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FOREX MARKET

www.professoraugustin.com

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FOREX MARKET

EXCHANGE RATE

DOMESTIC

CURRENCY

DIRECT QUOTE

INDIRECT QUOTE

LINK BETWEEN

DIRECT&INDIRECTQUOTE

AMERICAN TERM

EUROPEAN TERM

BID

ASK TWO WAY QUOTE

SPREAD

CONVERTINGTWOWAY QUOTE

Arbitrage


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FOREX MARKET

CROSS RATE

SPOT RATE

FORWARD RATE

APPRECIATION

DEPRECIATON

COMPUTATION OF

APPRECIATIONAND

DEPRECIATION

SWAP POINTS

FORWARD RATE,

PREMIUM AND

DISCOUNT


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EXCHANGE RATE

THE PRICE OF ONE CURRENCY

VIEWED IN RELATION TO ANOTHER

CURRENCY IS CALLED EXCHANGE

RATE.

EXAMPLE- Re/$ 44.76 means

44.76=1USD


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3. DIRECT QUOTE

X UNITS OF DOMESTIC CURRENCY

EQUAL ONE UNIT OF FOREIGN

CURRENCY.

EXAMPLE- Rs44.20 per USD IS A

DIRECT QUOTE FOR USD IN INDIA


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4. INDIRECT QUOTE

THE DOMESTIC CURRENCY IS THE

COMMODITY WHICH IS BEING

BOUGHT AND SOLD.

COMMODITY COMES FIRST AND

PRICE NEXT.

EXAMPLE- Re1=.02 USD


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5.CONVERTION (D TO I)

RUPEES Rs44.20=1$- DIRECT QUOTE

INDIRECT QUOTE Re1= 1/44.20=.0227

? KRONER 0.1481KRONERS PERRUPEE

?SAUDI RIYAL(SAR) .08RIYAL PER

RUPEE ? GBP 83.27 RUPEES PER POUND.


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6. AMERICAN AND

EUROPEAN TERMS AMERICAN TERM IS DIRECT.

EUROPEAN TERM INDIRECT.

EXAMPLE-THE RATE $ 1.5 PER POUND IS

AN AMERICAN TERM. THE QUOTE $1= INR 45 IN EUROPEAN

TERM.

? AMERICA OR EUROPE.

(a) 3.419$ PER QUWAITI DINAR- IN USA ITIS A DIRECT MODE- AMERICAN TERMS.

EUROPEAN TERM- 1/AMRICAN TERM :.2925 KWD PER USD.


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7. SOLVE

(a) 7.760 HKD PER $

(b) 7.57 PER DANISH KRONER

Direct quoteAmerican term

1HKD=.128$ European term

.128Rs=1HKD Indirect quote


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ANSWERS

(a) PERSON IN AMERICA THE QUOTE ISFOREIGN CURRENCY PER UNIT OF HOMECURRENCY. HENSE IT IS INDIRECT MODE-EUROPEAN TERM

THE AMERICAN TERM: 1/EUROPEANTERM IS 1/7.760= .13 $ PER HKD(HONG-KONG) DOLLAR.

(b)THE QUOTE IS NEITHER EUROPEANNOR IN AMERICAN TERM SINCE DOLLARIS NOT ONE OF THE PAIR OF CURRENCIES.


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BID AND ASK

THE BANKS QUOTE OF BID AND ASK ISFROM THE BANKERS PERSPECTIVE.

BID= BUY

ASK=SELL IF THE BID RATE FOR USD IS 40 IT MEANS

THAT THE BANK IS READY TO BUY 1$ FORRs.40

IF THE ASK RATE IS FOR USD IS 41, ITMEANS THAT THE BANK IS (ASKING IFSOMEONE WILL BUY) SELLING 1$ FORRs.41.


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Three tier architecture

A) bottom tire- Money changers licenced by

RBI

B) Second tire-cooperative and Commercial

Bank licenced to maintain accounts for NRI

C) TOP TIER- Authoried dealers-Scheduled

Banks-full-fledged foreign exchange

business.


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Two way quote

BID QUOTE AND ASK QUOTE

Ex: Re/$- 40.4241.63

Rs.40.42-bid(buying)-( Bank point of view)

Rs.41.63-ask(selling) Rs.40.42=1$ means the quote is in india

Yen33= Re.1 means the quote is in Japan

If you want to buy, if you have $, you will getRs.40.42

If you want to sell Rs. and buy $ you part withRs.41.63.


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Spread

ASK MINUS BID=SPREAD

EX. 40-41

SPREAD=

Rs.41-40=Rs.1

Factors:a) Stability of the exchange rate

b) depth of the market-volume of transaction

High volume(deep market)-narrow spread

Low volume (thin market)-wider spread


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Problem

Indian would like to have travelers cheques: GBP-

STERLING 72.70-73.25

A) explain the quote

B) compute the spread

C) how much would you pay for purchasing 250

pounds in TCS?

D) If you have a balance of pounds 23 in travellerscheques , how many rupees would you receive if

the bank in india quotes 73.65-73.92?


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Answer

A)Bank buys at 72.70and Ask rate is 73.25

B)Spread=.55

C) 250*73.25=Rs.18312.50D)Rs.23*73.65=Rs.1693.95

Note: in practice all forex transactions are

rounded off to a rupee ie Rs.1694


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PROBLEM

CONSIDER THE FOLLOWINGQUOTATIONS IN MUMBAI

Rupee/UAE Dirham(AED)=12.69

Rupee/Swedish kroner(SEK)=5.49

Rupee/New Zealand Dollar(NZD)=25.35

Euro/INR=0.0198

Compute a)The quote for SEK/AED

b) Euro/NZD


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Solutions

A)SEK/AED=SEK/INR*INR/AED=.18*12

.69

=1 AED

B)

EURO/NZD=EURO/Re*Re/NZD=.0198*2

5.35=.50


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SPOT RATE

RATE OF EXCHANGE FOR IMMEDIATESETTLEMENT

IT IS SETTLED ON THE SECOND WORKING

DAY SATURDAY AND SUNDAY ARE HOLIDAYS

EX:SPOT RATE:Rs./$40.35-41.36 SUPPOSINGYOU HAVE 124000 DOLLAR RECEIVED ON

THURSDAY THE BANK WILL SETTLE124000*40.35=50,03,400 ON THEFOLLOWING MONDAY.


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FORWARD RATE

RATE CONTRACTED TODAY FOR

EXCHANGE OF CURRENCIES AT A

SPECIFIED FUTURE DATE

THERE IS A FORWARD BID AND

FORWARED ASK

CASH DELIVERY-ON THE SAME DAY

TOM DELIVERY-ON WORKING DAY

ON THE FOLLOWING DAY


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APPRICIATION AND

DEPRECIATION IF F>S IN A DIRECT QUOTE THE FOREIGN

CURRENCY IS APPRECIATING

Home depreciate

Indirect quote: Foreign depreciates and HOMEAPPRECIATES

Ex: 1. SPOT: SGD .O370=Re 1

IN SINGAPORE ; FORWARD RATE THREE

MONTHS HENCE 0.0360 SGD APPRECIATES OR DEPRECIATES?

SPOT USD 1.5865= 1 POUND IN UK.FORWARD 1 MONTH 1.5833 .

?DEPRECIATE OR APPRICIATEwww.professoraugustin.com

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SWAP POINTS

DIFFRENCE BETWEEN SPOT BID AND

FORWARD BID OR SPOT ASK AND

FORWARD ASK

?DIFFRENCE BETWEEN SPREAD AND

SWAP POINTS

Spot price 42.3-43.2

Forward price 43.2-44.1


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FORWARD RATE, PREMIUM

AND DISCOUNT IF SWAP ASK> SWAP BID-FOREIGN

CURRENCY IS APPRECIATING HENCE

ADD SWAP POINTS

IF SWAP ASK

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Determinents and select theories

of Exchange RatesGeneral facts:

Pound, Euro and US dollar are having

higher values than other currencies like

rupee, yen,franc etc.

What are the major factors?


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Factors

1. Inflation rates

2. Interest rates

3. Balance of payment position 4. Volume of international reserves

5. Level of activity and employment


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1.Inflation rates

If domestic inflation rate >foreign inflation rate-

domestic goods are costlier than foreign goods

It encourages import of foreign goods

Foreign goods are cheaper

More demand for foreign currencies

Foreign currencies are costlier

Decline in the value of domestic currencies


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If domestic inflation rate < foreign inflation

rate

Domestic goods are cheaper

Encourages export

Foreign exchange inflow increases

Domestic currency appreciates


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The purchasing power

parity(PPP) theory Goods of equal value in different countries are equated through an

exchange rate

Ex: If a book costs in USA say $2 but the same book is available in

India for Rs86 the exchange rate between these currencies should be

Rs.43/$

PPPr=Spot rate x [1+r(H)]/[1+r(F)]

= spot rate x P(H)/P(F)

Where PPPr=purchasing power rate

r(H) and r(F)-inflation in the home and foreign countries

P(H) and P(F)-price indices of home and foreign countries.


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example

Spot rate=Rs 42 The price index is 110 and

In US it is 6% what is new exchange rate?

42 x 110/106=43.5849


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2.Interest rates

If interest rate in home country( India 10%)>foreign country(USA 4%)

USA funds are likely to be attracted in India as theinvestor can earn better return in India rater thanIn USA

Flight of funds from USA to India

There will be more demand for rupees in America

causing appreciation for Indian rupeeMore dollar is required to buy rupees in America

which devalue US Dollar


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The Interest rate Parity theory

The premium or discount of one currency inrelation to the other should reflect theinterest rate differentials between the two

currencies.Forward rate = spot rate x[1 + I(F)]/[1

+I(H)]

Where I(F) and I(H) represent interest rateson foreign and home currencies.

What is the impact?


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Impact

Foreign currency is at a premium when

interest rate is higher in foreign country

than home

Home currency is at a discount


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3. Balance of payment position

Deficit balance of paymentsnot able to

meet the demand of such currency say

dollar leads to devalue of home currency

It discourages import as foreign goods

becomes costlier

It encourages export as domestic goods are

cheaper in foreign country


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Favourable balance of payments?

The value of such a country appreciates and

likely to appreciate


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4. Volume of International

Reserves/Foreign exchange It includes gold

The reserve supports or stabilizes whenever

currency depreciates.

Release or sell foreign exchange reserves so

that demand for foreign met so further

devaluation is reduced.

The monetary authority can with stand only

to the extend to the reserves in hand.


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5.Level of Activity and

employmentHigher level of economic activity and full

employment have good potential and

prospects of appreciation in the value of

currencies.


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conclusion

Low inflation rate

Higher interest rates

Surplus balance of paymentPossession of sizeable foreign exchange

reserves

Higher level of economic activityDo have positive or negative impact on

exchange rate?


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Positive impact


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conclusion

Higher inflation rate

Low interest rate

Big/persistent deficit in the balance ofpayments

Inadequate reserves with the monetary

authority

Low level of economic activity

What is the impact?


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answer

Depreciates exchange rates


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Excercise

See Exercise no.12 and 14


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Arbitrage

Act of buying currency in one market at

lower prices and selling it in another at

higher price.

It helps the arbitrageurs in the market to

earn profit without risk

It is a balancing operations that do not allow

the same currency to have varying rates indifferent forex markets.


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Types of arbitrage

Geographical

Triangular arbitrage


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Geographical arbitrage

Different prices quoted in two geographicalmarkets for the same currency

Tokyo and London

1.Observe the following:Rs/US $

London Rs.: 42.5730--42.61

Tokyo $: 42.6750 -- 42.6675Can make money out of it?


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Buy at London market at 42.6100 and sell thesame at Tokyo market for Rs.42.6350.

Suppose you buy from London for 100 millionRupees you can get 100 million/42.61=$2,346,866.932

Sell $ 2,346,866.932 in Tokyo market at Rs.42.6350 gives Rs.100,058,671.16

There are transaction costs involved.Note: selling price of one market should be higher

than buying price of another market.


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Exercise-2

The following are three quotes in three

forex markets

1$=Rs.48.3011 in Mumboi

1pound=Rs.77.1125 in London

1Pound=$1.6231 in Newyork.

Are there any arbitrage gains possible?Assume there are no transaction costs and

the arbitrageaur has $1,000,000.


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Answer-2

The cross rate between Mumboi and London with

respect to$/pound=77.1125/48.3011

=$1.5965/pound

But in newyork the price is quoted $1.6231 There is an opportunity to earn by buing indian

rupee in in Mumboi market and convert them into

pounds in London Market

Then convert pounds into dollors in NewYork

market.


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Answer-2 continues

Rs.48.3011X 1 million

dollor=Rs.48,301,100

Pounds=48,301,100/77.1125=626,371.8592

Dollors=626,371.8592X1.6231

=$1,016,664.164.

The gain=$16,664.164.


E i 3 bi i f d

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Exercise-3: arbitrage in forward

marketDetermine arbitrage gain from the following

data:

Spot rate Rs.78.10/pound

3 month forward rate Rs.78.60/pound

3 month interest rates:

Rupees: 5%; British pound :9%Assume Rs10 million borrowings or pound

200,000 as the case may be.


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Answer-3

Since forward rate is higher than the spot

rate pound is at a premium.

Percentage premium = (78.60-

78.10)X12X100/(78.10X3)=2.56%

Interest rate differential =9%-5%=4%

This helps to borrow from Indian market

and invest today in pounds in the spot

market


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Method -2

1.Borrow in Uk and invest such pounds

after converting them into rupees in India

2.After three months re convert the rupees

including the interest into pounds at forward

rate

3.Deduct the loan including interest from

step2

If step-2 is more than step-3 there is a gain.


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Exercise-4

Spot rate=78.10; interest rates India-5%;

interest rate in UK-9% (pounds); At what

forward rate the arbitrage is not possible?


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Answer-4

Spot rate =78.10

Add: 4% premium for three month

period(78.10 X 4/100) X3/12=0.781

Forward rate= 78.10-0.781=77.319

What is the principle used?


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Principle

The arbitrageur earns 4% extra interest to

pay 4% forward premium yielding him no

gain.


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Exercise-5

Spot rate-78.10; forward rate for three

months-Rs.77.50; rate of interest for

pounds-6% for three months.Rate of interest

in India-5%. Is there any arbitrage ?


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Answer-5

The British pound is at a forward discount of3.073% ie.(78.10-77.50)x 100/78.10x (12/3)100

Interest rate differential is 6%-5%=1%

There are arbitrage gain possibilities. Borrow in UK 2,00,000 pounds at 6% and convert

them into Indian currency and invest them inIndia at rate of 5%

The total amount is converted into pounds at theforward rate

Net gain =1067.7419 pounds.


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Exercise-6

A Ltd is planning to import a multipurposemachine from Japan at a cost of 3400 lakhYen.The company can borrow at the rate of 18%

per annum with quarterly rests.However there is

an offer from Tokyo branch of Indian Bankextending credit of 180 days at 2% per annumagainst the opening of an irrevocable letter ofcredit. Other information is as follows:

Spot rate for Rs.100=340 yen; 180 days forwardrate for Rs.100=345 yen; commission charges forletters of credit are at 2% for 12 months.

Advise the company which mode of purchase is

better? www.professoraugustin.com

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Answer-6

Borrowing 3400 lakhs yen

Borrowing in Indian rupee=Rs.1000 lakhs

Interest for the first 3 months= 45

Interest for the second quarter=47.025 Total cash outflow at the end of 6 months equals

to Rs.1092.025 lakhs.

If letter of credit is followed:

Borrowings 3400 lakhs yen

Interest for 6 months 34 yen

Commission charges 3400 x .02 x6/12=34


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Answer-6 continues

Total payments =3468 lakhs yen

Conversion into indian rupees=1005.217

Conclusion:- Avail overseas offer


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Exercise-7

Spot Rs.48/$ ;6 month interest rate: India-

7.5%Per annum; US interest rate-2% per

annum.what forward rate will no arbitrage

gain be possible?


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Answer-7

Difference in rate-7.5%- 2%=5.5%p.a.

Spot rate $48

Add: 5.5% premium for three months

(48x (5.5/100) x 6/12) =1.32

Forward rate = 49.32/$


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Exercise-8

Spot rate- Rs.48.5/$ ; 6 month forward rate-

Rs.48.90/$ ; Annualised interest on US 6

month treasury bill2.5%; annualised

interest on Indian 6-month treasury bill-6.0%; what are the transactions the trader

will execute to receive arbitrage gain?


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Answer-8

Interest rate differential=6%-2.5%=3.5%pa

Premium of forward rate=(48.90-

48.5)/48.5x100 x(12/6)=1.65%


Since interest diferential is more

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than premium forward arbitrage

gain is possible.


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Exercise-9

Calculate cross currency rate between

Euro/pound(bid as well as ask)

Rs/Us $ Rs 48.35-48.90

Rs/Euro Rs.51.90-52.30

$/ Pound $ 1.49-1.50


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Answer-9

Euro/Pound(bid)=Rs/Us $ x $/Pound x

Euro/Rs=48.35 x1.49 x 1/51.90

Euro/Pound(ask)=48.90 x 1.50 x1/52.30


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Exercise-10

You are required to fill in the missing

figures and complete the table

US

dollar

Pound Canadi

an

Yen Euro

1USD

1 pound1Canadi

1 Yen

1 Euro

1.0

--

-

-

o.6161

1.0-

-

-

1.5259

-1.0

-

-

------

--

1.0

-

0.9287

--

-

1.0www.professoraugustin.com

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Answer-10

US

dollar

Pound Canadi

an

Yen Euro

1USD

1 pound

1Canadi1 Yen

1 Euro

1.0

1.623

0.65530.0085

1.0767

o.6161

1.0

0.40370.0052

0.6634

1.5259

2.4767

1.00.0129

1.6430

118.08

191.655

77.38381.0

127.145

0.9287

1.5074

0.60860.0078

1.0


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Exercise-11

The following quotations are available to

you:

by a bank in New York $ 1.6012/Pound

By a bank in Paris FFr4.9800/$

By a bank in London Pound 0.1350/FFr

Is any triangular arbitrage possible?


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Answer-11

From a direct quote of New York and Paris,

the cross rate for Pound/FFr is Pound/FFr=

Pound/$ x $/FFr= 1/1.6012 x1/4.9800

Or Pound/FFr =0.1254

Since in the direct quote the FFr in London

is pound 0.1350/FFr(different from 0.1254),

triangular arbitrage is possible.


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Answer-11

1/1.6012 x 1/ 4.9800=0.1254=Pound/FFr

Since in the direct quote the FFr in London

is 0.1350/FFr different from 0.1254,

triangular arbitrage is possible.


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Borrow in the country where the rate of

interest is low and invest in the country

where interest rate is high.


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Exercise-12

On 1st April 3 months interest rate in the US

$ and Germany are 6.5% and 4.5% per

annum respectively.The USD/DM spot rate

is 0.6560. What would be the forward ratefor DM, for delivery on 30th June?


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Answer-12

Spot rate is US $ 0.6560/DM Interest rate parity relationship

S0=[1+imA]/[1+inB

S0= Spot rate; S1= Future exchange rate

inA=Nominal interest in country A(USA)

inB= Nominal interest in countryB(Germany)

S1=0.6560{1+(0.065 x3/12)/1 +(0.045 x 3/12)}= 0.6560 x (1.01625/1.01125) = USD 0.6592

$/DM


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Exercise-13

Spot rate 47.88/$

3 month forward rate 48.28/$

3 month interest rates Re.7%

$ 11%

Is there any arbitrage gain?


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Answer-13

3 month forward rate of dollar is higher than spot rateimplies that the dollar is at premium.

Premium(percentage)= (48.28-47.88) /

47.88x(12/3) x 100=3.34% per annum.

Interest rate differential=11%-7%=4%

Since interest rate differential is more than

premium percentage there are arbitrage gainpossible.


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Exercise-14

On 1st April, 3 months interest rate in the

US and Germany are 4.5% and 6.5 % per

annum respectively. The $/DM spot rate is

0.6560. What would be the forward rate forDM for delivery on 30th June?


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S1=0.6560{1+(0.045 x3/12)/1 +(0.065 x3/12)}

= 0.6560 x ( 1.01125/1.01625)

= USD 0.652772 $/DM


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Exercise-15

In International Monetary Market aninternational forward bid for December, 15

on pound sterling is $ 1.2816 at the same

time that the price of IMM sterling futurefor delivery on December,15 is $1.2806.

The contract size of pound sterling is

62,500. How could the dealer use arbitragein profit from this situation and how much

profit is earned?


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Exercise-16

ABC Co. have taken 6-month loan from their foreigncollaborators for US Dollars 2 millions. Interest payableon maturity is at LIBOR plus 1.0%. Current 6-monthLIBOR is 2%.

Enquiries regarding exchange rates with their bank elicitthe following information:

Spot USD 1 Rs. 48.5275

6 months forward Rs.48.4575

1.What would be their total commitment in rupees, if theyenter into a forward contract?

2. Will you advise them to do so? Explain giving reasons.


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Exercise-17

The United States Dollar is selling in India atRs.45.50. If the interest rate for 6 month

borrowing in India is 8% per annum and the

corresponding rate in USA is 2%.

1.Do you expect US dollar to be at premium or at

discount in the Indian forward market?

2.What is expected 6 month forward rate for United

States Dollar in India?

3. What is the rate of forward premium or discount?


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Answer

Borrow in US at 2% and invest in India

Differential interest rate =8%-2%=6%

Since US interest rate is low dollar is at

premium.

Forward rate=45.50(1+[.04

x6/12)]=Rs.46.41


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Exercise-18

A company operation in Japan has today effectedsales to an Indian company, the payment beingdue 3 months from the date of invoice. Theinvoice amount is 108 lakhs yen. At todays spot

rate, it is equivalent to Rs.30 lakhs. It isanticipated that the exchange will decline by 10%over 3 months period and in order to protect theYen payments, the importer proposes to take

appropriate action in the foreign exchange market.The 3-months forward rate is presently quoted as3.3 Yen per rupee. You are required to calculatethe expected loss and to show how it can be

hedged by a forward contract.www.professoraugustin.com

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Exercise-19

The following table shows interest rates forthe United States dollar and French francs.

The spot exchange rate is 7.05 franks per

dollar. Complete the missing entries:

3 months 6 months 1 year

Dollar interest rate(annually compounded

Frank interest rate

(annually compounded)

Forward franc per dollar

Forward discount on franc per

cent per year

11 %19 %

?

?

12 %?

?

6.3%

?20%

7.5200

?www.professoraugustin.com

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Exercise-20

In march 2008, the multinational Industries makes the following

assessment of dollar rates per British pound to prevail as on 1.9.08.

1) What is the expected spot rate for 1.9.2008?

2) If , as of March,2003, the 6 month forward rate is $1.80, should the

firm sell forward its pound receivables due in September, 2008?

$/pound Probability

1.6

1.7

1.8

1.9

2.0

0.15

0.20

0.25

0.20

0.20


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Exercise-21

X Ltd. an Indian company has an export exposure of 10million(100 lacs) Yen, value September end. Yen is not directlyquoted against Rupee. The current spot rates are-USD/INR=41.79 and USD/JPY=129.75.

It is estimated that Yen will depreciate to 144 level and rupee todepreciate against dollar to 43

Forward rate for September, 2008 USD/Yen =137.35 andUSD/INR=42.89.

You are required

i) To calculate the expected loss if hedging is not done. How theposition will change with company taking forward cover?

ii) If the spot rate on 30th September, 1998 was eventuallyUSD/Yen=137.85 and USD/INR=42.78, is the decision to takeforward cover justified?


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Exercise-22

A company operating in a country having the dollar as its unit ofcurrency has today invoiced sales to an Indian company, the payment

being due three months from the date of invoice.The invoice amount is

$13,750 and at today spot rate of $0.0275 per Re.1, is equivalent to

Rs.5,00,000.

It is anticipated that the exchange rate will decline by 5% over thethree month period and in order to protect the dollar proceeds, the

importer proposes to take appropriate action through foreign exchange

market.

The three month forward rate is quoted as $0.0273 per Re.1

You are required to calculate the expected loss and to show, how it canbe hedged by forward contract.


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Exercise-23

Shoe Company sells to a wholesaler in Germany. The purchasesprice of a shipment is 50,000 deutsche marks with term of 90 days.

Upon payment, Shoe Company will convert the DM to dollars. The

present spot rate for DM per dollar is 1.71, whereas the 90-day

forward rate is 1.70.

You are required to calculate and explain:1) If Shoe Company were to hedge its foreignexchange risk, what

would it do? What transactions are necessary?

2) Is the deutsche mark at a forward premium or at a forward discont?

3) What is implied differential in interest rates between the two

countries?(Use interest rate parity assumption)


A 23

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Answer-23

Spot rate DM/US $ =1.71

If company receive payment then

50,000 x 1.71=


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Exercise-24

A customer with whom the Bank had entered into3 months forward purchase contract for SwissFrancs 10,000 at the rate of Rs.27.25 comes to the

bank after 2 months and requests cancellation of

the contract. On this date, the rates prevailing are: Spot CHF 1=27.30 27.35

One month forward Rs.27.45 27.52

What is the loss/gain to the customer oncancellation?

(loss to the customer $2700 due to exchangedifference)


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Exercise-25

In 2005 a foreign institutional investor investedUS dollar 1 million in the Indian stock market.

The rupee return from Indian stock market since

2005 has been 20% as dividend income. However

stock prices increased by 15% since 2005. The

currency rate at the time of purchase in 2005 was

Rs47 per dollar. If he sells today the currency rate

is Rs42.30 per dollar. What is profit /loss to theforeign institutional investor?


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Answer

(Rs4,70,00,000 +94,00,000+70,50,000)/42.30=15,00,000 dollars

Gain=5,00,000 dollars

Suppose stock price is declined by 20% do

they gain /lose?


B i t d l di t

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Borrowing rate and lending rate

US I month treasury bill 2.30-2.35% p.a

Here deposit interest is 2.30%

Lending interest rate is 2.35%


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Exercise-25

The following data is available from theforex market:

US 1 month treasury bill 2.60-2.65% p.a

India 1 month treasury bill 6.80-6.85% p.a

If the dollar spot rate in India is Rs.42.3-42.50

per US $ , find the no arbitrage range of

future prices for a month dollar future.


A

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Answer

Two option 1. Borrow rupee, buy dollar,invest in dollar

and buy rupees(sell dollar) in future

2. Borrow dollar, buy rupees, invest rupees,sell rupees in future.

Refer: Management Accounting andfinancial analysis by My Khan and P.K Jain

Chapter Foreign exchange markets andDealings


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Foreign Exchange Exposure

and Risk Management

By Prof. Augustin Amaladas

M.Com.,AICWA.,PGDFM.,DIM.,B.Ed.


FERM

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FERM

Various types of risk exposed

Techniques to deal with such risks

Hedge such risk

Techniques adopted in India to manage

FER


Types of Exposure to business

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yp p

risk 1. Transaction exposure

2.Translation exposure

3. Economic exposure


T ti E

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Transaction Exposure

Transactions that require settlement inforeign currency-obligations

Cross border trade

Domestic purchases and sale of goods andservices

Debtors receivable in foreign currencies

Creditors payable in foreign currencies,foreign loans and collaborationsinvestments


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Example

Infosys incurs loss of Rs.80 crore in thevolatile forex marketdue to5.6%depreciation of the rupee during thefirst quarter of 2008-09 fiscal year.ie rupeewas 40.02 depreciated to 43.04 ie 5.6%

This was after the company had hedged$760 million at Rs.40.6 as forward cover

Operationally a depreciating rupeebenefited the company by 111 crore


Translation Exposure-page 17.2b MGT and Financial Anal sis

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by MGT and Financial Analysis

by Khan and Jain Change in accounting income and balance sheet

statements due to change in exchange rate

Example: An Indian firm has taken a loan of Rs.20 million dollar from a bank in USA and imports

a machinery . When contract made Rs 40.2/$ but

at the time of settlement it was 43. The firm looses

as indian rupee depreciates. Due to which assethas to be provided more depreciation


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43-40.2=2.8 per dollar has to bepaid extra

20million dollars x 2.8=56 million rupees

to be paid extra

If depreciation rate is 20% then 0.2 x

56=11.2 million rupees will be written off

as depreciation


What is translation adjustment?

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What is translation adjustment?

Translation loss/gain may not be reflectedin the income statement but they are shown

in the balance sheet under the head

translation adjustment in the balance sheetwithout affecting accounting income.They

are carried out in the owners equity

accountThis practice differ from country to country.


Economic exposure

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Economic exposure

It is the most important as it has impact on thevaluation of firm.

Change in the value of a company thataccompanies an unanticipated change in exchange

rates. Expected change may not have any impact on the

business as it is accommodated well in advance

It is based on the extent to which the value of thefirm-as measured by the present value of theexpected future cash flowswill change whenexchange rates change


formula

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formula

Change in PV/Change in exchange rate

It measures variability in the value of the

firm due uncertain exchange rate changes.


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