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Foreign exchange risk management

Q1

Indirect quotes from direct quotes in India


i.

Rs 45 / $
= $

1
45

ii.

/ Re

= $ 0.022222 / Re

v. Rs 7.25 / FF
1

= FF

7.25

Q2

1
80

iii. Rs 25 / DM

/ Re

= DM

= 0.0125 / Re

vi.

Rs 108 /
=

/ Re

= FF 0.1379310/Re

Rs 80 /

1
108

/ Re

/ Re

= DM 0.04 / Re

vii.
=

= 0.009259 / Re

1
25

iv. Rs 35 / S $
= S$

1
35

/ Re

= S$ 0.028571/Re

Rs 0.44 /
1
0.44

/ Re

= 2.272727 / Re

Direct quotes ion US from following indirect quotes


i. Can $ 1.106 /$
= $

1
1.106

/ can $

= $ 0.904159 /can$

v. AUS $ 1.10782/$
=$

1
1.10782

/ AUS $

= $ 0.902674/AUS$

ii.

0.61995 / $
=$

1
0.61995

= $ 1.613033 /

iii. 0.70744 / $
=$

1
0.70744

= $ 1.413547 /

iv
= $

DM 1.9875 / $
1
1.9875

/ DM

= $ 0.503144 / DM

vi. 90.225 / $
=$

1
90.225

= $ 0.0110834 /

PRAVINN MAHAJAN CA CLASSES

Q3

Inverse of the given quotes

i. Rs 46.30/ 46.90 per $


= Rs

ii. Rs 78.45 / 79.10 per

per $

46.90 46.30

= Rs 0.021322 / 0.021598 per $

iii.

Rs 63 / 65 per

1
65

iv.
=

0.015385 / 0.015873 per Re

v.

FF 6.1563 / 6.4210 per $

1
6.4210

1
6.1563

1
78.45

per Re

= 0.012642 / 0.012747 per Re

per Re

63

1
79.10

$ 1.4236 / 1.6512 per


1
1.6512

per $

1.4236

= 0.605620 / 0.702445 per $

per FF

vi.

675 / 710 per

1
710

1
675

$ 0.155739 / 0.162435 per FF

= 0.001408 / 0.0014815 per

vii.

Roubles 250 / 255 per $

viii. $ 0.1086 / 0.1104 per 100

1
255

1
250

per Rouble

$ 0.003922 / 0.004 per Rouble

100
0.1104

100
0.1086

= 905.7971 / 920.8103 per $

Q4

a.

b.

Rs 42.50 per $
$ 1.0563 per

Direct quote in India i.e

180.80 per $
0.3264 per $

Indirect quote in UK i.e

= 42.50 x 1.0563
= 180.80 x 0.3264
= Rs 44.89275 per
= 59.01312 per

PRAVINN MAHAJAN CA CLASSES

c.

0.9033 per $
0.6437 per $
180.75 per

d.

180.80 / 181.30 per


Direct quote in Japan i.e

DEM 3.5250 / 3.5255 per

= 180.75 x 0.6437 x

=180.80 x

0.9033

3.5255

= 128.804135 per

/ 181.30 x

1
3.5250

= 51.283506 / 51.432624 DEM

e.

0.6125 per $
DM 1.3275 per $
108 per $

= 0.6125 per $

Direct quote in UK

, ,

= 0.6125 x 1.3275
= 0.461394 / DM

= 0.6125 x

1
108

= 0.005671 per

=
$

Direct quote in USA

, ,

=
=

=
=

1
0.6125

$ 1.632653 per
1
1.3275

$ 0.753296 per DM
1
108

$ 0.009259 per

Contd:

PRAVINN MAHAJAN CA CLASSES

0.6125

x = 1.3275 x

= DM 2.167347 per

Direct quote in Germany

= 1.3275

= DM 1.3275 per $

= 1.3275 x

108

= DM 0.0122917 per

Direct quote in Japan

, $ ,

Given

108 x

176.326531

108

108 per $

f.

0.6125

108 x

81.355932 per DM

1.3275

Rs 42.30 / 43.80 per $


Rs 80.50 / 82.20 per
$ 1.124 / 1.136 per
DM 6.243 / 6.725 per

=
=
=

1
82.20

x 42.30 x 1.124 x

1
6.725

1
80.50

x 43.80 x 1.136 x

1
6.243

0.086009 / 0.09906 per DM

PRAVINN MAHAJAN CA CLASSES

Q5

Given Spot rate


3 Month Forward

Rs 46.30 per $
Rs 46.95 per $

Annualised Premium or discount on $

=
=

Premium on $

x 12

= 5.616 % p.a

Annualised Premium or Discount on Re =

Discount on Re

Given Spot rate

x 12

46.30 46.95
46.95

Q6
.

x 12

3
46.95 46.30
46.30

x 12

5.538 % p.a

Rs 50 per $

3 Month Forward if
a. Annual premium on $ is 20%

b. Annual Discount on $ is 10%


x 12 = 0.20

3
50
50

x 12 = 0.20

c. Annual premium on Re is 20%


=
=

d. Annual discount on Re 10%

x 12 = 0.20

3
50

x 12 = - 0.10

F = Rs 48.75 per $

F = 52.5
Rs 52.5 per $

x12 = - 0.10

50
50

=
=

x 12 = 0.20

F = 47.619
3 month forward rate Rs 47.619 per $

x 12 = - 0.10

50

x 12 = - 0.10

50 F = - 0.025
F = Rs 50.25 / $

PRAVINN MAHAJAN CA CLASSES

Q7
Given

Spot rate

$ 1.3078 per
0.8075 per

a. 3 month forward rate if annualized premium on $ is 3.75%


x 12 = 0.0375

1.3078

x 12 = 0.0375

1.3078

0.0375
4

1.3078 F
= 0.009375 F
F
= 1.295653
3 Month forward rate = $ 1.295653 per
0.8075 per

b. Spot rate is
If 6 month forward rate is
i.

0.8134 per

Premium or discount on

x 12

0.8134 0.8075
0.8075

x 100 x 2

is 1.4613% p.a
ii.

Premium or discount on

x 12

6
0.8075 0.8134
0.8134

x 100 x 2

Discount on 1.451% p.a

PRAVINN MAHAJAN CA CLASSES

Q8

Given

Spot
1 Month Forward
2 month forward
3 Month Forward
6 Month Forward

Rs 47.00 / 47.30 per $


Rs 47.20 / 47.50 per $
Rs 47.40 / 47.75 per $
Rs 47.60 / 47.90 per $
Rs 47.90 / 48.40 per $

if $ is bought ie relevant rate is Ask rate


a

Premium or discount on $

i.

1 month forward

47.50 47.30
47.30

x 100

x 100

1 month forward premium on $ 0.423 % per month or 5.074% p.a


ii.

47.75 47.30

2 month forward

47.30

x 100

2 month forward premium on $ 0.9514% for 2 month or 5.708% p.a


iii.

47.90 47.30

3 month forward

47.30

x 100

3 month forward premium on $1.268 % for 3 month or 5.074% p.a


iv.

48.40 47.30

6 month forward

47.30

x 100

6 month forward premium on $ 2.236 % for 6 month or 4.651% p.a


b.

Premium or discount on Re

i.

1 month forward

x 100

47.30 47.50
47.50

x 100

1 month forward discount on Re 0.4210 % per month or 5.053% p.a


Contd.

PRAVINN MAHAJAN CA CLASSES

ii.

47.30 47.750

2 month forward

47.75

x 100

2 month forward discount on Re 0.942 % for 2 month or 5.654% p.a


iii.

47.30 47.90

3 month forward

47.90

x 100

3 month forward discount on Re 1.253 % for 3 month or 5.01% p.a


iv.

47.30 48.40

6 month forward

48.40

x 100

6 month forward discount on Re 2.2727 % for 6 month or 4.545% p.a


B

if $ is sold ie relevant rate is Bid rate


a
i.

Premium or discount on $

1 month forward

x 100

47.20 47
47

1
ii.

iii.

47.40 47
47

x 100

month forward premium on $ 0.851% for 2 month or 5.106% p.a


47.60 47

3 month forward
3

iv.

month forward premium on $ 0.4255 % per month or 5.106% p.a


2 month forward

x 100

47

x 100

month forward premium on $1.277 % for 3 month or 5.106% p.a


47.90 47

6 month forward

47

x 100

6 month forward premium on $ 1.915 % for 6 month or 3.830% p.a

Contd.

PRAVINN MAHAJAN CA CLASSES

b.
i.

Premium or discount on Re

1 month forward

x 100

47 47.20
47.20

x 100

1 month forward discount on Re 0.4237 % per month or 5.085% p.a


ii.

2 month forward
47 47.40
47.40

x 100

2 month forward discount on Re 0.844 % for 2 month or 5.063% p.a


iii.

3 month forward
47 47.60
47.60

x 100

3 month forward discount on Re 1.2605 % for 3 month or 5.042% p.a


iv.

6 month forward
47 47.90
47.90

x 100

6 month forward discount on Re 1.879 % for 6 month or 3.758% p.a

Q9

Spot Rate

Rs 46.30 / 46.64 per $

One month forward rate if swap points are .15 / .20


46.30 /
46.64
+
. 15
.20
46.45
46.84
One month forward rate is Rs 46.45 / 46.84 per $

Two month forward rate if swap points are .25 / .30


46.30 /
46.64
+
. 25
.30
46.55
46.94
Two month forward rate is Rs 46.55 / 46.94 per $

PRAVINN MAHAJAN CA CLASSES

Q10

Q11

Three month forward rate if swap points are .32 / .38


46.30 /
46.64
+
. 32
.38
46.62
47.02
Three month forward rate is Rs 46.62 / 47.02 per $

Spot Rate
Rs 46.30 / 46.55 per $
One month forward rate if swap points are .15 / .11
46.30 /
46.55
. 15
.11
46.15
46.44
One month forward rate is Rs 46.15 / 46.44 per $

Two month forward rate if swap points are .20 / .14


46.30 /
46.55
+
. 20
.14
46.10
46.41
Two month forward rate is Rs 46.10 / 46.41 per $

Three month forward rate if swap points are .27 / .22


46.30 /
46.55
+
. 27
.22
46.03
46.33
Two month forward rate is Rs 46.03 / 46.33 per $

Spot Rate
DEM 1.5880 / 1.5890 per $
One month forward rate if swap points are .10 / .05c
1.5880 /
1.5890
.0010
.0005
1.5870
1.5885
One month forward rate is DEM 1.5870 / 1.5885 per $
Two month forward rate if swap points are .20 / .10c
1.5880 /
1.5890
.0020
.0010
1.5860
1.5880
Two month forward rate is DEM 1.5860 / 1.5880 per $
Three month forward rate if swap points are .30 / .15c
1.5880 /
1.5890
.0030
.0015
1.5860
1.5880
Three month forward rate is DEM 1.5850 / 1.5875 per $
10
CLASSES

PRAVINN MAHAJAN CA

Q12

Spot Rate
$ 0.5875 / 0.5885 per DG
One month forward rate if swap points are .12 / .18c
0.5875 /
0.5885
+
.0012
.0018
0.5887
0.5903
One month forward rate is $ 0.5887 / 0.5903 per DG
Two month forward rate if swap points are .15 / .25c
0.5875 /
0.5885
+
.0015
.0025
0.5890
0.5910
Two month forward rate is $ 0.5890 / 0.5910 per DG
Three month forward rate if swap points are .20 / .30c
0.5875 /
0.5885
+
.0020
.0030
0.5895
0.5915
Three month forward rate is DEM 0.5895 / 0.5915 per DG

Q13

Given Spot rates

$ 1.1575 / 1.1595 per


Can $ 1.8500 / 1.8700 per
190 / 200 per

a. to be paid for purchasing 1,00,000 $ on spot


Since $ is to be purchased so relevant rate is Bid rate. Thus customer will buy
$ @ $ 1.1575 per
Customer will purchase 1,00,000 $ for

1,00,000
1.1575

, i.e 86,393 spot

b. to be paid for purchasing 1,00,000 can $ on 3 months forward rates


Since Can $ is to be purchased, relevant rate is Bid rate.
Thus customer will buy can $ at 3 month forward rate of
can $ (1.8500 +0.0030) per
Customer will purchase 1,00,000 can $ for

1,00,000
1.8530

, i.e 53,967

c. to be paid for purchasing 1,00,000 on 4 months forward rates


Since is to be purchased, relevant rate is Bid rate.
Thus customer will buy at 4 month forward rate of
(190 - 5) per
Customer will purchase 1,00,000 for

11
CLASSES

1,00,000
185

, i.e 540.541

PRAVINN MAHAJAN CA

Q14

Given

Spot

Dem 1.5975 / 1.5980 $

2 m forward

Dem 1.5955 / 1.5970 $

Riyal 3.7570 / 3.7600 $

3 m forward

DEM 1.5950 / 1.5965 $

Riyal 3.7580 / 3.7610 $

Cross rate DEM / Riyal =


2 month forward

3 month forward

Spot

Riyal 3.7550 / 3.7560 $

1.5955 x

DEM 0.424335 / 0.425073 Riyal

1.5950 x

DEM 0.424089 / 0.424827 Riyal

3.7600

1
3.7610

/ 1.5970 x

/ 1.5965 x

3.7570

1
3.7580

A firm wishes to buy Riyals against DEM 3 months forward


-

Applicable rate is Ask rate ie Firm will buy riyals @ DEM 0.424827 per Riyal

For 10,000 DEM , (

If the firm wishes to buy Riyals with option over the third month, quote provided
by Bank will be DEM 0.424335 / 0.424827 per Riyal

10,000
0.424827

) 23,539 riyals can be bought

Q15

Indian Rayon is importing machinery from the US . Thus Indian rayon has to pay $ to US
firm . Since exact date of delivery and payment is not known and payment is to be
made between second and third month, so Indian Rayon will take an option of over a
third month contract
Spot rate

Rs 45.4500 / 45.8525 USD

1 month forward

Rs 44.70 / 45.5025 USD

( 45.45 0.75)

2 month forward

Rs 44.30 / 45.1025

(45.45 1.15)

3 Month Forward

(45.8525 0.35)

(45.8525 0.75)

Rs 44.05 / 44.9025 USD

(45.45 1.40)

(45.8525 0.95)

If firm wants to hedge in the Forward market by over a third month contract, bank will
give following quote
Rs 44.30 / 44.9025 USD
i.e Indian Rayon will book a forward contract to purchase $ at Rs 44.9025 per USD
12
CLASSES

PRAVINN MAHAJAN CA

Q16

An exporter in London expects to receive $ 2,50,000 between 3rd and 4th month. To
protect its proceeds exporter should Hedge by over a fourth month contract.
Bank will provide following over a 4th month quote
$ 1.8066 / 1.8105 per
Exporter will sell $ to bank @ $ 1.8066 per

Q17

An importer requested Bank to remit SGD$ 25,00,000 on 28 Jan 2005, However due to
bank strike Bank was able to remit payment on 4th Feb.
Since Importer has to buy SGD $, thus from cross rate

relevant rate is Ask rate

Amount to be paid for purchasing 25,00,000 SGD $ if bank had remitted on 28th jan
2005.
On 28th jan 2005 importer could purchase SGD $ at

=
=

+ Exchange margin 0.125 %

=
=

45.90 x 1.7850 x

1
3.1575

25.948219
+ 0.032435
25.980654

Payment to be made for remitting 25,00,000 SGD on 28th Jan 2005


25,00,000 x 25.980654 = Rs 649,51,635

Amount actually paid for purchasing 25,00,000 SGD $ on 4th jan 2005.
On 4th 2005 importer could purchase SGD $ at

=
=

+ Exchange margin 0.125 %

=
=

45.97 x 1.7775 x

1
3.1380

26.039412
+ 0.032549
26.071961

Payment made for remitting 25,00,000 SGD on 4th Feb 2005


25,00,000 x 26.071961 = Rs 651,79,903
Thus net loss to importer due to delay in payment = 651,79,903 - 649,51,635
13
PRAVINN MAHAJAN CA
= Rs 2,28,268
CLASSES

Q18

M/s JVG of London made arrangements with Bank to make payment of 4,00,00,000
on 1st july 2008, However Bank made payment on 24th July 2008

Since M/s JVG has to buy yen, so from Cross rate , relevant rate is ASK rate

to be paid for purchasing 4,00,00,000 on 15th July 2008

= 1.4705 x 0.4840 x 0.7580 x


= 0.002248
= 0.000003
0.002251

+ 0.15% exch. Margin

JVG will purchase 4,00,00,000 @ 0.002251 per for ( 4,00,00,000 x 0.002251) =


90,040
th
to be paid for purchasing 4,00,00,000 on 24 July 2008

= 1.4740 x 0.4780 x 0.7620 x


+ 0.15% exch. Margin

1
240

1
265

= 0.002026
= 0.000003
0.002029

JVG will purchase 4,00,00,000 @ 0.002029 per for ( 4,00,00,000 x 0.002029) =


81,160
Gain to JVG due to delay
=
90,040 81,160 = 8,880

Q19

Customer has entered into 3 Month forward contract for selling 10,000 Swiss Francs
@ Rs 27.25 / SF
However after 2 Months customer approached bank for cancellation of Forward
Selling contract. For cancellation customer will enter into forward purchase contract
of 10,000 Swiss francs with Bank @ 1 month forward rate applicable on date of
cancellation i.e customer will purchase Swiss francs @ Rs 27.52 / SF (ask rate)
On due date
Customer will sell SF at
Buy SF at
Loss to customer per SF

Rs 27.25
Rs 27.52
0.27

14
Total loss to customer 10,000 CLASSES
x 0.27 = Rs 2700

PRAVINN MAHAJAN CA

Q20

Bank has entered into forward contract for Purchasing 50,000 @ Rs 82.75 /
However on maturity customer approached bank for cancellation of Forward contract.
For cancellation Bank will enter into Sale contract of 50,000 with customer @ rate
applicable on date of maturity i.e Bank will sell 50,000 @ 83.15 /
On maturity
Bank will buy at
Rs 82.75
Bank will sell at
Rs 83.15
Gain to bank per
0.40
On Maturity bank will recover from customer 50,000 x 0.40 = Rs 20,000

Q21

Bank has entered into forward contract for Selling $ 1,45,000 @ Rs 46.90 / $
After Maturity customer approached bank for cancellation of Forward contract. For
cancellation, Bank will enter into Purchase contract of 1,45,000 $ with customer @
rate applicable on 21st March i.e Bank will purchase $ 1,45,000 @ 47.05 / $.
Since customer approached bank after Maturity, so any gain to customer due to
cancellation shall NOT be paid to customer. However any loss to customer due to
such cancellation shall be recovered from customer
On 21st March
Bank will Sell $ at
Rs 46.90
Bank will Buy $ at
Rs 47.05
Loss to bank (or gain to customer )per $
0.15
Total gain to customer which shall not be paid by bank to customer is 1,45,000 x 0.15
= Rs 21,750

Q22

Bank has entered into forward contract for Selling $90,000 @ Rs 46.34/ $ due on 15 th March 08
customer did not approached the bank on/before/after date of Maturity ie 15 th March 08.
Bank will itself, after 14 days from date of maturity i.e on 15 th day from date of maturity cancel
the forward contract. For cancellation, Bank will enter into Purchase contract of 90,000 $ with
customer @ rate applicable on 30 th March i.e Bank will purchase $ 90,000 @ 46.50 / $.
Since customer did not approached the bank on / before /after Maturity, so any gain to
customer due to cancellation shall NOT be paid to customer. However any loss to customer
due to such cancellation shall be recovered from customer
On 30 th March
Bank will Sell $ at
Bank will Buy $ at

Rs 46.34

Rs 46.50
15 $
Loss to bank (or gain to customer )per
0.16 PRAVINN MAHAJAN CA
CLASSES
Total gain to customer which shall not be paid by bank to customer is 90,000 x 0.16
= Rs 14,400

Q23

AR constructions Ltd.
Bank has entered into 3 month forward contract for Selling 4,00,000 @ Rs 78.65 /
customer did not approached the bank on/before/after date of Maturity ie 15 th March 08.
Bank will itself, after 14 days from date of maturity i.e on 15 th day from date of maturity cancel
the forward contract. For cancellation, Bank will enter into Purchase contract of 90,000 $ with
customer @ rate applicable on 30 th March i.e Bank will purchase $ 90,000 @ 46.50 / $.
Since customer did not approached the bank on / before /after Maturity, so any gain to
customer due to cancellation shall NOT be paid to customer. However any loss to customer
due to such cancellation shall be recovered from customer
On 30 th March
Bank will Sell $ at
Bank will Buy $ at

Rs 46.34

Rs 46.50
Loss to bank (or gain to customer )per $
0.16
Total gain to customer which shall not be paid by bank to customer is 90,000 x 0.16
= Rs 14,400

Q24

Customer booked a forward contract to buy 2,00,000 $ due on 5 th March. Customer did not
approach the bank PQR ltd.for cancellation of forward contract. The bank will on 15 th day after
maturity i.e on 20th March, suo-moto cancel the contract.
In effect on 20th march a reverse contract is made on behalf of customer by PQR bank i.e
customer will sell 2,00,000 $ on 20th march. Since customer will Sell $ on 20th march, relevant
rate is BID rate. Customer will sell $ @ Rs 46.18 / $
Statement of Net gain or loss on cancellation of forward contract
Rs
th
Amount payable by customer on purchase of 2,00,000 $ on 5 march
2,00,000 x 46.10
92,20,000
Amount to be recieved on selling 2,00,000 $ @ 46.18 / $
2,00,000 x 46.18
92,36,000
Net Profit to customer on cancellation
16,000
Since customer did not approached the bank for cancellation, so any profit on cancellation to
PQR will not be paid by bank. But any loss on cancellation to PQR Ltd. will be recovered by
Bank. So Rs gain of Rs 16,000 to customer will not be paid by bank
OR gain to customer is 2,00,000 (46.18 46.10)
2,00,000 x 0.08 = Rs 16,000

16
CLASSES

PRAVINN MAHAJAN CA

Q25

customer has entered into forward contract to sell Swiss frank to bank @ Rs 36.25 after 3
months. Customer approached bank after 2 months for cancellation on forward contract.
For cancellation customer will make reverse contract to buy swiss frank from bank on due date.
Since customer has to buy CHF, so relevant rate is ASK rat e. Thus customer will book a 1 month
forward contract to buy Swiss frank from bank @ Rs 36.52 per swiss frank
Statement of net profit or loss to customer on cancellation of forward contract
Amount receivable by customer on original contract to sell CHF
1,00,000 x 36.25
Amount payable by customer on reverse contract to buy CHF
1,00,000 x 36.52
Net loss to customer

36,25,000
36,52,000
27,000

OR loss to customer 1,00,000 ( 36.52 36.25)


1,00,000 x 0.27 = 27,000
Q26

Customer has made a contract with bank to purchase 3,00,000 @ Rs 75.45 per due
on 15th dec
On due date customer approached bank for cancellation of forward contract. For cancellation
customer will make a reverse contract with bank to sell to bank at the rates applicable on due
date
Since for cancellation customer has to sell so relevant rate is BID rate
Inter bank bid rate on due date is Rs 75.35 per . Banks margin is 0.090%
So customer will sell to bank at 75.35

0.090
100

x 75.35 = Rs 75.282185 per

Statement of profit or loss to customer on cancellation of forward contract


Amount payable as per original contract to buy
3,00,000 x 75.45
Amount receivable on reverse contract to sell
3,00,000 x 75.282185
Net loss to customer
Q27

226,35,000
225,84,655.50
50,344.50

Customer made a forward contract to sell 2,50,000 to bank @ Rs 102.30 / due on 15 th oct. On
due date customer approached Bank for cancellation of forward contract.
For cancellation customer will make a reverse contract to buy from bank at the spot rates
applicable on due date. Since customer has to buy , so relevant rate is ASK rate
Inter bank ASK rate on due date is Rs 103.20 and inter bank margin is 0.150%
So customer will buy from bank @ Rs 103.20 + 0.0015 x 103.20 = Rs 103.3548 /
Statement of Profit or loss on cancellation of forward contract
Amount receivable as per original contract to Sell
2,50,000 x 102.30

17
CLASSES

255,75,000

PRAVINN MAHAJAN CA

Amount payable as per reverse contract to buy


2,50,000 x 103.3548
Net loss to customer

Q28

258,38,700
2,63,700

customer made a forward contract to sell $ 5,00,000 to bank @ Rs 35.30 per $ due on 31 st oct.
On 30th sept (before due date) customer approached bank for cancellation of forward contract
For cancellation customer will make a reverse contract to buy $ from bank at 1 Month Forward
rate applicable on 30th sept. Since customer had to buy $ in reverse contract , so relevant rate is
ASK rate.
1 month forward ask rate on 30th sept is
Spot ask rate (inter bank)
+ swap points
+ margin .0020 x 37.58

37.40
0.18
37.58
0.07516
37.65516

Statement of Profit or loss on cancellation of forward contract

Q29

Amount receivable as per original contract to Sell $


5,00,000 x 35.30

176,50,000

Amount payable as per reverse contract to buy $


5,00,000 x 37.65516
Net loss to customer

188,27,580
11,77,580

Customer made a forward contract to sell 2,00,000 to retail bank (which in turn will sell these
s to wholesale bank) @ Rs 85.7475 / due on 15 th October 2007.
On 15th june customer approached bank to cancel forward contract. For cancellation customer
will make a reverse forward contract to buy at forward rate applicable for October in june
Since customer has to buy for cancellation, so relevant rate is Ask rate. Customer will book a
forward contract on 15th june to buy on 15th October at following rate
Inter bank October Ask rate
+ margin of retain banker
October forward rate

85.7350
0. 0650
85.8000

Statement of profit or loss to customer on cancellation of forward contract


Amount to be received on selling of as per original contract
2,00,000 ( 85.7475 0.0475)
=

171,40,000

Amount payable on purchase of as per reverse contract


2,00,000 ( 85.8)

171,60,000

18
CLASSES

PRAVINN MAHAJAN CA

Net loss to customer

Q30

20,000

customer made a forward contract to sell $ 7,50,000 at Rs 46.70 / $ to bank due on 15 th feb. On
15th Jan customer approached bank for extension of forward contract by one month.
On 15th jan following contracts will be made by customer with bank
1.

A reverse contract to cancel original contract of selling $ on 15th feb. i.e customer will make
one month forward contract on 15th jan to purchase $ 7,50,000 on due date 15th feb. since
customer had to buy $ so relevant rate is ASK rate. Thus customer will buy $ on 15 th feb @
Rs 46.71 / $

2.

New two month forward contract to sell $ 7,50,000 due on 15 th march. Since customer has to
sell $ , so relevant rate is BID rate. Customer will on 15 th Jan book a 2 month forward contract
to sell $ at Rs 46.73 / $
Statement of profit or loss of customer on extension
Amount receivable from sale of 7,50,000 $ as per original contract
7,50,000 x 46.70
Amount payable for purchase of 7,50,000 $ as per reverse contract
to cancel original contract 7,50,000 x 46.71
loss to customer

Q40

350,25,000
350,32,500
7,500

Robinson shillings Pvt. Ltd. an Indian company purchased goods from US company for
$ 2,50,000, payable in 4 months. RS Ltd has to buy $,Quotes are

Rs
$

, so relevant rate is ASK rate

RS Ltd has 2 options


1.

Book a forward contract today, to purchase 2,50,000 $ after 4 months


RS pvt Ltd will book a forward contract today to purchase 2,50,000 $ after 4 months
@ Rs 44.85 per $
Rs Ltd will pay 2,50,000 x Rs 44.85
=
Rs 112,12,500

2.

Rs Ltd will purchase 2,50,000 after 4 months at Rs 45 per $


Rs Ltd will pay 2,50,000 x Rs 45

Rs 112,50,000

Since Rupee payment (outflow) is lower in Forward contract, son RS ltd will book a forward
contract today to purchase $ after 4 months.
Q41

Uk customer purchased machine from Japan for 20,00,000, payment to be made in 3 months. If
quotes are

and customer has to buy (and sell ), so relevant rate is BID rate.

19
CLASSES

PRAVINN MAHAJAN CA

UK customer has 2 options.


1.

Book a forward contract today to buy after 3 months

= 105 x 1.6320
= 171.36

Customer will book a forward today to buy 20,00,000 after 3 months @ 171.36 per
Customer will pay
2.

20,00,000
117.36

= 11,671.3352

To purchase after 3 months at spot rate after 3 months.

= 115 x 1.6330
= 187.795

Customer will purchase after 3 months at 187.795 per


Customer will pay

20,00,000
187.795

= 10,649.9108

Option to purchase at spot rate after 3 months is better option. Customer will save
(11,671.3352 10,649.9108) = 1,021.4244
Q42

An Indian company purchased goods having Invoice value of $ 13,750 to be paid in 3 months.
At todays spot rate of $ 0.0275 per Re, for $ 13,750 company has to pay Rs 5,00,000
Exchange rate is expected to decline in 3 months
Spot rate after 3 months is $ 0.0275 x 0.95 =
$ 0.026125 per Re
If company purchase $ 13,750 after 3 months at spot rate after 3 months of $ 0.026125 per Re.
company will pay
13,750
0.026125

= Rs 5,26,315.789

Thus loss to Indian company is (Rs 5,26,315.789 Rs 5,00,000) = Rs 26,315.789


This loss can be hedged, if company book a forward contract today to purchase
$ 13,750 @ $ 0.0273 per Re
Company will pay
13,750
0.0273

= Rs 5,03,663.004

Thus loss to company (5,05,663 5,00,000)

20
CLASSES

PRAVINN MAHAJAN CA

If forward hedge is taken, loss to company can be hedged to the extent of


Rs (5,26,315.789 5,03,663.004)
= Rs 22,652.785

Q43

An Indian company sold goods to US company for $ 2,50,000, expected to be received in 6


months.
Spot rate today is $ 0.0222 per Re
At todays spot rate company is expected to receive

2,50,000
0.0222

, Rs 112,61,261

$ will depreciate in 6 months by 20 % p.a


Spot rate after 6 months

0.0222
0.90

= $ 0.024667 per Re
If Indian company sells $ 2,50,000 at spot rate after 6 months, it will receive
2,50,000
Rs 101,34,998.175
0.024667
Thus loss to Indian company = 112,61,261 - 10134998 = Rs 11,26,263
This loss can be hedged if company book a forward contract today to sell 2,50,000 $ at
$ 0.0241 per Re
If forward contract is taken, company will receive

2,50,000
0.0241

Rs 103,73,444

Thus loss to company ( 112,61,261 103,73,444) = Rs 8,87,817


If forward contract is taken loss can be hedged (reduced) by 11, 26,263 8,87,817 = Rs 2,38,446
Q44

An Indian company Exported goods for 100 lac . is not quoted against Re. If Quote is

Re

, then

relevant rate is ASK rate, as Indian company had to buy .


Spot rate today is

129.75 and

So,

Re

Re
$

Re
$

41.79
$

1
= 41.79 x 129.75

= Re 0.32208 per
So according to todays spot rate company will receive 100 lac x 0.32208 = Rs 32,20,800

Spot rate after 6 months are


So,

Re

144 and
Re
$

Re
$

43

1
= 43 x 144

= Re 0.298611 per
If 100 lac are sold at spot rate after 6 months, company will receive 100 lac x 0.298611 =
Rs 29,86,110
So, loss to company if is sold at spot rate after 6 months (29,86,110 31,22,680) = Rs 1,36,570

21
CLASSES

PRAVINN MAHAJAN CA

This loss can be hedged if company book a forward contract today to sell in September

6 month forward contract is available at


So,

Re

137.35 and
Re
$

Re
$

42.89

= 42.89 x 137 .35


= Re 0.312268 per
If 100 lac are sold at forward rate after 6 months, company will receive 100 lac x 0.312268 =
Rs 31,22,680
So, loss to company if is sold at spot rate after 6 months (31,20,800 31,22,680) = Rs 98,120
If forward hedge is take , loss to company is reduced by (1,36,570 98,120) = Rs 38,450
b.

If Spot rate after 6 months are


So,

Re

137.85 and
Re
$

Re
$

42.78

= 42.78 x 1371.85
= Re 0.310337 per
If 100 lac are sold at spot rate after 6 months, company will receive 100 lac x 0.310337 =
Rs 31,03,370
If 100 lac are sold at forward rate after 6 months, company will receive 100 lac x 0.312268 =
Rs 31,22,680
Since Re amount received in forward contract is more than amount received on basis of spot rate
after 6 months, so it is justified to take forward cover .
Q45

A US company sold machine to Switzerland government @ CHF 1,00,000 to be received in 30


days
Todays spot rate is CHF 1.72 per $
1,00,000
At todays spot rate company is expected to receive
, $ 58,140
1.72
If company takes forward cover, it can sell CHF 1,00,000 @ CHF 1.71 per $
1,00,000
Company will receive
= $ 58480
1.71
b.

Q46

Spot rate is CHF 1.72 per $


Forward rate is CHF 1.71 per $
CHF is at premium
S F
Premium on CHF is
x 100
F
1.721.71
=
x 100 = 0.585%
1.71

A French company sold goods to American importer for $ 24,000.


Spot rate today is FF 5.70 per $
At todays spot rate company is expected to receive 24,000 x 5.70 = FF 1,36,800

22
CLASSES

PRAVINN MAHAJAN CA

FF to strengthen by 5% in 90 days i.e rate after 90 days is

5.70

= FF 5.428571 per $

1.05

If FF strengthen by 5% then company is expected to receive 24,000 x 5.428571 = FF 1,30,285


Loss to company 1,36,800 1,30,285 = FF6,515
If FF weaken by 5% in 90 days, then rate after 90 days is

5.70
.95

= FF 6 per $

If FF weaken by 5%, company is expected to receive 24,000 x 6 = FF 1,44,000


Profit to company = 1,44,000 1,36,800 = FF 7,200
Q47

Excel exporters an Indian company has to receive $ 1,00,000 in 60 days. When consignment was
priced exchange rate was Rs 45.50 per $
1.

Current spot rate Rs 45.60 per $


60 days forward rate quoted by bank Rs 45.20 per $
Forward Discount on $ =
=

F S
S

x 365

60

45.20 45.60
45.60

60

x 365 = - 0.0534

Discount on $ is 5.34%
2.

Q48

Consignment is priced when rate was Rs 45.50 per $. Thus when consignment was priced
company expected to receive Rs 45,50,000
At forward rate of rs 45.20 per $,, company is expected to receive Rs 45,20,000
Thus operating loss to company (45,50,000 45,20,000) Rs 30,000

Indian company purchased goods from Japanese company for 108 lac
At current spot rate it is equal to Rs 30 lacs
Thus current spot rate is

108 lac
30lac

= 3.6 per Re

Exchange rate is expected to decline by 10% in 3 months


Spot rate after 3 months is 3.6 x 0.9
= 3.24 per Re
Thus if is purchased at spot rate after 3 months, Indian company will pay

108 lac
3.24

= Rs 33.333 lac

Loss to Indian company if payment is made at spot rate after 6 months (33.33 30) = 3.333 lacs
This loss can be hedged by booking a forward contract today to buy @ 3.3 per Re
108 lac
3.3

= Rs 32.727 lac

Loss to Indian company if forward cover is taken (32.727 30) = Rs 2.727 lac
Thus if forward cover is taken loss of company is reduced by 3.333 2.727 = 0.606 lac
Q49

A US company is to receive DM 3,50,000 from a german co. in 6 months


If US company take a forward hedge, it will book a forward contract to sell DM @ 7.834 DM per $.
US company will receive

3,50,000
7.834

= $ 44,677

23
CLASSES

PRAVINN MAHAJAN CA

If Forward hedge is not taken, US company can sell DM after 6 months at spot rate after 6
months
i.
If after 6 months $ gained 5%, spot rate after 6 months will be 7.5 x 1.05
= DM 7.875 per $
Company will receive

3,50,000
7.875

= $ 44,444

In this case profit to US company due to forward hedge is ( 44,677 44,444) = $ 233
ii.

If after 6 months $ lost 2%, spot rate after 6 months will be 7.5 x 0.98 =
= DM 7.35 per $
Company will receive

3,50,000
7.35

= $ 47,619

In this case loss to company due to forward hedge is (47,619 44,677) = $ 2942
iii.

If after 6 months $ remained stable, spot rate after 6 months is DM 7.5 per $
Company will receive

3,50,000
7.5

= Rs 46,667

In this case if forward hedge is taken, company will incur a loss of (46,667 44,677)
= $ 1990
Q50

PQR Ltd an Indian company purchased goods for 2,00,000 from UK firm, payable after 4
months. Since PQR Ltd has to purchase 2,50,000 , so relevant rate ASK rate
PQR has 2 options
1.

Pay immediately without any interest charge


In this case company will borrow from bank @ 15% p.a and purchase for payment to UK
firm
Amount borrowed from Indian bank to purchase at
Spot rate of 78.60 per 2,00,000 x 78.60
Interest on amount borrowed @ 15% p.a for 4 months
157,20,000 x 0.15 x

4
12

Rs 157,20,000

Rs 7,86,000

Total cost of 2,50,000


2.

Rs 165,06,000

Pay to UK firm 2,50,000 along with interest @ 5% p.a


In this case firm will book a forward contract today to buy pay able along with interest after 4
months @ Rs 79.04 per
Amount of consignment

2,00,000

Interest on consignment amount 2,00,000 x 0.05 x


payable to UK firm

24
CLASSES

4
12

3,333
2,03,333

PRAVINN MAHAJAN CA

Amount payable to purchase 2,03,333 x 79.04

Rs 160,71,440

Re payment is lower in 2nd option, so PQR Ltd should make payment to UK firm after 4 months at
interest of 5 % p.a
Q51

CC Ltd is considering to purchase 20,000 bales of cotton @ 12 each . Cost of total


consignment is 2,40,000 , payable in 3 months. Since Cc ltd has to purchase , so relevant rate
is ASK rate
CC ltd. has 2 options
a.

To pay in 3 months @ 15% p.a and cover the exchange risk forward for 3 months
In this case. CC ltd will pay to vendor after 3 months along with interest of 15% p. a and will
book a forward contract today to purchase after 3 months

Amount of consignment

2,40,000

Interest on consignment 2,40,000 x 0.15 x 0.25

9,000

payable to vendor
Amount payable to purchase = 2,49,000 x ( 108.50 + 0.40)
b.

2,49,000
Rs 271,16,100

Settle now at current spot rate and pay interest on overdraft for 3 months
In this case, CC Ltd will pay 2,40,000 to vendor immediately by borrowing from bank @
18% p.a
Amount borrowed from bank to purchase 2,40,000
2,40,000 x 108.50
Interest on amount borrowed
260,40,000 x 0.18 x 0.25
Amount payable to bank

2,60,40,000
11,71,800
272,11,800

Since re outflow is lower in 1st option, So company should pay to vendor after 3 months along
with interest of 15% p.a
Q52

A firm is contemplating to purchase goods from US for 50,000$, to be paid in 90 days. US


supplier offered interest free credit of 60 days
Firm has two options
1.

To avail additional 30 days credit from supplier


In this case firm will pay to US vendor after 90 days, along with interest @ 6% p.a, for 30
days. Firm will take a 90 days forward contract to buy $ at Rs 45.55 per $

25
CLASSES

PRAVINN MAHAJAN CA

Amount of consignment
Interest payable to vendor @ 6% p.a for 30 days
50,000 x 0.06 x

30

$ 50,000
$

365

Total $ payable to vendor

246.57

50,246.57

Firm will purchase $ amount payable to vendor at 50,246.57 x 45.55 = Rs 22,88,731.26


2.

To pay to supplier after 60 days.


In this case, firm will pay to US vendor after 60 days by borrowing from bank @ 9% p.a for 30
days. Firm will book a 60 days forward contract today, to purchase dollars after 60 days
Amount borrowed from bank for purchasing $ after 60 days
50,000 x 45.30
Interest payable to bank for 30 days
22,65,000 x 0.09 x

30
365

Total amount payable to bank

22,65,000
16,754.79
22,81,754.79

Since Re outflow is lower in 2nd option so, firm should pay to vendor in 60 days, by taking 30
days credit from Bank
Q53

US co. purchased goods worth 1,00,000 DM from a firm in Germany. German firm offered a
discount of 2%, if payment is to be made in 10 days
a.

If payment is made in 10 days


US company will avail discount of 2% and amount payable to German firm is 1,00,000 x 0.98
= DM 98,000
US company will purchase 98,000 DM at spot rate of $ 0.55 / DM
US company will pay 98,000 x 0.55 = $ 53,900

b.

If payment is made in 90 days


US company will book a forward contract today to purchase 1,00,000 DM @ $ 0.56 per DM
US co. will pay 1,00,000 x 0.56 = $ 56,000

c.

Difference between a and b is 56,000 53,900 = $ 2,100


If payment is made after 90 days, 2,000 additional DM had to be paid. Which are avoidable if
payment is made in 10 days. Thus cost of 2,000 DM is due to currency fluctuation
Thus difference between a and b due to time value is 2,000 x 0.56 = $ 1120
If payment is made after 10 days, 98,000 DM is purchased at $ 0.55 per DM, whereas if
payment is made after 90 days, 98,000 DM are purchased at $ 0.56 per DM. Thus $ 0.01 per
DM is paid in excess due to currency fluctuation
Difference between a and b due to currency fluctuation is 98,000 x 0.01 = $ 980

26
CLASSES

PRAVINN MAHAJAN CA

Q54

Alert Ltd is planning to import a machine from japan costing 3400 lac to be paid in 180 days
Alert Ltd has 2 options
1.

To pay Japanese firm immediately by purchasing at spot rate today by borrowing from bank
in India @ 18% p.a with quarterly rests
Amount borrowed from bank in India to purchase at spot rate today
3400 lac
340

x 100

Rs 1,000 lac

Interest on amount borrowed 1000 ( 1 +

0.18 2
)
4

92.025

Total cost to Alert Ltd


2.

Rs 1,092.025 lac

To pay Japanese firm immediately by borrowing from Tokyo bank. Bank in Tokyo will
extend a loan of 3400 lac @ 2% p.a, if Indian bank gives LC for which Indian Bank charges
Commission of 2% p.a
Commission will be 1000 lacs x 0.02 x 0.5

10 lac

For paying commission Alert Ltd will take a loan of Rs 10 lac from Indian bank @ 18% p.a
with quarterly rests
Amount payable after 6 months to Indian Bank 10 lac (1 + 0.045) 2 = Rs 10.92025
Amount payable to Tokyo Bank after 180 days
3400 x ( 1 + 0.02x

6
12

3434 lacs

Amount payable to Tokyo bank can be purchased at 180 days forward rate of 345 per Rs
100
Alert Ltd will pay

3434 lac
345

x 100

Rs 995.3623 lacs

Total re outflow in 2nd option 10.92 lac + 995.3623 lac = Rs 1006.2823 lac
Total cash outflow in 2nd option is lower than cash outflow in option 1. Therefore, offer from
foreign branch should be accepted.
Q55

a.

US
Japan

240.85 / 242.46 per $


244 / 246 per $

Since 2 quotes are not overlapping each other, so arbitrage opportunity exist
If trader has 10,000 $
He will sell $ in Japan @ 244 / $, and receive
10,000 x 244
He will buy $ from US @ 242.46 per $
And will receive
Arbitrage profit
b.

France
India

24,40,000

=
=

242 .46

(10,063.5156 10,000)

24,40,000
10,063.5156 $
63.5156 $

Rs 140/ 145 per


Rs 133 / 138 per

27
CLASSES

PRAVINN MAHAJAN CA

Since 2 quotes are not overlapping each other, so arbitrage opportunity exists
If trader has 10,000
He will sell in france @ Rs 140 per and receive
10,000 x 140
He will buy from Indian bank @ Rs 138 per and receive
14,00,000

10,144.93

138

144.93

Net profit
UK
US

c.

Rs 14,00,000

0.6322 / 0.6352 per $


$ 1.5960 / 1.5944 per

( calculate inverse of Us quote to check overlapping)

Since 2 quotes are not overlapping each other, so arbitrage exists


If Trader has 10,000 $
He will sell $ in UK @ 0.6322 per $ and receive
10,000 x 0.6322
He will sell in US @ $ 1.5960 per and receive
6322 x 1.5960
Arbitrage profit ( 10,089.912 10,000)
d.

6322

=
=

$ 10,089.912
$ 89.912

Switzerland CHF 1.3689 / 1.3695 per $


US
$ 0.7090 / 0.7236 per CHF
Since 2 quotes are not overlapping each other, so arbitrage opportunity exist
If trader has 10,000 CHF
He will buy $ from Switzerland and receive
10,000

1.3695

$ 7,301

He will buy CHF from US bank and receive


7301

0.7236

e.

Frankfurt
New York

CHF 10,091.12

DM 1.3579 / 1.3585 per $


$ 0.7149 / 0.7925 per DM

Since 2 quotes are not overlapping, so arbitrage exists


If trader has 10,000 DM
He will sell DM in Frankfurt and buy $
10,000
1.3585

= $ 7361.059

He will sell $ in Newyork and buy DM


7361.059

= 10,090.55

0.7295

Arbitrage profit
Q56

London

DM 90.55

DEM 3.5250 / 3.5255 per

180.80 / 181.30 per

28
CLASSES

PRAVINN MAHAJAN CA

a.

DM

DM
180.80

181.30

per DM
3.5255 3.5250
= 51.283505 / 51.432624 per DM

b.

If Spot rate in Frankfurt is 51.1530 / 51.2550 per DM


Check overlapping between

Spot rate 51.1530 / 51.2550 per DM


Cross rate 51.283505 / 51.432624 per DM
Since two quotes are not overlapping each other so arbitrage exist
London
DEM 3.5250 / 3.5255 per

180.80 / 181.30 per


Frankfurt

Spot rate 51.1530 / 51.2550 per DM

Arbitrage opportunity exist


If trader has 10,000 DM
-

He will sell DM in London @ DM 3.5255 per and receive

10,000
3.5255

He will sell 2836.4771 in London @ 180.80 per and receive


2836.4771 x 180.80
=
5,12,835.06
He will sell 5,12,835.06 in Frankfurt @ 51.2550 per DM and receive

5,12,835.06
51.2550

Q57

Arbitrage profit

New York

a.

= 2,836.4771

SFr

DM 10,005.56159

DM 5.5619

$ 1.5275 / 1.5285 per


SFr 1.5330 / 1.5335 per $

SFr
$

= 1.5330 x 1.5275 / 1.5335 x 1.5285


=
b.

SFr 2.341657 / 2.34395 per

If London Bank quotes SFr 2.3730 / 2.3740


Along with (cross rate) SFr 2.341657 / 2.34395
Quotes does not overlap each other, so arbitrage possibility exist
New York

$ 1.5275 / 1.5285 per


SFr 1.5330 / 1.5335 per $

London

SFr 2.3730 / 2.3740

29
CLASSES

PRAVINN MAHAJAN CA

If trader has 10,000


-

He will sell to London @ SFr 2.3730 / and buy SFr


10,000 x 2.3730
SFr 23,730
He will sell SFr & buy $ from NewYork Bank @ $ 1.5335 / $
23,730 x

He shall buy from NewYork @ $ 1.5285 /


15,474.404 x

c.

$ 15,474.404

1.5335
1
1.5285

10,123.914

Arbitrage Profit

123.914

If London Bank Quotes SFr 2.3750 / 2.3770 per


Cross Rate
SFr 2.341657 / 2.34395 per
Since quotes are not overlapping each other, so arbitrage opportunity exist
Newyork

$ 1.5275 / 1.5285 per


SFr 1.5330 / 1.5335 per $

London
-

SFr 2.3750 / 2.3770 per If trader has 10,000

He will sell to London @ SFr 2.3750 / and buy SFr


10,000 x 2.3750
SFr 23,750
He will sell SFr & buy $ from NewYork Bank @ $ 1.5335 / $
23,750 x

He shall buy from NewYork @ $ 1.5285 /


15,487.4470 x

Q58

a.

$ 15,487.4470

1.5335
1
1.5285

Arbitrage Profit

New York
France
London

10,132.448
132.448

$ 2.4110 /
Ff 3.997 / $
0.1088 / FF

If trader has 50,000, he will arbitrage profit as follows


-

He will buy $ from New York @ $ 2.4110/


50,000 x 2.4110
He will Buy FF from france @ FF 3.997/ $
1,20,550 x 3.997
He will buy in London @ 0.1088 / FF
0.1088 x 4,81,838.35
Profit ( 52,424.01248 50,000)

b.

London
India
New York

$ 1,20,550
FF 4,81,838.35
52,424.01248
2424.01248

Rs 77.52 /
Rs 48.30 / $
$ 1.6231 /

30
CLASSES

PRAVINN MAHAJAN CA

If trader has $ 1,00,000, he will make arbitrage profit as follows


-

He will sell $ 1,00,000 in India and buy Rs @ Rs 48.30 / $


1,00,000 x 48.30
He will Buy in London @ Rs 77.52 /
48,30,000 x

Q59

Spot rate
ROI

a.

c.

d.
Q60

62,306.5015

77.52

He will Buy $ in New York @ $ 1.6231 /


62,306.5015 x 1.6231
Arbitrage profit

1,01,129.682 $
$ 1129.682

120 / $
8%
12%

Forward Rate (FA ) =

SA (

b.

Rs 48,30,000

Swap rate =
=
=

1 + rA
1+ rB

3
12
120 x
3
1 + 0.12 x
12

120 x

1 + 0.08 x
1.02
1.03

118.834 per $

Forward Rate Spot rate


118.34
120
1.166 / $

Premium or Discount on

S F
x 100
F

) x 12

120 118.834
x 100
118.834

3.9248 %

) x 12

Since ROI of is lower so is at premium

Spot Rate
ROI
US
Germany

$ 0.6560 per DM
6.5%
4.5%

Forward Rate (FA )

SA (
B

1 + rA
1+ rB

3
12
0.6560 x
3
1 + 0.045 x
12

0.6560 x

1 + 0.065 x

1.01625
1.01125

$ 0.65924 per DM

31
CLASSES

PRAVINN MAHAJAN CA

Q61

Spot Rate
ROI
India
US
a.

b.

Rs 45.50 / $
8%
2%

USD will be at Premium as Interest rate in US is lower than Interest Rate in US

Forward Rate (FA )


B

c.

1 + rA

SA (

1+ rB

6
12
6
1 + 0.2 x
12

1 + 0.08 x

45.50 x

45.50 x

Rs 46.85 per $

Premium or discount on $

1.04
1.01

F S
x 100
S

) x 12

46.85 45.50
x 100
45.50

5.93%

) x 12

OR
(1 + rcurrency)

( 1 + rBase Currency)

Q62

a.

Spot Rate
ROI
India
UK
Forward Rate

6
1.04 1.01
x 100
1.01

5.94%

=
=
=
=

Rs 85 /
9%
?
Rs 87

Let ROI in UK is

( 1 + rBase Currency)

x 100
) x 12

) x 12

Forward Rate (FA )

87
87 (1 + p x

SA (

4
12

)=

1 + rA
1+ rB

4
12
4
1+ px
12

1 + 0.09 x
85 x

85 x 1.03

32
CLASSES

PRAVINN MAHAJAN CA

87 + 29 p

=
=

b.

Spot Rate
3 Month forward rate
ROI
London
US
Forward Rate (FA )

=
=
=
=
=

87.55
87.55 87
29
1.896552 %

$ 1.5654 /
$ 1.7500 /
2%
?
1 + rA

SA (

1.5654 x

1.7500 ( 1.005)

=
=

1.5654 x ( 1 + p x

=
=

a.

1+ px

Spot rate
ROI
India
US

1 + 0.02 x

3
12

3
12

0.39135
49.41% p.a

Rs 46.30 / $
10%
6%

Forward Rate (FA )

SA (
B

1 + rA
1+ rB

6
12
6
1 + 0.6 x
12

1 + 0.10 x

46.30 x

46.30 x

Rs 47.199029 per $

1.05
1.03

Premium or Disc on $
(spot and forward rates) =

c.

3
12

1.5654 + 0.39135p
0.19335

b.

1.7500

1.75875

Q63

1+ rB

F S
x 100
S

) x 12

47.199 46.30
x 100
46.30

3.88%

) x 12

Premium or Disc on $

33
CLASSES

PRAVINN MAHAJAN CA

(interest rates)
(1 + rcurrency)

Q64

( 1 + rBase Currency)

( 1 + rBase Currency)

3.883%

) x 12

Spot Rate
=
3 month forward =

$ 2.450 /
$ 2.650 /

ROI

4%
2%

i.

Since ROI of US is higher, so $ currency will depreciate

=
=

=
=

ii.

(
(

S F
x 100
F

) x 12

2.450 2.650
x 100
2.650

3
=
- 30.1887 %
Annualised discount on $ =
30.188%
1 + rA
Forward Rate (FA )
=
SA (
1+ rB
B
B
(according to interest rates)

) x 12

6
1.05 1.03
x 100
1.03

x 100

) x 12

3
12
3
1 + 0.2 x
12

1 + 0.04 x

2.450 x

2.450 x

1.01
1.005

$ 2.46218 per

Forward rate according to rate of Interest is different from forward rate quoted in market,
so forward rates are not in equilibrium.

Q65
$ interest rate
(annually
compounded
FF interest rate
(annually
compounded)
Forward FF / $
Forward disc on FF

3 Months

6 Months

1 year

11.5%

12.25%

?
(**1)

19.5%

? (**6)

20%

? (**3)
? (**4)

? (**5)
- 6.3%

7.5200
? (**2)

34
CLASSES

PRAVINN MAHAJAN CA

a.

Forward Rate (FA ) =

SA (

7.5200

7.5200 (1 + x )

=
=

(1+x)
X

b.

=
=

Discount on FF(1 year)

7.05 x

1+ rB
1 + 0.20
1+ x

8.46
8.46
7.52
1.125 - 1
0.125 or 12.5%

=
=
=

c.

1 + rA

(**1)

S F

x 100

7.05 7.52
7.52

6.25%

Forward Rate (FA ) (3 months)

(**2)

SA (

d.

Discount on FF

e.

f.

1 + rA
1+ rB

1.195

7.05 x

7.05 x

FF 7.173 / $

1.115
1.045543
1.027587
(**3)

=
(

x 100

S F
x 100
F

) x 12

7.05 7.173
x 100
7.173

6.859%

) x 12
(**4)

months

Discount on FF

-0.063

-0.0315 F
F

=
=

S F
x 100
F

6
7.05 F
F

6
7.05 F
7.2792

Forward Rate (FA ) (6 months)


B

) x 12
(**5)

SA (
B

35
CLASSES

) x 12

1 + rA
1+ rB

PRAVINN MAHAJAN CA

1.0325106

1.093925

( 1 + x)

(1.093925)2

=
=

(1 + x )
0.1967
Or 19.67%

Q66

Forward Rate (FA )

SA (

Q67

1 + rA

1+ rB

7.05 x

1.1225

) / SA (

1 + rA

=
=

46.50 x

( 1 + 0.12 x

( 1.03 )

1.1225

( 1 + x )

3
)
12
46.50 x
3
( 1 + 0.06 x )
12

( 1+x)

7.2792

1 + rB

(**6)

3
)
12
/ 46.75 x
3
( 1 + 0.05 x )
12

/ 46.75 x

( 1 + 0.14 x

(1.035)

( 1.015)
(1.0125)
Rs 47.187192 / 47.788889 per $

An Indian company exported goods to US for $ 3,50,000 to be received in 3 months.


Since Indian company has to sell $, so relevant rate is BID rate.Indian company has two options.
1.

To take forward market hedge


Indian company will book a forward contract today to sell $ 3,50,000 after 3 months
@ Rs 46.5 per $
Indian company will receive
3,50,000 x Rs 46.5
=
Rs 162,75,000

2.

To take money market hedge


Forward Rate (FA )

SA (
B

1 + rA
1+ rB

) / SA (
B

3
)
12
46 x
3
( 1 + 0.06 x )
12

46 x

( 1 + 0.10 x

( 1.025 )

/ 46 x

1 + rA
1 + rB

3
)
12
/ 48 x
3
( 1 + 0.04 x )
12

( 1 + 0.12 x

(1.03)

( 1.015)
(1.01)
Rs 46.453201 / 48.950495 per $
3,50,000

Indian company will borrow present value of 3,50,000 $ i.e

Indian company will sell $ 3,44,827.586 at todays spot rate @ Rs 46/ $ and receive
3,44,827.586 x 46 = Rs 158,62068.956
Company will deposit Rs 158,62,068.956 @ 10% p.a for 3 months and receive
158,62,068.956 x 1.025 = Rs 162,58,620

1.015

= $ 3,44,827.586

Cash inflow in forward market hedge i.e Rs 162,75,000 is higher than cash inflow in money
market hedge i.e Rs 162,58,620. So forward market hedge is better.

36
CLASSES

PRAVINN MAHAJAN CA

Q68

Indian firm purchased machinery from US for $ 5,00,000, payment to be made in 4 months
Indian firm had to buy $, so relevant rate is ASK rate. Firm has 2 options
1.

To take Forward market hedge


Firm will book a forward contract today to purchase $ 5,00,000 after 4 months @ Rs 46.45
per $
Firm will pay 5,00,000 x 46.45 =
Rs 232,25,000

2.

To take Money market hedge


Forward Rate (FA )

SA (

1 + rA
1+ rB

) / SA (
B

4
)
12
45.50 x
4
( 1 + 0.04 x )
12

45.50 x

( 1 + 0.6 x

1 + rA
1 + rB

4
)
12
/ 45.82 x
4
( 1 + 0.03 x )
12

( 1 + 0.09 x

( 1.02 )
(1.03)
/ 45.82 x
( 1.0133)
(1.01)
Rs 45.799342 / 46.727362 per $

5,00,000

Firm will deposit present value of 5,00,000 $, i.e

For this deposit firm will buy $ 4,95,049.5049 @ Rs 45.82 /$ and pay
4,95,049.5049 x 45.82 = Rs 226,83,168.3145
For buying $ firm will borrow Rs 226,83,168.3145 @ 9% for 4 months. After 4 months
firm will pay 226,83,168.3145 x 1.03 = Rs 233,63,663

1.01

= $ 4,95,049.5049

Since cash outflow in forward market hedge i.e 232,25,000 is lower than cash outflow in
money market hedge i.e Rs 233,63,663, so Forward market hedge is better.
Q69

UK firm sold goods worth 2,50,000 to be received in 6 months. Since quotes are

, and firm

had to sell , so relevant rate is BID rate. Firm has two options
1.

To take forward market hedge


Firm will take a forward contract today to sell 2,50,000 @ 1.2650 per . Firm will receive
2,50,000 x 1.2650 = 3,16,250

2.

To take money market hedge

Forward Rate (FA )

SA (
B

1 + rA
1+ rB

) / SA (

6
)
12
1.2635 x
6
( 1 + 0.035 x )
12

=
=
=

( 1 + 0.04 x

1.2635 x

( 1.02 )

1 + rA
1 + rB

6
)
12
/ 1.2680 x
6
( 1 + 0.03 x )
12

( 1 + 0.06 x

/ 1.2680 x

( 1.0175)
1.266604 / 1.286738 per

UK firm will borrow present value of 2,50,000 i.e

37
CLASSES

2,50,000
1.0175

(1.03)
(1.015)

, 2,45,700.2457

PRAVINN MAHAJAN CA

Firm will sell 2,45,700.2457 @ todays spot rate i.e 1.2635 / and Receive
2,45,700.2457 x 1.2635 = 3,10,442.2604
Firm will deposit 3,10,442.2604 @ 4% p.a for 6 months and receive
3,10,442.2604 x 1.02 = 3,16,651.1056

inflow in forward market hedge i.e 3,16,250 is lower than inflow in money market
hedge i.e 3,16,651.1056, so money market hedge is better.
Q70

A US firm imported goods for 8,00,000 DM to be paid in 3 months. Since US firm has to buy DM
and quotes are
1.

, so relevant rate is ASK rate. US firm has 2 options

DM

To take forward market hedge


US firm will book a forward contract today to buy 8,00,000 DM in 3 months @ $ 0.16200 / DM
US firm will pay 8,00,000 x 0.16200 = $ 1,29,600

2.

To take money market hedge


Forward Rate (FA )

SA (

1 + rA
1+ rB

3
)
12
0.1650 x
3
( 1 + 0.06 x )
12

( 1 + 0.2x

= 0.1650 x
=

( 1.005 )

) / SA (
B

1 + rA
1 + rB

3
)
12
/ 0.1680 x
3
( 1 + 0.04 x )
12

( 1 + 0.03 x

(1.0075)

/ 0.1680 x

( 1.015)
(1.01)
$ 0.1633743 / 0.167584 per DM
8,00,000

US firm will Deposit Present value of 8,00,000 DM i.e

To deposit DM firm will purchase 7,92,079.20792 DM @ $ 0.1680 / DM. Firm will pay
7,92,079.20792 x 0.1680 = $ 1,33,069.307
To buy DM firm will borrow $ 1,33,069.307 @ 3 % p.a for 3 months. After 3 months
firm will pay $ 1,33,069.307 x 1.0075 = $ 1,34,067.327

1.01

= 7,92,079.20792 DM

Since $ outflow in forward market hedge is lower than $ outflow in money market hedge,
so forward market hedge is better.
Q71

Indian firm imports goods from US firm worth $ 2,00,000, payment to be made in 3 months. Since
Quotes are
a.

and Indian firm will buy $, so relevant rate is BID rate. Indian fir has 2 options

Take forward market hedge


Indian firm will book a forward contract today to buy $ 2,00,000 @ $ 0.0220 per Re. Firm will
pay

b.

$
Re

2,00,000
0.02193

= Rs 91,19,927

Take money market hedge

Forward Rate (FA )


B

SA (
B

1 + rA
1+ rB

38
CLASSES

) / SA (
B

1 + rA
1 + rB

PRAVINN MAHAJAN CA

3
)
12
.02217 x
3
( 1 + 0.14 x )
12

( 1 + 0.08 x

= 0.02217 x
=

( 1.02 )

3
)
12
/ 0.0222 x
3
( 1 + 0.12 x )
12

( 1 + 0.09 x

(1.0225)

/ 0.0222 x

( 1.035)
(1.03)
$ 0.021849 / 0.022038 per Re
2,00,000

Indian firm will deposit present value of $ @ 8% p.a . i.e

To deposit $ firm will buy $ 1,96,078.4313 @ spot rate of $0.02217 per Re


1,96,078.4313

= $ 1,96,078.4313 $

= Rs 88,44,313.54533

0.02217

1.02

To buy $ firm will borrow Rs 88,44,313.54533 @ 14% p.a and pay after 3 months
88,44,313.54533 x 1.035 = Rs 91,53,864.519
Re outflow in forward market hedge is lower than Re outflow in money market hedge,
so forward market hedge is better.

Q72

P ltd purchased goods worth $ 51 lac from US, to be paid in 3 mont hs. Pltd want to ensure that
Re

cost of $ 51 lac should not exceed Rs 22 crore. Since quotes are

, and Pltd has to buy $, so

relevant rate is ASK rate. Pltd has two options


1.

To take forward market hedge


Pltd will book a forward contract today to buy $ 51 lac after 3 months @ Rs 45 per $
P ltd will pay 51 lac x 45 = Rs 22,95,00,000

@. To take money market hedge


Forward Rate (FA )

1+ rB

) / SA (
B

=
=

40 x

( 1 + 0.13 x

( 1.0325 )

1 + rA
1 + rB

3
)
12
/ 42 x
3
( 1 + 0.08 x )
12

/ 42 x

( 1 + 0.16 x

(1.04)

( 1.0275)
(1.02)
Rs 40.194647 / 42.823529 per $

Pltd will deposit present value os $ 51,00,000 for 3 months @ 8% p.a


i.e

1 + rA

3
)
12
40 x
3
( 1 + 0.11 x )
12

=
-

SA (

51,00,000
1.02

= $ 50,00,000

For deposit Pltd will buy $ 50,00,000 at spot rate of Rs 42 per $ and pay
50,00,000 x 42 = Rs 21,00,00,000
Pltd will borrow Rs 21,00,00,000 @ 16% p.a for 3 months. After 3 months Plt will pay
21,00,00,000 x 1.04 = Rs 21,84,00,000

Since Re outflow in money market is lower, so money market hedge is better.


Q73

US co. has payable 4,80,000 after 3 months and receivable 1,38,000 after 3 months.
Thus net to be bought after 3 months 3,42,000

39
CLASSES

PRAVINN MAHAJAN CA

Since quote is

, relevant rate is Bid rate.

Company has 2 options:


1. Forward Market hedge
Company will book a forward contract today to buy 3,42,000after 3
months @ 0.9520/ $
Co. will pay $ 3,59,243.69
2. Money market hedge
For hedge in Money market Deposit and borrow $
-

Deposit present value of 3,42,000 i.e company will deposit


3,42,000 / 1.025 = 3,33,658.5365
Company will buy 3,33,658.5365 by borrowing $.
Co. will borrow 3,33,658.5365 / 0.9830 = $ 3,39,428.8266 $
$ payable after 3 months @ 13% (3,39,428.8266 x 1.0325)
= 3,50,460.26 $

Incase of payables, since payable in Money market hedge is lower so money


market hedge is better.
US co has 5,90,000 receivable after 4 months. i.e company has to sell after 4
$

months. Since quote is , so relevant rate is BID rate.


Co. has 2 options
1. Forward market hedge
Co. will book a forwrad contract today to sell 5,90,000 after 4 months @
$ 1.9510 /
Co. will receive 5,90,000 x 1.9510 = 11,51,090 $
2. Money market hedge
For hedge company will deposit $ and borrow
- Co will borrow present value of 5,90,000
i.e company will borrow 5,90,000 / 1.05333 = 5,60,128.3548
-

Co. will convert in $ at spot rate of $ 1.8890 / .


Co will receive 5,60,128.3548 x 1.8890 = $ 10,58,082.46

Co. will deposit $ @ 11.5% p.a for 4 months


After 4 months co. will receive (10.58,082.46 x 1.038333) = 10,98,642$
40
CLASSES

PRAVINN MAHAJAN CA

In case of receivables, since $ receivable is higher in forwrad market, so


forward market hedge is better.

Q74

Shoe company sold goods to German company for 50,000 DM to be received in 90 days.
a.

Shoe company can hedge its Foreign exchange risk by


Forward market hedge or
Money market hedge or
Currency option hedge or
Currency future hedge

b.

Spot rate
DM 1.71 per $
Forward rate
DM 1.70 per $
Since Forward rate is more than Spot rate, hence DM is at premium.

c.

According to interest rate parity high interest rates on currency are off set by forward discount
and low interest rates on currency are offset by forward premium
Premium on DM

=
=

S F

x 100
F
1.71 1.70

365

x 100 x
90
1.70
=
2.385%
Interest rate in Germany is lower than interest rate in US by 2.385 %
Q75

F Ltd a UK co. sold goods to US worth $ 1,97,000, to be received in 3 months. Quotes


are

1.

, and UK firm has to sell $ , So relevant rate is ASK rate. F Ltd has 2 options

To take Forward market hedge


F ltd will book a forward today to sell $ 1,97,000 @ $ 1.7063 per .
Fltd will receive

2.

1,97,000

1,15,454.492

1.7063

To take money market hedge

Forward Rate (FA )

SA (
B

1+ rB

) / SA (

3
)
12
1.7106 x
3
( 1 + 0.125 x )
12

( 1 + 0.06 x

= 1.7106 x
=

1 + rA

( 1.015 )

1 + rA
1 + rB

3
)
12
/ 1.7140 x
3
( 1 + 0.095 x )
12

/ 1.7140 x

( 1 + 0.9 x

(1.0225)

( 1.03125)
(1.02375)
$ 1.683465 / 1.7119072 per

41
CLASSES

PRAVINN MAHAJAN CA

1,97,000

= 1,92,665.036674 $

F ltd will borrow Present value of $ 1,97,000 i.e

F ltd will Purchase at todays spot rate of $ 1.740 per and receive
1,92,665 .036674
1.740

1.0225

= 1,12,406.6725

F ltd will deposit received @ 9.5% p.a. F ltd will receive


1,12,406.6725 x 1.02375 = 1,15,076.330

Since receipts are higher in forward hedge than receipts in money market, so forward
market hedge is better

F ltd imported goods worth $ 2,93,000 payable after 6 months. Quotes are

, since Fltd

has to Buy $, so relevant rate is BID rate. F ltd has 2 options


1.

To take forward market hedge


F ltd will book a forward contract today to purchase $ 2,93,000 after 6 months
@ $ 1.6967 per
F Ltd will pay

2.

2,93,000
1.6967

To take money market hedge

Forward Rate (FA )

SA (

1+ rB

) / SA (

6
)
12
1.7106 x
6
( 1 + 0.125 x )
12

( 1.03 )

1 + rA

1 + rB

6
)
12
/ 1.7140 x
6
( 1 + 0.095 x )
12

( 1 + 0.9 x

(1.045)

/ 1.7140 x

( 1.0625)
(1.0475)
$ 1.65827 / 1.709909 per

F Ltd will deposit present value of $ 2,93,000 for 6 months


i.e

1 + rA

( 1 + 0.06 x

= 1.7106 x

= 1,72,688.159

2,93,000

2,84,466.0194 $

1.03

For deposit of $, firm will purchase $ 2,84,466.0194 at todays


spot rate of $ 1.7106 per . F ltd will pay
For buying $ firm will borrow 1,66,296.048 @ 12.5% for
6 months after 6 months F ltd will pay 1,66,296.048 x 1.0625

1,66,296.048
1,76,689.551

Since outflow is lower in forward market hedge, so forward market hedge is better.
Q76

UK co. is to receive 5,00,000 northland $ in 6 months.


If UK company take money market hedge
Forward Rate (FA )
B

SA (
B

1 + rA
1+ rB

42
CLASSES

PRAVINN MAHAJAN CA

6
)
12
2.5 x
6
( 1 + 0.12 x )
12

=
=
-

( 1.075 )

( 1.06)
N$ 2.535377 per

5,00,000

N$ 4,65,116.279

1 .075

From N$, firm will buy @ spot rate


And receive

2.5 x

UK company will borrow present value of 5,00,000 N$ for 6 months.


i.e

( 1 + 0.15 x

4,65,116.279

1,86,046.512

2.5

firm will deposit 1,86,046.512 for 6 months


And rceive after 6 months 1,86,046.512 x 1.06

1,97,209.302

If Company does not take money market hedge


Company will buy N$ after 6 months @ spot rate after 6 months
1.

If after 6 months gained 4%


Spot rate after 6 months will be 2.5 x 1.04, N$ 2.6 per
Company will sell 5,00,000 N$ for

5,00,000
2.6

1,92,307.692

Thus if after 6 months gained by 4%, firm will receive 1,92,307.692 for selling 5,00,000
N$ if no hedge is taken, against 1,97,209.302 if money market hedge is taken. Thus if
money market hedge is taken firm will gain 1,97,209.302 - 1,92,307.692
= 4901.61
2.

If after 6 months lost 2%


Spot rate after 6 months will be , 2.5 x 0.98 ,N$ 2.45 per
Company will buy 5,00,000 N$ for

5,00,000
2.45

2,04,081.632

Thus if after 6 months lost by 2%%, firm will receive 2,04,081.632 for selling 5,00,000 N$
if no hedge is taken, against 1,97,209.302 if money market hedge is taken. Thus if money
market hedge is taken firm will loose 1,97,209.302 - 2,04,081.632
= 6872.331
3.

If after 6 months remained stable


Spot rate after 6 months will be N$ 2.5 per
Company will buy 5,00,000 N$ for

5,00,000
2.5

2,00,000

Thus if after 6 months remains firm will receive 2,00,000 for selling 5,00,000 N$ if no
hedge is taken, against 1,97,209.302 if money market hedge is taken. Thus if money
market hedge is taken firm will loose 1,97,209.302 - 2,00,000
= 2790.698
Q77

on 1st march 07 B Ltd, a US firm, purchased an equipment from foreign firm for LC 9,00,000 due
on 31st may 07
Spot rate today (1st March) LC 10 / $

43
CLASSES

PRAVINN MAHAJAN CA

9,00,000

If Purchased today Bltd will pay for buying LC 9,00,000

$ 90,000

10

B Ltd has 3 options


a.

To enter into forward contract today to Buy LC 9,00,000 @ LC 9/ $ on 31 st May


B Ltd will pay

9,00,000

$ 1,00,000

Loss to B ltd due to exchange fluctuation in option a (1,00,000 90,000)


Tax saving on loss 40% of $ 10,000
Thus net cost of equipment in option a
$ 1,00,000 - $ 4,000

b.

$ 10,000
$ 4,000
$ 96,000

To Borrow in $ and invest in LC (Money market Hedge)


Effective rate of interest
Interest rate
Tax on interest 40%
Interest rate after Tax (p.a)

$
12 %
4.8%
7.2%

LC
8%
3.2%
4.8%

3
12
10 x
3
1+0.072 x
12

1+0.048 x

Synthetic rate

(Bid)

10 x

1.012
1.018

LC 9.941061 / $

1.

B Ltd will deposit PV of 9,00,000 LC for 3 months.


9,00,000
i.e B Ltd will deposit
1.012
2. For deposit B Ltd will purchase LC 8,89,328.06 @ LC 10 / $
8,89,328.06
B Ltd will pay
10
2. For purchase of LC, B Ltd will borrow $ 88,932.81 @ 7.2% p.a
After 3 months company will pay 88,932.81 x 1.018
Thus cost under money market hedge
c.

8,89,328.06 LC

$ 88,932.81
$ 90,533.60

$ 90,533.60

To buy LC 9,00,000 At spot rate on 31st may


B Ltd will buy LC 9,00,000 on 31st May @ LC 8 / $
9,00,000
B Ltd will pay
8
Loss to B Ltd
( 112500 90,000)
Tax saving on loss $ 22,500 x 0.4
Net cost of LC 9,00,000 ($1,12,500 9,000)

44
CLASSES

$ 1,12,500
$ 22,500
$ 9,000
$ 1,03,500

PRAVINN MAHAJAN CA

Cost Of LC 9,00,000 is least in option 2. So b ltd will Take hedge in money market for Foreign
exchange fluctuation
Q78

An Indian Co. has Receivable $ 2,00,000 in 3 months and payable 3,00,000 in 6 months

Incase on Receivable $ 2,00,000, Since company has to sell $ and quotes are

Rs
$

, Relevant rate

is Bid rate .company has 2 options


a.

Forward market hedge


To book a forward contract today to sell $ 2,00,000 after 3 months @ Rs 44.75 / $
Company will receive
2,00,000 x 44.75
=
Rs 89,50,000

b.

Money market hedge


Forward Rate (FA )

=
=

1+ rB

3
)
12
43.65 x
3
( 1 + 0.0425 x )
12

( 1 + 0.09 x

( 1.0225 )

43.65 x

( 1.010625)
Rs 44.162894 / $

Indian company will borrow present value of 2,00,000 $ for 3 months.


i.e

1 + rA

SA (

2,00 ,000

$ 19,78,973.40

1.010625

From $, firm will buy Rs @ spot rate


And receive $ 19,78,973.40 x 43.65

Rs 863,82,189

firm will deposit Rs 863,82,189 for 3 months


And receive after 3 months 863,82,189 x 1.0225

Rs 883,25,788

Amount received In forward market hedge is more than amount received in Money market hedge,
so Forward market hedge is better
For payable 3,00,000, Company has to Buy and since quotes are

Rs

, so relevant rate is Ask

rate. Company has 2 options


a.

Forward market hedge


Company will book a forward contract today to Buy 3,00,000 after 6 months @ Rs 71.80 /
Company will pay 3,00,000 x 71.80 =
Rs 215,40,000

b.

Money Market hedge


Forward Rate (FA )
B

SA (
B

1 + rA
1+ rB

45
CLASSES

)
PRAVINN MAHAJAN CA

6
)
12
70.50 x
6
( 1 + 0.06 x )
12

=
=
-

( 1 + 0.11 x

( 1.055 )

70.50 x

( 1.03)
Rs 72.211165 /

Company will deposit PV of 3,00,000, for 6 months


3,00,000
i.e company will deposit
2,91,262.135
1.03
For deposit company will buy 2,91,262.135 @ Rs 70.50 /
Company will pay 291262.135 x 70.50
Rs 205,33,980.5825
For buying , company will borrow Rs 205,33,980.5825 for 6 months
Amount payable after 6 months 205,33,980.5825 x 1.055
Rs 216,663,349.514

Since Amount payable in forward market hedge is lower than amount payable in money market
hedge, so forward market hedge is better
Q79

A british firm has following cash transactions


Net amount receivable or payable after 1 month
a.

Payment to creditors after 1 month

b.

Amount receivable after 1 month


Company has to Receive $ 1,78,500 after 1 month. Company will sell $ and
$
Buy . Since quotes are
, So relevant quote is Ask rate. Company has 2 options

i.
Forward market hedge
Book a forward contract today to sell $ after 1 month at (1.5050 0.0050)
$ 1.5000 /
1,78,500
Company will receive
1,19,000
1.5
ii.

1,20,000

Money Market Hedge


Forward Rate (FA )

SA (

1.5050 x

( 1.0075 )

( 1.006667)
$ 1.5062454 /

Company will borrow PV of $ 1,78,500 @ 9% p.a


1,78,500
i.e company will borrow
1.0075
Company will convert $ 1,77,171 in @ $ 1.5050/
Company will receive

( 1 + 0.09 x

1+ rB

1
)
12
1.5050 x
1
( 1 + 0.08 x )
12

1 + rA

1,77,171
1.5050

$ 1,77,171

1,17,721

Company will deposit 1,17,721 @ 8% p.a and receive

46
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PRAVINN MAHAJAN CA

1,17,721 x 1.006667

1,18,507

Since amount received in Forward market hedge is higher, so forward market hedge is
better
Thus receipts after 1 months
Net payment after 1 month

1,19,000
1,000

Net amount receivable or payable after 2 months


a.
b.

Dividend receipts after 2 months


Amount payable after 2 months
Company has to pay $ 5,00,000 after 2 months, Since company has to buy $
And Quotes are

, so relevant rate is Bid rate. Company has 2 options

1.

Forward market hedging


Company will book a forward contract today to buy $ after 2 months
@ $ (1.5000 + .10) = $ 1.5100 /
5,00,000
Company will pay
=
3,31,125 .83
1.5100

2.

Money Market hedge


Forward Rate (FA )

SA (

=
=
=
-

1,00,000

1 + rA
1+ rB

2
)
12
1.5000 x
2
( 1 + 0.12 x )
12

( 1 + 0.06 x

1.5000 x

( 1.01 )

( 1.02)
$ 1.4852941 /

Company will deposit PV of 5,00,000 $ for 2 months


5,00,000
@ 6% p.a i.e company will deposit
1.01
Company will Buy $ 4,95,050 $ at spot rate of
4,95,050
$ 1.5000 / . Company will pay
1.5
Company will borrow 3,30,033 @ 12% p.a,. Amount
payable after 2 months
3,30,033 x 1.02

4,95,050 $

3,30,033.00
3,36,634

Since amount payable in forward market hedge is lower than amount payable in money
market hedge, so forward market hedge is better
Thus amount payable after 2 months
3,31,125
Net payments after 2 months
2,31,125
Q80

An Indian exporter has to receive $ 1,000,000 after 3 months. Since company will sell $ and Quote
available is Rs/$ so relevant rate is Bid rate
Indian firm has 3 options
a.

Borrow PV of Rupees and Sell $ 10,00,000 forward


-

Firm will book a forward contract today to sell 10,00,000 $ after 3 months @
(35.60 + 1.25) = Rs 36.85 / $

47
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PRAVINN MAHAJAN CA

Firm will receive


Firm will borrow PV of Rs 360,85,000
360,85,000
i.e borrowings will be
3
1+0.135 x

Rs 360,85,000

Rs 349,06,892

12

Firm will repay Re loan when 10,00,000 Received and sold


b.

Borrow $ and repay $ when $ payment is received after 3 months


-

Firm will borrow Present value of 10,00,000 $


10,00,000
i.e Firm will borrow
3
1+0.06 x

$ 9,85,221.67$

12

c.

Firm will convert $ borrowed in rupees at spot rate of Rs 35.60/$


Firm will receive 9,85,221.67 x 35.60
Rs 350,73,891

Allow a discount of 6.25% and receive payment today


After discount firm will receive 10,00,000 (1 0.0625)
Firm will sell $ 9,37,500 @ spot rate of Rs 35.60 per $
Firm will receive 9,37,500 x 35.60

$ 9,37,500
Rs 333,75,000

Since Re amount received in 2nd option is highest , so 2nd option should be accepted
Q81

Spot rate

Can $ 1.235 1.24 / $

3
12
Synthetic forward rate - 1.235 x
3
1+0.09 x
12

1+0.095 x

= 1.235 x
=

1.02375

/
/

3
12
1.24 x
3
1+0.08 x
12

1+0.105 x

1.24 x

1.02625

1.0225
1.02
can $1.236509 / 1.247598 per $

3 months forward rate can $ 1.255 / 1.26 per $


Since the quotes does not overlap each other, so arbitrage exist
Investor will borrow can $ and deposit $
Suppose investor borrowed 1,00,000 can $ for 3 months @ 10.50% p.a
Amount payable after 3 months 1,00,000 x ( 1 + .105 x
-

Q82

Spot rate

3
12

1,00,000 x 1.02625
Investor will Purchase US $ from Can $ 1,00,000 @ can $ 1.24/ $
1,00,000
Investor will get
1.24
Investor will deposit $ 80,645 @ 8% for 3 months. After
3 months investor will get 80,645 x 1.02
He will sell $ 82,258 at forward rate of Can $ 1.255 / $ and receive
82,258 x 1.255

can $ 1,02,625
$ 80,645

$ 82,258
Can $ 1,03,233.87

After repayment of amount borrowed, net profit is (1,03,233.87 1,02,625)


Can $ 608.87
63.05 63.20 / $

48
CLASSES

PRAVINN MAHAJAN CA

Case 1

6 month forward rate is 63.15- 63.40/$


6 month forward rate acc to IRPT 63.981773 / 65.077228

Case 2

Case 3

Q83

6 month forward rate is 65.42 65.70 / $


6 month forward rate according to IRPT
1.03
1.04
= 63.05 x
/ 63.20 x
1.015
1.01
= 63.981773 65.077228 / $
Since quotes does not overlap, so arbitrage exist
For arbitrage, trader will borrow Re and deposit $
Trader will borrow 1,00,000 @ 8% p.a for 6 months
payable after 6 months 1,04,000
Trader will convert 1,00,000 in $ at spot rate of 63.20/$
Trader will receive 1582.278481 $
Trader will deposit $ @ 2% p.a for 6 months . after 6 months trader will receive
1582.278481 x 1.01 = $ 1598.101266
Trader will convert $ into at 6 month forward rate of 65.42/$
Trader will receive 1,04,548
Arbitrage profit 1,04,548 1,04,000 = 548

Since Quote does not overlap each other, so arbitrage exist.


For arbitrage trader will borrow $ and deposit
Trader will borrow 1,00,000 $ @ 3 % p.a
$ payable fter 6 months 1,01,500 $
Trader will convert $ 1,00,000 in at spot rate of 63.05 / $
Trader will receive 63,05,000
Trader will deposit @ 6% p.a for 6 months
receivable after 6 months 63, 05,000 x 1.03= 64,94,150
Trader will convert into $ after 6 months @ 6 months forward rate of 63.40/$
Trader will receive $ 1,02,431
Arbitrage profit 1,02,431 1,01,500 = $ 931
6 month forward rate 64.55 65.20/$
6 month forward rate acc to IRPT 63.981773 / 65.077228
Since quotes overlap each other so arbitrage does not exist.

Spot rate
3 month forward rate

DM 3.6248 3.6292 /
DM 3.6360 3.6398 /

3
12
Forward rate according to IRPT = 3.6248 x
3
1 +0.04 x
12

1+0.05 x

= 3.6248 x

1.0125

3.6292 x

3
12
3.6292 x
3
1+0.03 x
12

1+0.06 x

1.015

1 .01
1.0075
=
DM 3.633772 / 3.649890 per
Since quotes overlap each other, so arbitrage does not exist

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PRAVINN MAHAJAN CA

Q84

Spot rate
3 month forward rate

C$ 0.665/DM
C$ 0.670/DM

Interest DM 7%
C$ 9%

3
12
Forward rate = 0.655 x
3
1 + 0.07 x
12

1 +0.09 x

= 0.655 x

1+0.0225

1 + 0.0175
= C$ 0.6682/DM
For arbitrage profit,Borrow C$ and deposit DM
Borrow 1 lac C$ @ 9% for 3 months.
(Amount payable after 3 months 1,00,000 x 1.0225) = C$ 1,02,250
2. Convert 1,00,000 C$ into DM at spot rate C$ 0.665 /DM = 1,50,375.938 DM
3. Deposit 1,50,375.938 DM @ 7% for 3 months
4. DM receivable after 3 months 1,50,375.938 x 1.0175 = 1,53,007.5 DM
5. Convert 1,53,007.5 DM into C$ at C$ 0.670 /DM
1,53,007.5 x 0.670 =
C$ 1,02515
Arbitrage profit = 1,02,515 1,02,250 = C$ 265
1.

Q85

Spot rate

0.5711 0.5714 / $

3
12
0.5711 x
3
1 + 0.0820 x
12

0.5711 x

1+0.105 x

Synthetic forward rate

=
3 month forward rate

1.02625

3
12
0.5714 x
3
1 + 0.08 x
12

1+0.11 x

0.5714 x

1.0205
0.574317 / 0.575601 per $

1.0275
1.02

0.5747 / 0.5754 per $

Since synthetic forward rate and 3 month forward rate are overlapping each other, so arbitrage
opportunity does not exist
Q86

Spot rate

Can $ 0.665 per DM


3
12
0.665 x
3
1 + 0.07 x
12

1 +0.09 x

Synthetic forward rate


=

3 month forward rate

0.665 x

1.0225

1.0175
can $ 0.6682678 per DM

Can $ 0.670 / DM

Synthetic rate is less than forward rate. Investor will borrow can $ and deposit DM
-

Suppose investor borrowed 1,00,000 can $ @ 9% p.a for 3 months


Amount payable after 3 months 1,00,000 x 1.0225 = can $ 1,02,250

50
CLASSES

PRAVINN MAHAJAN CA

Q87

He will convert 1,00,000 Can $ into DM @ can $ 0.665 / DM


1,00,000
He will receive
= 1,50,375.938 DM
0.665
He will deposit DM 1,50,375.938 DM @ 7% for 3 months and receive
1,50,375.938 x 1.0175 = DM 1,53,007.5187 DM
He will purchase DM at 3months forward rate of can$ 0.670 / DM
He will receive 1,53,007.5187 x 0.670 = Can $ 1,02,515.0375 per DM
After repayment of amount borrowed, net profit is
1,02,515.0375 1,02,250
=

265.0375 can $

48.0213 /$
48.8190/$

Spot rate
180 days forward rate

6
12
48.0123 x
6
1 + 0.07 x
12

48.0123 x

1+0.12 x

Synthetic forward rate

1.06

1.035
49.17207/$

For arbitrage profit, trader will borrow $ and deposit Re


Trader will borrow $ 83,312 for 6 months @ 8% p.a
Amount payable after 6 months 83,312 x 1.04 = $ 86,644.48
Trader will convert $ 83,312 into at spot rate of 48.0123 /$
Trader will receive 83,312 x 48.0123 = 40,00,000
Trader will deposit 40,00,000 for 6 months @ 12% p.a
After 6 months in hand 42,40,000
Trader will convert in $ at 6 month forward rate of 48,8190 /$
$ in hand 86,851.43
Arbitrage profit 86,851.43 86,644.48 = $ 206.95
Q88

2year forward rate for no opportunity of arbitrage


Forward Rate (FA )

SA (
B

0.05 2

0.75 x

0.75 x

0.75 x 1.17359

0.08 2
0.1
0.16
1.10522

=
0.706307 / $
Thus if 2 year forward rate is 0.706307 / $, arbitrage opportunity will not
exist.
Actual 2 year forward rate is 0.85 / $
Since synthetic rate is less than forward rate so borrow and deposit $
Arbitrage process

51
CLASSES

PRAVINN MAHAJAN CA

1.
2.
3.
4.
5.
Q89

Suppose investor borrows 1,00,000 for 2 years @ 5% p.a


Amount payable after 2 years 1,00,000 x 1.10522 = 1,10,522
Investor will convert 1,00,000 in $ at spot rate of 0.75 / $
Investor will receive $ 1,33,333.33
Investor will receive $ @ 8% for 2 years. $ in hand after 2 years
1,33,333.33 x 1.17359 = $ 1,56,478.66
Investor will convert $ in at 2 year forward rate of 0.85 / $
1,56,478.66 x 0.85
= 1,33,006.86
Profit = 1,33,006.86 1,10,522 = 22,484.86

John a foreign exchange dealer in Paris buys 1,00,000 , 90 days forward In Zurich
@ $ 1.9477 /
John will pay 1,00,000 x 1.9477
$ 1,94,770
He sells 1,00,000 90 day forward in Montreal @ $ 1.9512 per
John will receive 1,00,000 x 1.9512
$ 1,95,120
Net profit ( 1,95,120 1,94,770)

Q90

$ 350

An investor borrowed $ 10,00,000 @ 5% in US for 1 year


Amount payable after 1 year
$ 10,50,000
From 10,00,000 $, he purchased @ spot rate of $ 1.5 /
He received

10,00,000
1.5

= 6,66,667

He deposited 6,66,667 @ 8% p.a in UK for 1 year


He received 6,66,667 x 1.08 = 7,20,000
From 7,20,000 he purchased $ at forward rate of $ 1.48 /
He received 7,20,000 x 1.48 = $ 10,65,600
After Repayment of amount borrowed, Net profit is 10,65,600 $ - 10,50,000 = $ 15,600
Q91

a.

Indian Importer bought a machinery for $ 1,00,000 payable after 3 months. He has 3
options
Option 1

Currency option

Call option gives right to buy $ and Put option gives right to sell $. Since Importer has to
buy $, so he will buy call option, to buy $ 1,00,000 after 3 months @ Rs 49.20 / $
Statement of Cost of 1,00,000 $
Premium paid 1,00,000 x 0.40
On due date importer will buy 1,00,000 $ and pay
1,00,000 x 49.20
Total payment

40,000
49,20,000
49,60,000

Option 2
Forward market hedge
Importer will book a forward contract today to purchase $ 1,00,000 @ Rs 49.90 / $

52
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PRAVINN MAHAJAN CA

Importer will pay

1,00,000 x 49.90

49,90,000

Option 3
No Hedging
He will buy 1,00,000 $ after 3 months @ spot rate after 3 months of Rs 51 / $
Amount payable 1,00,000 x 51
51,00,000
Since cash outflow in hedging through currency option is least, so currency option is
better
b.

Indian exporter exported goods for $ 2,00,000 to be received after 4 months. Exporter
has 3 options
Option 1
Currency option
Call option gives right to buy $ and put option gives right to sell $. Since exporter has to
sell $, so he will buy a put option to sell 2,00,000 $ after 3 months @ Rs 45.40 / $.
Statement of Net amount received
Rs
60,000
90,80,000
90,20,000

Amount of premium paid


2,00,000 x 0.30
On due date exporter will sell 2,00,000 $ @ 45.40 / $
Amount received

Option 2
Forward market hedge
Exporter will book a forward contract today to sell 2,00,000 $ after 4 months
@ Rs 44.90 / $
Amount received
2,00,000 x 44.90
89,80,000
Option 3
No hedging
Exporter will sell 2,00,000 $ at spot rate after 6 months @ Rs 44.95 / $
He will receive
2,00,000 x 44.95

89,90,000

Since cash inflows in hedging through currency option is highest, so currency option is
better
c.

PQR Ltd has to pay $ 2,50,000 in 4 months to a US firm. PQR has 3 options.
Option 1
Currency options
Call option gives right to buy Re and Put option gives Right to sell Re. Since PQR has to
buy $ ( i.e sell Re), So PQR will buy Put option and Buy $ after 4 months
@ $ 0.02198 / Re
Statement of Amount paid
Premium payable
$ 0.00015 / Re
2,50,000
PQR has to sell
, Rs 113,73,976
0 .02198
Premium payable
113,73,976. x $ 0.00015 = $ 1706.0964
1706.0964
Amount paid for paying premium
Rs 76,782.016
0.02222
On due date he will buy 2,50,000 $ and pay
Rs 113,73,976

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PRAVINN MAHAJAN CA

Total amount payable

Rs 114,50,758

Option 2
forward market hedge
PQR will book a forward contract today to buy 2,50,000 $ at $ 0.02183 / Re
2,50,000
He will pay
Rs 114,52,130.096
0.02183
Option 3
No hedging
PQR will buy 2,50,000 $ after 4 months at spot rate after 4 months
2,50,000
@ $ 0.02178 / Re
0.02178

Rs 114,78,421

Since amount payable in currency option is least, so currency option is better


d.

Indian company has to receive $ 1,50,000 after 3 months. Indian company has 3 options
Option 1
Hedging through currency options
Call option gives right to buy Re and Put option gives right to sell Re. since Company has to
sell $ ( i.e buy Re), so company will buy call option and sell $ after 3 months
@ $ 0.02264 / Re

Statement of net amount Receivable


Premium payable
$ 0.00025/Re
1,50,000
He will buy
Rs 66,25,441.7
0.02264
Premium payable 66,25,441.7 x 0.00025 = $ 1,656.3604
Amount paid for $ 1,656.3604 at spot rate of $ 0.02273 per Re
Amount received from selling $
Amount receivable

Rs 72,871.113
Rs 66,25,441.7
Rs 65,52,570.6

Option 2
Forward Market Hedge
Company will book a forward contract today to sell $ 1,50,000 @ $ 0.2290 / Re
1,50,000
Company will receive
Rs 65,50,218.3
0.02290
Option 3
Company will sell 1,50,000 $ at spot rate after 3 months @ 0.023200 / Re
1,50,000
Company will receive
Rs 64,65,517.2
0.023200
Since amount receivable in currency option is highest, so currency option hedge is better.
Q92

a.

Sun Ltd, a UK co. has to receive $ 2,40,000 on 30 th sept.Sun ltd is considering to hedge
this receipt through currency options
Call option gives right to buy and Put option gives right to sell . Since UK co has to sell
$ and buy , so UK co. will buy call option to sell to sell $ 2,40,000 @ $ 1.60 / at a
premium of 600 per contract
No. of contracts

54
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PRAVINN MAHAJAN CA

Size of each contract is

30,000

UK co. has to sell $ 2,40,000 @ $ 1.60 / , i.e Co. will buy


No. of contracts to be taken by UK. Co.

2,40,000

30,000

3,000
1,50,000
1,47,000

If on due date Spot rate is


i.

$ 1.20 /
Since MP < Exercise Price, So call option will not be exercised.
Company will sell $ 2,40,000 in market

Statement of amount to be received


5 contracts x 600
2,40,000
Amount received on due date
1.2
Net amount received
Premium paid

3,000
2,00,000
1,97,000

ii.

$ 1.60 /
Since MP = EP, Co. will be indifferent whether to exercise the call option or sell $
in market
Statement of amount to be received
Premium paid
5 contracts x 600
3,000
Amount received on due date
1,50,000
Net amount received
1,47,000

iii.

$ 2.00 /
Since MP > EP, Co. will exercise call option and sell $ 2,40,000 to writer
Statement of amount to be received
5 contracts x 600
2,40.000
Amount received on due date
1.60
Net amount received
Premium paid

Q93

1,50,000

1,50,000

Statement of amount to be received


Premium paid
5 contracts x 600
Amount received on due date
Net amount received
b.

1.60

3,000
1,50,000
1,47,000

Currency Market Arbitrage


a. Since $ is expected to depreciate, So for Arbitrage profit Romesh may either buy a call or
write a Put
b.

If Romesh Bought a 30 day call


Premium paid
On due date, he will buy @ $ 1.1 / and sell in market
@ $ 1.220 / . Net amount received ( 1.220 1.1 )
Profit on arbitrage
If Romesh wrote a Put

55
CLASSES

$ 0.085
$ 0.120
$ 0.035

PRAVINN MAHAJAN CA

Premium received
On due date Put holder will not exercise Put option as $ is
expected to depreciate and will appreciate, i.e on due date
MP > EP, so put holder will sell in market.
Arbitrage Profit
Q94

$ 0.110

.
$ 0.110

An Indian Exporter has to Receive $ 1,00,000 in 90 days. Indian company has 2 options
Option 1

No hedging
Company will sell $ 1,00,000 after 90 days, at spot rate after
90 days i.e @ Rs 46.50/$
Company will receive 1,00,000 x 46.50

Rs 46,50,000

Option 2

Hedging through currency options


Company will buy a put option at a premium of Re 1 /$ which gives the company,
right to sell $ @ Rs 48 / $ after 90 days
Statement of amount to be received
Premium paid
1,00,000 x 1
Rs 1,00,000
Amount received on due date
Rs 48,00,000
Net amount received
Rs 47,00,000

b.

Since amount received in Currency option is higher so currency option is better


If Spot rate after 90 days is Rs 47.50 / $
Since MP < EP, so Put will be exercised, and net amount received will be Rs 47,00,000
If spot rate after 90 days is rs 48.50
Since MP > EP , Company will not exercise put option and sell, $ in market
Statement of amount to be received
Premium paid
1,00,000 x 1
Rs 1,00,000
Amount received on due date
Rs 48,50,000
Net amount received
Rs 47,50,000
Inthis case hedging through currency options is not viable.

Q95

US firm has to buy 3,00,000 after 180 days

$
Since quote is

, relevant

rate is Ask rate

Company has following options


1.

Hedge through currency options


Company will buy call options today, to buy 3,00,000 after 180 days @ $ 1.97 / .
Statement of payment
Premium paid ($ 0.04 / )
Amount paid
( 5,00,000 x 0.04 )

12,000 $

Due date

56
CLASSES

PRAVINN MAHAJAN CA

EP
MP

$ 1.97 /
1.91 x 0.25 + 1.95 x 0.6 + 2.05 x 0.15
= $ 1.955
MP < EP , call will not be exercised
US firm will purchase from market @ $ 1.955 /
Amount paid 3,00,000 x 1.955
2.

5,86,500 $
5,98,500 $

Money market hedge


Process ($ borrow, deposit )
1. Deposit present value of 3,00,000 , co. will deposit
3,00,000
2.

3.

2,93,398.53

1.0225
To deposit 2,93,398.53 co. will borrow $
$ to borrowed is ascertained is ascertained by converting
2,93,398.53 @ spot rate of $ 2 /
$ borrowed 2,93,398.53 x 2 = 5,86,

$ 5,86,797.06 $

$ payable after 180 days @ 5.57


5,86,797.06 x 1.0275

$ 6,02,933.98 $

3.. Forward market hedge


Co. will book a forward contract today to buy 3,00,000 after 180 days
@ 1.96 /
$ payable 3,00,000 x 1.96

$ 5,88,000

4.. No Hedging
Co. will buy 3,00,000 after 180 days at spot after 180 days of
$ 1.955 /
$ payable 3,00,000 x 1.955

$ 5,86,500

Since amount payable is least if no hedging is done, so no hedging is better.


Q96

UK company has to buy 3,64,897 $ after 6 months


Since quote is $/, relevant rate is Bid rate
Company has following options
1.

Hedge through currency options


Call option gives right to buy and put option gives right to sell
Since company has to buy $ (i.e sell ), so company will buy put option
$ to be bought
3,64,897 $
Since put option is taken
So $ is to be bought at EP of $ 1.70 /
to be sold

3,64,897

Contract size

1.70

2,14,645.29
12,500

57
CLASSES

PRAVINN MAHAJAN CA

2,14,645.2941

Number of contacts

12,500

= 17.17

contracts

Number of contracts to be taken is 17 or 18.


If 17 contracts are taken
1 contract is 12,500
sold 12,500 x 17 = 2,12,500
If sold is 2,12,500 then $ received $ received 2,12,500 x 1.7
$ required
Shortage

= 3,61,250
= 3,64,897
3,647.8

For shortage of $, company will book a forward contract to purchase 3,647.8 $ after 6
months @ $ 1.5455/
Statement of Payment
Premium paid 2,12,500 x 0.96
payable for payment of premium

20,400 $
13,062.69

20,400
1.5617

$ bought and sold

2,12,500

paid for purchasing 3,647 $


2.

3647 .8

2,359.75

1.5455

2,27,922.44
Hedge through forward market
Company will book a forward contract today to buy 3,64,897 $ in 6 months @
$ 1.5455 / . Company will pay

3,64,897
1.5455

= 2,36,102.88

3. Money Market Hedge.


a. Company will deposit $ and borrow
b. Co. will deposit present value of 3,64897 $, i.e company will
3,64,897
deposit
=
$ 3,56,867.48
1.0225

c. To deposit $ 3,56,867.48 company will borrow for 6


months @ 7%. to be borrowed is to be ascertained by
converting 3,56,867.48 $ @ $ 1.5617 /
3,56,867
1.5617

= 2,28,512.18

d. payable after 6 months 2,28,512.18 x 1.035


= 2,36,510.11
Since payment is lowest in currency options, so hedge through currency
options is better
Q97

ABC co. has taken a $ loan of @ million $ @ L+1%, payable in 6 months.


Current L is 2%
i.
Interest payable for 3 months 20,00,000 x .03 x 6 / 12
30,000 $
If forward market hedge is taken toatal commitment in is
58
CLASSES

PRAVINN MAHAJAN CA

Principal + interest
Forward rate
Value of commitment 20,30,000 x 48.4575
ii.

20,30,000 $
48.4575/$
9,83,68,725

By evaluating spot rate and forward rate, it is visible that market


expectation about $ is that, $ will depreciate in near future. If firms own
expectation is that $ will depreciate more than what the bank has
quoted, it may be worthwhile not to cover obligation in forward market
and keep the exposure open.
If the firm has no specific view regarding future $ price movements, it
would be better to cover exposure. This would freeze the total
commitment and save the firm from undue market fluctuations. Thus in
this situation it will be advisable to cut the losses at this point of time.
Given the interest rate differentials and inflation rates between and $,
it wouls be unwise to expect continuous depreciation of the $. The $ is
a strong currency than the Indian and it would be advisable to cover
the exposure.
Statement of payable if loan taken in given currency

Q98

Currency

$
DM
Ffr

Amt of loan Interest


3 months
10,00,000
45,000
18,779.34
352.11
28,818.44
450.29
41,322.31
568.18
1,40,845.07 2,464.79

Loan
Payable
10,45,000
19,131.45
29,268.73
41,890.49
1,43,309.86

FR

Amt()

54.80
35.95
25.15
7.35

10,45,000
10,48,403
10,52,211
10,53,546
10,53,327

Since amount payable after 3 months is lowest if loan is taken in , so


loan should be taken in
Statement of payable if loan taken in given currency
Currency

$
DM
Ffr

Amt of loan Interest


3 months
10,00,000
45,000
18,779.34
352.11
28,818.44
450.29
41,322.31
568.18
1,40,845.07 2,464.79
59
CLASSES

Loan
Payable
10,45,000
19,131.45
29,268.73
41,890.49
1,43,309.86

FR

Amt()

54.30
35.60
24.85
7.20

10,45,000
10,38,837.74
10,41,966.79
10,40,978.68
10,31,830.99

PRAVINN MAHAJAN CA

Since amount payable after 3 months is lowest if loan is taken in Ffr, so


loan should be taken in Ffr.

Q99

Indian company borrowed $ 10,00,000 @ 5% for 2 years.


At spot rate of 48/$, indian company borrowed

480 lac

Interest payable at the end of 1 st year


At one year forward rate $48.5/$, Interest in is
Interest cost after tax
(23,28,000 x 0.65)

$ 50,000
24,25,000
15,76,250

Interest payable at the end of 2nd year


At 2 year end forward rate 49/$, Interest in is
Interest cost after tax is
(24,50,000x 0.65)

$ 50,000
24,50,000
15,92,500

Principal payable after 2 years @ 49/$ (10 lac x 49)


Tax saving on loss on payment of principal 10,00,000 x 0.35
Net outflow in payment of principal

490,00,000
3,50,000
486,50,000

Cost of debt is, rate at which present value of all future cash outflows is equal to
principal
480,00,000 =
15,76,250
15,92,500
490,00,000
PV of cash outflows @ 7%
=15,76,250 x 0.935 + 505,92,500 x 0.873
= 14,73,794 + 441,67,253
= 456,41,047
Pv of cash outflows @ 4%
= 15,76,250 x 0.962 + 505,95,200 x 0.925
= 15,16,353 + 468,00,560
= 483,16,913
For diff of 3%, change in value is 26,75,866. For diff in value of 3,16,913 diff in
rate is

3,16,913
26,75,866

x 3 = 0.355

Thus effective cost of debt is 4.355%


Q100 a.

Japanese company lend 700 lac @ 10% for 4 years.


Japanese company will receive after 4 years
700lac (1.1)4 =
1024,87,000
60
CLASSES

PRAVINN MAHAJAN CA

b.

Spot rate 140 / $


$ is expected to decline @ 5 / $ p.a
Expected spot rate after 4 years 120 /$
$ equivalent of 1024.87 received by japanese company is
1024.87
120

= 8,54,058 $

c.

Japanese subsidiary co. will pay to US co. after 4 years


5,00,000 ( 1.13)4
5,00,000 (1.630474)
= 8,15,237 $

d.

Japanese company received from US company 8,54,058$


Japnese company company paid to US company 8,15,237$
Since amount received from US company is more than amount paid to US
company, so Japanese company is better off in swap deal.

e.

If does not change i.e exchange rate after 4 years is 140 / $


Then $ equivalent of 1024,87,000 received by japanese company is
1024.87
140

= $ 7,32,050

Amount paid by japanese company is $ 8,15,237$


Since amount paid by japenese company is more than amount
received, so US company is better off in swap deal, if exchange rate is
same.
Q101 A intend to borrow $ 2,00,000 and B intend to borrow equivalent of 2,00,000 $
A and B entered in currency swap.
A will borrrow @ 5% and give to B. B will pay to A 1% over As cost, i.e B will
pay to A 6%
B will take $ loan @ 10% and give to A, and A will Give to B 9%

Rate of Interest payable to bank for borrowing


Rate received from other party in Swap
Rate payable to other party
Net cost to each party

A
5%
(6%)
9%
8%

B
10%
(9%)
6%
7%

A intend to borrow $, which can be borrowed @ 9%. However under swap


Interest cost to A is 8%. So gain to A under swap is 1%
61
CLASSES

PRAVINN MAHAJAN CA

B intend to borrow , which can be borrowed @ 8%. However under swap


interest cost to B is 7%. So gain to B under swap is 1%.
Q102 a.
.
.
.

b.

To mitigate the risk arising due to exchange rate fluctuations US company


will arrange currency swap with any other party to whom it can give $ loan
in US against receipt of Re loan from such party in India for the amount of
Re 500 crore at agreed rate.
After 1 year this loan will be swap back.
On account of this currency swap, risk on account of exchange rate
fluctuation on initial investment of rs 500 crore is avoided, but profit of Rs
240 crore receivable after 1 year is still exposed to exchange rate
fluctuations
Statement of Profit if company opts for swap
Loan taken in US to invest 500 crore in India
50,000

($ 1000 Lac)

50

Amount received after 1 year 74,000 Lac


Coverted 50,000 lac at swap rate of 50/$
Profit of 24,000 lac converted in $ @ 54/$

$ 1000 lac
$ 444.44 lac

Interest paid in US 1000 lac $ x 8%


Net profit in $

(80 lac $)
$ 364.44 lac

Statement of Profit if Company does not opt for swap


Loan taken in US to invest 500 crore in India
50,000

($ 1000 Lac)

50

Amount received after 1 year 74,000 Lac


Coverted 74,000 lac at 54/$

$ 1370.370

Interest paid in US 1000 lac $ x 8%


Net profit in $

(80 lac $)
$ 290.37 lac

Since amount received is higher if company opts for currency swap, so


company should opt for currency swap.
Q103

Statement of profit if company opts for currency swap


Amount to be borrowed in india to invest $ 50 million In US
62
CLASSES

PRAVINN MAHAJAN CA

By converting amount required for investment @46.50/$

(2325 mil)

Amount received after 1 yr in US $ 60 million


- Converted $ 50 million at swap rate of 48.75/$
- Converting profit of 10mil $ @ 49.25

2437.5 mil
492.5 mil

Interest paid in India @ 16% 2325 mil x 0.16


Profit in $

(372 mil)
233 mil

If hedge is taken in forward market


Amount to be borrowed in india to invest $ 50 million In US
By converting amount required for investment @46.90/$

(2345 mil)

Amount received after 1 year 60 mil, converted in @ 49.25/$ 2955 mil


Interest on amount borrowed in india
2345 x 0.16
(375.2)
Profit in $
234.8 mil

Q104 UK company sold goods for $ 50,00,000, receivable in 1 year. Company has 2
options.
1. Borrowing $ 50,00,000 and convert into
UK co. will borrow $ 50,00,000 for 1 year @ 3.5%
Co. will convert $ 50,00,000 into at spot rate $ 1.4165 /
And receive

50,00 ,000

34,59,011

1.4455

Co. will deposit 34,59,011 @ 5.75 %


Interest payable on $ loan 50,00,000 x 0.035
payable for interest
Net receipts

36,57,904
$ 1,75,000

1,75,000

1,23,544

1.4165

36,57,904 1,23,544

35,34,360

2. Hedge through forward market and borrow amount in


Co will book a forward contract today to sell $ 50,00,000 after 1 year @ $
1.4165 / .
Today co will borrow 34,59,011@ 5.75% and deposit it @ 5.75%
in hands after 1 year
34,59,011
receivable after 1 year under forward cover

50,00,000

35,29,827

1.4165

Net receipts 35,29,827 + 34,59,011 34,59,011

35,29,827

Since receipts are higher in method 1, so method 1 is better.


63
CLASSES

PRAVINN MAHAJAN CA

Q105 UK company exported goods worth DM 7,50,000 to germany, receivable in 3


months.
Company has 2 options
i.
Borrow DM 7,50,000 for 3 months, convert the loan into
Company will borrow DM 7,50,000 for 3 months @ 3% p.a
Company will convert DM 7,50,000 into @ DM 2.3834 / 3,14,677
Company will deposit 3,14,677 @ 6% for 3 months and
receive
3,14,677 x 1.015
3,19,397
DM loan will be repayable after 3 months
7,50,000 x 1.0075
DM 7,55,625
DM 7,50,000 payable from receipts and payable for
Interest of DM 5,625
5625

2374.62

2.3688

Net receipts
ii.

3,19,397 2374.62

3,17,022.38

Hedge through forward cover


Company will book a forward contract today to sell DM 7,50,000 after 3
months @ DM 2.3688 /
receivable =

7,50 ,000
2.3688

= 3,16,616

receipts in method 1 is higher, so method 1 is benificial.


Q106

M
8%
T + 0.6
Floating

Fixed
Floating
Prefrence
Interest according to own prefrence =
Interest under swap
=
Benefit of swap
=
=
Case 1 :
If benefit shared equally
Share of M
Share of S

=
=

Cost to each Party =


M
=
S
=
Case 2 :

S
9.20
T + 1.20
Fixed

T + 0.6 + 9.20
8 + T + 1.2
T + 9.8 ( T + 9.2)
0.6 %

0.3
0.3

Paid to I - Recd from I + paid to bank - Share in benefit from swap


T + 0.6 - 8 + 8 0.3
= T + 0.3
9.20 + (T + 1.2) ( T + 1.2) 0.3
= 8.90%

If benifit shared in the ratio of 3:1

64
CLASSES

PRAVINN MAHAJAN CA

Share of M
Share of S

=
=

Cost to each Party =


M
=
S
=

0.45
0.15

Paid to I - Recd from I + paid to bank - Share in benefit from swap


T + 0.6 - 8 + 8 0.45
= T + 0.15
9.20 + (T + 1.2) ( T + 1.2) 0.15
= 9.05%

Q107 a

P
10
L +0.2%
fluctuating

Fixed
Floating
Prefrence

Q
11.6
L+ 0.5%
Fixed

P fluctuating

Q Fixed
L+0.2

10%

11.6

Intermediary

L+ 0.5

10%

Bank
Fixed

Recd. = L + 0.2 + 11.6 = L + 11.8


Paid = 10 + L + 0.5 = L + 10.5
Benefit of Swap
1.3
Share of I 10%
0.13
P
0.585
Q
0.585

Interest according to own prefrence =


Interest under swap
=
Benefit of swap
=
=

65
CLASSES

L + 0.5%

Bank
Fluctuating

L + 0.2 + 11.6
10 + L + 0.5
L + 11.8 - ( L + 10.5 )
1.3 %

PRAVINN MAHAJAN CA

Share of Intermediary
Share of P
Share of Q
Cost to each Party =
P
=
Q
=

=
=
=

0.13
0.585
0.585

Paid to I - Recd from I + paid to bank - Share in benefit from swap


L + 0.2 - 10 % + 10% - 0.585
= L 0.385
11.6 - ( L + 0.5 ) + ( L + 0.5 ) 0.585 = 11.015

A
11
M +0.2%
fluctuating

b.

Fixed
Floating
Prefrence

B
12.3
M+ 0.6%
Fixed

A fluctuating

B Fixed
M+0.2

11%

12.3

Intermediary

M+ 0.6

11%

Bank
Fixed

Recd. = M + 0.2 + 12.3 = M + 12.5


M+0.6%
Paid = 11 + M+ 0.6 = M + 11.6
Benefit of Swap
0.9
Share of I
0.1
A
0.48
B
0.32
Bank
Fluctuating

Interest according to own prefrence =


Interest under swap
=
Benefit of swap
=
=
Share of Intermediary
=

66
CLASSES

M + 0.2 + 12.3
11 + M + 0.6
M + 12.5 ( M + 11.6)
0.9 %
0.1

PRAVINN MAHAJAN CA

Share of P
Share of Q

=
=

Cost to each Party =


P
=
Q
=

0.48
0.32

Paid to I - Recd from I + paid to bank - Share in benefit from swap


M + 0.2 - 11 % + 11% - 0.48
= M 0.28
12.3 - ( M + 0.6 ) + ( M + 0.6 ) 0.32 = 11.98

f.

A
5
L +0.5%
fluctuating

Fixed
Floating
Prefrence

B
6
L + 0.75%
Fixed

A fluctuating

B Fixed
L+0.5

5%

Intermediary

L+0.75

5%

Bank
Fixed

Recd. = L + 0.5 + 6
Paid = 5 + L + 0.75
Benefit of Swap
Share of I
A
B

Interest according to own prefrence =


Interest under swap
=
Benefit of swap
=
=

67
CLASSES

= L + 6.5
= L + 5.75
0.75
0.25
0.25
0.25

L + 0.75%

Bank
Fluctuating

L + 0.5 + 6
5 + L + 0.75
L + 0.5 + 6 ( 5 + L + 0.75)
0.75

PRAVINN MAHAJAN CA

Share of Intermediary
Share of A
Share of B
Cost to each Party =
P
=
Q
=

=
=
=

0.25
0.25
0.25

Paid to I - Recd from I + paid to bank - Share in benefit from swap


L+ 0.5 - 5 + 5 0.25
= L + 0.25
6 ( L + 0.75) + (L + 0.75) 0.25
= 5.75

g.

A
10
L +0.5%
fluctuating

Fixed
Floating
Prefrence

B
12
L + 1.5%
Fixed

A fluctuating

B Fixed
L+0.5

10%

12

Intermediary

L+1.5

10%

Bank
Fixed

Recd. = L + 0.5 + 12
Paid = 10 + L + 1.5
Benefit of Swap
Share of I
A
B

Interest according to own prefrence =


Interest under swap
=
Benefit of swap
=

68
CLASSES

= L + 12.5
= L + 11.5
1.00
0.1
0.45
0.45

L+1.5%

Bank
Fluctuating

L + 0.5 + 6
5 + L + 0.75
L + 0.5 + 6 ( 5 + L + 0.75)

PRAVINN MAHAJAN CA

=
=
=
=

Share of Intermediary
Share of A
Share of B
Cost to each Party =
A
=
B
=

0.75
0.25
0.25
0.25

Paid to I - Recd from I + paid to bank - Share in benefit from swap


L+ 0.5 - 10 + 10 0.45
= L + 0.05
12 (L+1.5) + ( L + 1.5) 0.45
= 11.55

h.
Fixed
T
PLR
Prefrence

14
T+4
P+2
fixed

12
T+3
P+3
T

15
T+5
P+4
PLR

Allotment under swap


1. Fixed = 15 12 = 3
T
= T+5 - (T+3) = 2
PLR = P+4 (P+2) = 2
Highest of all difference 3, associated with fixed rate of interest. Out of
fixed lowest rate is alloted to B. under swap B is alloted Fixed rate @ 12%
2.

T = T+5 ( T+4) = 1
P = P+4 (P+2) = 2
Highest of all difference 2, associated with PLR. Out of PLR lowest rate is alloted
to A. under swap A is alloted P+2

3.

Under swap C is alloted T+5

Intrest according to own prefrence


Interest under Swap
Benefit under swap

= 14 + T+3 + P + 4
= 12+P+2+T+5
= 2

Share
Share
Share
Share

=
=
=
=

of
of
of
of

I A
B
C

Cost to each Party


A
B
C

=
=
=
=

2 x 0.25

= T+P+21
= T + P + 19

0.5
0.5
0.5
0.5

Paid to I - Recd from I + paid to bank - Share in benefit from swap


14 (P+2) + (P+2) - 0.5
= 13.5
T+3 - 12 + 12 0.5
= T + 2.5
P+4 - ( T+5) + (T+5) 0.5
= P + 3.5

Q108

A
69
CLASSES

B
PRAVINN MAHAJAN CA

Fixed
Floating
Prefrence
a.

9.5
L +2
fluctuating - L

13.5
L+2
Fixed-12

A fluctuating

B Fixed
L

9.5

12
Intermediary

L+2

9.5%
Recd. = L + 12
Paid = 9.5 + L + 2
Benefit of Swap
Share of I

= L + 12
= L + 11.5
0.5
0.5

Bank
Fixed

b. Cost to each Party =


A
=
B
=

c.

Bank
Fluctuating

Paid to I - Recd from I + paid to bank - Share in benefit from swap


L - 9.5 + 9.5
= L
12 (L+2) + (L+2)
= 12

Interst savings by each company


A
B
Interest according to own prefrence
Interest under swap
Benefit of swap
Share of Intermediary

Q109

L+2%

=
=
=
=
=
=
=
=

cost under own prefrence - cost under swap


L + 2 - L
=
2
13.5 - 12
=
1.5
L + 12
9.5 + L+ 2
L + 12 - L+ 11.5
0.5
0.5

Dealer quotes All in cost of generic swap @ 8% against 6 month L on notional principal
of 5,00,000
a.

Amount payable under fixed rate , if payable semiannualy


5,00,000 x 0.08 x 6/12 = 20,000

b.

Amount payable under floating rate of L, if days in 6 months is 181 days


5,00,000 x 0.06 x 181/ 360 = 15,083
If settlement is made on net basis, fixed rate payer will pay to floating rate payer
20,000 15,083
=
4,917

Q110

ABC prefers fixed rate funding

70
CLASSES

PRAVINN MAHAJAN CA

Company can raise loan at L + 0.25%


Bank can swap into fixed rate @ 7.5% against L
Fixed ABC
7.5%

L
L+ 0.25
Intermediary

Loan = Fluctuating
Cost to each Party

b.

=
=
=

Paid to I - Recd from I + paid to bank


7.5 L + L + 0.25
7.75% p.a for 5 years

ABC still prefers fixed rate funding


Now ABC will raise loan by issuing hybrid instrument in which 7.5% is payable for first 3
years and L 0.25% is payable for next 2 years
Bank can swap into fixed rate @ 7.5% against L. Another swap is available @ 8% against L
First 3 years

Next 2 years

ABC

7.5

ABC

7.5

L
Intermediary 1

Intermediary 1

8
Intermediary 2

Loan 7.5%

Loan L 0.25%

Cost for first 3 years = 7.5% - L + L 8% + 7.5%


Cost for next 2 years = 7.5% - L + L 0.25%

71
CLASSES

=
=

7%
7.25%

PRAVINN MAHAJAN CA

Q111

Since fixed rate funding achieved by 2nd option is cheaper so, 2 nd option is better
Dealer quotes All in cost of generic swap @ 8% against 6 month L on notional principal
of 6,00,000
c.

Amount payable under fixed rate , if payable semiannualy


6,00,000 x 0.08 x 6/12 = 24,000

d.

Amount payable under floating rate of L, if days in 6 months is 181 days


6,00,000 x 0.06 x 181/ 360 = 18,100
If settlement is made on net basis, fixed rate payer will pay to floating rate payer
20,000 15,083
=
5,900

Q112

Y
9.5%
L+2%
Float = ?

Fixed
Floating
Prefrence

H
13.5%
L+2%
Fixed = 12%

Y fluctuating

H Fixed
???

9.5

12
Intermediary

L+2

9.5%
Recd. = ??? + 12
Paid = 9.5 + L + 2
Benefit of Swap
Share of I

= x + 12
= L + 11.5
0.5
0.5

Bank
Fixed

L+2%

Bank
Fluctuating

Benefit under swap or


Share of I
= Amount recd by I - amount paid by I
0.5
= ( X + 12 ) ( 9.5 + L + 2)
0.5
= X + L + 0.5
X
=L

72
CLASSES

PRAVINN MAHAJAN CA

Cost to Y under swap

Interest savings to each party


Y
H

L
= cost under own prefrence
=
L+2 - L
=
13.5 12

- cost under swap


= 2%
= 1.5%

M
7
L +0.6
fluctuating

Q113

Fixed
Floating
Prefrence

C
8.2
L+1.2
Fixed

M fluctuating

C Fixed
L + 0.6

7%

8.2

Intermediary

L+1.2

7
Recd. = L +0.6 + 12
Paid = 7 + L + 1.2
Benefit of Swap
Share of M
C

= L + 8.8
= L + 8.2
0.6
0.4
0.2

Bank
Fixed

L+1.2%

Bank
Fluctuating

Interest according to own prefrence =


Interest under swap
=
Benefit of swap
=

73
CLASSES

L + 0.6 + 8.2
7 + L + 1.2
L + 8.8 ( L + 8.2 )

PRAVINN MAHAJAN CA

Share of M
Share of C
Cost to each Party =
M
=
Q
=

0.6 %

=
=

0.4
0.2

Paid to I - Recd from I + paid to bank - Share in benefit from swap


L + 0.6 - 7 + 7 0.4
=
L + 0.2
8.2 ( L + 1.2) + ( L+ 1.2) 0.2
=
8

Q114

X
7.5%
L + 0.25
floating

Fixed
Floating
Prefrence

Y
8.45%
L + 0.37
fixed

X fluctuating

Y Fixed
L

7.6

7.75
Intermediary

7.5%
Recd. = L + 7.75
Paid = 7.6 + L
Benefit of Swap
Share of I
Bank
Fixed
b. Cost to each Party =
X
=
Y
=

= L + 7.75
= L + 7.6
0.15
0.15

L + 0.37

Bank
Fluctuating

Paid to I - Recd from I + paid to bank - Share in benefit from swap


L - 7.6 + 7.5
= L 0.1
7.75 L + (L+0.37)
= 8.12

74
CLASSES

PRAVINN MAHAJAN CA

c.

Interst savings by each company


X
Y
Interest according to own prefrence
Interest under swap
Benefit of swap
Share of Intermediary

Q115

=
=
=
=
=
=
=
=

cost under own prefrence


L + 0.25 (L-0.1)
8.45 7.75
L + 7.75
7.6 + L
L + 7.75 - (L+7.6)
0.15
0.15

- cost under swap


=
0.35
=
0.7

Derivative bank entered into plain vanilla swap through OIS in which Bank will pay at fixed rate
and receive at floating rate
OIS is an interest rate swap involving a fixed rate being exchanged for an
indexed rate like LIBOR or MIBOR. LIBOR or MIBOR is an overnight refrence rate.

READ

Note - Under OIS, Interest would be computed on a NOTIONAL PRINCIPAL amount for

fixed rate and on the floating side, INTEREST AMOUNTS ARE COMPOUNDED ON DAILY
BASIS
Statement of amount received by bank under floating rate
Day
Principal
Tuesday
10,00,00,000
Wednesday
10,00,21,233
Thursday
10,00, 43,567
Friday
10,00,65,823
Saturday & Sunday
10,00,87,618
Monday
10,01,31,382
Interest received under floating

MIBOR
7.75%
8.15
8.12
7.95
7.98
8.15

Interest
21,233
22,334
22,256
21,795
43,764
22,358
1,53,740

Bank received 317 in net settlement i.e amount received under floating is more than amount
paid under fixed by 317
Amount paid under fixed 1,53,740 317 = 1,53,423

75
CLASSES

PRAVINN MAHAJAN CA

1,53,423

Rate paid under fixed rate

Q116 a.

Spot rate
Inflation rate

100,00,000

SA (

b.

1 + iA
1+ iB

= 7.999 or 8 %

3
)
12
2.70 x
3
( 1 + 0.02 x )
12

( 1.0125 )

2.70 x

$ 2.72/

Spot rate
3 month forward rate
Inflation in germany
Inflation in US

( 1.005)

DM 1.50/$
DM 1.51/$
4%
?

1.51

1.51 x + 1.51
X

=
=

1 + iA

SA (

Spot rate
Inflation rate

( 1 + 0.05 x

Forward Rate (FA )

c.

365

1 = $ 2.70
5%
2%

US
London

Forward Rate (FA )

x 100

1+ iB

( 1 + 0.04 x
1.50 x

3
)
12

( 1 + X)

1.5150
1.32%

46.5 /$
India
9%
US
4%

Forward Rate (FA )

% Premium or discount on $

1 + iA

SA (

1+ iB

46.5 x

48.73

=
=

76
CLASSES

( 1 + 0.09 )
( 1 + 0.04)

x 100

46.5 48.73
48.73

x 100

4.57%

PRAVINN MAHAJAN CA

% Premium on Re.

x 100

48.73 46.5

46.5

x 100

=
4.80%
d. Cost of transistor in US
$ 22.84/ transistor
In Singapore S$ 69/Transistor
In Moscow RR 3240/transistor
According to law of One price, exchange rate in
Singapore

$
$

= 69 x
Moscow

$
1

= S$ 3.0210 /$

22.84

= 3240 x
Exchange rate in singapore
Moscow

1
22.84

= RR 141.85 /$

S$ 1.63/$
RR 250 /$

Cost of transistor in US in $

$ 22.84/Transistor

Cost of Transistor In singapore in $


1
=
69 x 1.663

$ 42.33 / Transistor

Cost of Transistor In Moscow in $


=
3240 x

1
250

$ 12.96 / transistor

Since transistor is cheapest in Moscow, so transistor should be purchased


from moscow
e.

Cost of one racket in Uk


Cost of one racket in US

100 / racket
$ 150 / racket

Acc to purchase power parity


100 = 1 Racket = $ 150
i.e 100 = $ 150
i.e $ 1.5 /
After one year, inflation in UK 0% and in US 10%
Cost of racket in UK after 1 year 100 (1 + 0)
= 100
Cost of racket in US fter 1 year $ 150 ( 1+ .10) = $ 165
77
CLASSES

PRAVINN MAHAJAN CA

i.e after 1 year

$ 165 = 100
i.e $1.65/
Thus after 1 year, $ depreciated.
Q117 a.

Rate of Interest in India


In US
Rate of Inflation in India
In US

14.5%
?
6.5%
8.5%

1 +
1 +
1 + .085
1 + .065

=
=

1 +
1 +
1+
1 + .145

(1.085)(1.145) = (1+x)(1.065)
x

( 1.085)(1.145)
(1.065)

-1

= 0.1665 or 16.65%
b.

Rate of Interest in Germany


In UK
Rate of Inflation in Germany
In UK
1 +
1 +
1+
1 + .05

11%
9%
5%
?

=
=

1 +
1 +
1 + .09
1 + .11

(1+ x)(1.11) = (1.05)(1.09)


1.11 + 1.11x = 1.1445
1.1445 1.11
x =
1.11

= 0.03108
= 3.108 %
c.

Rate of inflation on $
On
Spot rate
1 year forward rate
Forward Rate (FA )

?
8%
40.10/$
41.80/$
=

SA (
B

78
CLASSES

1 + iA
1+ iB

PRAVINN MAHAJAN CA

40.10 x

41.80 + 41.80x

43.308

Rate of Interest in France


In Germany
Spot rate

( 1 + x)

43.308 41.80
41.80

=
d.

( 1 + 0.08 )

41.80

0.03607 or 3.607%

9%
12%
DM 3.5/FF

Forward Rate (FA )

SA (

e.

f.

1 + rA
1+ rB
1.12

3.5 x

DM 3.5963 / FF

1.09

Rate of Inflation in India


7%
In switzerland
2%
Spot rate
24/SF
Rate of appreciation of SF against Re 5% p.a
1.07

Iyr forward rate

24 x (

2 yr forward rate

24 x

3 Yr forward rate

24 x (

) (1.05)

1.02
1.07
(1.02 )2
1.07 3
1.02

= 26.435/SF

(1.05)2 = 29.1176/SF

) (1.05)3 =

32.0722/SF

Rate of inflation in India


8%
In UK
3%
Spot rate
82/
Rate of appreciation of against 5% p.a
1.08

= 90.28/

Iyr forward rate

82 x (1.03 ) (1.05)

2 yr forward rate

82 x (1.03 )2 (1.05)2 = 99.40/

3 Yr forward rate

82 x (1.03 )3 (1.05)3 =

1.08
1.08

109.44/

Q118 An american FII is considering to invest $ 100 lac in India or Malaysia.


If investment is made in India
79
CLASSES

PRAVINN MAHAJAN CA

US FII will convert $ 100 lac in at spot rate of 43.5 / $


FII will receive 100 lac x 43.5
Earning in India in 1 year @ 20% 4350 x 0.2
Tax in India @ 20%
Cash in hand with FII after tax ( 4350 + 870 174)
$ in hand after 1 year, at spot rate after 1 year
43.60 x
=

1.04
1.02

4350 lac
870 lac
174 lac
5046 lac

44.45 / $

5046

$ 113.521 lac

44.45

$ profit in India

$ 13.521 lac

If Investment is made in malaysia


US FII will conver $ 100 lac in MS at spot rate of 3.80/$
FII will receive $ 100 lac x 3.80
Earning in Malaysia in 1 year @ 16% 380 x 0.16
Tax in Malaysia @ 10%
Cash in hand after tax ( 380 + 60.8 6.08)
$ in hand after 1 year
1.06
3.82 x 1.02
= MS 3.97 / $
=

434 .72

380 lac MS
60.8 lac
6.08 lac
434.72 lac

$ 109.50 lac

3.97

$ profit in Malaysia

$ 9.50 lac

Since $ profit in Indai is higher, so investment should be made in India.


Q119 X Ltd is considering to invest $ 110 lac in US
Rupee rate of return is 14%
India
(1 + Risk adj)
=
( 1 + Risk free) )( 1 + Risk premium)
( 1.14)
=
( 1.12) (1+ Risk premium)
(1+ Risk premium) =

1.14
1.12

US
(1 + x)

(1+x)
X

=
=

Cash outflow

1.14
1.12

( 1.08)

1.0993
9.93 %

Statement of NPV (in $)


Amount
time factor
110 lac
0
1
80
CLASSES

PV
$ 110 lac

PRAVINN MAHAJAN CA

Cash inflow

20 lac
25 lac
30 lac
40 lac
50 lac

1e
2e
3e
4e
5e

0.910
0.827
0.753
0.685
0.623

NPV
NPV (10.015 x 48)

$ 18.2 lac
$ 20.675
$ 22.59
$ 27.4
$ 31.15 lac
$120.015 lac
$ 10.015 lac
480.72 lac

Q120 A company has to purchase $ 100 million after 3 months.


Company has two options
a. To book a forward contract today to purchase $ 100 million after 3 months @
36/$
b. No hedging
Co. will purchase $ 100 mil At spot rate after 3 months
Expected spot rate after 3 months
(35 x 0.20 + 35.50 x 0.3 + 36 x 0.3 + 36.5 x 0.2) = 35.75/$
However, accuracy of expected spot rate variates + 5%
If expected spot rate variates + 5% , spot rate after 3 months will be ( 35.75 x
1.05) = 37.54
If expected spot rate variates 5%, spot rate after 3 months will be (35.75 x
0.95) = 33.96/$
The confirmed forward rate is 36/$ and under worst situation the rate per $
may be 37.54 . Hedging is done to cover uncertain worst position, so
company will hedge through forward market.
Q121 Calculation of Rupee NPV by discounting cash flows in EA $
1 +

1 +

1 +
1 +
1+
1.09
1.03

1.07

(1+x)(1.07) = (1.03)(1.09)
1.1227
X
= 1.07 - 1
X =

4.93%

81
CLASSES

PRAVINN MAHAJAN CA

1 +
1 +
1.03
1.0493

X=

=
=

1 +

1 +
1+
1.16

(1.03 )(1.16)
1.0493

- 1

= 13.87%

Statement of NPV
Amount
Time
250 lac
0
75 lac
1
95
2
125
3
135
4
PV of cash inflow
NPV in EA $
54.06
NPV in Re

Cash outflow
Cash Inflow

Factor
1
0.878
0.771
0.677
0.595

Present value
250 lac
65.85
73.25
84.63
80.33
304.06
54.06
27.03 lac

Calculation of Rupee NPV by discounting Rupee cash flows


EA $ Cash flows
250
75

Forward rate
A$ 2/Re
1.07
2 x 1.09 = 1.963
1.07

95

1.963 x 1.09 = 1.927

125

1.927 x

135

1.892 x 1.09 = 1.857

Cash outflows
Cash Inflows

1.07
1.09
1.07

= 1.892

Re cash flows
125
38.21
49.30
66.08
72.70

Statement of NPV
Amount
Time Factor
125
0
1
38.21
1
0.862
49.30
2
0.743
66.08
3
0.641
72.70
4
0.552
PV of Cash inflows
82
CLASSES

Present value
125
32.94
36.63
42.36
40.13
152.06

PRAVINN MAHAJAN CA

NPV

27.06

Q122 XY Ltd an Indian company is considering to acquire group of stores in Africa


Statement of Inflation adjusted cash flows in and Rand
Year
0
1
2
3

Real CF Inflation rate


- 50,000
1
-1,500
1.1
- 2,000
1.21
- 2,500
1.331

Adjusted CF
- 50,000
- 1,650
- 2,420
-3,328

Real Rand CF Inflation Rate


- 2,00,000
1
+ 50,000
1.4
+ 70,000
1.96
+ 90,000
2.7440

Adjusted Rand CF
- 2,00,000
+ 70,000
+ 1,37,200
+ 2,46,960

Statement of Expected future spot rates


1+
Forward rate =
spot rate x
1 +

1.4

Year 1

6 x

Year 2

7.6364 x

Year 3

9.7190 x

1.1
1.4
1.1
1.4
1.1

Rand 7.6364

Rand 9.7190

Rand 12.3696

Statement of NPV
Amount

period

PV factor(20%)

PV

Cash outflows
2,00,000
6

(33,333.33)
(50,000)

3,328

3328 + 0.20

(83,333.33) 0

(83,333.33)

(1,650)
(2,420)
19,968

0.833
0.694
0.579

(1,374.45)
(1,679.48)
(11,561.47)

1
2
3

(97,948.73)
Cash inflows
Operating CI

70,000
7.6364
1,37,200
9.7190
2,46,960
19,965.08
12.3696

0.2

9,166.62

0.833

7,635.79

14,166.68

0.694

9,831.68

1,19,790.48 3

0.579

69,358.69

NPV
83
CLASSES

86,826.16
(11,122.57)

PRAVINN MAHAJAN CA

Since NPV is negative, investment in african country is not feasible.


Q123 HEG has to pay 15,00,000 and receive 24,45,000 from Toys and trains.
Converting payables into .
Since company has to buy , so relevant rate is ask rate i.e 0.3750/Re
HEG has to pay 15,00,000 x 0.3750 = 5,62,500
Net receivables by HEG from Toys and Trains (24,45,000 5,62,500) =
18,82,500
Toys and Trains have to pay 18,82,500 to HEG
payable to purchase 18,82,500 (

Q124
Currency
$
Ffr
UK
Jap

18,82,500
0.37

) = 50,87,838

Statement of Net exposure of each foreign currency in


inflow
Outflow
Net inflow
spread
Net exposure
(Millions)
(Millions)
(Millions)
(Millions)
40
20
20
0.81
16.20
20
8
12
0.67
8.04
30
20
10
0.41
4.10
15
25
-10
-0.80
8.00

c. The exposure of Japanese position is being offset by a better forward rate.


Q126 Parent company in US has to settle some reciepts and payments from its
subsidiary if Canada, Germany and UK
30 $
USA

CANADA
20 $
40$

35$

60$

10$
40$
25$

10$
20$

GERMANY

UK

30$
84
CLASSES

PRAVINN MAHAJAN CA

30$

a. Bilateral netting
10 $
USA

25$

CANADA

20$

10$
15$
UK

GERMANY

10$

i.

US have to Pay 20$ to canada and


receive 30$ from canada
Under bilateral settlement US will receive 10$ from Canada

ii.

US have to pay 10$ to germany and


receive 35 $ from Germany
Under bilateral settlement US will receive 25$ from Germany

iii.

US have to pay 40$ to UK and


Receive 60 $ from UK
Under bilateral agreement US will pay 20$ to UK

Iv

Canada has to Pay 25$ to Germany and


receive 10$ from germany
Under bilateral agreement Canada will pay 15$ to germany

Canada has to pay 30 $ to UK and


Receive 40 $ from UK
Under bilateral agreement Canada will receive 10$ from UK

VI

Germany has to pay 20$ to UK and


receive 30 $ from UK
Under bilateral agreement Germany will receive 10$ from UK.

85
CLASSES

PRAVINN MAHAJAN CA

Thus due to bilateral netting 12 transactions are reduced to 6 transactions and


payments and receipts between Parent Co. in US and its subsidiary is settled.
b. Multilateral Netting
USA

(30-20+35-10+60-40)
= + 55

GERMANY

(20 -30+10-25+40-30)
= - 15

(10 - 35 +25 10+30 20) (40 60 +30- 40 +20 30)

CANADA

UK

= 0
= - 40
Under multilateral netting,
UK and canada will pay 40$ and 15$ to US for final settlement.

Q127
UK

60

GERMANY

100

200

$125

75 $

150

USA

Converting all receipts and payments in one curreny, say


40
UK
86
CLASSES

GERMANY
PRAVINN MAHAJAN CA

100

200

60

100

100

USA

Multilateral Netting
GERMANY

UK

(100 40+200 -60)


= 200

(40 -100+100-100)
= -60

USA

(60 -200 + 100 -100)


= - 140
Under Multilateral netting US and Germany will pay 140 and 60 respectively to
UK parent company
Q128 In case of decentralised cash management, easch subsidiary will finance its own
deficit and invest its own surplus
Surplus
Deficit
Swiss subsidiary

150 ,00,000

Canadian subsidiary
UK subsidiary

1.48
250 ,00,000

101,30,000 $
158,23,000 $

1.58

30,00,000 x 1.5
Total

101,35,000

45,00,000 $
203,23,000

Centralised cash management will facilitate to adjust deficit with surplus. Thus
net surplus with American company is 203,23,000 101,35,000 = 101,88,000 $

87
CLASSES

PRAVINN MAHAJAN CA

Q129 a.

In case of decentralised cash management, easch subsidiary will finance .


its own deficit and invest its own surplus
Statement of cash in hand after 30 days in case of
Decentralised cash management
US subsidiary
Surplus in hand
$ 125 lac
Invested in US @ 1.5% p.a for 30 days
Interest received
$ 0.15625
Cash in hand after 30 days
$ 125.15625
Cash in hand after 30 days in
UK subsidiary
Surplus in hand
Invested in UK @ 3.7% p.a for 30 days
Interest received
Cash in hand after 30 days
Cash in hand after 30 days in
Indian co.
Deficit
Loan in india @ 6.4% p.a for 30 days
Interest payable
Cash payable after 30 days
Net surplus after 30 days

b.

$ 125 .15625

5767.57 lac

0.0217

60 lac
0.185 lac
60.185 lac
60 .185
0.015

4012.33 lac

5000 lac
26.67 lac
( 5026.67 lac)
4753.23 lac

Centralised cash management will facilitate to adjust deficit with surplus


Statement of cash in hand after 30 days in case of
centralised cash management
Surplus in US converted in
Surplus in UK converted in

125
0.0215
60
0.0149

Cash deficit in india


Net cash in hand today
Invested in India for 30 days @ 6.2%
Interest received
Cash in hand after 30 days

88
CLASSES

5813.95 lac
4026.85 lac
(5000 lac)
4840.80 lac
25.01018 lac
4865.81 lac

PRAVINN MAHAJAN CA

f.

Since in hand after 30 days is higher if cash is pooled in India and balance is
. invested in India, so investment in India is better option

Q130 Buyers Ltd had to pay $ 86,000 to US firm after 6 months.


Buyers Ltd booked a forward contract today to purchase $ 86,000 after 6months
Since quote is

, so relevant rate is ask rate. Thus co. booked a forward contract to

purchase $ 86,000 @ (45.75 + 0.60) 46.35.


Due to Lack of supply by US firm Buyers ltd does not need 86,000 $.Company need
to buy only 50,000 $. Company will cancell forward contract to the extent of 36,000 $
by selling 36,000 $ at spot rate of 45.70. Thus loss to company is ( 46.35
45.70)= 0.65 x 36,000 = 23,400 payable to bank.
Q131 A french firm purchased a machinery from US firm for $ 1,00,000.
Since the quote is

, relevant rate is bid rate

Firm booked a forward contract today to purchase 1,00,000 $ after 3 months @


( 1.25 0.0010) = $ 1.249 /
Machine was substandard and French firm will pay only 70,000 $ to US firm, I.e
French firm will purchase only 70,000 $ from Bank
French will cancel Forward Purchase contract to the extent of 30,000 $, ie frm will
make an opposite contract to sell 30,000 $ at spot rate on due date i.e @ $ 1.27 /
Statement of payable by french firm to bank
Amt papble for purchase of 30,000 $ (
Amt receivable on sale of 30,000 $ (

30,000

1.249
30,000
1.27

24,019

23,622

Net loss or payable to bank

397

Q132 A trader in London purchased on 31st Dec 1500 tons of X @ Escudos 11,820 / ton
from portugal, payable immediaely
500 tons of X will be shipped to germany @ DM 462/Ton at the end of January,
payment in respect of which will be received at the end of february and 1000 tons
will be shipped at the end of february, payment in respect of which will be received
at the end of March.
Statement of Profit
Payment of Escudos in portugal at spot rate of
Escudos 107.45 /

11,820 1500
107 .45

89
CLASSES

1,65,007
PRAVINN MAHAJAN CA

DM recd at the end of feb and converted in at 2 months


forward rate of (3.88 0.03) = 3.85

500 462

60,000

3.85

(Since swap point are decreasing, so reduced from spot rate to ascertain
forward rate)

DM recd at the end of march and converted in at 3 months


1000 462
Forward rate of (3.88 0.055) = 3.825

1,20,784

3.825

Net profit

15,777

Q133 Skylark a US company is considering to establish a manufacturing plant in UAE

Cash outflows
Fixed Assets
Initial working capital

Statement of NPV
Amount
Period

Factor

PV

5,00,000
5,00,000

1
1

5,00,000
5,00,000

3.791
0.621
0.621

6,44,470
3,10,500
3,10,500
2,65,470

Cash inflows
Operating cash inflows
Terminal value 10,00,000 x 0.5
Release of working capital

0
0

1,70,000
15
5,00,000
5e
5,00,000
5e
Net present value
Since NPV is positive project should be accepted.

Statement of Net operating cash inflows ($)


Sales
1000 x 12 x 50
6,00,000
Less Variable cost 1000 x 12 x (15 + 10 + 5)
3,60,000
Less depreciation
1,00,000
Profit before tax
1,40,000
Less Taxes 50%
(70,000)
Profit after tax
70,000
Add depreciation
1,00,000
Cash flows ater tax
1,70,000
Annual loss of profit on exports to UAE
nil
b.

If skylark rejects the project, enitre export sales of 500 units per month will be lost
Statement of annual profit from exports to UAE
Sales
500 x 12 x 60
3,60,000
Less variable cost 500 x 12 x 40
2,40,000
PBT
1,20,000
Less taxes
60,000
90
CLASSES

PRAVINN MAHAJAN CA

60,000
Profits on exports to UAE will be lost whether project to establish plant in
UAE is accepted or rejected. So such profit on exports is in the nature of sunk cost.
Thus loss of profit on exports, if project si rejected will not affect decision
Q134 OJ Ltd a UK company is entering into JV with south American company for
implementation of project in South America
1. If Exchange controls exist.
Statement of Received by OJ from JV annually
Year Cash flows (SA $) OJ share (SA$) 50% div (SA$) Exch rate OJ share
1
4,250
2,125
1,062.5
SA$ 10/
106.25
2
6,500
3,250
1,625
SA$ 15 / 108.33
3
8,350
4,175
2087.5
SA $ 21/
99.40
rd
In 3 year balance 50% p.a can be transfrred (1062.5 +
1,625 + 2,087.5) SA $ 21/ 227.38

Cash outflow
Investment
Cash Inflow
Operating cash inflow

Statement of NPV
Amount
Period

Factor

PV

450

450

106.25
108.33
326.78

1
2
3

0.862
0.743
0.641

91.59
80.49
209.47
(68.45)

2. If Exchange control does not exist.


Statement of Received by OJ from JV annually
Year Cash flows (SA $) OJ share (SA$)
Exch rate
OJ share
1
4,250
2,125
SA$ 10/
212.5
2
6,500
3,250
SA$ 15 / 216.67
3
8,350
4,175
SA $ 21/
198.81

Cash outflow
Investment
Cash Inflow

Statement of NPV
Amount
Period

Factor

PV

450

450

91
CLASSES

PRAVINN MAHAJAN CA

Operating cash inflow

212.5
216.67
198.81

1
2
3

0.862
0.743
0.641

183.18
161
127.44
21.62

If exchange control exists, NPV of project is negative, so JV should not be


undertaken. Whereas is exchange control does not exist NPV of project is positive,
so JV should be undertaken.
Q135 LMN exports a UK company exported goods to France and uganda
a. receivable from French customer
Invoice value of order in at todays spot rate
Spot rate today

3,50,000

= 5.7485 x 1.4920
Invoice value in FF 3,50,000 x 8.5768
3 month forward rate 5.7833 x 1.4873
Receipts after 3 months

FF 8.5768 /
FF 30,01,880
FF 8.6015 /
3,48,995

b. Receipts from ugandan customer if offer to receive US $ after 3 mnoths is


accepted. UK co has 2 options
1. To cover the receipts in forward market
Co will book a forward contract today to sell 2,25,000 $ after 3 months at
$ 1.4873 /
1,51,281
2. Hedge receipts in Money market.
LMN will borrow $ and deposit
- LMN will borrow Present value of 2,25,000 $ @ 6% for 3 months
$ borrowed
-

2,25,000

$ 2,21,675

1 .015

LMN will convert $ into at spot rate of $ 1.4920 /


LMN will receive
LMN will deposit 1,48,576 for 3 months @ 5%
After 3 months LMN will receive 1,48,576 x 1.0125

1,48,576
1,50,433

Since receipts in forward market hedge is higher so Forward market hedge is


better.
Since forward rate of Ugandan shillings is not available, so it is assumed that
receipts are 1,50,000 if payment is receieved in Ugandan shillings.
It is better to receive $ from Ugandan customer as receipts will be higher.
Q136 Spot rate Re 0.8 / Bhat
92
CLASSES

PRAVINN MAHAJAN CA

Risk free rate in India is 6% and risk premium is 8% over risk free rate. Money rate
in India 14%
Real cf(in bhat)
600mil

Money cash flows(bhat)


600 mil

Forward rate
0.8

Money cash flows ()

480

1.06

350 mil

350(1.06) = 371 mil

0.8 x 1.08 = 0.785

350 mil

350(1.06)2 = 393.26 mil

0.785 x

350 mil

350(1.06)3 = 416.86 mil

0.770 x

1.06
1.08
1.06
1.08

= 0.770

302.81

= 0.756

Statement of PV of cash inflows


Amount
Time Factor
480 mil
0
1
291.24
1e
0.877
302.81
2e
0.769
315.15
3e
0.675
PV of cash inflows
NPV

Cash outflows
Cash inflows

291.24

315.15

PV
480mil
255.42
232.86
212.73
701.01
221.01mil

Q137 Spot rate Re 5.75 / HKD


Risk free rate in India is 7% and risk premium is 6% over risk free rate.Project is
1.25 Money rate in India (7+ 1.25 x 6) = 14.5
Real CF (HKD)
300

Money CF (HKD)
300

Forward rate
5.75

100

100 (1.06) = 106

5.75x 1.1 = 5.59

100

100 (1.06)2 = 112.36

5.59x 1.1 = 5.44

100

100(1.06)3 = 119.10

5.44x 1.1 = 5.29

100

100 (1.06)4= 126.25

5.29x 1.1 = 5.15

1.07
1.07
1.07
1.07

Money cash flows()


1725
592.54
611.24
630.04
650.19

Statement of present value of cash Flows

Cash outflow
Cash inflows

Amount
1725
592.54
611.24
630.04
650.19
93
CLASSES

time
0
1e
2e
3e
4e

Factor
1
0.873
0.763
0.666
0.582

Present value
1725
517.29
466.38
419.61
378.41

PRAVINN MAHAJAN CA

PV of cash inflows
NPV
Since NPV of project is positive, so project should be accepted.

1781.69
56.69

Q138 A UK company is considering to invest in australia.


If discounting is done
Spot rate A$ 2 /. A$ is depreciated against @ 10% p.a
2
1 year forward rate 0.9 = A$ 2.22
2 year forward rate
3 year forward rate
4 year forward rate

2.22
0.9
2.47
0.9
2.74

= A$ 2.47 /

= A$ 2.74 /

0.9

Cash outflow
Cap expenditure
Working capital

= A$ 3.04
Statement of present value of cash Flows
Amount
Time Factor
Pv
A$

(20%)
10,00,000/2
5,00,000
0
1
5,00,000
5,00,000/2
2,50,000
0
1
2,50,000

Cash inflow
Operating cash inflows

Realise value of WC

3,49,099
7,75,000/2.47
3,13,765
7,75,000/2.74
2,82,847
7,75,000/3.04
2,54,934
5,00,000/3.04
1,64,474
PV of Cash inflows
NPV
7,75,000/2.22

1e
2e
3e
4e
4e

0.833
0.694
0.579
0.482
0.482

2,93,443
2,17,753
1,63,768
1,22,878
79,276
8,77,118
1,27,118

Statement of Net operating cash inflows


PBDT
13,00,000
Less depreciation
2,50,000
Profit before tax
10,50,000
Less taxes
5,25,000
PAT
5,25,000
+ depreciation
2,50,000
Cash flow after tax
7,75,000
If discounting is done in A$
Forward Rate (FA )

94
CLASSES

SA (
B

1 + rA
1+ rB

PRAVINN MAHAJAN CA

2.22
2.22 ( 1.2)
2

- 1 =

1 +
1 .20

0.332 or 33.2%

Statement of Present value of cash flows


Amount
Time Factor (33.2%)
Cash outflow
Capital expenditure
Working capital

10,00,000
5,00,000

0
0

1
1

10,00,000
5,00,000

Cash Inflow
Operating cash inflows
7,75,000
1-4e 2.055
Release of working capital 5,00,000
4e
0.318
PV of cash inflows
NPV
NPV in 251625 / 2
Q139 a.

PV

15,92,625
1,59,000
17,51,625
2,51,625
1,25,812

paper Ltd has to pay HKD 2,10,000 after 2 months.


Company has 2 options
i.

Avail full credit of 60 days


Co. will book a forward contract today to purchase 2,10,000 HKD
after 2 months @ 6.6/ HKD
Amount payable = 2,10,000 x 6.6 =
13,86,000

ii.

Does not avail credit and pay today at spot rate


Co will Buy 2,10,000 HKD @ 6.5 by borrowing from
Bank for 2 months
Amount payable to bank after 2 months if ROI is 11% p.a
(2,10,000 x 6.5) (1.018333)
13,90,024
Amount payable to bank after 2 months if ROI is 6.5% p.a
(2,10,000 x 6.5)(1.0108333)
13,79,787
IF ROI is 11 %, then its better to avail credit of 2 months and take
hedge in forward market
If ROI is 6.5%, then its better not to avail credit and make paymet
today by borrowing from bank.
If company has surplus cash
95
CLASSES

PRAVINN MAHAJAN CA

Amount payable if credit not taken


Amount payable if credit taken
Interest on 13,65,000 for 2 months
If ROI is 11% p.a

13,65,000
13,86,000
25,025

13,60,975

Amount payable if ROI is 6.5 %


1386,000 14,788
13,71,212
If ROI is 11%, it is better to avail credit and if ROI is 6.5 % it is advisable
not to take credit
b.

Glass company has made exports of KD 20,000.Glass company has 2


options
1. To insist on immediate payment
Co. will receive KD 20,000 today and will convert
in 154.10 / KD. receivable
Co. will invest @ 6% for 90 days. after 90 days

30,82,000
31,28,230

2. To allow credit for 90 days.


Co will book a forward contract tody to sell KD after 90
Days @ 155.80

31,16,000

It is advisable to receive payment immediately


d. UK company has purchased goods for $ 29,50,000, payable in 3 months. Co.
has 3 options
1. Forward market hedge
Company will book a forward contract today to buy 29,50,000 $
After 3 months @ (1.5865 0.0180) = $1.5685/
18,80,778
2. Hedge through Money market
1+0.07 x
Synthetic forward rate

= 1.5685 x
= 1.5865 x

3
12

1 + 0.1425 x

3
12

1.0175

1.035625
= $ 1.558734
For hedge in money Market company will borrow and deposit $

Company will deposit PV of 29,50,000 $ for 3 months


29,50,000
1.0175

96
CLASSES

$ 28,99,262
PRAVINN MAHAJAN CA

For deposit, company will purchase 28,99,262$ at


spot rate of $ 1.5865/, by borrowing @ 14.25% 18,27,458

payable after 90 days 18,48,430 x 1.035625

18,92,561

3. Hedge by leading the payment


Co. will buy 29,50,000 $ today at spot rate $1.5865/
By borrowing @ 14.25%
Amt payable after 3 months (

29,50 ,000
1.5865

x 1.035625) 19,25,682

Since payment is least in forward maket hedge, so hedge must be


taken in forward market.
Q140 NP & Co. has to pay $ 7,00,000 after 3 months and receive 4,50,000 $ after 2
months. Co. has booked a two month forward contract to sell 4,50,000 $ @
48.90/$.
To cover risk on payables co has two options.
1. To cover payables in forward market.
Co. will book a forward contract today to purchase 7,00,000 $ after 3 months
@ (48.70 + 0.45) 49.15/$
Statement of outflow
Amount received on sale of 4,50,000 $ @ 48.90/$
Intrest received for 1 month @ 12% p.a on 220,05,000
payable for purchase of 7,00,000 $ = 7,00,000 x 49.15
Net outflow

220,05,000
2,20,050
344,05,000
121,79,950

2. To lag the receivables by one month(No interest is earned on lagging


receipts)
Co. will cancell 2 month forward contract to sell 4,50,000 $ and book a
forward contract today to purchase 2,50,000 $ after 3 months @ 49.15/$
Statement of outflow
Loss on cancellation of forward sale contract by making
opposite contract to purchase 4,50,000 $ at (48.7+ 0.3)= 49
4,50,000 ( 49 48.9)
Interest on Loss @ 12% p.a 45,000 x .01

45,000
450

(assuming cancellation charges paid after 2 months)

97
CLASSES

PRAVINN MAHAJAN CA

Amount payable for purchase of 2,50,000 $ ( 2,50,000 x 49.15) 122,87,500


Total payable
123,32,950
Since outflow in first option is lower, so company should cover entire payables in
forward market.
Q141 a.

Statement of exchange position


Particulars
Debit
Balance brought down
50,000
Purchased a bill on zurich
80,000
Sold forward TT
Forward purchase contract cancelled Remittance by TT
Draft cancelled
30,000
Total
1,60,000
Balance oversold 5,000

Credit
60,000
30,000
75,000
1,65,000

Nostro Account
Particulars
Balance b/d
Remitted by TT
Total
Balance over bought

Debit
75,000
75,000
25,000

credit
1,00,000
1,00,000

Statement of balancing Nostro A/c


Purchase
1,00,000
Sale
75,000
Over bought
25,000
Required balance (over bought) 30,000
Step required spot purchase
5,000
Statement of Balancing of exchange position
Purchase
1,60,000
Sale
1,65,000
Over sold
5000
Spot purchase
5,000
Net balance
nil
Balance required overbought 10,000
Step required forward purchase 10,000
b.

Statement of Exchange position


98
CLASSES

PRAVINN MAHAJAN CA

Particulars
Balance b/d
Purchase TT
Issued a draft on london
Remittance outward
Purchased bills on london
Forward sales
Total
Balance over purchase

Debit
5,000
50,000
75,000
1,30,000

Credit
20,000
25,000
75,000
1,20,000
10,000

Debit
20,000

Credit
50,000
45,000
95,000

Nostro Account
Particulars
Balance b/d
Purchase TT
Remittance outward
Export bill realised
Total
Balance over bought

25,000
45,000
50,000

Statement of balancing of Nostro account


Purchased
95,000
Sold
45,000
Over bought
50,000
Balance required over bought
10,000
Step required spot sale
40,000
Statement of balancing of exchange position
Purchased
1,30,000
Sold
1,20,000
Overpurchase
10,000
Spot sale
40,000
Over sold
30,000
Balance required
nil
Step required forward purchase 30,000
c

Statement of balancing of exchange position


Balance b/d over sold
Purchased
Forward sales
Forward purchase
99
CLASSES

3,75,000
3,28,000
163,86,000
146,06,250
PRAVINN MAHAJAN CA

Drafts issued -sold


Purchased bills
Balance oversold
Balance required
Step taken forward purchase
Q142

12,20,080
28,85,640
1,61,190
nil
1,61,190

EL is to receive 250 lac swiss francs after 2 months. El has obtained hedge through currenc y
futures
EL will short sell index futures of 250 lac swiss francs today
Statement of receipts
Amount received on sale of 250 lac CHF after 2 months at spot rate
after 2 months
250 lac x 0.4985

124.625 lac $

Future
Sell 250 lac CHF future @ $ 0.5150 / CHF
250 x 0.5150
Number of contracts

250
1,25,000

= 200 contracts

Purchased 250 lac CHF future @ $ 0.5025 / CHF


250 x 0.5025
Profit on CHF future
Total amount received

Q143

128.75 lac $

125.625 lac $
3.125 lac $
$ 127.75 lac

American airlines has to pay 40 lac after 1 month


Company will obtain hedge through currency futures. Company will buy futures of 40 lac s
today
Statement of payments
Amount paid for purchase of 40 lac s @ $ 1.4220/

$ 56.880 lac

Futures
Amount paid for purchase of 40 lac futures @ $ 1.4190/
40 lac x 1.4190
$ 56.76 lac
Amount received on sale of 40 lac futures @ $ 1.4250 /

100
CLASSES

PRAVINN MAHAJAN CA

40 lac x 1.4250
Profit on currency futures

Q144

$ 57.00 lac
$ 0.24 lac
$ 56.64 lac

XYZ Plc has to sell US $ 1,40,000 after 3 months.


Since quote is $/, relevant rate is Ask rate
Statement of Reciepts
XYZ will sell $ 140000 @ spot rate of $ 1.6140 /
XYZ will receive

140000

86,741.06

1.6140

Future
Buy future @ $ 1.59 /
140000
future to be bought
= 88050.314
Number of contracts

1 .59
88050
25000

3.522, future contracts to be

bought
88050.314 (3.522 contrats) future bought for
140000 $
88050.314 (3.522 contrats) future sold @ 1.6100 /$ 141761 $
Profit on futures in $
1761 $
$ profit in futures converted in at spot rate
1761
in june @ $ 1.6140 / 1.6140

1091

Net receipts

Q145

87832.016

LJP has to buy 4,50,000 $ after 75 days i.e on 30th sept.


Statement of payment if hedge is taken through currency futures
Japenese company will buy 4,50,000 $ at spot rate after 75 days
4,50,000 x 124

558,00,000

Future
Co. will sell future today @ 122 / $
future to be sold $ 450000 x 124 = 549,00,000
Amoumt receivable on selling 549,00,000 futures today

101
CLASSES

= $ 4,50,000

PRAVINN MAHAJAN CA

$ payable on buying 549,00,000 futures after 75 days


@ 123 / $
$ profit in future market

= $ 4,46,341.46
$ 3,658.53 $

Converting $ profit in @ spot rate after 75 days @ 123 / $ , 3658.53 x 123


Net amount paybale

4,50,000
553,50,000

Q146 Nitrogen Ltd, has to export goods to the amount of 4 Million to germany,
receivable after 6 months. Nitrogen Ltd has 3 options
(i)

Invoicing in sterling on the basis of current exchange rate i.e


@ 1.1770 /
4000000
By invoicing in sterling company will receive 1.1770
33,98,471

(ii)

Invoicing in and obtaining hedge through forward market


Company will book a forward contract today to sell 4 million
After 6 months @ ( 1.1770 0.0055 )= 1.1715 /
Company will receive

(iii)

34,14,426

Invoicing in and obtaining hedge in futures market using


Sterling futures

Statement of Receipts
received on selling 4 million in spot market at
40 ,00,000
spot rate after 6 months 1.1785

33,94,145

Future
Nitrogen Ltd will buy future today @ 1.1760 /
40,00,000
future to be bought 1.1760 = 34,01,361 futures
Size of each future contract 62,500
102
CLASSES

PRAVINN MAHAJAN CA

Number of future contract to be bought


34,01 ,361
62,500

= 54.422 contracts

Number of contracts bought to nearest = 54


Thus futures bought 54 x 62500 = 33,75,000
payable on buying 54 contracts
33,75,000 x 1.1760
receivable on selling 54 contracts
33,75,000 x 1.1785
Profit in futures in

39,69,000
39,77,438
8,438

Converting profit in at spot rate after 6 months


8438

7,160

1.1785

34,01,305

Since received is higher if hedge is taken in forward market, so option b


is better.
Q147 XYZ has to receive $ 1,00,000 after 3 months on september 1, 2009.
XYZ has 3 options
(i)

Using forward market hedge


XYZ will book a forward contract today to sell 1,00,000 $ after
3 months @ 3 months forward rate of $ 0.02127 / Re.
XYZ will receive

(ii)

100000

47,01,457

0.02127

Using hedge through currency futures i.e futures


XYZ will buy future today and sell 4 future after 3 months
Statement of reciepts
received on selling $ 1,00,000 after 3 months at spot rate
1,00,000
after 3 months
0.02133

46,88,233

Futures
103
CLASSES

PRAVINN MAHAJAN CA

Buy futures today @ $ 0.02118 /


100000
future to be bought 0.02118 = 47,21,435
47,21,435

( 4,72,000 ) = 10 contracts
$ payable for purchasing 47,21,435 futures
$ receivable after 3 months on selling
47,21,435 futures @ $ 0.02134 /
$ profits in future market

1,00,000
1,00,755
755

Converting $ profit in at spot rate after 3 months

755
0.02133

Less interest on initial margin 15000 x 10 x 0.08 x 3/12


Net receipts
(iii)

No hedging
XYZ will sell 1,00,000 $ after 3 months at spot rate after
3 months. received

35,396
47,23,629
3,000
47,20,629

46,88,233

Since amount received in hedge through currency futures is higher, so


currency future hedge is better.
Q148 Forward Bid on for dec is $ 1.2816 / and
Rate of Dec future is $ 1.2806 /
Contract size 62,500
Statement of profit
Purchase December future 62,500 x 1.2806
Sell december Forward
62,500 x 1.2816
Profit in $

$ 80037.50
$ 80100
62.50

Q149 Trader sold HKD 1,00,000 @ 5.70 / HKD


Trader also covered himself in london market i.e he book a contract to purchase
1,00,000 HKD in London
Statement of profit
Amount received on sale of HKD, 1,00,000 x 5.70
5,70,000
Amount payable on Purchase of 1,00,000 HKD

104
CLASSES

PRAVINN MAHAJAN CA

= 42.85 x

1
7.5880

= 5.647 / HKD

5,64,700

Profit on cover deal


5300
Q150 Bank sold 10,00,000 DK @ 6.5150 / DK.
Dealer or Bank can cover the transaction by purchasing 10,00,000 DK from
London or Newyork
If rate is / DK, then relevant is Ask rate
If DK purchased from London, Rate will be

= 74.3200 x

1
11.4200

= 6.508 / DK

If DK purchased from Newyork, Rate will be

= 49.2625 x

1
7.5610

= 6.515 /Dk

Since rate of DK is lower If DK is purchased from London, so purchasing DK


from london is preferrable.
Profit on Coverdeal is 10,00,000 ( 6.515 6.508 )
7000
Q151 Omega electronics exports air conditioners to Germany by importing components
from singapore. 2400 units are exported @ 500 per unit to germany by
importing components @ S$ 800 / unit. Amounts payable and receivable after 6
months
i.

Profit or Loss due to transaction exposure.


Profit if amount paid and received at spot rate today
2400 [ 500 x 51.50 - ( S$ 800 x 27.25 + 1000 + 1500)]
2400 [ 25,750 24,300]
34,80,000

ii.

Profit if amount is paid and received after 6 months


2400 [ 500 x 52 - ( S$ 800 x 27.75 + 1000 + 1500)]
2400 [ 26,000 - 24,700]

31,20,000

Loss due to Transaction exposure

3,60,000

Export price Of Air conditioner 25,000


Profit/loss due to transaction exposure
105
CLASSES

PRAVINN MAHAJAN CA

Profit if amount paid and received today on new exchange rates


2400 [ 25,000 - ( S$ 800 x 27.15 + 1000 + 1500)]
2400 [ 25,000 24,220]

18,72,000

Profit if amount is paid or received after 6 months


2400 [ 25,000 ( 800 x 27.75 + 1000 + 1500)]
2400 [ 25,000 24,700]

7,20,000

Loss due to Transaction exposure [18,72,000 7,20,000]

11,52,000

Profit/Loss due to operating exposure


Export price of Each unit in
Export price of Each unit in at spot rate

25000
51.50

Export price of Each unit in at rate after 6 months

25000
51.75

Change in price due to change in exchange rate


485.44 483.09

25000

485.44

483.09

= 2.35 or

2 .35
485.44

x100

Price elasticity of demand


Increase in Demand due to fall in price 0.48 x 1.5
Unit sales after increase in demand 2400 x 1.0072

=
=
=

0.48%
1.5
0.72%
2417 units

Profit if amount is received and paid after 6 months


2417 [ 25,000 ( 800 x 27.75 + 1000 + 1500)]
2417 [ 25000 24,700]

7,25,100

Loss of profit due to transaction and operating exposure


[18,72,000 7,25,100]
=
Loss of profit only due to transaction exposure
=
(Reduction in loss) or profit due to operating exposure
11,52,000 11,46,900
=

11,46,900
11,52,000
5,100

Q153 AB Tech has to borrow $ 100 lakh after 30 days for 90 days. So company will buy
1x4 FRA @ L+ 1% with L at 6%
Actual L after 30 days is 7.5%. company will sell FRA after 30 days at 7.5%
Amount of compensation received by AB
106
CLASSES

PRAVINN MAHAJAN CA

( )

(1+

)
12

(0.075 0.06 ) 100 3


=

1 + 0.075

12

3
12

0.36809 Lac

=
Effective rate of Borrowing for AB
Amount of Loan required
Compensation received
Net loan taken
Amount payable after 90 days

100 lacs
0.36809 lacs
99.63191 lacs

99.63191 x

Effective rate =

( 1 + 0.085 x

3
12

101.74908 100
100

101.74908 lacs

= .069963 0r 7%

Q154 Price of 3 x 9 FRA


1 + 9 month rate = ( 1 + 3 month rate ) ( 1 + 6 month rate)
9
3
6
( 1 + 0.0655 x 12 ) = ( 1 + 0.0625 x 12 ) ( 1 + r x 12 )
(1.049125)

= (1.015625) (1+ .5r)

0.5 r

-1

1.015625
= 0.06596 0r 6.6 %

r
Q155

1.049125

Equilibrium Price of 3 x 6 FRA


( 1 + 6 Month rate ) = ( 1 + 3 month rate) ( 1 + 3 month rate)
6
( 1 + 0.0685 x
) = ( 1 + 0.065 x 123 ) ( 1 + r x 123 )
12

1.03425
0.25 r

= (1.01625) (1+ .25r)


1.03425
=
-1
1.01625

= 0.0708 or 7.08 %

Actual price of 3x6 FRA = 6.90 % 6.95 %


Since Equilibrium price is more than actual Price, so trader will buy FRA
Statement of profit
Re 1 is borrowed for 3 months @ 6.5% and @ 6.95%
For next 3 months. Amount payable after 6 Months

( 1 + 0.065 x

3
12

) ( 1 + 0.0695 x

3
12

107
CLASSES

1.03391
PRAVINN MAHAJAN CA

12

Re 1 deposited for 6 months @ 6.85%


6
( 1 + 0.0685 x 12 )

1.03425

Profit on Re 1
Q156

1.

Price of 3 x 6 FRA
( 1 + 6 Month rate ) =
6
( 1 + 0.05 x
) =
12

( 1 + 3 month rate) ( 1 + 3 month rate)

(1.025)

(1.01125) ( 1 + 0.25 r )

0.25 r

=
r

2.

0.00034

( 1 + 0.045 x
1.025
1.01125

3
12

) ( 1 + r x 12 )

-1

5.44%

Equilibrium price of 6 x 12 FRA


( 1 + 12 Month rate ) = ( 1 + 6 month rate) ( 1 + 6 month rate)
( 1 + 0.065

) =

0.5 r =

( 1 + 0.05 x 12 ) ( 1 + r x 12 )
1.065
1.025

-1

r =
7.805%
Actual price of 6 X 12 FRA = 6.5/ 6.75%
Since Equilibrium price is more than actual price, so trader will buy FRA
Statement of profit
Re 1 is borrowed for 6 months @ 5% and @ 6.75%
For next 6 months. Amount payable after 12 Months
6
6
( 1 + 0.05 x 12 ) ( 1 + 0.0675 x 12 )
=

1.05959

Re 1 deposited for 12 months @ 6.5%


( 1 + 0.065 )
Profit on Re 1

1.065
0.00540

Q157 P & Co. is considering to borrow 60 crores after 6 months for a period of 3
months. Current rate of interest is 9%.To hedge against risk of increase in rate of
interest after 6 months, company will buy 6 x 9 FRA today at 9.3%
a. If 3 month rate of Interest after 6 month is 9.6%
Co. will sell FRA after 6 month @ 9.6%
Amount of compensation received by P & Co.
=

( )

(1+
)
12

108
CLASSES

PRAVINN MAHAJAN CA

12

(0.096 0.093 ) 60 3
=

12

3
1 + 0.096
12

0.0439 crore

=
Effective rate of Borrowing for P & Co.
Amount of Loan required
Compensation received
Net loan taken

60 crores
0.0439 crore
59.9561 crore

Amount payable after 3 months 59.9561 x (

Effective rate =
Ii

61.395 crore

1 + 0.096 x 12 )

61.395 60
60

x 12 = .093 or 9.3%

if actual ROI after 6 months is 8.8%


Company will sell FRA after 6 months at 8.8%
Amount of compensation received by P & Co.
=
=

( )
(1+

)
12

12

(0.088 0.093 ) 60 3
1 + 0.088

12

3
12

- 0.073385 crores

Compensation payable by P& Co. 0.073385


Effective rate of Borrowing for P & co.
Amount of Loan Required
Compensation paid
Loan taken
Amount payable after 3 months
60.073385 ( 1 + 0.088 x

Effective rate =

61.395 60
60

60 Crores
0.073385 crores
60.073385 crores
3
12

61.395 crores

x 12 = .093 or 9.3%

Q158 Co. will borrow 500 lakh after 3 months for a period of 6 months.

109
CLASSES

PRAVINN MAHAJAN CA

a. Company can use FRA to hedge against increase in Interest rates. Since Co.
has to borrow funds, so company will buy 3x9 FRA today @ 5.94%
i.

If actual interest rate is 4.5%


Company bought FRA @ 5.94% and will sell FRA at 4.5%
Amount of compensation received by Co.
=

( )
(1+

)
12

12

(0.045 0.0594 ) 500 6


=

6
1 + 0.045
12

12

=
3.520782 lacs
Effective ROI to company
Loan required
Amount payable by company
Amount borrowed
Amount payable after 6 months
6
503.520782 ( 1 + .045x12 )

Effective ROI
ii.

514.85 500
500

500 Lac
3.520782 lac
503.520782
514.85 lac

x 12 = 5.94%

If actual Interest rate is 6.5%


Company bought FRA @ 5.94% and will sell FRA at 6.5%
Amount of compensation received by Co.
=

( )
(1+

(0.065 0.0594 ) 500 6


=

1 + 0.045

6
12

Effective ROI to company


Loan required
Amount Receivable by company
Amount borrowed
Amount payable after 6 months
110
CLASSES

12

)
12

12

= 1.369193 lac
500 Lac
1.369193 lac
498.631 lac
PRAVINN MAHAJAN CA

498.631 ( 1 + .065x

12

Effective ROI

514.8365 lac

514.8365 500
500

x 12 = 0.059346 or 5.94%

b. Company can also take hedge through Interest rate futures


Since company has to borrow funds, so company will sell Interest rate futures
today at 94.15 (100 5.85)
i.

If actual interest rate is 4.5%


Company will buy interest rate future at 95.5
Loss to company ( 95.5 94.15) = 1.35 %
Amount payable

6
12
6

12

0.0135 x 500 x
1 + 0.045

= 3,30,073.35

Effective ROI to company


Loan required
Amount payable by company
Amount borrowed
Amount payable after 6 months
6
503,30,073.35 ( 1 + .045x )

500 Lac
3,30,073.35 lac
503,30,073.35
514,62,500

12

Effective ROI
ii.

514.625 500
500

x 12 = 5.85%

If actual Roi is 6.5%


Company will buy interest rate future at (100 6.5) = 93.5
Gain to company ( 94.15 93.5) = 0.65%
Amount receivable =

6
12
6
12

0.0065 x 500 x
1 + 0.065

Effective ROI to company


Loan required
Amount Receivable by company
Amount borrowed
111
CLASSES

= 1,57,385

500 Lac
1,57,389
498,42,611
PRAVINN MAHAJAN CA

Amount payable after 6 months


6
498,42,611 ( 1 + .065x12 )

Effective ROI

514,62,496

514.62496 500
500

Note : Number of Interest rate future


Size Of each 3 Month contract
Loan
Number of contract for 3 months
So number of contracts for 6 months

x 12 = 5.85%

Contracts
=
50,000
=
500 lac
=
500,00,000/ 50,000 = 1000
=
1000 x 2
= 2000

Q159 Fincorp has bought a 6X9 100 crore FRA @ 5.25%.


Actual MIBOR on date of settlement is 5.50%. Company will sell FRA @ 5.50%
So gain to company 5.5 5.25 = 0.25 i.e 25 basis points
Amount of compensation received by Co.
=

( )
(1+
(0.055 0.0525 ) 100 3

Q160 i.

1 + 0.055

3
12

12

)
12

12

= 6,16,523

Price of 2x3 FRA for XYZ


(1.0448)3 = (1.042)2 (1 + x)
1.140511

= 1.085764 - 1

= 0.05042 or 5.042%
Price of 2x3 FRA for ABC
(1.0578)3 = (1.0548)2 ( 1+ x)
X =
ii.

1.183615
1.112603

- 1 = 6.3825%

Bank offers interest rate guarantee to XYZ (that ROI will not exceed 5.04%) at a
premium of 0.1% of loan amount
Amount of Interest payable by XYZ if actual rate of Interest is
a. 4.5%
XYZ will pay interest at 4.5% I.e Guarantee will lapse. Total cost will be
4.5% interest + 0.1% premium payable to Bank
Amount payable by XYZ
=
100 crore x 0.046 = 4.6 crore
b. 5.50%
112
CLASSES

PRAVINN MAHAJAN CA

If ROI is 5.5%, XYZ will exercise Interest rate guarantee and pay interest
@ 5.04%. So total cost of XYZ is 5.04% + 0.1% i.e 5.14%
Amount payable = 100 crore x 0.0514 = 5.14 crore.
Q161

a.

To hedge against fall in interest rate, treasurer will short FRA today.

b.

Since deposit is to be made after 90 days (3 months) for 90 days (3


months), So Company will sell 3 x 6 FRA

c.

Company will sell FRA today at 1.5% and will buy FRA at 1.25%
gain to company is 0.25%
Amount of compensation

( )
(1+

12

)
12

(0.015 0.0125 ) 150 3


=

Q162

Loan Amount
Rate of Loan
Reference rate
Reset period
Total period of loan
Date
31/12/13

1 + 0.0125

3
12

12

93,453.2858

100 Lac
L + 0.5
6 Month LIBOR
6 month
3 years

Cap rate 7%
Floor rate 4%

Statement of Effective Interest interest paid on each reset date


Actual
Days L + 5%
Cap Recd
Floor paid
Effective
LIBOR
Interest
6%
184 3,27,671
3,27,671
113
CLASSES

PRAVINN MAHAJAN CA

30/06/14
31/12/14
30/06/15
31/12/15
30/06/16

7%
5%
3.75%
3.25%
4.25%

181
184
181
184
182
1096

16,00,751
100

Effective rate of interest

Q163 a.

3,71,918
2,77,260
2,10,752
1,89,041
2,36,202

1096

Cap Rate (EP)


Floor Rate
Reset Period
Refrence Rate

24,975
-

Floor Rate
Notional amount
Reset Period
Refrence rate
Quarter
1
2
3
4.

Q164

Premium

3,47,123
2,77,260
2,10,752
2,01,643
2,36,202
16,00,651

x 365 = 0.0533 or 5.33%

8%
100 crore
3 Months
3 Month MIBOR

Statement of Pay off


Quarter
MP
Cap rate(EP)
( Actual LIBOR)
1
8.7%
8%
2
8%
8%
3
7.8%
8%
4.
8.2%
8%
b.

12,602
-

Pay off (Recd)


17,50,000 (0.7%)
5,00,000 (0.2%)

4%
200 Crore
3 Month
3 Month MIBOR

MP
( Actual LIBOR)
4.7%
4.4%
3.8%
3.4%

Cap rate(EP)

Pay off (Recd)

4%
4%
4%
4%

10,00,000 (0.2%)
30,00,000 (0.6%)
40,00,000

Cap rate
Borrowing rate
Notional amount
Period of Loan
Reset Period
150 lac x 1% =
1.5lac
114
CLASSES

8%
L + 10%
150 Lac
24 month
6 Month

PRAVINN MAHAJAN CA

1.50
3.673

Half yr

= 40,838

Actual
Strike
LIBOR
Price
9%
8%
9.5%
8%
10%
8%
Additional amount paid

1
2
3

Q165

Recd from
Bank
75000
1,12,500
1,50,000
3,37,500

ABC
Fixed
4.5%
P+2

Prefrence
Fixed
Floating

Premium

Net Receipt

40,838
40,838
40,838
hedged upto

34,162
71,662
1,09,162
2,14,986

DEF
Floating
5%
P+3

(a) Swap should be arranged between ABC and DEF, where ABC will take floating and
DEF will take Fixed rate loan
ABC fixed

DEF Float
4.5

P+2

P+3
Intermediary

5%

P+2
Recd. = 4.5 + P+3
Paid = 5 + P + 2
Benefit of Swap
Share of ABC
DEF
Bank
Float
Cost to each Party =
ABC
=
Y
=

(b) Cost of funding of ABC


Cost of Funding of DEF

= P + 7.5
= P+7
0.5
0.25
0.25

5%

Bank
Fixed

Paid to I - Recd from I + paid to bank - Share in benefit from swap


4.5 - (P+2) + (P+2) 0.25
= 4.25
(P+3) 5 + 5 0.25
= P+ 2.75

4.25%
P+2.75%

DEF Ltd bought Interest rate Cap @ 5.625%


(interest rate of higher period) = Int rate in lower period x int rate of intermediate period

1
2

Actual PLR
2.75%
(1.03)2 = (1.0275)(1+x)

Payable rate(P+2.75)
2.75 + 2.75 = 5.5

Cap rate
5.625

effective rate
5.5

3.2506 + 2.75

115
CLASSES

PRAVINN MAHAJAN CA

X = 3.2506

= 6.0006

5.625

5.625

3 (1.032)3=(1.0275)(1.032506)
(1+x) = 3.6011

3.6011 + 2.75
= 6.3511

5.625

5.625

4 (1.033)4 =(1.0275)(1.032506)
(1.036011)(1+x)
= 3.6006

3.6006 + 3.75
= 6.3506

5.625

5.625
22.375

Rate p.a =

22.375
4

= 5.59375 %

Cap rate
Borrowing rate
Notional amount
Period of Loan
Reset Period

Q166

Premium

200 lac x 1% =
2
3.717

Half yr
1
2
3

7%
L + 0.25%
200
24 month
6 Month

2 lac

= 53,807

Actual
Strike
LIBOR
Price
8%
7%
8.5%
7%
10%
8%
Additional amount paid

Recd from
Bank
1,00,000
1,50,000
2,00,000
4,50,000

Premium

Net Receipt

53,807
53,807
53,807
hedged upto

46,193
96,193
1,09,162
2,88,579

Q167 ABN Amro bank wants to purchase 150 lac from canara bank. Current interbank rate
is 51.3625 51.3700 / $
Since quote is

, so relevant rate is Bid Rate.

Amount payable for purchase of 150 lac is


Q168 Interest rate in India
Interest rate in France
Interest rate differential
Forward Discount

150,00,000
51.3625

= $ 2,92,042

9% p.a
12% p.a
9 12 = 3%
=
=

12

3
6.5 6.6
6.6

116
CLASSES

x 100
12
3

x 100

- 6.061 (forward discount)

PRAVINN MAHAJAN CA

Since the forward discount is greater than interest rate differential there will be
arbitrage inflow into India.
The decision taken by Mr E was not correct because as Interest rate parity theory,
forward rate of sale should be 1 FFr = 6.65, calculated as follows:
Let F be the forward rate then as per IRP theory, it should have been as follows:
6.6
12
x 3 x 100 = - 3
6.6
6.6
6.6

3
400

400 F 2640 = - 19.8


F = 6.6495 or 6.65%
Q169 American firm has to pay Interest of Can$ 10,10,000 after 1 month on July 31 st and
Can$ 7,05,000 after 3 month on 30 th sept. Firm has 2 options.
1. Use forward market hedge
Firm will book a forward contract today to purchase Can$ after 1 month and 3
month
Amount payable to purchase 10,10,000 Can $ after 1 month
10,10,000 x 0.9301
9,39,401 $
Amount payable to purchase 7,05,000 Can$ after 3 month
7,05,000 x 0.9356
6,59,598 $
2. To hedge through currency options.
Call option gives right to buy Can$
Put option gives right to sell Can$
Since firm has to buy Can$, so Firm will buy call option
Amount payable to purchase Can$ 10,10,000, if Call option with strike price of
$ 0.94 is bought at 1.02c / Can $
Premium payable 0.0102 x 10,10,000
10302
Amount paid for 10,10,000 Can $ 10,10,000 x 0.94
9,49,400
9,59,702

Amount payable to purchase Can$ 7,05,000, if call otion with strike price of 0.95
is bought at 1.64c / can$
Premium payable 0.0164 x 7,05,000
11,562
Amount payable for 7,05,000 Can$ 7,05,000 x 0.95 6,69,750
6,81,312
117
CLASSES

PRAVINN MAHAJAN CA

Since amount payable is lower if cover is taken in forward market in both I month
payment and 3 month payment, so forward market hedge is better.
Q170 office of Bank in London is considering to invest surplus funds of $ 5,00,000 in
London or Frankfurt or Newyork. Cost of funds is 4%.
If Investment is made in london
Purchasing for $ 5,00,000 at spot rate

5,00 ,000
1.5390

Add : interest for 3 months 0.05 x 3,24,886


Less amount invested with interest
5,00,000 (1.01) = $ 5,05,000
required to pay off $ @ $ 1.5430/
profit in
If investment is made in Newyork
Cash in hand after 3 months 5,00,000 x 1.02
Less principal along with interest
Gain in $
Gain in 5,000 / 1.5475

3,24,886

4,061
3,28,947

3,27,285
1662

$ 5,10,000
$ 5,05,000
$ 5,000
3,231

If investment is made in Frankfurt


Purchasing from $ 5,00,000
$

= 1.5390 x
received

1
1.8260

5,00,000

$ 0.842826
5,93,242

0.842826

in hand after 3 months 5,93,242 ( 1.0075)


Converting in @(1.8290 0.014) 1.815/
Less required to pay off $ @ $ 1.5430/
profit in

597,691
3,29,306
3,27,285
2021

Profit in is highest if investment is made in Newyork. So investment


should be made in newyork
Q171 AKC Ltd Makes exports to japan, USA and Europe
i.

Average contribution to sales ratio if hedge taken

118
CLASSES

PRAVINN MAHAJAN CA

Sales
3 month forward rate
Re sales
Sp/unit
No. of units sold
VC/Unit
Total variable cost
Total contribution
Contribution ratio
ii.

Statement of Contribution
Japan
USA
78,00,000
$ 1,02,300
2.427/
$0.0216/
32,13,844
47,36,111

Europe
95,920
0.0178/
53,88,764

650
12000
225
27,00,000

11.99
8000
510
40,80,000

133,38,719

107,30,000
26,08,719
19.56%

Average contribution to sales ratio if hedge not taken

Spot rate
Re sales
Variable cost
Contribution

Japan
2.459/Re
31,72,021

Contribution ratio

Q172

$ 10.23
10,000
395
39,50,000

Total

USA
$ 0.02156
47,44,898

Europe
0.0179
53,58,659

Total
132,75,578
107,30,000
25,45,578
19.17%

Statement of Profit and Loss account of the Indian software .


development unit
Revenue
48,00,00,000
Less Costs:
Rent
15,00,000
Man power (400 x 80 x 10 x 365) 11,68,00,000
Administrative and other costs
12,00,000
11,95,00,000
119
CLASSES

PRAVINN MAHAJAN CA

PBT
Less tax
PAT
Less withholding tax
Amount transferred to US ()
($) 22,71,15,000 / 48

120
CLASSES

36,05,00,000
10,81,50,000
25,23,50,000
2,52,35,000
22,71,15,000
47,31,563

PRAVINN MAHAJAN CA