1. 1
FOREX MARKET
♦ EXCHANGE RATE
♦ DOMESTIC
CURRENCY
♦ DIRECT QUOTE
♦ INDIRECT QUOTE
♦ LINK BETWEEN
DIRECT&INDIRECT
QUOTE
♦ AMERICAN TERM
♦ EUROPEAN TERM
♦ BID
♦ ASK
♦ TWO WAY QUOTE
♦ SPREAD
♦ CONVERTING
TWOWAY QUOTE
♦ Arbitrage

2. 2
FOREX MARKET
♦ CROSS RATE
♦ SPOT RATE
♦ FORWARD RATE
♦ APPRECIATION
♦ DEPRECIATON
♦ COMPUTATION OF
APPRECIATION
AND
DEPRECIATION
♦ SWAP POINTS
♦ FORWARD RATE,
PREMIUM AND
DISCOUNT

3. 3
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

4. 4
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

5. 5
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

6. 6
5.CONVERTION (D TO I)
♦ RUPEES Rs44.20=1$- DIRECT QUOTE
♦ INDIRECT QUOTE Re1= 1/44.20=.0227
♦ ? KRONER 0.1481 –KRONERS PER
RUPEE
♦ ?SAUDI RIYAL(SAR) .08 –RIYAL PER
RUPEE
♦ ? GBP 83.27 RUPEES PER POUND.

7. 7
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 IT
IS A DIRECT MODE- AMERICAN TERMS.
♦ EUROPEAN TERM- 1/AMRICAN TERM : .
2925 KWD PER USD.

8. 8
7. SOLVE
♦ (a) 7.760 HKD PER $
♦ (b) 7.57 PER DANISH KRONER
♦ Direct quote
♦ American term
♦ 1HKD=.128$ European term
♦ .128Rs=1HKD Indirect quote

9. 9
ANSWERS
♦ (a) PERSON IN AMERICA THE QUOTE IS
FOREIGN CURRENCY PER UNIT OF HOME
CURRENCY. HENSE IT IS INDIRECT MODE-
EUROPEAN TERM
♦ THE AMERICAN TERM: 1/EUROPEAN
TERM IS 1/7.760= .13 $ PER HKD(HONG-
KONG) DOLLAR.
♦ (b)THE QUOTE IS NEITHER EUROPEAN NOR
IN AMERICAN TERM SINCE DOLLAR IS
NOT ONE OF THE PAIR OF CURRENCIES.

10. 10
BID AND ASK
♦ THE BANK’S QUOTE OF BID AND ASK IS
FROM THE BANKER’S PERSPECTIVE.
♦ BID= BUY
♦ ASK=SELL
♦ IF THE BID RATE FOR USD IS 40 IT MEANS
THAT THE BANK IS READY TO BUY 1$ FOR
Rs.40
♦ IF THE ASK RATE IS FOR USD IS 41, IT
MEANS THAT THE BANK IS (ASKING IF
SOMEONE WILL BUY) SELLING 1$ FOR
Rs.41.

11. 11
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.

12. 12
Two way quote
♦ BID QUOTE AND ASK QUOTE
♦ Ex: Re/$- 40.42 – 41.63
♦ Rs.40.42-bid(buying)-( Bank point of view)
♦ Rs.41.63-ask(selling)
♦ Rs.40.42=1$ 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 get
Rs.40.42
♦ If you want to sell Rs. and buy $ you part with
Rs.41.63.

13. 13
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

14. 14
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 travellers
cheques , how many rupees would you receive if
the bank in india quotes 73.65-73.92?

15. 15
Answer
♦ A)Bank buys at 72.70and Ask rate is 73.25
♦ B)Spread=.55
♦ C) 250*73.25=Rs.18312.50
♦ D)Rs.23*73.65=Rs.1693.95
♦ Note: in practice all forex transactions are
rounded off to a rupee ie Rs.1694

16. 16
Converting two way quotes
♦ Formula
♦ Bid(Rs/$)=1/Ask($/Rs)or
♦ Ask(Rs/$)=1/Bid ($/Rs)or
♦ Take the inverse of each rate (bid and ask)
and switch them around.
♦ Ex:INR/USD 40.25-41.35
♦ 1/40.25 1/41.35
• USD/INR =0.0248 =.02418

17. 17
PROBLEM
♦ CONSIDER THE FOLLOWING
QUOTATIONS 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

18. 18
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

19. 19
SPOT RATE
♦ RATE OF EXCHANGE FOR IMMEDIATE
SETTLEMENT
♦ IT IS SETTLED ON THE SECOND WORKING
DAY
♦ SATURDAY AND SUNDAY ARE HOLIDAYS
♦ EX:SPOT RATE:Rs./$40.35-41.36 SUPPOSING
YOU HAVE 124000 DOLLAR RECEIVED ON
THURSDAY THE BANK WILL SETTLE
124000*40.35=50,03,400 ON THE
FOLLOWING MONDAY.

20. 20
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

21. 21
APPRICIATION AND
DEPRECIATION
♦ IF F>S IN A DIRECT QUOTE THE FOREIGN
CURRENCY IS APPRECIATING
♦ Home depreciate
♦ Indirect quote: Foreign depreciates and HOME
APPRECIATES
♦ 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 APPRICIATE

22. 22
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

23. 23
FORWARD RATE, PREMIUM
AND DISCOUNT
♦ IF SWAP ASK> SWAP BID-FOREIGN
CURRENCY IS APPRECIATING HENCE
ADD SWAP POINTS
♦ IF SWAP ASK <SWAP BID FOREIGN
CURRENCY IS DEPRECIATING.
HENCE DEDUCT THE SWAP POINTS.

24. 24
Determinents and select theories
of Exchange Rates
♦ General facts:
Pound, Euro and US dollar are having
higher values than other currencies like
rupee, yen,franc etc.
What are the major factors?

25. 25
Factors
♦ 1. Inflation rates
♦ 2. Interest rates
♦ 3. Balance of payment position
♦ 4. Volume of international reserves
♦ 5. Level of activity and employment

26. 26
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

27. 27
If domestic inflation rate < foreign inflation
rate
♦ Domestic goods are cheaper
♦ Encourages export
♦ Foreign exchange inflow increases
♦ Domestic currency appreciates

28. 28
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.

29. 29
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

30. 30
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 the
investor can earn better return in India rater than
In USA
Flight of funds from USA to India
There will be more demand for rupees in America
causing appreciation for Indian rupee
More dollar is required to buy rupees in America
which devalue US Dollar

31. 31
The Interest rate Parity theory
♦ The premium or discount of one currency in
relation to the other should reflect the
interest 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 rates
on foreign and home currencies.
♦ What is the impact?

32. 32
Impact
♦ Foreign currency is at a premium when
interest rate is higher in foreign country
than home
♦ Home currency is at a discount

33. 33
3. Balance of payment position
♦ Deficit balance of payments –not 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

34. 34
Favourable balance of payments?
♦ The value of such a country appreciates and
likely to appreciate

35. 35
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.

36. 36
5.Level of Activity and
employment
♦ Higher level of economic activity and full
employment have good potential and
prospects of appreciation in the value of
currencies.

37. 37
conclusion
♦ Low inflation rate
♦ Higher interest rates
♦ Surplus balance of payment
♦ Possession of sizeable foreign exchange
reserves
♦ Higher level of economic activity
Do have positive or negative impact on
exchange rate?

38. 38
♦ Positive impact

39. 39
conclusion
♦ Higher inflation rate
♦ Low interest rate
♦ Big/persistent deficit in the balance of
payments
♦ Inadequate reserves with the monetary
authority
♦ Low level of economic activity
What is the impact?

40. 40
answer
♦ Depreciates exchange rates

41. 41
Excercise
♦ See Exercise no.12 and 14

42. 42
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 in
different forex markets.

43. 43
Types of arbitrage
♦ Geographical
♦ Triangular arbitrage

44. 44
Geographical arbitrage
♦ Different prices quoted in two geographical
markets for the same currency
♦ Tokyo and London
♦ 1.Observe the following:
♦ Rs/US $
♦ London Rs.: 42.5730--42.61
♦ Tokyo $: 42.6750 -- 42.6675
♦ Can make money out of it?

45. 45
♦ Buy at London market at 42.6100 and sell the
same at Tokyo market for Rs.42.6350.
♦ Suppose you buy from London for 100 million
Rupees 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.

46. 46
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.

47. 47
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.

48. 48
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.

49. 49
Exercise-3: arbitrage in forward
market
♦ Determine 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.

50. 50
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

51. 51
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
step –2
♦ If step-2 is more than step-3 there is a gain.

52. 52
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?

53. 53
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?

54. 54
Principle
♦ The arbitrageur earns 4% extra interest to
pay 4% forward premium yielding him no
gain.

55. 55
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 ?

56. 56
Answer-5
♦ The British pound is at a forward discount of
3.073% 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 in
India at rate of 5%
♦ The total amount is converted into pounds at the
forward rate
♦ Net gain =1067.7419 pounds.

57. 57
Exercise-6
♦ A Ltd is planning to import a multipurpose
machine from Japan at a cost of 3400 lakh
Yen.The company can borrow at the rate of 18%
per annum with quarterly rests.However there is
an offer from Tokyo branch of Indian Bank
extending credit of 180 days at 2% per annum
against the opening of an irrevocable letter of
credit. Other information is as follows:
♦ Spot rate for Rs.100=340 yen; 180 days forward
rate for Rs.100=345 yen; commission charges for
letters of credit are at 2% for 12 months.
♦ Advise the company which mode of purchase is
better?

58. 58
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

59. 59
Answer-6 continues
♦ Total payments =3468 lakhs yen
♦ Conversion into indian rupees=1005.217
♦ Conclusion:- Avail overseas offer

60. 60
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?

61. 61
Answer-7
♦ Difference in rate-7.5%- 2%=5.5%p.a.
♦ Spot rate $48
♦ Add: 5.5% premium for three months
(48x (5.5/100) x 6/12) =1.32
Forward rate = 49.32/$

62. 62
Exercise-8
♦ Spot rate- Rs.48.5/$ ; 6 month forward rate-
Rs.48.90/$ ; Annualised interest on US 6
month treasury bill –2.5%; annualised
interest on Indian 6-month treasury bill-
6.0%; what are the transactions the trader
will execute to receive arbitrage gain?

63. 63
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%

64. 64
Since interest diferential is more
than premium forward arbitrage
gain is possible.

65. 65
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

66. 66
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

67. 67
Exercise-10
♦ You are required to fill in the missing
figures and complete the table
US
dolla
r
Pound Canadi
an
Yen Euro
1USD
1 pound
1Canadi
1 Yen
1 Euro
1.0
-
-
-
-
o.6161
1.0
-
-
-
1.5259
-
1.0
-
-
------
-
-
1.0
-
0.9287
-
-
-
1.0

68. 68
Answer-10
US
dollar
Pound Canadi
an
Yen Euro
1USD
1 pound
1Canadi
1 Yen
1 Euro
1.0
1.623
0.6553
0.0085
1.0767
o.6161
1.0
0.4037
0.0052
0.6634
1.5259
2.4767
1.0
0.0129
1.6430
118.08
191.655
77.3838
1.0
127.145
0.9287
1.5074
0.6086
0.0078
1.0

69. 69
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?

70. 70
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.

71. 71
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.

72. 72
♦ Borrow in the country where the rate of
interest is low and invest in the country
where interest rate is high.

73. 73
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 rate
for DM, for delivery on 30th
June?

74. 74
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 country
B(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

75. 75
Exercise-13
♦ Spot rate 47.88/$
♦ 3 month forward rate 48.28/$
♦ 3 month interest rates Re.7%
$ 11%
Is there any arbitrage gain?

76. 76
Answer-13
3 month forward rate of dollar is higher than spot rate
implies 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 gain
possible.

77. 77
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 for
DM for delivery on 30th
June?

78. 78
♦ S1=0.6560{1+(0.045 x3/12)/1 +(0.065 x
3/12)}
= 0.6560 x ( 1.01125/1.01625)
= USD 0.652772 $/DM

79. 79
Exercise-15
♦ In International Monetary Market an
international forward bid for December, 15
on pound sterling is $ 1.2816 at the same
time that the price of IMM sterling future
for delivery on December,15 is $1.2806.
The contract size of pound sterling is
62,500. How could the dealer use arbitrage
in profit from this situation and how much
profit is earned?

80. 80
Exercise-16
♦ ABC Co. have taken 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 elicit
the following information:
Spot USD 1 Rs. 48.5275
6 months forward Rs.48.4575
1.What would be their total commitment in rupees, if they
enter into a forward contract?
2. Will you advise them to do so? Explain giving reasons.

81. 81
Exercise-17
♦ The United States Dollar is selling in India at
Rs.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?

82. 82
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

83. 83
Exercise-18
♦ A company operation 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 will decline by 10%
over 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.

84. 84
Exercise-19
♦ The following table shows interest rates for
the 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 ½%
19 ½%
?
?
12 ¼%
?
?
6.3%
?
20%
7.5200
?

85. 85
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

86. 86
Exercise-21
♦ X Ltd. an Indian company has an export exposure of 10
million(100 lacs) Yen, value September end. Yen is not directly
quoted 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 to
depreciate against dollar to 43
♦ Forward rate for September, 2008 USD/Yen =137.35 and
USD/INR=42.89.
You are required
i) To calculate the expected loss if hedging is not done. How the
position will change with company taking forward cover?
ii) If the spot rate on 30th
September, 1998 was eventually
USD/Yen=137.85 and USD/INR=42.78, is the decision to take
forward cover justified?

87. 87
Exercise-22
♦ A company operating in a country having the dollar as its unit of
currency has today invoiced sales to an Indian company, the payment
being due three months from the date of invoice.The invoice amount is
$13,750 and at 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 the
three 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
can be hedged by forward contract.

88. 88
Exercise-23
♦ Shoe Company sells to a wholesaler in Germany. The purchases
price 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 foreign –exchange 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)

89. 89
Answer-23
♦ Spot rate DM/US $ =1.71
♦ If company receive payment then
♦ 50,000 x 1.71=

90. 90
Exercise-24
♦ A customer with whom the Bank had entered into
3 months forward purchase contract for Swiss
Francs 10,000 at the rate of Rs.27.25 comes to the
bank after 2 months and requests cancellation of
the contract. On 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 on
cancellation?
♦ (loss to the customer $2700 due to exchange
difference)

91. 91
Exercise-25
♦ In 2005 a foreign institutional investor invested
US 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 the
foreign institutional investor?

92. 92
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?

93. 93
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%

94. 94
Exercise-25
♦ The following data is available from the
forex 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.

95. 95
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 and
financial analysis by My Khan and P.K Jain
♦ Chapter Foreign exchange markets and
Dealings

96. 96
Foreign Exchange Exposure
and Risk Management
By Prof. Augustin Amaladas
M.Com.,AICWA.,PGDFM.,DIM.,B.Ed.

97. 97
FERM
♦ Various types of risk exposed
♦ Techniques to deal with such risks
♦ Hedge such risk
♦ Techniques adopted in India to manage
FER

98. 98
Types of Exposure to business
risk
♦ 1. Transaction exposure
♦ 2.Translation exposure
♦ 3. Economic exposure

99. 99
Transaction Exposure
♦ Transactions that require settlement in
foreign currency-obligations
♦ Cross border trade
♦ Domestic purchases and sale of goods and
services
♦ Debtors receivable in foreign currencies
♦ Creditors payable in foreign currencies,
foreign loans and collaborations
investments

100. 100
Example
♦ Infosys incurs loss of Rs.80 crore in the
volatile forex marketdue to
5.6%depreciation of the rupee during the
first quarter of 2008-09 fiscal year.ie rupee
was 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 rupee
benefited the company by 111 crore

101. 101
Translation Exposure-page 17.2
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 asset
has to be provided more depreciation

102. 102
♦ 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

103. 103
What is translation adjustment?
♦ Translation loss/gain may not be reflected
in the income statement but they are shown
in the balance sheet under the head
translation adjustment in the balance sheet
without affecting accounting income.They
are carried out in the owners’ equity
account
♦ This practice differ from country to country.

104. 104
Economic exposure
♦ It is the most important as it has impact on the
valuation of firm.
♦ Change in the value of a company that
accompanies 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 the
firm-as measured by the present value of the
expected future cash flows – will change when
exchange rates change

105. 105
formula
♦ Change in PV/Change in exchange rate
♦ It measures variability in the value of the
firm due uncertain exchange rate changes.

106. 106