on due date.

Inter-bank SR = 72.75/95

1 month swap = 45/25

2 month swap = 35/20

Contract size = $ 1,00,000

Margin = 0.08%

(i) Calculate extension charges.

(ii) New forward rate.

Solution:

i) Calculation of Emersion Charges

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Selling rate of Bank = ₹75.50

Buying Rate of Bank = ₹72.69

(72.75-0.08%)

Gain to Bank = ₹2.81

(×) Contract size = $1,00,000

New Emersion Rate ₹2,81,000

ii) New FR : SR 72.95

(+) 1 Month swap 0.25

Inter Bank 73.20

(+) Margin 0.08%

New forward rate 73.26

(2) Automatic Cancellation

Provisions of automatic cancellation by RBI

(i) The rules for settlement are:

− Contract is automatically cancelled either on the date customer comes or on the

3rd day after due date whichever is earlier.

− Calculate loss on cancellation.

(ii) Calculate swap loss.

(iii) Calculate net cash outflow for the bank on cancellation date and calculate interest on
cash outlay from cancellation date to due date.

(ii) Overdue Forward Contract

Question – 90
An importer booked a forward contract with his bank on 10th April for USD 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 13th June were:

10th June 13th June

Spot USD 1= ₹ 63.8000/8200 ₹ 63.6800/7200

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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%. The importer requested on
14th 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:

(i) Cancellation rate

(ii) Amount payable on $ 2,00,000
(iii) Swap loss
(iv) Interest on outlay of funds, if any
(v) New contract rate
(vi) Total Cost

Solution:

i) Cancellation rate
Buying rate of Bank (13/6) = ₹63.6800
(-) Margin = 0.1%
Customer Rate = ₹63.6163
Rounded off = ₹63.6175
ii) Cancellation charges

Selling rate of Bank ₹64.4000

(-)Buying rate of Bank ₹63.6175

Gain to Bank 0.7825

(×) Contract size $2,00,000

Amount payable by customer ₹1,56,500

* If gain to customer than amount can not be paid to customer.

iii) Swap Loss

On 10th June Bank Sell spot to other Bank & buy forward from other Bank

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Sell Spot ₹63.8000

(-)Buy forward ₹63.9500

Swap loss ₹0.15

(×) Contract size $2,00,000

Swap Loss ₹30,000

{vxj Swap Gain gksrk rks Ram dks Transfer ugha djrsA}

iv) Interest on outlay of fund

On 10th June Bank buy $2,00,000 at cover rate hence cash outflows & sell $2,00,000
at SR

Cash Outflows = ($2,00,000 × 64.2800) = ₹1,28,56,000

Cash Inflows = ($2,00,000 × 63.8000) = ₹1,27,60,000

Net Cash outflows = ₹96,000

Interest on Net Cash outlay (₹96,000 ×12% × 3/360) = ₹96

v) New Contract Rate (Available 13/6)

Selling Rate of Bank ₹64.2500

(+) Margin 0.10%

Customer Rate ₹64.3142

Rounded off ₹64.3150

vi) Total Cast

Cancellation Charger ₹1,56,500

(+) Swap Loss ₹30,000

(+) Interest on outlay of fund 96

₹186596

(3)Early Delivery

(i) Old contract with the customer is not cancelled it is executed at the old rate on the
early delivery date.

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(ii) Bank has to enter into a swap.

(iii) Swap gain/loss shall be transferred to/charged from the customer.

(iv) Calculate net inflow/outflow for the bank on the early delivery date.

Bank will pay/charge interest on that.

Compare old contractual rate with spot rate of the swap.

Question – 94
On 19th January, Bank A entered into forward contract with a customer for a forward sale of
US $ 7,000, delivery 20 th March at ₹ 46.67. On the same day, it covered its position by
buying forward from the market due 19th March, at the rate of ₹46.655. On 19th February,
the customer approaches the bank and requests for early delivery of US $. Rates prevailing in
the interbank markets on that date are as under:

Spot (₹/$) 46.5725/5800

March 46.3550/3650

Interest on outflow of funds is 16 % and on inflow of funds is 12 %.

Flat charges for early delivery are ₹ 100.

What is the amount that would be recovered form the customer on the transaction?

Note: Calculation should be made on months basis than on days basis.

(Exam November – 2018)

Solution:

Amount receivable from customer sell $7000 at contracted rate ($7000 ×46.67)

= ₹326690

Swap Loss/Gain

Bank enter into buy-sell swap where Bank buy spot from other bank & sell 1 month forward
to other bank

Buy spot ₹46.5800

Sell forward ₹46.3550

Swap loss: ₹0.225

(×) Contract size $7000

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Swap lose ₹1575

{vxj Swap gain gksrk rks customer dks Transfer djuk iM+rk}

* Interest on outlay of fund/Inflow of fund (19/2)

Cash outflows on buy spot ($7,000 ×46.5800) = ₹3,26,060

Cash Inflows on sell to customer ($7000 ×46.67) = ₹326690

Net Cash Inflows = ₹630

Interest on Inflows of fund = ₹630 × 12% × 1/12 = ₹6.30

* Interest on Inflow of fund ₹6.30 Payable to Customer.

Total Amount recoverable from customer

Selling Amount = ₹326690

(+) Swap Loss = 1575

(-) Interest on inflow of fund = (6.30)

Total = ₹328258.70

(8) Foreign Currency A/C

There are three types of foreign currency A/c

(1) NOSTRO A/C

(2) VOSTRO A/C

(3) LORO A/C

(1) NOSTRO A/C

There are two statement are prepared in NOSTRO A/C

(i) Cash position (NOSTRO A/C)

(ii) Exchange position

Question – 96
You as a dealer in foreign exchange have the following position in Swiss Francs on 31 st
October, 2009:

Swiss Francs
Balance in the Nostro A/c credit 1,00,000

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Opening position overbought 50,000

Purchased a bill on Zurich 80,000
Sold forward TT 60,000
Forward purchase contract cancelled 30,000
Remitted by TT 75,000
Draft on Zurich cancelled 30,000

What steps would you take, if you are required to maintain a credit Balance of Swiss Francs
30,000 in the Nostro A/c and keep as overbought position on Swiss Francs 10,000?

(Study Material &n MTP March – 2022)

Solution:

(i) Nostro A/C

Swiss Francs
Debit Credit
Opening Balance - 1,00,000
Remitted by TT 75,000 -
Total 75,000 1,00,000
Credit Balance 25,000 -

(ii) Exchange Position

Swiss Francs
Long Short
Opening Position 50,000 -
Bill purchased 80,000 -
Sod forward - 6,000
Forward purchased contract - 30,000
Cancelled - -
Remitted by TT - 75,000
Draft Cancelled 3,000 1,65,000
Oversold Position 5,000 -

* In Order to maintain SF 30,000 in Nostro A/c spot buy SF 5,000

* Due to above transaction, Exchange position is nit but we have to maintain

overbought position SF 10,000 than forward buy SF 10,000.

(9) Currency of Borrowing

Question – 101
Sun Ltd. is planning to import equipment from Japan at a cost of 3,400 lakh yen. The
company may avail loans at 18 percent per annum with quarterly rests with which it can
import the equipment. The company has also an offer from Osaka branch of an India based

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bank extending credit of 180 days at 2 percent per annum against opening of an
irrecoverable letter of credit.

Additional information:

Present exchange rate ₹ 100 = 340 yen

180 day’s forward rate ₹ 100 = 345 yen

Commission charges for letter of credit at 2 percent per 12 months.

Advice the company whether the offer from the foreign branch should be accepted.

(Study Material, PM & Exam January – 2021)

Solution:

Option I:Loan from Indian Bank

¥ Payable = ¥ 3,400 Lacs at spot rate

¥/₹ = 3.40

¥ 3,400/ 3.40 = ₹ 1,000 L

Borrow ₹ 10,00 Lacs from Indian Bank @ 18% P.a. Quarterly compounded 6 Months

Cash Outflows after 6 months

2
= 100 × 1+ 0.18 ×3/12

= ₹ 1092.025 Lacs

Option II: Loan from Osaka Branch

− Borrow ¥ 3400 lacs from Osaka Branch@ 2% P.a. for 6 months.

− Cash outflows after 6 months in yen = ¥ 3,400 (1.01) = ¥ 3434 Lacs

− Buy ¥ 3434 Lacs at 180 days FR ¥/₹ = 3.45

Cash outflows in ₹ after 6 months

¥ 3,434
= = ₹ 995.36 lacs
3.45

Commission

Loan Amt in ¥ = ¥ 3400 L

¥ 3,400
Loan Amt in ₹ at SR =
3.40

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= ₹1,000 Lacs

Commission = ₹1,000 × 1% = ₹ 10 Lacs

2
= 10 × 1+ 0.18 ×3/12 = ₹10.92 Lacs

₹ 1,006.28 Lacs

Loan from Osaka Branch is better due to lower cash outflows.

(10) Currency Of Investment

Question – 106
Your bank’s 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 1.5350/90

1 month 15/18

2 months 30/35

3 months 80/85

London on Frankfurt

Spot 1.8260/90

1 month 60/55

2 months 95/90

3 months 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?

(Study Material, PM, RTP Nov – 2021 & Exam Nov - 2013)

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Solution:

(i) Investment in London

− Convert $ 5,00,000 in £ at SR $/£ = 1.5390

$ 5,00,000
= £ 3,24,886.29
1.5390

− Invest £ 3,24,886.29 in London @ 5% P.a. for 3 Months.

Cash Inflows after 3 months

£ 3,24,886.29 × 1+ 0.05 ×3/12 = £ 3,28,947.37

− Buy $ 5,05,000 at 3 months FR $/£ (1.5350 + 0.0080) = 1.543

$ 5,05,000
Cash Outflows = =£ 3,27,284.51
1.543

Gain = £ 3,28,947.37 − £ 3,27,284.51

= £ 1663

(ii) Investment in New York

Invest $ 5,00,000 @ 8% P.a for 3 Months

Cash Inflows in $ = $ 5,00,000 × 1+ 0.08 ×3/12

= $ 5,10,000

Cash outflows in $ = $ 5,05,000

Gain is $ = $ 5,000

Sell $ 5,000 at 3 months FR & Buy £ $/£ (1.5390 + 0.0085) = 1.5475

$ 5,000
= £ 3231
1.5475

(iii) Investment in €

First buy £ from $ = $/£ = 1.5390

Thereafter sell £ & Buy € = €/£ = 1.8260

1.5390
$/€ = = 0.8428
1.8260

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$ 5,00,000
Convert $ 5,00,000 in € = = € 5,93,260
0.8428

Invest € 5,93,260 in Frankfort @ 3% P.a. for 3 months

Cash Inflows in € = € 5,93,260 × 1+ 0.03 ×3/12

= € 5,97,709

Buy £ from € 5,97,709 at 3 months FR €/£ = (1.8290 – 0.0145) = 1.815

€ 5,97,709
= £ 3,29,316
1.815

Buy $ 5,05,000 from £ at

$ 5,05,000
3 months FR = £ 3,27,284
1.543

Gain = £ 3,29,316 − £3,27,284 = £ 2,031

The investment in New York is best due to highest gain.

Question – 108
Suppose 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 725,000 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 998,077 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 2.3295 − 2.3326

91 day Pts 0.0242 − 0.0228

Interest rates for the Deposits

Amount of Currency 91 Days Interest Rate % p.a.

£ € CHF
0 – 1,00,000 1 ¼ 0
1,00,001 – 5,00,000 2 1½ ¼
5,00,001 – 10,00,000 4 2 ½

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Over 10,00,000 5.375 3 1

(Practice Manual)

Solution:

i) Without Swapping

UK firm

Invest £ 75,000 @ 1% P.a. for 91 days £ 75,000 × [1 + (0.01× 91/360)] = £ 75,189.58

Amsterdam

Invest € 7,25,000 @ 2% P.a. for 91 days € 7,25,000 × [1 + (0.02 × 91/360)]

= € 7,28,665.28

Buy £ at 91 days FR £/€ (0.6858+0.0037) = 0.6895

€ 7,28,665.28 × 0.6895 = ₹ 5,02,414.71

With swap

Invest CHF 9,98,077 @ 0.5% for 91 days

91
Cash Inflows CHF 9,98,077 × 1 + (0.005 × =CHF 9,99,338.46
360

Sell CHF & buy £ at 3 months FR CHF/£ (2.3326-0.0228) = 2.3098

CHF 9,99,338.46
= £ 4,32,651.51
2.3098
Total £ at the end of 91 days without swiping 75,189.58 + 5,02,414.71 + 4,32,651.51

= £10,10,255.80

Swapping

* UK £ 75,000

* Amsterdam

Sell € 7,25,000 at SR £/€ 0.6858 €7,25,000 × 0.6858

= £ 4,97,205

* Swap

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CHF 9,98,077
Sell CHF 998077 at SR CHF/£ 2.3326 = £ 4,27,881.76
2.3326

Total £ Available Total = £ 1,00,00,086.76

Invest £ @ 5.375% P.a. for 91 days

91
Cash Inflows £ 10,00,086.76× 1 + (0.05375 × 360

= £ 10,13,674.74

Swapping is better due to higher Cash Inflows.

Question – 110
The Treasury desk of a global bank incorporated in UK wants to invest GBP 200 Million on
1st January, 2019 for a period of 6 months and has the following options:

(1) The equity trading desk in Japan wants to invest the entire GBP 200 million in high
dividend yielding Japanese securities that would earn a dividend income of JPY 1,182
million. The dividends are declared and paid on 29 th June. Post dividend, the
securities are expected to quote at a 2% discount. The desk also plans to earn JPY 10
million on a stock borrow lending activity because of this investment. The securities
are to be sold on June 29th with a T+1 settlement and the amount remitted back to
the Treasury in London.

(2) The fixed income desk of US proposed to invest the amount in 6 months G-Secs that
provides a return of 5% p.a.

The exchange rates are as follows:

Currency Pair 1st January, 2019 30th Jun, 2019

(Spot) (Forward)
GBP – JPY 148.0002 150.0000
GBP – USD 1.28000 1.30331

As a treasure, advise the bank on the best investment option. What would be your
decision from a risk perspective? You may ignore taxation.

(Exam November – 2018)

Solution:

(i) Investment in Japan

Buy yen at SR ¥/£ = 148.0002

£ 200 M × 148.0002 = ¥ 29,600.04 M

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Cash Inflows After 6 months in yen

Dividend Income JPY1,182 M

Income from stock Lending JPY10 M

Sales of Equity (¥ 2,96,000.04 × 0.98) JPY2,90,080 M

¥ 30,200.04 M

Buy £ at 6 month FR = ¥/£ 150

¥ 30,200.04
Cash Inflow in £ =
150

= £ 201.33 M

Income = £ 201.33 - £ 200 = 1.33M

(ii) Investment in US

− Buy $ at SR $/£ 1.2800

£ 200 × 1.28 = $ 2.56M

− Invest $ 256 M @ 5% P.a. in G. Sec for 6 months

Cash Inflows in $

$ 256 × [1 + (0.05 × 6/12)] = $ 262.40 M

Sell $ 262.40 M at 6 months FR = $/£ 1.30331

$ 262.40
Cash Inflow in £ = = £ 201.33 M
1.30331
Income = £ 201.33 - £ 200 = 1.33M.

Income in both alternatives are same & investment can be made anywhere but
on the basis of Risk Investment in US is better because G. Securities in US has
lower Risk than equity of Japan.

(11) INTERNATIONAL CASH MANAGEMENT

Question – 112
AMK Ltd. an Indian based company has subsidiaries in U.S. and U.K.

Forecasts of surplus funds for the next 30 days from two subsidiaries are as below:

U.S. $12.5 million

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U.K. £ 6 million

Following exchange rate information is 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 company’s point of view?

(Practice Manual)

Solution:

I Each company borrow/Invest Independently (₹ in 010)

Indian Company

30
₹ 5,00,000 1 + 0.064 × 360 = - ₹ 5,02,666.67+

30 $ 12,515.625
US Subsidiary $12,500 1 + 0.015 × 360 = = ₹5,76,756.91
0.0217

30 £6018 .50
UK £ 6,000 1 + 0.037 × 360 = = ₹4,01,233.33
0.0150
Cash Balance in ₹after 30 days ₹ 4,75,323.57

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II Cash Balance are pealed in India Immediately (000)

India -₹5,00,000

$ 12,500
USA = ₹ 5,81,395.35
0.0215
£ 6000
UK = ₹4,02,684.56
0.0149
Surplus 4,84,079.91

Invest in India

30
Cash Inflows = ₹4,84,079.91× 1 + 0.062 × 360
= ₹4,86,580.99

Option II is the best due to Higher Cash

(12) Currency Swap

Question – 113
Drilldip Inc. a US based company has a won a contract in India for drilling oil field. The
project will require an initial investment of ₹500 crore. The oil field along with equipments
will be sold to Indian Government for ₹740 crore in one year time. Since the Indian
Government will pay for the amount in Indian Rupee (₹) the company is worried about
exposure due exchange rate volatility.

You are required to:

(a) Construct a swap that will help the Drilldip to reduce the exchange rate risk.

(b) Assuming that Indian Government offers a swap at spot rate which is 1US$ = ₹50 in
one year, then should the company should opt for this option or should it just do
nothing. The spot rate after one year is expected to be 1US$ = ₹54. Further you may
also assume that the Drilldip can also take a US$ loan at 8% p.a.

(Study Material & PM)

Solution:

Drill dip Incorporation enter into Buy sell swap with Bank where it spot buy ₹ 500 Cr. &
forward sell ₹ 500 Cr. At ₹/$ 50 Profit in Swap Arrangement

₹500 Cr
Cash outflows today = = ($ 10 Cr.)
₹ 50

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₹500 Cr
Cash Inflow after 1 year = $ 10 Cr.
₹ 50

₹ 240
Remaining = ₹ 740-500 = = $ 4.44 Cr.
54

Cost of $ fund = $ 10 Cr × 8% = $ 0.8 Cr.

Profit = 3.64 Cr.

If drilldip not Enter into Swap

₹500 Cr
Cash outflows Today = = $ 10 Cr.
₹ 50

Cost of $ fund ($ 10 × 8%) = $ 0.8 Cr.

₹740 Cr
Cash Inflows = = $ 13.704 Cr.
₹54
Profit = 2.904 Cr.

Swap Arrangement is better due to Higher profit.

(13) Economic Exposure

Question – 114
M/s Omega Electronics Ltd. exports air conditioners to Germany by importing all the
components from Singapore. The company is exporting 2,400 units at a price of Euro 500
per unit. The cost of imported components is S$ 800 per unit. The fixed cost and other
variables cost per unit are ₹1,000 and ₹1,500 respectively. The cash flows in Foreign
currencies are due in six months. The current exchange rates are as follows:

₹/Euro 51.50/55

₹/S$ 27.20/25

After six months the exchange rates turn out as follows:

₹/Euro 52.00/05

₹/S$ 27.70/75

(A) You are required to calculate loss/gain due to transaction exposure.

(B) Based on the following additional information calculate the loss/gain due to
transaction and operating exposure if the contracted price of air conditioners is
₹25,000 :

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 FOREX REVISION
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(i) the current exchange rate changes to

₹/Euro 51.75/80

₹/S$ 27.10/15

(ii) Price elasticity of demand is estimated to be 1.5

(iii) Payments and receipts are to be settled at the end of six months.

(Study Material & PM)

Solution:

(i) Calculation of Transaction Exposure Current Exchange Rate

2400 unit × € 500 × 51.50 – 2400 × S $ 800 × 27.25 – 2400 × 2500

= ₹ 3480000

6 Months Exchange Rate

2400 unit × € 500 × 52 – 2400 × S $ 800 × 27.75 – 2400 × 2500

= ₹ 3120000

Loss due to transaction Exposure = ₹34,80,000 −₹31,20,000

= 3,60,000

If Current Exchange Rate Change then Calculation of Loss due to Transaction

Exposure

Current Exchange Rate

2,400 unit × 25,000 – 2,400 × S $ 800 × 27.15 – 2,400 × 2,500 = ₹ 18,72,000

6 Months Exchange Rate

2,400 unit × 25,000 – 2,400 × S $ 800 × 27.75 – 2400 × 2500 = ₹ 7,20,000

Loss due to transaction Exposure = 11,52,000

Calculation of New demand of Units Price of Unit of Germen customer at Old rate =
₹25,000
= € 485.44
51.50

₹ 25,000
Price of Unit at New Exchange Rate = = € 483.09
51.75

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 FOREX REVISION
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€ 485.44-€ 483.09
% Decrease in price = × 100
€ 485.44

= 0.48%

% Increase In demand = 0.48 × 1.5 = 0.72%

New Unit = 2400 × 0.72% = 17 Units

Total Units = 2400 + 17 = 2417 Units

Profit due to Increase in New units 6 Months

2,417 Unit × 25,000 – 24,17× S $ 800 × 27.75–2,400 × 1,000 – 2417 × 1500 =

Loss due to Economics = 18,72,000–7,42,100 Exposure

= 11,29,900.

Question – 117

ABC Ltd. of UK has exported goods worth Can $ 5,00,000 receivable in 6 months. The
exporter wants to hedge the receipt in the forward market. The following information is
available:

Spot Exchange Rate Can $ 2.5/£

Interest Rate in UK 12%

Interest Rate In Canada 15%

The forward rates truly reflect the interest rates differential. Find out the gain/loss to UK
exporter if Can $ spot rates (i) declines 2%, (ii) gains 4% or (iii) remains unchanged over next
6 months.

(Study Material & PM)

Solution:

F 1+rA
Calculation of FR as Per IRP =
S 1+rB
F 1.075
=
Can $ 2.5 1.06
F = Can $ 2.535

Can $ 5,00,000
Receipts Under Forward Cover = £1,97,238.66
2.535

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 FOREX REVISION
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Calculation of Gain/Loss

Can $/£ 2.50

i) If Can $ decline by 2% it means £ will appreciate by 2%

Can $/£ 2.5 × 1.02 = 2.55

Can $ 5,00,000
Convert Can $ 5,00,000 at 6 months SR = = £1,96,078.43
2.55
Receipts as per forward Cover = £1,97,238.66

Gain due to forward Cover = £ 1,160.23

ii) If Can $ Gains by 4% means £ depreciates by 4% 2.5 × 0.96 = 2.40

Can $ 5,00,000
Receipt Under 6 months SR = = £2,08,333.33
2.40
Receipt Under forward cover = £1,97,238.66

Loss due to forward cover = £11,094.67

iii) Remain Unchanged

Can $ 5,00,000
Receipt under 6 month SR = = £2,00,000
2.50
Receipt under forward cover = £1,97,238.66

Loss due to forward Cover = £2,761.34

Question – 117
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 management’s guidelines had to square – up the position when the 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

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 FOREX REVISION
MAY - 2023

What will be the gain or loss in the transaction?

(Study Material & PM)

Solution:

Calculation of Gain/loss (€)

Sell $ €1.4400

Buy $ €1.4450

Loss per $ €0.0050

(×) Contract Size $10,00,000

Loss (€) 65,000

Gain or Loss (₹)

First buy $ ₹/$ ₹31.4500

Thereafter buy € & Sell $ €/$ 1.4400

1
₹/€ 31.4500 ×
1.4400
₹21.84

€5,000 ×₹ 21.84 = ₹ 1,09,201

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