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FINAL LEVEL- MAY 2021PAPER 2: STRATEGIC FINANCIAL MANAGEMENT

Faculty Name: CA. Parvesh Aghi

Date: 31st Dec 2020

HEDGING CURRENCYRISK

30 December 2020 2

HEDGING CURRENCY RISK : is a way for a company to minimize or eliminate foreign exchange risk.

Internal Techniques-within

the business itself

External Techniques-

involve dealing with a third party

3

Internal Techniques

Leading and Lagging-Leading means advancing a payment i. e. making a payment before

it is due. Lagging involves postponing a payment i. e.

delaying payment beyond its due date.

Example: X Ltd imports $1,00,000 goods from

abroad ( current rate 1$ =Rs 75) Payable after 6 months

X :Ltd expects $ to appreciate significantly in

next 6 months . So X plans to pay the amount upfront

30 December 2020 4

Internal Techniques

Invoicing in Domestic Currency- invoicing in

domestic currency, an exporter can shift

transaction risk to his customer abroad

X Ltd invoices Rs75,000 for their exports (at the

time of export 1$ =Rs 75 ) Payment receivable after

6 months

1$ = Rs 70 after 6 months

X receives Rs 75,000

Importer has to pay $ 1071.42 as against $1000

30 December 2020 5

Internal Techniques

Netting-Exposure netting is a method of hedging currency risk by offsetting exposure in one currency with exposure in the same or another currency.

Example : X India Ltd owes $1,00,000 to its group

company X USA Ltd for the goods supplied and X USA ltd also owes $ 80,000 for the services provided to X India

Ltd

30 December 2020 6

Internal Techniques

Netting-Exposure netting is a method of hedging currency risk by offsetting exposure in one currency with exposure in the same or another currency.

Example : X India Ltd owes $1,00,000 to its group

company X UK Ltd for the goods supplied and X UK ltd also owes ₤ 78000 for the services provided to X India

Ltd ( 1$ = £.78)

30 December 2020 7

Internal Techniques

Matching-Matching-extends this concept to include third parties

such as external suppliers and customers

Price Variation involves increasing selling prices to counter the adverse

effects of exchange rate change.

30 December 2020 8

Netting refers to netting off group receipts and payments

Internal Techniques

Price Variation involves increasing selling prices to counter the adverse

effects of exchange rate change.

If a company expects GBP to strengthen

against the currency of an overseas customer, it may raise the contract

price.

30 December 2020 9

Internal Techniques

Asset and Liability Management- ensuring

that assets are available to appropriately cover

liabilities when they are due or expected to be due.

30 December 2020 10

Asset and Liability Management-

Example : suppose A company has a

Deposit of $1,00,000

Payables of $1,00,000 after

six months

Spot exchange rate is Rs75/$

After six months the spot exchange

rate is 76.50/$

The Asset & Liability is well

Managed

Asset and Liability Management-

Example : suppose A company has receivable

of $80,000 after six months and also an

investment of $20,000 maturing in next 6 months

Payables of $1,00,000 after six months

Spot exchange rate is Rs75/$

After six months the spot exchange rate is 76.50/$

The Asset & Liability is well Managed

Internal Techniques

The concept of asset/liability management focuses on the timing of cash flows because

company managers must plan for the payment of

liabilities.

The process must ensure that assets are available to pay debts as they come due and that assets or earnings can be converted into cash.

30 December 2020 13

Internal Techniques

Assume, for example, that a bank earns an average rate of

8% on three-year loans and pays a 6% rate on three-year

certificates of deposit. The interest rate margin the

bank generates is 8% - 6% = 2%

Since banks are subject to interest rate risk, or the risk that interest rates increase,

clients demand higher interest rates on their deposits to keep

assets at the bank

30 December 2020 14

PRACTICE QUESTIONS

30 December 2020 15

Exercise2

■ Following are the details of cash inflows and outflows in foreign currency denominations of MNP Co. an Indian export firm, which have no foreign subsidiaries:

■ (i)Determine the net exposure of each foreign currency in terms of Rupees.

■ (ii)Are any of the exposure positions offsetting to some extent?

16

Currency Inflow Outflow Spot rate Forward rate

US $ 4,00,00,000 2,00,00,000 48.01 48.82

French Franc (FFr) 2,00,00,000 80,00,000 7.45 8.12

U.K. £ 3,00,00,000 2,00,00,000 75.57 75.98

Japanese Yen 1,50,00,000 2,50,00,000 3.20 2.40

Solution ■ Net exposure of each foreign currency in Rupees

■ The exposure of Japanese yen position is being offset by a better forward rate

17

Inflow Outflow Net Inflow Spread Net Exposure

(Millions) (Millions) (Millions) (Millions)

US$ 40 20 20 48.82-48.01 0.81 16.20

FFr 20 8 12 8.12-7.45 0.67 8.04

UK£ 30 20 10 75.57-75.98 0.41 4.10

Japan Yen 15 25 -10 3.2-2.4 -0.80 8.00

Exercise 3

■ 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.

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

18

Cost and Sales information:

Japan USA Europe

Variable cost per unit Rs225 Rs395 Rs 510

Export sale price per unit Yen 650 US$10.23 Euro 11.99

Receipts from sale due in 90 days Yen 78,00,000 US$1,02,300 Euro 95,920

Foreign exchange rate information:

Yen/Rs US$/Rs Euro/Rs

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

Solution

19

Particulars HEDGING OPTION

Total

(Rs )

Sales Yen 78,00,000 US$1,02,300 Euro 95,920

Unit input price Yen 650 US$10.23 Euro 11.99

Unit sold ( sales / input price) 12,000 10,000 8,000

Variable cost per unit Rs 225/- Rs 395 Rs 510

Variable cost ( unit sold X variable cost) Rs 27,00,000 Rs 39,50,000 Rs 40,80,000 Rs 1,07,30,000

Three months forward rate for selling

1Rs =

¥ 2.427

1Rs =

$0.0216

1Rs =

€0.0178

Rupee value of receipts Rs 32,13,844 Rs 47,36,111 Rs 53,88,764 Rs 1,33,38,719

Contribution Rs 5,13,844 Rs 7,86,111 Rs 13,08,764 Rs 26,08,719

Average contribution to sale ratio 26,08,719/

1,33,38,719

19.56%

Yen 78,00,000 / 2.427

= Rs 32,13,844

$1,02,300 /.0216=

Rs 47,36,111

Euro 95,920 /.0178

=Rs 53,88,764

Solution

20

Particulars

Total

(Rs )

Sales Yen 78,00,000 US$1,02,300 Euro 95,920


Unit sold 12000 10000 8000


Variable cost Rs 27,00,000 Rs 39,50,000 Rs 40,80,000 Rs 1,07,30,000

Spot rate after 3 – months 2.459 0.02156 0.0179



Average contribution to sale ratio 19.56%

78,00,000 /2.459= Rs

31,72,021 $1,02,300/.02156=

Rs 47,44,898

Euro 95,920/.0179 =

Rs 53.58,659

If risk is not hedged

Rupee value of receipt Rs 31,72,021 Rs 47,44,898 Rs 53,58,659 Rs 1,32,75,578

Total contribution Rs 25,45,578


Solution

21

Particullars Total

(Rs )

Sum due Yen 78,00,000 US$1,02,300 Euro 95,920


Unit sold 12000 10000 8000


Variable cost Rs 27,00,000 Rs 39,50,000 Rs 40,80,000 Rs 1,07,30,000

Three months forward rate for selling 2.427 0.0216 0.0178




If risk is not hedged

Rupee value of receipt Rs 31,72,021 Rs 47,44,898 Rs 53,58,659 Rs 1,32,75,578

Total contribution Rs 25,45,578


78,00,000 /2.459= Rs

31,72,021$1,02,300/.02156=

Rs 47,44,898

Euro 95,920/.0179 =

Rs 53.58,659

WORKINGS- Use 3–months fwd. rates

■ 1Rs = ¥ 2.397-2.427

■ 1 ¥ = 1

2.427−

1

2.397

■ 1¥ = Rs .4120- .4172

■ Yen 78,00,000X .4120 =Rs 32,13,844

■ We will use lower bid rate as the bank will buy from

exporter

30 December 2020 22


■ 1Rs = $ .0213 - .0216

■ 1$ = 1

.0216−

1

.0213

■ 1$ = 46.2963 – 46.9483

■ BID ASK

■ US$1,02,300 X 46.2963 = Rs 47,36,111

30 December 2020 23


■ 1Rs = € 0.0177-0.0180

■ 1 € = 1

.0180−

1

.0177

■ 1 € = 55.5555 – 56.2746

■ BID ASK

■ € 95,920 X 55.5555 = Rs 53,28,764

30 December 2020 24

Workings – 3 months spot

■ 1Rs = ¥ 2.423-2.459

■ 1 ¥ = 1

2.459−

1

2.423

■ 1¥ = Rs .40667- .4127

■ Yen 78,00,000X .40667 = 31,72,026

30 December 2020 25

WORKINGS- Use 3–months spot

■ 1Rs = $ . 0.02144-0.02156

■ 1$ = 1

.02156−

1

.02144

■ 1$ = 46.3822 –

■ BID ASK

■ US$1,02,300 X 46.3822 = Rs 47,44,897

30 December 2020 26

WORKINGS- Use 3–months spot rates

■ 1Rs = € 0.0177-0.0179

■ 1 € = 1

.0179−

1

.0177

■ 1 € = 55.8660 –

■ BID ASK

■ € 95,920 X 55.8660 = Rs 53,58,659

30 December 2020 27

External Techniques:

Money Market Hedging

Derivative Instruments

28

Money Market Hedging

29

A money market hedge is a technique

used to lock in the value of a foreign currency transaction

in a company's domestic currency.

Therefore, a money market hedge can help a domestic

company reduce its exchange rate or currency risk

when conducting business transactions with a foreign

company

30 December 2020

30

For example, suppose a business owner in India expects to receive 1 Million USD in six

months

This Owner could create an agreement now (today) to

exchange 1Million USD for INR at roughly the current exchange

rate

Thus, if the USD dropped in value by the time the business

owner got the payment, he would still be able to exchange the

payment for the original quantity of U.S. dollars specified.

Steps – Money market hedge- ExportsRs / $ Case

Borrow in $

(Foreign currency)

Convert $ into Rupee at the

spot rates

Invest in Rupee so that

amounts grows

Pay $ loan with interest using receivables

30 December 2020 31

Steps – Money market hedge –ImportsRs / $ case

Borrow in Rs

(home currency)

Convert Rupee into dollars at the spot rates

Invest in dollars so that amounts grows to pay off the USD liability

30 December 2020 32

PRACTICE QUESTIONS

30 December 2020 33

Exercise 4

■ An Indian exporting firm, Rohit and Bros., would be covering itself against a likely depreciation of pound sterling. The following data is given:

■ Receivables of Rohit and Bros : £ 500,000

■ Spot rate : Rs 56.00/£

■ Payment date : 3-months

■ 3 months interest rate : India : 12 per cent per annum

■ UK : 5 per cent pa What should the exporter do?

34

Solution

Rohit and Bros will cover the risk in the

money market.

The following steps are required to be

taken

Borrow pound sterling for 3- months

The borrowing must be such that at the

end of three months, the amount becomes

£ 500,000.

5,00,000 /(1+.05/4) 5,00,000/ (1.0125) = £4,93,827

solution

Convert the borrowed sum into rupees at the spot rate. This gives: £493,827 × Rs

56 = Rs 2,76,54,312

The sum thus obtained is placed in the money

market at 12 per cent to obtain at the end of 3-

months

= Rs 2,76,54,312 X (1+ .12∗3

12) =

Rs 2,84,83,941

The sum of £500,000 received from the client at

the end of 3- months is used to refund the loan

taken earlier.

From the calculations. The money market operation

has resulted into a net gain of Rs 4,83,941 ( Rs

2,84,83,941 – £ 500,000 × Rs 56).

Answer

The only thing left with Rohit and Bros is to cover the risk in the money market. The following steps are required to be taken:

Borrow pound sterling for 3- months. The borrowing has to be such that at the end of three months, the amount becomes £ 500,000. Say, the amount borrowed is £ Therefore

Convert the borrowed sum into rupees at the spot rate. This gives: £493,827 × Rs 56 = Rs 2,76,54,312

37

UK

borrowing

rate : 5 % pa

Spot

rate:56.00/£

Answer

The sum of £500,000 received from the client at the end of 3-months is used to refund the loan taken earlier.

From the calculations. The money market operation has resulted into a net gain of Rs 4,83,941 ( Rs 2,84,83,941 – £ 500,000 ×Rs 56).

If pound sterling has depreciated in the meantime. The gain would be even bigger.

38

2,84,63,941/

5,00,000=56.97

India : 12 %pa

Exercise 5

■ 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:

■ 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

■ The company has 2 choices:

(i) Forward cover

(ii) Money market cover, and

■ Which of the alternatives is preferable by the company?

Spot rate USD 1.5617-1.5673

6 months’ forward rate USD 1.5455 –1.5609

Exercise

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

Exercise

The company has 2 choices:

(1)Forward cover(2)Money market

cover, and

Which of the alternatives is

preferable by the company?

Forward cover

The amount payable in six months time is USD 3,64,897

6-month forward are

1£ =

$1.5455 – 1.5609

1$ =

£.64065 - £.64704

Payable in pounds

3,64,656 X 0.64704

£2,36,102

Steps – money market hedge

Borrow in pounds

(home currency)

Convert pounds into dollars at the spot rates


30 December 2020 43

How much should he deposit in dollars so that he can make import payment

30 December 2020 44

Amount payable after six months$ 3,64,897

Deposit rates in US : 4.5%

Present value @ 4.5%

3,64,897/ 1.0225=

$3,56,8671+.045/2

Borrow in pounds @ 7%

Borrow in pounds

How much ? =$3,56,867 equivalent to

pounds

Spot rate 1₤ = USD 1.5617-

1.5673

1$= £ .6379-.6403

Use Ask rate

3,56,867 X £.6403

£ = 2,28,512

30 December 2020 45

Total outflow after six months

Interest @ 7% for six months

£7,998Principal +

Interest =£2,36,510

Payable after six months

Total out flow ==£2,36,510

30 December 2020 46

Total Out flow in Pounds all options

Forward Contract

£ 2,36,102Money Market

Hedge £2,36,510

The company should take

forward cover to hedge the risk

30 December 2020 47

Exercise 6

X Ltd.has exported some chemical worth of USD 1,00,000 from one of the U.S. suppliers. The amount is receivable in one year's time. The spot rate is 74.00/$. The Interest rates in India and U.S. are 6% and 2% respectively

(a) How the exporter will cover his risk ? (b)What is effective exchange rate ? (c) What would be the forward rate after one year if the interest rate parity theory prevails ? (d) What should the exporter do if the one year forward exchange quoted by bank is Rs 77.25/$ ?

Solution 6

X Ltd will cover the risk in the money

market.

The following steps are required to be

takenBorrow $ for one year

The borrowing must be such that at the end of one year the amount becomes $

100,000.

$1,00,000/1.02=

$98039.21

solution

Convert the borrowed sum into rupees at the spot rate. This gives:

$98039.21 × Rs 74 = Rs 72,54,902

The sum thus obtained is placed in the money market at 6 per cent to

obtain at the end of one year

= Rs 72,54,902 X (1.06) =

Rs 76,90,196

The sum of $100,000 received from the client at the end of one year is used to refund the

loan taken earlier.

From the calculations. The money market

operation has resulted into a net gain of Rs

2,90,196*

*Rs 76,90,196 -Rs 74,00,000=Rs 2,90,196

Solution 6

Effective exchange Rate is

Rs 76,90,196 / $1,00,000= Rs

76.9019

The forward rate as per interest Parity theory is

Rs 74 X 1.06/1.02 = Rs

76.9019

X ltd should go far Forward Cover if the Fwd. rate is

Rs77.25/$

Exercise 7

X Ltd. of has imported some chemical worth of USD 1,00,000 from one of the U.S. suppliers. The amount is payable in one year’s time. The spot rate is 74.00

The Interest rates in India and U.S. are 6% and 2% respectively

(a)how should the importer cover his risk ? (b) what is the effective rate (c ) what is the forward rate if interest parity prevails (d) what importer should do if the forward rate is Rs 76/$

Steps – money market hedge

Borrow in Rupees

(home currency)

Convert Rupee into dollars at the spot rates


30 December 2020 53

How much should he deposit in dollars so that he can make import payment

30 December 2020 54

Amount payable after one year

$ 1,00,000

Interest rates in US : 2%

Present value @ 2 %

1,00,000/ 1.02=

$98039.21

Borrow in INR @ 6%

Borrow in Rs How much ? =$98039.21

Spot rate Rs 74

$98039.21 X Rs 74=

Rs 72,54,902

30 December 2020 55

Total outflow after six months

Payable after one year

Rs 72,54,902 X (1.06)

Total out flow Rs 76,90,196

Effective rate = Rs 76.9019/$

FWD rate would be 74x

1.06/1.02 =76.9019/$

He should go for Forward Cover@

Rs 76/$

30 December 2020 56

Derivative Instruments

FORWARD CONTRACT

FUTURES CONTRACTS

OPTION CONTRACTS

SWAP CONTRACTS

57

FORWARD CONTRACT

Simplest form of derivatives is the forward contract

It obliges one party to buy, and the other to sell, a specified

quantity of a nominated underlying financial instrument

at a specific price, on a specified date in the future.

There are markets for a multitude of underlying

commodities, currencies and interest rates .

58

Forward contracts

59

Forwards are not standardized.

The terms in relation to contract size, delivery

grade, location, deliverydate and credit periodare always negotiated

Forward Rate – Gains & Losses

60

In a forward contract, the buyer of the contract draws its value at maturity from its delivery terms

or a cash settlement. .

On maturity, if the price of the underlying is higher than the

contract price the buyer makes a profit. If the price is lower, the buyer suffers a loss. The gain to the buyer is a loss to the seller

PRACTICE QUESTIONS

30 December 2020 61

Exercise 8

■ An Australian exporter will be receiving US$5,00,000 in one year’s time.

■ Spot A$1 = US$0.7020/25

■ 1 year forward margin 50/45 (decreasing numbers from left to right means the foreign currency is at discount)

■ (a) What will the A$ proceeds be if it is hedged?

■ (b) If at the end of the year the spot rate is A$1 = US$0.7025/30, what would the A$ proceeds be if unhedged?

■ (c ) Would the exporter be better off hedged or unhedged?

62

Solution

An Australian exporter will be receiving

US$5,00,000 in one year’s time

Spot A$1 = US$0.7020/25

1 year forward margin 50/45

Forward A$ 1= $ (0.7020-.0050)-(0.7025-.0045)

So 1 year forward rate would be A$1 =

US $ .6970- .6980

solution

Therefore $1 = A$ 1.4326-

1.4347

US$ 5,00,000 X A$1.4326 = A$

7,16,300

Proceeds if unhedged : spot rate after one

year A$1 = US$0.7025/30

therefore $1 = AS$ 1.42247 – 1.42348

US $ 5,00,000 x 1.42247 = A$

7,11,235

The exporter is better off , if hedged

SolutionAmount AS $

Australian exporter will be receiving US$5,00,000 in one year’s time.

Proceeds if hedged

Spot A$1 = US$0.7020/25

1 year forward margin 50/45 Bid Ask

So 1 year forward rate would be A$1 = US $ .6970- .6980

Therefore $1 = A$ 1.4326- 1.4347

US$ 5,00,000 X 1.4326 7,16,300

Proceeds if unhedged : spot rate after one year A$1 = US$0.7025/30

therefore $1 = AS$ 1.42247 – 1.42348

US $ 5,00,000 x 1.42247 7,11,235

The exporter is better off , if hedged hedging gain 5065

30 December 2020 65

Exercise 9

■ 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 Canada15%

■ 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.

66

solution

Spot Exchange Rate :

C $ 2.5/£

1£ = C$ 2.5 ( direct quote of

pound in Canada)

Interest Rate inUK 12%

Interest Rate InCanada 15%

6-month Forward rate =

1 £ = C$2.5 (1.075 / 1.06 )

6- month Forward rate

1 £ = C$ 2.535

Answer

Spot Exchange Rate : C $ 2.5/£

Spot Exchange Rate 1£ = C$ 2.5 ( direct quote of pound in Canada)

6-month Forward rate = 1 £ = C$2.5 (1..075 / 1.06 )

6- month Forward rate 1 £ = C$ 2.535

68

(i) If Can $ spot rates decline by 2% (or £ appreciates by 2%)

■ Spot rate after 6 months = 2.5 (1.02) = C$ 2.55

69

£

£ receipt as per Forward Rate 1 £ = C$ 2.535

or 1 C$ =1

2.535= £ .39448

C$ 5,00,000X .39448

1,97,239

£ receipt as per Spot Rate 1£ = C$2.50 (1.02) = 2.55

1£ = C$2.55

C$ 5,00,000/2.55

1,96,078

Gain due to forward contract 1,161

(ii) If Can $ spot rates gains by 4% (or £ depreciates by 4%)

■ Spot rate after 6 months = 2.5 (.96) = C$ 2.4

70

£


or 1 C$ = £ .39448

C$ 5,00,000X .39448

1,97,239

£ receipt as per Spot Rate 1£ = C$2.50 (.96) = 2.40

1£ = C$2.40

C$ 5,00,000/2.40

2,08,333

loss due to forward contract (11,094)

(iii ) If spot rate remains unchanged

■ Spot rate after 6 months = C$ 2.5

71

£


or 1 C$ = £ .39448

C$ 5,00,000X .39448

1,97,239

£ receipt as per Spot Rate

1£ = C$2.50

C$ 5,00,000/2.502,00,000

loss due to forward contract (2761)

Exercise 10

An importer customer of your bank wishes to book a

forward contract with your bank on 3rd September for

sale to him of SGD 5,00,000 to be delivered on 30th

October.

The spot rates on 3rd

September are USD 49.3700/3800 and

USD/SGD 1.7058/68. The swap points are:

Calculate the rate to be quoted to the importer by assuming an exchange

margin of paisa.

USD /Rs 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

solution

Since direct quote of SGD/ Rs is not given , we need to calculate

through cross rates

The spot rates on 3rd

September are

$ 1= Rs 49.3700/49.3800 (European quote )

$ 1 = SGD 1.7058 –SGD 1.7068

(European quote)

We need to buy dollars ( sell Rs ) & buy SGD ( sell dollars )

BUY Dollars Sell Rupee2-month forward rates ( calculations )

USD / RS BID ASK

Spot rate 1$ Rs 49.3700 Rs 49.3800

2 months Swap points .1100 .1300

Inter bank 2-month FWD rate Rs 49.4800 Rs 49.5100

Banks margin .0500

Merchant dollar buying Rate Rs 49.5600

Buy SGD Sell Dollars

USD / SGD BID ASK

Spot Rate 1$ = SGD 1.7058 SGD 1.7068

2 months swap points .0096 .0097

1$ SGD 1.7154 SGD 1.7165

1SGD = $ 1/1.7615 $ 1/1.7154

1SGD $ .58258 $ .58295

solution

Cross Rate for SGD/ Rs of 30th October

1 $ = Rs 49.56 2 month forward European quote

1 SGD = $ .58295 2 month forward American quote

𝑅𝑠

$×

$

𝑆𝐺𝐷=

𝑅𝑠

𝑆𝐺𝐷

1SGD = Rs 49.56 X $ .58295 = Rs

28.8912

rate to be quoted to the importer

SGD1=

Rs 28.8912

Exercise 11

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 Rs 30 lakhs.

It is anticipated that the exchange rate will

decline by 10% over the 3 months period

and in order to protect the yen payments, the importer proposes to

take appropriate action in the foreign exchange

market

The 3 months forward rate is presently quoted as 3.3 yen per rupee.

You are required to calculate the expected loss and to show how it

can be hedged by a forward contract.

Solution

Spot rate of Rs 1 against yen = 108 lakhs yen/Rs 30 lakhs = 3.6 yen

3 months forward rate of Re. 1 against

yen = 3.3 yen

Anticipated decline in Exchange rate = 10%.

Expected spot rate after 3 months = 3.6 yen – 10% of 3.6 =

3.6 yen – 0.36 yen = 3.24 yen per rupee

Present cost of 108 lakhs yen = Rs 30 lakhs

Cost after 3 months:

108 lakhs yen/ 3.24 yen =Rs 33.33 lakhs

Expected exchange loss =

Rs 3.33 lakhs

If the expected exchange rate risk

is hedged by a Forward contract

Cost after 3 months if forward

contract

is taken 108 lakhs yen/ 3.3 yen =Rs

32.73 Lakhs

Expected loss = 30-32.73 = Rs

2.73 Lakhs

Hence, taking forward contract is suggested as the loss is reduced

Exercise 12

ABC Co. have taken a 6-month loan from

their foreign collaborators for US Dollars 2 millions.

Interest payable on maturity is at LIBOR

plus 1.0%.

Current 6-month LIBOR is 2%.

Enquiries regarding exchange rates with their bank elicits the following information:

Spot USD 1=

Rs 48.5275

6 months forward

Rs 48.4575

What would be their total commitment in Rupees, if they enter

into a forward contract?

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

solution

Firstly, the interest is calculated at 3% p.a. for

6 months.

USD 20,00,000 × 3/100 × 6/12 = USD 30,000

From the forward points quoted, it is seen that the second figure is less than the first, this means that the currency is quoted at

a discount

The value of the total commitment in Indian

rupees is = $ 20,30,000 * 6-month fwd. rate Rs

48.4575 = Rs 9,83,68,725

solution

It is seen from the forward rates that the market

expectation is that the dollar will depreciate

If the firm's own expectation is that the dollar

will depreciate more than what the bank has quoted

, it may be worthwhile not to cover forward and keep the

exposure open.

If the firm has no specific view regarding future dollar price movements, it would

be better to cover the exposure

This would freeze the total commitment and insulate

the firm from undue market fluctuations. In other words, it will be advisable to cut the losses at this point of time.

solution

Given the interest rate differentials and inflation rates between India and

USA, it would be unwise to expect continuous depreciation of the dollar. The US Dollar is a stronger currency

than the Indian Rupee based on past trends and it would be advisable to

cover the exposure

Exercise 13

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 (Rs /$) :

48.35 /48.36

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

The importer seeks your advice. Give your advice.

solution

If importer pays now, he will have to buy US$ in Spot Market by availing

overdraft facility. Accordingly, the outflow under this option will be

Amount required to purchase $130000XRs

48.36] = 62,86,800,

Add: Overdraft Interest for 3 months @15% p.a.

=Rs 2,35,755

Total outflow = Rs 65,22,555

Spot rate (Rs /$) : 48.35 /48.36

solution

If importer makes payment after 3 months then, he

will have to pay interest for 3 months @ 5% p.a. for 3 month along with the sum

of import bill.

Accordingly, he will have to buy $ in forward market.

The outflow under this option will be as follows:

Amount of Bill = $1,30,000 Add: Interest for 3 months @5% p.a.=

$1625= Total $ 1,31,625

Amount to be paid in Indian Rupee after 3

month under the forward purchase contract =Rs

64,27,249 (US$ 1,31,625 X Rs 48.83)

Outflow

option1 =65,22,555

Option 2 =64,27,249

Since outflow of cash is least in (ii) option, it should be opted for.

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

Exercise 14

Gibralater Limited has imported 5000 bottles of shampoo at landed cost in Mumbai, of

US $ 20 each.

The company has the choice for paying for the goods immediately

or in 3 months’ time.

It has a clean overdraft limited where 14% p.a. rate of interest is

charged.

Calculate which of the following method would be cheaper to

Gibralter Limited.

Pay in 3 months’ time with interest @ 10% and cover risk forward for

3 months.

Settle now at a current spot rate and pay interest of the over draft

for 3 months.

The rates are as follows:

Mumbai Rs /$ spot :

60.25-60.55

3 months swap :

35/2555

Solution – option 1

Repayment in 3 months time =

$1,00,000 x (1 + 0.10/4) = $ 1,02,500

Spot rate :60.25-60.55

3 months swap :

35/25

60.25 -.35= Rs 59.90

60.55-.25=Rs 60.30

3-months outright forward rate = Rs 59.90/ Rs 60.30

Repayment obligation in Rs ($1,02,500 X

Rs 60.30) = Rs 61,80,750

Solution – Option 2

Overdraft ($1,00,000 x Rs

60.55)

= Rs 60,55,000

Interest on Overdraft (Rs 60,55,000 x

0.14/4)=Rs 2,11,925

Total Out flow Rs 62,66,925

Option I should be preferred as it has

lower outflow

Exercise 15

The price of a bond just before a year of maturity is $ 5,000. Its redemption value is $ 5,250 at the end of the said period. Interest is $ 350 p.a. The Dollar appreciates by 2% during the said period. Calculate the rate of return

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