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FOREX MARKET
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FOREX MARKET
EXCHANGE RATE
DOMESTIC
CURRENCY
DIRECT QUOTE
INDIRECT QUOTE
LINK BETWEEN
DIRECT&INDIRECTQUOTE
AMERICAN TERM
EUROPEAN TERM
BID
ASK TWO WAY QUOTE
SPREAD
CONVERTINGTWOWAY QUOTE
Arbitrage
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FOREX MARKET
CROSS RATE
SPOT RATE
FORWARD RATE
APPRECIATION
DEPRECIATON
COMPUTATION OF
APPRECIATIONAND
DEPRECIATION
SWAP POINTS
FORWARD RATE,
PREMIUM AND
DISCOUNT
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EXCHANGE RATE
THE PRICE OF ONE CURRENCY
VIEWED IN RELATION TO ANOTHER
CURRENCY IS CALLED EXCHANGE
RATE.
EXAMPLE- Re/$ 44.76 means
44.76=1USD
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3. DIRECT QUOTE
X UNITS OF DOMESTIC CURRENCY
EQUAL ONE UNIT OF FOREIGN
CURRENCY.
EXAMPLE- Rs44.20 per USD IS A
DIRECT QUOTE FOR USD IN INDIA
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4. INDIRECT QUOTE
THE DOMESTIC CURRENCY IS THE
COMMODITY WHICH IS BEING
BOUGHT AND SOLD.
COMMODITY COMES FIRST AND
PRICE NEXT.
EXAMPLE- Re1=.02 USD
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5.CONVERTION (D TO I)
RUPEES Rs44.20=1$- DIRECT QUOTE
INDIRECT QUOTE Re1= 1/44.20=.0227
? KRONER 0.1481KRONERS PERRUPEE
?SAUDI RIYAL(SAR) .08RIYAL PER
RUPEE ? GBP 83.27 RUPEES PER POUND.
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6. AMERICAN AND
EUROPEAN TERMS AMERICAN TERM IS DIRECT.
EUROPEAN TERM INDIRECT.
EXAMPLE-THE RATE $ 1.5 PER POUND IS
AN AMERICAN TERM. THE QUOTE $1= INR 45 IN EUROPEAN
TERM.
? AMERICA OR EUROPE.
(a) 3.419$ PER QUWAITI DINAR- IN USA ITIS A DIRECT MODE- AMERICAN TERMS.
EUROPEAN TERM- 1/AMRICAN TERM :.2925 KWD PER USD.
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7. SOLVE
(a) 7.760 HKD PER $
(b) 7.57 PER DANISH KRONER
Direct quoteAmerican term
1HKD=.128$ European term
.128Rs=1HKD Indirect quote
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ANSWERS
(a) PERSON IN AMERICA THE QUOTE ISFOREIGN CURRENCY PER UNIT OF HOMECURRENCY. HENSE IT IS INDIRECT MODE-EUROPEAN TERM
THE AMERICAN TERM: 1/EUROPEANTERM IS 1/7.760= .13 $ PER HKD(HONG-KONG) DOLLAR.
(b)THE QUOTE IS NEITHER EUROPEANNOR IN AMERICAN TERM SINCE DOLLARIS NOT ONE OF THE PAIR OF CURRENCIES.
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BID AND ASK
THE BANKS QUOTE OF BID AND ASK ISFROM THE BANKERS PERSPECTIVE.
BID= BUY
ASK=SELL IF THE BID RATE FOR USD IS 40 IT MEANS
THAT THE BANK IS READY TO BUY 1$ FORRs.40
IF THE ASK RATE IS FOR USD IS 41, ITMEANS THAT THE BANK IS (ASKING IFSOMEONE WILL BUY) SELLING 1$ FORRs.41.
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Three tier architecture
A) bottom tire- Money changers licenced by
RBI
B) Second tire-cooperative and Commercial
Bank licenced to maintain accounts for NRI
C) TOP TIER- Authoried dealers-Scheduled
Banks-full-fledged foreign exchange
business.
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Two way quote
BID QUOTE AND ASK QUOTE
Ex: Re/$- 40.4241.63
Rs.40.42-bid(buying)-( Bank point of view)
Rs.41.63-ask(selling) Rs.40.42=1$ means the quote is in india
Yen33= Re.1 means the quote is in Japan
If you want to buy, if you have $, you will getRs.40.42
If you want to sell Rs. and buy $ you part withRs.41.63.
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Spread
ASK MINUS BID=SPREAD
EX. 40-41
SPREAD=
Rs.41-40=Rs.1
Factors:a) Stability of the exchange rate
b) depth of the market-volume of transaction
High volume(deep market)-narrow spread
Low volume (thin market)-wider spread
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Problem
Indian would like to have travelers cheques: GBP-
STERLING 72.70-73.25
A) explain the quote
B) compute the spread
C) how much would you pay for purchasing 250
pounds in TCS?
D) If you have a balance of pounds 23 in travellerscheques , how many rupees would you receive if
the bank in india quotes 73.65-73.92?
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Answer
A)Bank buys at 72.70and Ask rate is 73.25
B)Spread=.55
C) 250*73.25=Rs.18312.50D)Rs.23*73.65=Rs.1693.95
Note: in practice all forex transactions are
rounded off to a rupee ie Rs.1694
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PROBLEM
CONSIDER THE FOLLOWINGQUOTATIONS IN MUMBAI
Rupee/UAE Dirham(AED)=12.69
Rupee/Swedish kroner(SEK)=5.49
Rupee/New Zealand Dollar(NZD)=25.35
Euro/INR=0.0198
Compute a)The quote for SEK/AED
b) Euro/NZD
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Solutions
A)SEK/AED=SEK/INR*INR/AED=.18*12
.69
=1 AED
B)
EURO/NZD=EURO/Re*Re/NZD=.0198*2
5.35=.50
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SPOT RATE
RATE OF EXCHANGE FOR IMMEDIATESETTLEMENT
IT IS SETTLED ON THE SECOND WORKING
DAY SATURDAY AND SUNDAY ARE HOLIDAYS
EX:SPOT RATE:Rs./$40.35-41.36 SUPPOSINGYOU HAVE 124000 DOLLAR RECEIVED ON
THURSDAY THE BANK WILL SETTLE124000*40.35=50,03,400 ON THEFOLLOWING MONDAY.
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FORWARD RATE
RATE CONTRACTED TODAY FOR
EXCHANGE OF CURRENCIES AT A
SPECIFIED FUTURE DATE
THERE IS A FORWARD BID AND
FORWARED ASK
CASH DELIVERY-ON THE SAME DAY
TOM DELIVERY-ON WORKING DAY
ON THE FOLLOWING DAY
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APPRICIATION AND
DEPRECIATION IF F>S IN A DIRECT QUOTE THE FOREIGN
CURRENCY IS APPRECIATING
Home depreciate
Indirect quote: Foreign depreciates and HOMEAPPRECIATES
Ex: 1. SPOT: SGD .O370=Re 1
IN SINGAPORE ; FORWARD RATE THREE
MONTHS HENCE 0.0360 SGD APPRECIATES OR DEPRECIATES?
SPOT USD 1.5865= 1 POUND IN UK.FORWARD 1 MONTH 1.5833 .
?DEPRECIATE OR APPRICIATEwww.professoraugustin.com
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SWAP POINTS
DIFFRENCE BETWEEN SPOT BID AND
FORWARD BID OR SPOT ASK AND
FORWARD ASK
?DIFFRENCE BETWEEN SPREAD AND
SWAP POINTS
Spot price 42.3-43.2
Forward price 43.2-44.1
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FORWARD RATE, PREMIUM
AND DISCOUNT IF SWAP ASK> SWAP BID-FOREIGN
CURRENCY IS APPRECIATING HENCE
ADD SWAP POINTS
IF SWAP ASK
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Determinents and select theories
of Exchange RatesGeneral facts:
Pound, Euro and US dollar are having
higher values than other currencies like
rupee, yen,franc etc.
What are the major factors?
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Factors
1. Inflation rates
2. Interest rates
3. Balance of payment position 4. Volume of international reserves
5. Level of activity and employment
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1.Inflation rates
If domestic inflation rate >foreign inflation rate-
domestic goods are costlier than foreign goods
It encourages import of foreign goods
Foreign goods are cheaper
More demand for foreign currencies
Foreign currencies are costlier
Decline in the value of domestic currencies
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If domestic inflation rate < foreign inflation
rate
Domestic goods are cheaper
Encourages export
Foreign exchange inflow increases
Domestic currency appreciates
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The purchasing power
parity(PPP) theory Goods of equal value in different countries are equated through an
exchange rate
Ex: If a book costs in USA say $2 but the same book is available in
India for Rs86 the exchange rate between these currencies should be
Rs.43/$
PPPr=Spot rate x [1+r(H)]/[1+r(F)]
= spot rate x P(H)/P(F)
Where PPPr=purchasing power rate
r(H) and r(F)-inflation in the home and foreign countries
P(H) and P(F)-price indices of home and foreign countries.
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example
Spot rate=Rs 42 The price index is 110 and
In US it is 6% what is new exchange rate?
42 x 110/106=43.5849
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2.Interest rates
If interest rate in home country( India 10%)>foreign country(USA 4%)
USA funds are likely to be attracted in India as theinvestor can earn better return in India rater thanIn USA
Flight of funds from USA to India
There will be more demand for rupees in America
causing appreciation for Indian rupeeMore dollar is required to buy rupees in America
which devalue US Dollar
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The Interest rate Parity theory
The premium or discount of one currency inrelation to the other should reflect theinterest rate differentials between the two
currencies.Forward rate = spot rate x[1 + I(F)]/[1
+I(H)]
Where I(F) and I(H) represent interest rateson foreign and home currencies.
What is the impact?
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Impact
Foreign currency is at a premium when
interest rate is higher in foreign country
than home
Home currency is at a discount
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3. Balance of payment position
Deficit balance of paymentsnot able to
meet the demand of such currency say
dollar leads to devalue of home currency
It discourages import as foreign goods
becomes costlier
It encourages export as domestic goods are
cheaper in foreign country
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Favourable balance of payments?
The value of such a country appreciates and
likely to appreciate
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4. Volume of International
Reserves/Foreign exchange It includes gold
The reserve supports or stabilizes whenever
currency depreciates.
Release or sell foreign exchange reserves so
that demand for foreign met so further
devaluation is reduced.
The monetary authority can with stand only
to the extend to the reserves in hand.
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5.Level of Activity and
employmentHigher level of economic activity and full
employment have good potential and
prospects of appreciation in the value of
currencies.
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conclusion
Low inflation rate
Higher interest rates
Surplus balance of paymentPossession of sizeable foreign exchange
reserves
Higher level of economic activityDo have positive or negative impact on
exchange rate?
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Positive impact
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conclusion
Higher inflation rate
Low interest rate
Big/persistent deficit in the balance ofpayments
Inadequate reserves with the monetary
authority
Low level of economic activity
What is the impact?
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answer
Depreciates exchange rates
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Excercise
See Exercise no.12 and 14
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Arbitrage
Act of buying currency in one market at
lower prices and selling it in another at
higher price.
It helps the arbitrageurs in the market to
earn profit without risk
It is a balancing operations that do not allow
the same currency to have varying rates indifferent forex markets.
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Types of arbitrage
Geographical
Triangular arbitrage
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Geographical arbitrage
Different prices quoted in two geographicalmarkets for the same currency
Tokyo and London
1.Observe the following:Rs/US $
London Rs.: 42.5730--42.61
Tokyo $: 42.6750 -- 42.6675Can make money out of it?
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Buy at London market at 42.6100 and sell thesame at Tokyo market for Rs.42.6350.
Suppose you buy from London for 100 millionRupees you can get 100 million/42.61=$2,346,866.932
Sell $ 2,346,866.932 in Tokyo market at Rs.42.6350 gives Rs.100,058,671.16
There are transaction costs involved.Note: selling price of one market should be higher
than buying price of another market.
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Exercise-2
The following are three quotes in three
forex markets
1$=Rs.48.3011 in Mumboi
1pound=Rs.77.1125 in London
1Pound=$1.6231 in Newyork.
Are there any arbitrage gains possible?Assume there are no transaction costs and
the arbitrageaur has $1,000,000.
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Answer-2
The cross rate between Mumboi and London with
respect to$/pound=77.1125/48.3011
=$1.5965/pound
But in newyork the price is quoted $1.6231 There is an opportunity to earn by buing indian
rupee in in Mumboi market and convert them into
pounds in London Market
Then convert pounds into dollors in NewYork
market.
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Answer-2 continues
Rs.48.3011X 1 million
dollor=Rs.48,301,100
Pounds=48,301,100/77.1125=626,371.8592
Dollors=626,371.8592X1.6231
=$1,016,664.164.
The gain=$16,664.164.
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E i 3 bi i f d
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Exercise-3: arbitrage in forward
marketDetermine arbitrage gain from the following
data:
Spot rate Rs.78.10/pound
3 month forward rate Rs.78.60/pound
3 month interest rates:
Rupees: 5%; British pound :9%Assume Rs10 million borrowings or pound
200,000 as the case may be.
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Answer-3
Since forward rate is higher than the spot
rate pound is at a premium.
Percentage premium = (78.60-
78.10)X12X100/(78.10X3)=2.56%
Interest rate differential =9%-5%=4%
This helps to borrow from Indian market
and invest today in pounds in the spot
market
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Method -2
1.Borrow in Uk and invest such pounds
after converting them into rupees in India
2.After three months re convert the rupees
including the interest into pounds at forward
rate
3.Deduct the loan including interest from
step2
If step-2 is more than step-3 there is a gain.
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Exercise-4
Spot rate=78.10; interest rates India-5%;
interest rate in UK-9% (pounds); At what
forward rate the arbitrage is not possible?
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Answer-4
Spot rate =78.10
Add: 4% premium for three month
period(78.10 X 4/100) X3/12=0.781
Forward rate= 78.10-0.781=77.319
What is the principle used?
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Principle
The arbitrageur earns 4% extra interest to
pay 4% forward premium yielding him no
gain.
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Exercise-5
Spot rate-78.10; forward rate for three
months-Rs.77.50; rate of interest for
pounds-6% for three months.Rate of interest
in India-5%. Is there any arbitrage ?
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Answer-5
The British pound is at a forward discount of3.073% ie.(78.10-77.50)x 100/78.10x (12/3)100
Interest rate differential is 6%-5%=1%
There are arbitrage gain possibilities. Borrow in UK 2,00,000 pounds at 6% and convert
them into Indian currency and invest them inIndia at rate of 5%
The total amount is converted into pounds at theforward rate
Net gain =1067.7419 pounds.
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Exercise-6
A Ltd is planning to import a multipurposemachine from Japan at a cost of 3400 lakhYen.The company can borrow at the rate of 18%
per annum with quarterly rests.However there is
an offer from Tokyo branch of Indian Bankextending credit of 180 days at 2% per annumagainst the opening of an irrevocable letter ofcredit. Other information is as follows:
Spot rate for Rs.100=340 yen; 180 days forwardrate for Rs.100=345 yen; commission charges forletters of credit are at 2% for 12 months.
Advise the company which mode of purchase is
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Answer-6
Borrowing 3400 lakhs yen
Borrowing in Indian rupee=Rs.1000 lakhs
Interest for the first 3 months= 45
Interest for the second quarter=47.025 Total cash outflow at the end of 6 months equals
to Rs.1092.025 lakhs.
If letter of credit is followed:
Borrowings 3400 lakhs yen
Interest for 6 months 34 yen
Commission charges 3400 x .02 x6/12=34
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Answer-6 continues
Total payments =3468 lakhs yen
Conversion into indian rupees=1005.217
Conclusion:- Avail overseas offer
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Exercise-7
Spot Rs.48/$ ;6 month interest rate: India-
7.5%Per annum; US interest rate-2% per
annum.what forward rate will no arbitrage
gain be possible?
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Answer-7
Difference in rate-7.5%- 2%=5.5%p.a.
Spot rate $48
Add: 5.5% premium for three months
(48x (5.5/100) x 6/12) =1.32
Forward rate = 49.32/$
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Exercise-8
Spot rate- Rs.48.5/$ ; 6 month forward rate-
Rs.48.90/$ ; Annualised interest on US 6
month treasury bill2.5%; annualised
interest on Indian 6-month treasury bill-6.0%; what are the transactions the trader
will execute to receive arbitrage gain?
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Answer-8
Interest rate differential=6%-2.5%=3.5%pa
Premium of forward rate=(48.90-
48.5)/48.5x100 x(12/6)=1.65%
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Since interest diferential is more
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than premium forward arbitrage
gain is possible.
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Exercise-9
Calculate cross currency rate between
Euro/pound(bid as well as ask)
Rs/Us $ Rs 48.35-48.90
Rs/Euro Rs.51.90-52.30
$/ Pound $ 1.49-1.50
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Answer-9
Euro/Pound(bid)=Rs/Us $ x $/Pound x
Euro/Rs=48.35 x1.49 x 1/51.90
Euro/Pound(ask)=48.90 x 1.50 x1/52.30
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Exercise-10
You are required to fill in the missing
figures and complete the table
US
dollar
Pound Canadi
an
Yen Euro
1USD
1 pound1Canadi
1 Yen
1 Euro
1.0
--
-
-
o.6161
1.0-
-
-
1.5259
-1.0
-
-
------
--
1.0
-
0.9287
--
-
1.0www.professoraugustin.com
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Answer-10
US
dollar
Pound Canadi
an
Yen Euro
1USD
1 pound
1Canadi1 Yen
1 Euro
1.0
1.623
0.65530.0085
1.0767
o.6161
1.0
0.40370.0052
0.6634
1.5259
2.4767
1.00.0129
1.6430
118.08
191.655
77.38381.0
127.145
0.9287
1.5074
0.60860.0078
1.0
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Exercise-11
The following quotations are available to
you:
by a bank in New York $ 1.6012/Pound
By a bank in Paris FFr4.9800/$
By a bank in London Pound 0.1350/FFr
Is any triangular arbitrage possible?
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Answer-11
From a direct quote of New York and Paris,
the cross rate for Pound/FFr is Pound/FFr=
Pound/$ x $/FFr= 1/1.6012 x1/4.9800
Or Pound/FFr =0.1254
Since in the direct quote the FFr in London
is pound 0.1350/FFr(different from 0.1254),
triangular arbitrage is possible.
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Answer-11
1/1.6012 x 1/ 4.9800=0.1254=Pound/FFr
Since in the direct quote the FFr in London
is 0.1350/FFr different from 0.1254,
triangular arbitrage is possible.
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Borrow in the country where the rate of
interest is low and invest in the country
where interest rate is high.
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Exercise-12
On 1st April 3 months interest rate in the US
$ and Germany are 6.5% and 4.5% per
annum respectively.The USD/DM spot rate
is 0.6560. What would be the forward ratefor DM, for delivery on 30th June?
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Answer-12
Spot rate is US $ 0.6560/DM Interest rate parity relationship
S0=[1+imA]/[1+inB
S0= Spot rate; S1= Future exchange rate
inA=Nominal interest in country A(USA)
inB= Nominal interest in countryB(Germany)
S1=0.6560{1+(0.065 x3/12)/1 +(0.045 x 3/12)}= 0.6560 x (1.01625/1.01125) = USD 0.6592
$/DM
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Exercise-13
Spot rate 47.88/$
3 month forward rate 48.28/$
3 month interest rates Re.7%
$ 11%
Is there any arbitrage gain?
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Answer-13
3 month forward rate of dollar is higher than spot rateimplies that the dollar is at premium.
Premium(percentage)= (48.28-47.88) /
47.88x(12/3) x 100=3.34% per annum.
Interest rate differential=11%-7%=4%
Since interest rate differential is more than
premium percentage there are arbitrage gainpossible.
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Exercise-14
On 1st April, 3 months interest rate in the
US and Germany are 4.5% and 6.5 % per
annum respectively. The $/DM spot rate is
0.6560. What would be the forward rate forDM for delivery on 30th June?
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S1=0.6560{1+(0.045 x3/12)/1 +(0.065 x3/12)}
= 0.6560 x ( 1.01125/1.01625)
= USD 0.652772 $/DM
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Exercise-15
In International Monetary Market aninternational forward bid for December, 15
on pound sterling is $ 1.2816 at the same
time that the price of IMM sterling futurefor delivery on December,15 is $1.2806.
The contract size of pound sterling is
62,500. How could the dealer use arbitragein profit from this situation and how much
profit is earned?
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Exercise-16
ABC Co. have taken 6-month loan from their foreigncollaborators for US Dollars 2 millions. Interest payableon maturity is at LIBOR plus 1.0%. Current 6-monthLIBOR is 2%.
Enquiries regarding exchange rates with their bank elicitthe following information:
Spot USD 1 Rs. 48.5275
6 months forward Rs.48.4575
1.What would be their total commitment in rupees, if theyenter into a forward contract?
2. Will you advise them to do so? Explain giving reasons.
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Exercise-17
The United States Dollar is selling in India atRs.45.50. If the interest rate for 6 month
borrowing in India is 8% per annum and the
corresponding rate in USA is 2%.
1.Do you expect US dollar to be at premium or at
discount in the Indian forward market?
2.What is expected 6 month forward rate for United
States Dollar in India?
3. What is the rate of forward premium or discount?
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Answer
Borrow in US at 2% and invest in India
Differential interest rate =8%-2%=6%
Since US interest rate is low dollar is at
premium.
Forward rate=45.50(1+[.04
x6/12)]=Rs.46.41
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Exercise-18
A company operation in Japan has today effectedsales to an Indian company, the payment beingdue 3 months from the date of invoice. Theinvoice amount is 108 lakhs yen. At todays spot
rate, it is equivalent to Rs.30 lakhs. It isanticipated that the exchange will decline by 10%over 3 months period and in order to protect theYen payments, the importer proposes to take
appropriate action in the foreign exchange market.The 3-months forward rate is presently quoted as3.3 Yen per rupee. You are required to calculatethe expected loss and to show how it can be
hedged by a forward contract.www.professoraugustin.com
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Exercise-19
The following table shows interest rates forthe United States dollar and French francs.
The spot exchange rate is 7.05 franks per
dollar. Complete the missing entries:
3 months 6 months 1 year
Dollar interest rate(annually compounded
Frank interest rate
(annually compounded)
Forward franc per dollar
Forward discount on franc per
cent per year
11 %19 %
?
?
12 %?
?
6.3%
?20%
7.5200
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Exercise-20
In march 2008, the multinational Industries makes the following
assessment of dollar rates per British pound to prevail as on 1.9.08.
1) What is the expected spot rate for 1.9.2008?
2) If , as of March,2003, the 6 month forward rate is $1.80, should the
firm sell forward its pound receivables due in September, 2008?
$/pound Probability
1.6
1.7
1.8
1.9
2.0
0.15
0.20
0.25
0.20
0.20
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Exercise-21
X Ltd. an Indian company has an export exposure of 10million(100 lacs) Yen, value September end. Yen is not directlyquoted against Rupee. The current spot rates are-USD/INR=41.79 and USD/JPY=129.75.
It is estimated that Yen will depreciate to 144 level and rupee todepreciate against dollar to 43
Forward rate for September, 2008 USD/Yen =137.35 andUSD/INR=42.89.
You are required
i) To calculate the expected loss if hedging is not done. How theposition will change with company taking forward cover?
ii) If the spot rate on 30th September, 1998 was eventuallyUSD/Yen=137.85 and USD/INR=42.78, is the decision to takeforward cover justified?
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Exercise-22
A company operating in a country having the dollar as its unit ofcurrency has today invoiced sales to an Indian company, the payment
being due three months from the date of invoice.The invoice amount is
$13,750 and at today spot rate of $0.0275 per Re.1, is equivalent to
Rs.5,00,000.
It is anticipated that the exchange rate will decline by 5% over thethree month period and in order to protect the dollar proceeds, the
importer proposes to take appropriate action through foreign exchange
market.
The three month forward rate is quoted as $0.0273 per Re.1
You are required to calculate the expected loss and to show, how it canbe hedged by forward contract.
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Exercise-23
Shoe Company sells to a wholesaler in Germany. The purchasesprice of a shipment is 50,000 deutsche marks with term of 90 days.
Upon payment, Shoe Company will convert the DM to dollars. The
present spot rate for DM per dollar is 1.71, whereas the 90-day
forward rate is 1.70.
You are required to calculate and explain:1) If Shoe Company were to hedge its foreignexchange risk, what
would it do? What transactions are necessary?
2) Is the deutsche mark at a forward premium or at a forward discont?
3) What is implied differential in interest rates between the two
countries?(Use interest rate parity assumption)
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Answer-23
Spot rate DM/US $ =1.71
If company receive payment then
50,000 x 1.71=
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Exercise-24
A customer with whom the Bank had entered into3 months forward purchase contract for SwissFrancs 10,000 at the rate of Rs.27.25 comes to the
bank after 2 months and requests cancellation of
the contract. On this date, the rates prevailing are: Spot CHF 1=27.30 27.35
One month forward Rs.27.45 27.52
What is the loss/gain to the customer oncancellation?
(loss to the customer $2700 due to exchangedifference)
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Exercise-25
In 2005 a foreign institutional investor investedUS dollar 1 million in the Indian stock market.
The rupee return from Indian stock market since
2005 has been 20% as dividend income. However
stock prices increased by 15% since 2005. The
currency rate at the time of purchase in 2005 was
Rs47 per dollar. If he sells today the currency rate
is Rs42.30 per dollar. What is profit /loss to theforeign institutional investor?
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Answer
(Rs4,70,00,000 +94,00,000+70,50,000)/42.30=15,00,000 dollars
Gain=5,00,000 dollars
Suppose stock price is declined by 20% do
they gain /lose?
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B i t d l di t
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Borrowing rate and lending rate
US I month treasury bill 2.30-2.35% p.a
Here deposit interest is 2.30%
Lending interest rate is 2.35%
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Exercise-25
The following data is available from theforex market:
US 1 month treasury bill 2.60-2.65% p.a
India 1 month treasury bill 6.80-6.85% p.a
If the dollar spot rate in India is Rs.42.3-42.50
per US $ , find the no arbitrage range of
future prices for a month dollar future.
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Answer
Two option 1. Borrow rupee, buy dollar,invest in dollar
and buy rupees(sell dollar) in future
2. Borrow dollar, buy rupees, invest rupees,sell rupees in future.
Refer: Management Accounting andfinancial analysis by My Khan and P.K Jain
Chapter Foreign exchange markets andDealings
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Foreign Exchange Exposure
and Risk Management
By Prof. Augustin Amaladas
M.Com.,AICWA.,PGDFM.,DIM.,B.Ed.
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FERM
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FERM
Various types of risk exposed
Techniques to deal with such risks
Hedge such risk
Techniques adopted in India to manage
FER
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Types of Exposure to business
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yp p
risk 1. Transaction exposure
2.Translation exposure
3. Economic exposure
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T ti E
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Transaction Exposure
Transactions that require settlement inforeign currency-obligations
Cross border trade
Domestic purchases and sale of goods andservices
Debtors receivable in foreign currencies
Creditors payable in foreign currencies,foreign loans and collaborationsinvestments
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Example
Infosys incurs loss of Rs.80 crore in thevolatile forex marketdue to5.6%depreciation of the rupee during thefirst quarter of 2008-09 fiscal year.ie rupeewas 40.02 depreciated to 43.04 ie 5.6%
This was after the company had hedged$760 million at Rs.40.6 as forward cover
Operationally a depreciating rupeebenefited the company by 111 crore
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Translation Exposure-page 17.2b MGT and Financial Anal sis
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by MGT and Financial Analysis
by Khan and Jain Change in accounting income and balance sheet
statements due to change in exchange rate
Example: An Indian firm has taken a loan of Rs.20 million dollar from a bank in USA and imports
a machinery . When contract made Rs 40.2/$ but
at the time of settlement it was 43. The firm looses
as indian rupee depreciates. Due to which assethas to be provided more depreciation
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43-40.2=2.8 per dollar has to bepaid extra
20million dollars x 2.8=56 million rupees
to be paid extra
If depreciation rate is 20% then 0.2 x
56=11.2 million rupees will be written off
as depreciation
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What is translation adjustment?
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What is translation adjustment?
Translation loss/gain may not be reflectedin the income statement but they are shown
in the balance sheet under the head
translation adjustment in the balance sheetwithout affecting accounting income.They
are carried out in the owners equity
accountThis practice differ from country to country.
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Economic exposure
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Economic exposure
It is the most important as it has impact on thevaluation of firm.
Change in the value of a company thataccompanies an unanticipated change in exchange
rates. Expected change may not have any impact on the
business as it is accommodated well in advance
It is based on the extent to which the value of thefirm-as measured by the present value of theexpected future cash flowswill change whenexchange rates change
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formula
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formula
Change in PV/Change in exchange rate
It measures variability in the value of the
firm due uncertain exchange rate changes.
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