Uestion Paper Ift

7/31/2019 Uestion Paper Ift

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uestion PaperInternational Finance and Trade II (222) : July 2006

Section D : Case Study (50 Marks)

This section consists of questions with serial number 1 - 5.

Answer all questions.

Marks are indicated against each question.

Do not spend more than 80 - 90 minutes on Section D.

Case Study

Read the case carefully and answer the following questions:

1. For an Indian Company, the choice between the borrowing in home currency or foreigncurrency would depend on a number of criteria. Discuss those criteria for choosing a currency ofborrowing.

(10 marks) < Answer >

2. What are the reasons for the growth of Eurodollar market? Discuss the advantages; SevenSeas Info-tech can gain by borrowing in Eurodollar market than in borrowing dollar in the USmarket.


3. Explain how the Eurocurrency interest rates are determined.


4. a. Show the cash-flows from the Eurodollar loan and euro currency loan and find out theeffective rupee cost of the loans if the 6-month dollar and euro LIBOR turned out as follows:

Period(Months)612121818 2424 30303636 4242-4848-5454-60

US$ LIBOR

LIBOR5.30%

3.00%5.45%

3.25%5.50%


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3.50%5.25%

3.35%5.50%

3.10%

5.40%

3.00%5.25%

3.25%5.50%

3.30%5.50%

3.30%

b. Show the cash-flows of the yen loan and find out the effective cost of the loan in rupee term.

(14 + 6 = 20 marks) < Answer >

5. Explain the types of foreign exchange exposure Seven Seas Info-tech will face if it borrows inforeign currency.


Mr. Praveen, recently appointed as a Vice-President (Finance) in the Seven Seas Info-tech Ltd.,(SSIL) Bangalore and also a member of Top Management Committee (TMC) of the company. Henoticed that in the middle of June, 2006 the Head of the Financial Planning Group placed a noteto TMC that the SSIL would soon reach the threshold limits fixed for short term working capitalborrowings from banks in India. The company also requires term loan to the extent of Rs.200

crore to meet companys ongoing international expansion plans. For international expansionplans it is considering to borrow in foreign currency as the company can avoid the transactioncost for converting rupee into foreign currency, and also international interest rates areconsidered to be lower than the rupee term rates, so it can be cheap abroad.

TMC is of the opinion that Govt. of India liberalized the terms and conditions for ExternalCommercial Borrowings by Indian companies, the company should borrow from US market inview of companys good reputation in US market, even though the funds can be obtained on asofter terms from financial institutions in Japan and European countries. Mr. Praveen, explainedthat the company could opt for borrowings from European market at a lesser rate of interest andmore softer terms than from financial institutions from USA. Due to various reasons and lessnumber of regulations Euro banks can charge lower cost of dollar borrowings than the banks inUS. It is far easier to get a dollar loan in the Eurodollar market than US since there is no centralbank which controls this market.

Another market Mr. Praveen considering is the Japanese yen market, due to prevailing lowinterest rates in Japanese market and ample liquidity it is easy to get a yen denominated loan.

Mr. Praveen and his key staff members have negotiated with a number of banks to explore thepossibility of getting loan for the company on favorable terms from the international market.The staff members of Mr. Praveen after a month long negotiations with various internationalfinancial institutions has short listed following three loan proposals:

Proposal I


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$ 44 million Eurodollar loan from a bank in London, interest is payable half-yearly at 6-monthLIBOR + 100 basis points. The principal is to be repaid after 5 years with a bullet payment.

Proposal II

35 million loan from a bank in Zurich, Switzerland. Interest is payable half-yearly at 6-month

LIBOR + 250 basis points. The principal is to be repaid after 5 years with a bullet repayment.

Proposal III

5 year 5000 million loan from a bank in Japan, interest is payable half-yearly at fixed rate of3.00% p.a. and the principal is to be repaid in two equal annual installments at the end of 48and 60 months.

Mr. Praveen does not want to bear any foreign exchange risk and intend to hedge all his foreignexchange cash flows in the forward market. He is of the firm opinion that 6-month forward ratesfor euro, dollar and yen reflect values as per the purchasing power parity and current inflationrate will remain same for the future periods also. Further, the loan will be availed from July 1st,2006.

Current Exchange Rates on July 01, 2006

Rs./$45.48/45.52

Rs./0.4081/0.4091

Rs./58.43/58.47

Current Interest Rates on July 01, 2006

6-month LIBOR:US$5.5%

3.0%

Inflation Rates

India

5.0%

USA3.5%

Japan0.5%

Euro-zone2.0%


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END OF SECTION D

Section E : Caselets (50 Marks)




Do not spend more than 80 - 90 minutes on Section E.

Caselet 1

Read the caselet carefully and answer the following questions:

6. How do you compare continuous linked settlement with CCIL settlement model? Do you thinkthe settlement through CCIL has been able to increase the operational efficiency of the marketparticipants? Discuss.


7. Explain how CCIL settlement model has helped in risk reduction to market participants.


Domestic market in Indian rupee closes before the US dollar market becomes active. Settlementin Indian rupee funds for any Indian rupee/US dollar trade, therefore, happens beforesettlement of US dollar funds i.e., the settlement is not on Payment vs. Payment (PVP) basisand this type of settlement is known as continuous linked settlement. A trader who buys USdollar against Indian rupee can therefore loose the entire amount if the counterparty fails to payUS dollar after receiving Indian rupee. The counterparty exposure is therefore a major cause ofconcern for participants in this market.

Increase in the size of the market over the years has been causing increase of counterpartyexposures of the market participants. A possible consequence of a default by any marketparticipant has also been increasing correspondingly. Moreover, with the increase in tradevolume, settlement cost has also been mounting. To reduce the risk from any possible failedsettlement, banks started changing their settlements from deal-wise settlements to settlements

on net-basis with their counterparties (i.e. through bilateral netting).

The Clearing Corporation of India Ltd. (CCIL) was set up in 2001. It came into existence to takeover the responsibility of settlements in the Government Securities and Forex markets. Itstarted working for development of a process for settlement of interbank trades in Indianrupee/US dollar. The settlement started in November 2002. The process that was formulatedhas remained more or less unchanged so far. In the process, the settlement participants are toreport their trades to CCIL through electronic mode using RBI's INFINET network. The matchingof reported trades of the participants (counterparties) are to happen in the books of CCIL.Following this, CCIL sets limits in terms of net US dollar sale positions per settlement date for all


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settlement participants. Trades within limits are accepted for guaranteed settlement by CCIL asa Central Counterparty. On the other hand, forward trades are taken for guaranteed settlementonly after those enter the Spot Window. US dollars payable to the settlement participants are tobe released only after receipt of counter-value Indian rupee funds. For US dollar receivables,however, counter-value Indian rupee funds are to be paid to the settlement participants withoutwaiting for receipt of the US dollar funds, causing principal risk to come into play in such cases.

In case of settlement default in Indian rupee, counter-value US dollar funds are not to bereleased. Instead, if Indian rupee funds are not received by the next day, US dollar amountsheld back are to be sold to arrange for the required Indian rupee amount. On the other hand, incase of a settlement default in US dollar, a principal risk for the respective amount is to arise. Aprovision to claw back funds from the defaulting participant's principal Indian rupee account withRBI also exists. In case the Indian rupee funds recovered are inadequate and the margin of theconcerned member is also not adequate to take care of the likely loss, a provision exists forallocation of residual loss through a clearly designed and pre-notified loss allocation mechanism.The mechanism contains a provision for distribution of losses arising out of any settlementdefault to the bilateral counterparties, pro-rata, based on their exposures on the defaultingcounterparty.

The settlement of Indian rupee/US dollar trade started initially with only spot and forwardtrades. Maximum time allowed for reporting by the settlement participants was up to the midday

of the day prior to the settlement date. A day's time was initially kept available as a buffer forthe participants to get used to the process. It was also felt that the specific interaction protocolwhich was developed with the ABN AMRO Bank as settlement bank, would need time to mature.The developed process was to be efficient with abilities on the part of CCIL to monitor themovement of each transaction through the account so that operational slippages did not causeany payment failure. The settlement system worked efficiently from the very beginning and themarket participants reposed their confidence in the newly developed settlement system byshifting most of their trades to the system for settlement. RBI, as a regulator, was closelymonitoring the development. They also played the role of a catalyst by arranging anindependent vetting of the processes in 2003 by an expert from the European Central Bankwhich gave the comfort to the settlement participants about the robustness of the settlementand risk management processes.

Settlement of TOM and CASH trades i.e., trades with settlement on the next working day and on

the same working day respectively, started in February 2004. It required significantrestructuring of the processes and of the risk management systems. As CASH trades wereallowed to be reported and matched in the CCIL system up to 12.30 pm of the day of settlementand the settlement participants were required to settle the trades which were not taken up forguaranteed settlement by CCIL through direct settlement, maintaining time discipline regardingprocessing at CCIL was critical for the success of the system. On the part of settlementparticipants also, this demanded a much more efficient response. It was a big challenge, but theIndian Financial System took it almost effortlessly.

Caselet 2


8. Discuss the various factors which influence the exchange rate of US dollar.


9. Do you think dollar can depreciate sharply against other major currencies? Discuss.


10. How falling dollar is affecting the Asian countries? How they can combat the situation?



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A gigantic current-account deficit ought to be bad news for a currency. For the dollar, realityseems at last to be coming into line with the textbooks. In the past month or so the greenbackhas lost 6% against the euro, 7% against the yen and 3% on a broad trade-weighted basis. Thisweek it dipped below eight yuan for the first time since China abandoned its fixed rate of 8.28 tothe dollar last July. Even before the markets' recent upset, caused largely by inflation worries,there was reason to believe that the dollar was on the prolonged slide that economic logic

suggests is overdue.

Before anybody starts talking about a turning point it is worth considering two caveats. First, thedollar has defied gravity less dramatically than many people thinkespecially once you castyour gaze beyond the euro, the yen and the yuan. The dollar's broad trade-weighted index hasfallen by 18% since February 2002. Last year, notes Jim O'Neill, of Goldman Sachs, thegreenback lost against the Canadian dollar (which has a weight almost as big as the euro's) andsome important emerging-market currencies such as the South Korean won (which counts forabout the same as the pound sterling).

The second caveat is that once you look at the euro and the yen, the dollar has been herebefore, and not that long ago. At the start of 2005, the greenback was weaker against both theeuro and the yen than it is now, but gained against both currencies in the course of the year.Asian central banks, which have helped sustain both the current-account deficit and the dollar

by buying Treasury bonds in startlingly large quantities, have little interest in a weakergreenback. Oil-exporting countries are also thought to have been putting at least some of theirextra revenues into dollar-denominated assets, including treasuries. Neither source of current-account funding looks likely to dry up just yet.

Against these caveats there are a number of reasons to argue that something fundamental mayjust have shifted against the dollar. The first is the removal of a temporary prop. Last yearAmerican companies were allowed a lower tax rate on profits repatriated from abroad. Now, thatsupport for the external deficit and the dollar has been taken away.

A second change has to do with international differences in interest rates. Until recently, thedollar was helped by the Federal Reserve's policy of raising interest rates (a quarter of apercentage point at 16 consecutive meetings after June 2004) at a time when the Europeansheld steady. Now the tables are turned: markets are worried that the Fed will stop at 5%, but

the European Central Bank is raising interest rates and will probably soon be joined by the Bankof Japan.

This is linked to a third point: there has been a change in beliefs about how economies arefaring. Whereas the rattling pace of America's economy is expected to slacken in the second halfof the year, the slower-growing euro area and Japan are thought to be picking upeven if inEurope this is still more evident in confidence surveys than in hard figures. Fourth and mostpressing, there are deeper concerns about the American economy. Wall Street is much moreworried about inflation than it was a few months agoand markets are yet to be convinced thatthe Fed's newish chairman, Ben Bernanke, will tackle inflation with sufficient vigour.

It would be nice to think that the dollar's decline heralded an orderly adjustment of globalimbalances (the greenback's latest tumble may have been started by a stern communiqu fromthe G7 last month about the world economy). But do not get your hopes up. Although a fall in

the dollar should help to reduce America's current-account deficit, by making exports cheaperand imports dearer, it will have to go a lot further to make much of a dent. Indeed, the current-account deficit has carried on climbing these past few years, even though the greenback hasbeen weakening for most of the time. One way or another, America is still going to have to savemore and the rest of the world save less.

Caselet 3



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11. Keeping aside the positives and the negative outcomes of the meeting, the case for theLeast Developing Countries (LDCs) is comparable to providing people with money to buy theircoffins. Discuss.


12. Discuss the probable impact of the ministerial meet on India's farm and manufacturing

exports in the global markets.


The liberalization drive that is being promoted by the WTO has a potential to lead to the closureof local firms, resulting in the loss of livelihoods to many farmers. That is a cause of concernsince in the past also; liberalization has proved disastrous for several local firms leading to theirclosure. With tariffs going down followed by cheaper imports, there is always a possibility oflocal products and jobs getting displaced. At the same time, one cannot ignore the brighter sideof liberalization. Liberalization leads to the increase in exports that brings with it more jobs andrevenues. At the same time, it needs to be kept in mind that not all countries possess theproduction capacity and efficiency to take the fullest of the advantage. There are some countriesthat benefit out of it while certain countries find it difficult to generate any gains out of thesame. In the recently concluded sixth ministerial conference, both the aspects of fear of losing

out the imports as well as the potential of increasing the exports were the center of discussion.

The six days of the WTO Ministerial Conference held in Hong Kong were not free frombrouhahas. There were several issues. Some of them had positive implications whereas some ofthe outcomes were shrouded in uncanny ambiguities. The biggest success that emerged out ofthe discussion was the concerted decision that one would not sacrifice the Doha Round at thecost of minimal national economic interests. Further there was also agreement on the fact thatall the developed countries arrived at pertaining to the ending of all export subsidies by the endof 2013 and to begin the process of substantial reduction before that period, though thedeveloping nations preferred a timeline of 2010. This was added to the removal of the cottonsubsidies by the next year. Cotton exports from the Least Developed Countries (LDC) wereallowed into the developed countries with zero duty. But, it is also to be remembered that thedumping of subsidized cotton would continue in days to come. One more important aspect of thediscussion hovered around the aspect of the LDCs struggling hard to allow all their products to

enter the markets of the rich countries free of duties and quotas.

At the same time, it is worth mentioning that the meeting also had its share of certain negativeaspects. A closer look at the declaration will reveal the fact that there lies no finality about theschedules pertaining to the export subsidies, since the same has been made dependent on thecompletion of the modalities, the timeframe for which has been set as April 30, 2006. Keeping inmind that the organization has failed several times to meet its deadline, there is no certaintythat this date will be conformed to. One school of thought postulates that the poor countries lackthe capacity to export most of the products and one of the clauses namely the escape clausefacilitates the rich countries to block the imports of the products that the poor countries findcompetent to produce. The US feels apprehensive of the cheap textiles and the clothing fromBangladesh, and Japan feels jittery about the cheap rice from Cambodia. The outcome of thesix-day conference also gave certain setbacks to the developing countries. The draft declarationrequires these countries to participate in the new type of negotiations in the WTO that are

designed primarily by the rich countries.

Keeping aside the positives and the negative outcomes of the meeting, the case for the LeastDeveloping Countries (LDCs) is comparable to providing people with money to buy their coffins.As rightly quoted by an activist "the results of the meeting has been a way to facilitate thecountries to get into the trade agreements and calling it aid or developmental packages, it ismore like moving forward the trade agenda that is about trade and not development". Well,whatever may be the viewpoints of the critics, the plan chalked out by the members is believedto benefit at least 50 LDCs in Africa, the Caribbean and the Pacific region. These countriesmainly export agricultural products like bananas, sugar and tea. The so-called developmental


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package includes the "quota-free and duty-free" access for all the 50 LDCs to markets in richnations by 2008.

END OF SECTION E

END OF QUESTION PAPER

Suggested AnswersInternational Finance and Trade II (222) : July 2006

Section D : Case Study

1. For an Indian company, the choice between the domestic and international market woulddepend on a number of criteria, some of which are listed below:

i. Currency Requirements: A decision has to be taken about the currency needs of the company,keeping in view the future expansion plans, capital imports, export earnings/potential export

earnings. A conscious view on the exchange rate also needs to be taken.

ii. Pricing: Pricing of an international issue would be a factor of interests rates and the value ofthe underlying stock in the domestic market. Based on these factors, the issue price conversion(for convertible) premium would be decided. Given the arbitrage available between interestrates in rupees and say, US dollars, and given the strength of the rupee, as well as theresilience a company can have in its operations against exchange fluctuation risk, due to exportearnings, it is possible to take advantage of the low interest rates that are prevailing in theinternational markets. The above is possible without dilution of the value of the underlyingstock. This is so, because, in the case of international issues, open pricing/book building ispossible, which has the advantage of allowing the foreign investors to set the premium ensuringtransparency and creating price tension.

iii. Investment: At present greater flexibility is available in structuring an international issue in

terms of pure equity offering, a debt instrument or a hybrid instrument like foreign currencyconvertible bond (FCCB). Each company can take a view on instrument depending upon thefinancials of the company and its future plans.

iv. Depth of the Market: Relatively larger issues can be floated, marketed and absorbed ininternational markets more easily than in the domestic markets.

v. International Positioning: Planning for an international offering has to be a part of the long-term perspective of a company. An international issue positions the issuing company, for a muchhigher visibility and an international exposure. Besides, it opens up new avenues for further


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fund-raising activities.

vi. Regulatory Aspects: For an international issue, approvals are required from the governmentof India and the Reserve Bank of India, whereas for a domestic issue the requirements to besatisfied are those of the SEBI and the stock exchanges.

vii. Disclosure Requirements: The disclosure requirements for an international issue are more

stringent as compared with a domestic issue. The requirements would, however, differdepending upon the market addressed and the place where listing is sought.

viii. Investment Climate: The international offering would be affected by factors like theinternational liquidity and the country risk, which will not have an effect in a domestic issue.With the current country rating, companies have to depend on the strength of their balancesheets to raise funds at competitive rates in the international markets.

< TOP >

2. Euro dollar market is mostly unregulated. This meant that Eurodollar banks could offer higherrates on deposits and charge lower rates on loans. So the most important factor affecting thesupply of and demand for Eurodollars is the desire of dollar depositors to receive highest yieldand the desire of dollar borrowers to pay the lowest interest on loans. Because of the absence of

reserve requirements, deposit-insurance requirements and other costly regulations, the Eurobanks can offer higher yields on dollar deposits than can US Banks. At the same time, the Eurobanks can charge lower interest on their advances. The lower interest rates on loans are madepossible by the absence of severe regulations and by the sheer size and number of informalcontacts among Euro banks. Higher rates on deposits and lower costs to borrowers meanoperating on narrow spreads for banks. So the growth of Eurodollar market is best attributed tothe ability of the Euro banks to operate on a narrow spread.

There are some advantages AIL can derive by borrowing Eurodollars rather than dollars in USA.There are many regulations of Federal Reserve like reserve requirements, deposit insuranceetc., which make dollar deposits costly in the US. The controls and restrictions of FederalReserve on borrowing funds in the US for reinvestment abroad make dollar borrowing costly forthe outsiders. Euro currency market does not face such stiff financial regulations as the USdomestic banking system. Also the flow of dollars in the Eurocurrency market is sufficient to

keep the euro dollar interest rate lower than US domestic rates. Also credit rating criteria ismuch more lenient in euro currency markets than in the US. So the cost of borrowing will alsobe lower in Eurocurrency market than in US market.

< TOP >

3. Eurocurrency interest rates cannot differ much from rates offered on similar deposits in thecurrencys home country. As we know, the rate offered to Eurodollar depositors is slightly higherthan in the United States, and the rate charged to borrowers is slightly lower. Each countrysmarket interest rates influence the euro currency interest rates, and vice versa, as they are allpart of the global money market. The total supply of each currency in this global market,together with the total demand, determines the rate of interest.

The interest rate charged to borrowers of euro currencies are based on London Interbank Offer

Rates (LIBOR) in the particular currencies. LIBOR rates are those charged in interbanktransactions and are base rates for non-bank customers. LIBOR rates are calculated as theaverages of the lending rates in the respective currencies of six leading London banks.Borrowers are charged on a LIBOR-plus basis, with the premium based on the credit worthinessof the borrower. With borrowing maturities of over 6 months, a floating interest rate is charged.

Every 6 months, the loan is rolled over, and the interest rate is reset based on the currentLIBOR rate. This reduces risk to both the borrowers and the lender, as neither will be left with along-term contract that does not reflect the current interest costs. For example, if interest ratesrise after the credit is extended, the lender will lose the opportunity to earn more interest rate


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for maximum 6 months. If interest rates fall after a loan is arranged, the borrower will lose theopportunity to borrow more cheaply for only 6 months. With the lower interest-rate risk, creditterms frequently reach 10 years.

< TOP >

4. a. i. Spot Rate Rs./$ 45.48/45.52

Middle rate = 45.50

Forward6 monthRs./$45.50 =45.8354

12 monthRs./$45.8354

=46.1733

18 monthRs./$46.1733 =46.5136

24 monthRs./$46.5136

=46.8565

30 monthRs./$46.8565 =47.2019

36 monthRs./$47.2019

=47.5498

42 monthRs./$47.5498 =47.9003


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48 monthRs./$47.9003 =48.2534

54 monthRs./$48.2534 =48.6091

60 monthRs./$48.6091 =48.9674

MonthPrincipal ($ Million)Interest rate (%)Interest payment ($ Million)Principal repayment ($ Million)Exchange rate (Rs./$)Total repayment (Rs. crore)

04445.48(200.11)

6446.501.430

45.83546.5545

12446.301.38646.17336.3996


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18446.451.41946.5136

6.6003

24446.501.43046.85656.7005

30446.251.375

47.20196.4903

36446.501.43047.54986.7996

4244

6.401.40847.90036.7444

48446.251.37548.25346.6348

54446.501.43048.60916.9511

60


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6.501.4304448.9674222.4589

Effective cost of the loan in rupee term is given by r in the following equation.

200.11 = 6.5545 PVIF (r/2, 1) + 6.3996 PVIF (r/2, 2) + 6.6003 PVIF (r/2, 3) + 6.7005 PVIF(r/2, 4) + 6.4903 PVIF (r/2, 5) + 6.7996 PVIF (r/2, 6) + 6.7444 PVIF (r/2, 7), 6.6348 PVIF (r/2,8) + 6.9511 PVIF (r/2, 9) + 222.4589 PVIF (r/2, 10)

For r/2 = 3% R. H. S. = 217.2616

For r/2 = 4% R. H. S. = 199.6650

\ = =

= 3 + 0.9747 = 3.9747%

\ r = 7.95%

a. ii. Spot Rate Rs./ 58.43/58.47

Middle rate = 58.45

Forward6 monthRs./ 58.45 =59.3181

12 monthRs./ 59.3181 =60.1990

18 monthRs./ 60.1990 =61.0931

24 monthRs./ 61.0931 =62.0003

30 monthRs./ 62.0003


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=62.9212

36 monthRs./ 62.9212

=63.8557

42 monthRs./ 63.8557 =64.8040

48 monthRs./ 64.8040

=65.7665

54 monthRs./ 65.7665 =66.7432

60 monthRs./ 66.7432

=67.7344

MonthPrincipal ( Million)Interest rate (%)Interest payment ( Million)Principal repayment ( Million)Exchange rate

(Rs./ )Total repayment (Rs. in crores)

03558.43


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(204.505)

6355.500.9625

59.31815.7094

12355.500.962560.19905.7942

18355.75

1.0062561.09316.1475

24356.001.050062.00036.5100

30

355.851.0237562.92126.4416

36355.600.980063.85576.2579

42355.500.962564.80406.2374

48


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355.751.0062565.76656.6178

54355.801.015066.74326.7744

605.801.01503567.7344

243.9454


204.505 = 5.7094 PVIF (r/2, 1) + 5.7942 PVIF (r/2, 2) + 6.1475 PVIF (r/2, 3) + 6.5100 PVIF(r/2, 4) + 6.4416 PVIF (r/2, 5) + 6.2579 PVIF (r/2, 6) + 6.2374 PVIF (r/2, 7) + 6.6178 PVIF(r/2, 8) + 6.7744 PVIF (r/2, 9) + 243.9454 PVIF (r/2, 10)

For r/2 = 4% R. H. S. = 211.2528

For r/2 = 5% R. H. S. = 194.1163

\ = =

= 4.3938%

\ r = 8.79%

b. Spot Rate Rs./ 0.4081/0.4091

Middle rate = 0.4086

Forward6MonthRs./0.4086

=0.4178

12MonthRs./ 0.4178 =0.4271


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18MonthRs./ 0.4271 =

0.4367

24MonthRs./ 0.4367 =0.4465

30MonthRs./

0.4465 =0.4566

36MonthRs./ 0.4566 =0.4668

42

MonthRs./ 0.4668 =0.4773

48MonthRs./ 0.4773 =0.4880

54MonthRs./ 0.4880 =0.4989

60


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MonthRs./ 0.4989 =0.5101

MonthPrincipal ( million)Interest rate (%)Interest paymentPrincipal repaymentExchange rate (Rs./)Total repayment rupees in crores

05000

0.4081(204.05)

650003.0075.000.41783.1335

125000

3.0075.000.42713.2033

1850003.0075.000.43673.2753

2450003.0075.000.44653.3488

305000


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3.0075.000.45663.4245

36

50003.0075.000.46683.5010

4250003.0075.000.47733.5798

4825003.0075.0025000.4880125.6600

5425003.0037.50

0.49891.8709

603.0037.5025000.5101129.4379


204.05 = 3.1335 PVIF (r/2, 1) + 3.2033 PVIF (r/2, 2) + 3.2753 PVIF (r/2, 3) + 3.3488 PVIF(r/2, 4) + 3.4245 PVIF (r/2, 5) + 3.5010 PVIF (r/2, 6) + 3.5798 PVIF (r/2, 7) + 125.66 PVIF(r/2, 8) + 1.8709 PVIF (r/2, 9) + 129.4379 PVIF (r/2, 10)

For r/2 = 4% R. H. S. = 200.6275

For r/2 = 3% R. H. S. = 217.7761

\ = =


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= 3.8004%

\ r = 7.60%.

Though the effective interest rate on yen borrowing is lower than dollar borrowing, SSIL isadvised to borrow in Eurodollar since yen is a very much volatile currency which may increasethe cost of borrowing in yen.

< TOP >

5. SSIL will face transaction and translation exposure if it borrows in dollar.

Transaction Exposure

Transaction exposure is the exposure that arises from foreign currency denominatedtransactions which an entity is committed to complete. In other words, it arises fromcontractual, foreign currency, future cash flows. For example, if a firm has entered into acontract to sell computers to a foreign customer at a fixed price denominated in a foreigncurrency, the firm would be exposed to exchange rate movements till it receives the paymentand converts the receipts into the domestic currency. The exposure of a company in a particularcurrency is measured in net terms, i.e. after netting off potential cash inflows with outflows.

Translation Exposure

Translation exposure is the exposure that arises from the need to convert values of assets andliabilities denominated in a foreign currency, into the domestic currency. For example, acompany having a foreign currency deposit would need to translate its value into its domesticcurrency for the purpose of reporting at the time of preparation of its financial statements. Anyexposure arising out of exchange rate movement and the resultant change in the domestic-currency value of the deposit would classify as translation exposure. It needs to be noted thatthis exposure is mostly notional, as there is no real gain or loss due to exchange ratemovements since the asset or liability does not stand liquidated at the time of reporting. Hence,it is also referred to as accounting exposure. This fact makes the measurement of translationexposure dependent on the accounting policies followed for the purpose of converting theforeign-currency values of assets and liabilities into the domestic currency.

< TOP >

Section E: Caselets

Caselet 1

6. Unlikely to the continuous linked settlement system, in the CCIL settlement system thesettlements are guaranteed by CCIL. Principal risk is substantially reduced in CCIL system. Alsomarket risk is taken care of by CCIL which is not done in the continuous linked settlement

system. All settlement participants are equal. They take exposures on CCIL as CentralCounterparty. Under continuous linked settlement system Settlement Members are required totake credit exposure on another Settlement Member. Third party members settling through aSettlement Member really have no control on the exposures they take on the SettlementMember through whom they decide to settle their transactions. As CCIL settlement system isdeferred net settlement, liquidity requirement is significantly lower compared to the continuouslinked settlement system. The model is simple, easy to implement and extremely efficient. Itbrings in almost all market participants into the system irrespective of their credit standingswhile simultaneously reducing the systemic risk substantially.


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Interbank settlements require huge settlement related activities: Matching of counterpartyconfirmations, effecting payments through the nostro accounts, tracking payments and receipts,reconciliation of nostro accounts, effecting back-valuation or payment of interest for delayedpayments, ensuring collection of interest for delayed receipts etc. Settlement through CCILresults in contraction of all these activities into effecting a single payment in either of thecurrencies (Indian rupee or US dollar) and tracking a single payment and a single receipt perday. Cost savings in the form of reduction in back office activities has therefore been

substantial.

Payment or receipt of interest on delayed settlements had always been a contentious issuebetween the counterparties and required considerable cost and effort on the part of both theinvolved entities to resolve. In the past, these disputes or cases of delays used to finally reachFEDAI and used to take significant portion of their time and attention. Since settlement of tradesstarted through the settlement system of CCIL, cases of such claims have come down tonegligible numbers evidencing the extent of cost savings and efficiency achieved by the financialmarket as a whole. Standardization of the processes in regard to deal reporting, gettinginformation about the status of the deals etc. has also provided opportunities for the creation ofa cost effective online system for tracking of positions based on exceptional events. This offerssignificant opportunities for reduction of operational risk.

< TOP >

7. On the risk management front, the benefits as expected have been enormous. Multilateral netsettlement with closely controlled processes has virtually eliminated all principal risks except forthe net US dollar sale position of the participants. This element of risk has also been keptrestricted to acceptable amounts in respect of all participating entities by setting Exposure Limitsand is also additionally covered by the margins collected for the principal risk element (varyingfrom 3% for highly rated entities to 8.5% for the lowest rated entities allowed into the system).Moreover, the ability created to claw back the counter-value Indian rupee funds from theprincipal account of any defaulting entity with RBI has further reinforced the system.

Furthermore, from the three days in the Spot Window (CASH, TOM and SPOT), principal risk iskept confined to only the CASH date by ensuring that in case of a default, no payout happens onthe subsequent days to the account of any defaulting entity without receipt of the counter-valuefunds. Market risk in the system is taken care of by adding a market risk factor, for collection of

margin, in respect of each settlement date. Thus market risk cover is also available for almostall positions of the participants for all settlement dates.

The process, apart from causing huge reduction of risk to the individual settlement participanthas also caused huge reduction of total risk to the system as a whole. In absence of asettlement system like the system run by CCIL, the maximum possible reduction in counterpartyexposures could have been to reach such level of bilateral exposures. Moreover, for a bank,even US dollar sale position creates exposure as it is not possible for it to ensure receipt ofcounter-value Indian rupee funds before release of the US dollar payments. Thus, at bilaterallevel, both US dollar sale and US dollar buy positions create exposures Indian rupee exposure incase of US dollar sale and US dollar exposure in case of US dollar Buy. The counterparty wisenet bilateral exposures, irrespective of whether those were US dollar Buy positions or US dollarSale positions, were therefore summed up for each settlement date to arrive at the totalbilateral exposures of the settlement participants for such settlement date.

For the same settlement dates, total exposures of the settlement participants for settlementthrough CCIL were arrived at by taking the sum of net US dollar payable amounts for therespective settlement dates. As against such huge number of transactions, the settlementthrough CCIL's settlement system caused the number of payment transactions for thesettlement participants to come down The enormous cost reduction and reduction in operationalrisk due to the reduced number of settlement is thus evident. It also made the system robustand significantly more reliable.

< TOP >


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Caselet 2

8. There are many factors that influence the exchange rate of US dollar. Generally speaking,there are mainly four reasons: first, the health condition and the rate of return for investment of

the US economy, secondly, the balance of international payment in the US, thirdly, the level ofinterest rates in the US compared with those in other countries, and fourthly, the rate ofinflation. Meanwhile, there are also many other temporary pounding factors from without, suchas wars, oil price, scandals from large companies as well as psychological factors etc, which arebelieved to have connections with former four factors.

Judging from the estimation by various parties, evident enough, many economists take thebalance of international payments as the decisive factor for the trend of the US dollar. Althoughthis kind of view is not unreasonable, it is partial. If considered from history, people will find outthat the balance of international payment featuring trade deficit and current account deficit hasbeen dominating the US economy since 1970s. But the track of the US dollar's circulation doesnot show a plummet drop.

The exchange rate of US dollar used to be high for two times since the US implemented the

floating exchange rate: one occurred during Reagan's reign while the other was in Clinton's rule.So far as Reagan's reign is concerned, the federal budget deficit, trade deficit and currentaccount deficit were high, but the exchange rate of US dollar was also high. It is simply becausethe high deficit triggered the high interest rate and high interest rate consequently resulted inhigh exchange rate. The trade deficit is not the result of the change of exchange rate but ratherits reason. What was worth mentioning is that the surplus was realized during Clinton's rule. Butthe condition of international payment hadn't been much improved due to the low private savingrate and the exchange rate of US dollar still strong. The major reason is because of the stronggrowth of the US economy, low returning rate and high interest rate.

< TOP >

9. Generally speaking, the sharp drop of the US dollar exchange rate is impossible unless all theUS dollar holders worldwide sell US dollars in large amount simultaneously, just like depositors

draw money from banks during the bank credit crisis. First, the US economy still boasts thehighest growth rate and strongest competitiveness among major developed countries, and othercountries are still confident about the US economy; secondly, the US dollar, serving a role of acurrency for international reserve, has become the natural defense for the sharp devaluation ofUS dollar; thirdly, since foreigners hold a huge amount of US dollars, they will suffer severelosses if they sell dollars in large amount and will not easily find a suitable substitution.Furthermore, the safety and circulation of euro, Japanese yen and gold are no better than theUS dollar.

Although there is no sign of sharp drop in the exchange rate of US dollar, the possibility ofgradual depreciation of it cannot be removed. In the view of Bush administration, instead ofbringing harm on the growth of US economy, the orderly devaluation of US dollar can boost theexportation and narrow the trade deficit, particularly when the inflation is under control.

Therefore, should the balance of international payment exist for a long time, it would definitelybe the decisive factors for the depreciation of the US dollar. But some other factors wouldprobably counteract its function in different periods and lead the US dollar to appreciation. Thistendency is believed to be likely to happen in medium or short term.

< TOP >

10. A falling dollar can substantially reduce the trade deficit. A lower US trade deficit will ofcourse mean a decline in the exports of Asian countries. Countries that lose exports need toadopt policies to stimulate domestic spending in order to prevent a decline in their GDP and


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employment levels.

Where this all ends will depend not only on market forces but also on the policies of thegovernments and central banks of Asia. It will be tempting but wrong for them to resist thedecline in the US trade imbalance by using a combination of monetary policy and exchangemarket intervention to prevent the dollar's shift to an appropriately competitive level.

Without that competitive dollar, the higher saving rate in the US will mean slower US growthand rising unemployment. If that happens, the American political process is likely to turn toprotectionist measures to shrink the trade imbalance and maintain employment.

It would be far better to allow the natural market forces to bring about the needed currencyrealignment. Instead of seeking to resist the dollar's shift to a more competitive level,governments in Asia should focus on developing policies to maintain aggregate demand in theirindividual economies as their export sales decline.

< TOP >

Caselet 3

11. There is general talk of hopeful prospects for poor farmers gaining greater access to rich-

world markets. But the benefits will not flow evenly from rich to poor. The package includesquota-free and duty-free" access for 50 LDCs to markets in rich nations and increase in fundsfor the aid for trade program that is meant for the increasing capability of the poor countries totake part in trade. The package also makes a mention about technical assistance, helping totrain the developing nations with the global regulations pertaining to trade and mechanisms.There were certain element of resistance from the US and Japan relating to the exclusion ofcertain products from duty-free, trade-free formula. One of the primary reasons for thisresistance can be due to the fact that the US can take advantage of the ban and implement thesame in the case of textiles. As a consequence, textile being one of the crucial exports of thepoorest nations from the LDCs, namely Cambodia and Bangladesh, it would compensate for allthe benefits arising out of exports in these countries. In another instance, Japan has also put upa cause for the inclusion of rice and leather products in the deal. Though some of the LDCsexpect that the benefits arising out of the package would even be felt at the poorest sections ofthe society, mainly the farmers as most of their exports are in the agricultural products. At the

same time, it needs to be mentioned that with the existent inequalities in the market, it isquestionable as to how much effectively things would be put in place. Thus, it is important thatone reviews the policy that seems to have an exaggerated focus towards market access as aroad towards economic development.

< TOP >

12. According to our commerce minister India had certain reasons to smile. It ensures that nosubsidy-ridden farm products are exported to India the phase out of the export subsidies bydeveloped countries would also give the Indian farmers a chance to compete in the worldmarket. The success of India in the meet resulted out of its strategy of forming a coalition of thedeveloping nations (G-110) that was established in the summit. The agreement intends toprotect the domestic farmers against increase in imports through the provisions of SpecialProducts and Special Safeguard Mechanism that was a part of the ministerial declaration. Under

the provisions of the Special Products, India and other developing countries would not have tocut the tariffs on certain products while the Special Safeguard Mechanism would take intoaccount both the prices and volume triggers in an effort to check the increase in cheap imports.Added to this, India will not have to undertake any cuts in the domestic support. In the non-agricultural market access, India's proposal along with that of Argentina and Brazil continues totop on agenda. On the services front, India has succeeded in confirming that there will be nocompulsion on the part of developing countries to open up its service sectors. It has also beenagreed that in relation to the discussions pertaining to geographical indications and thebiological diversities that were of particular interest to India, it would be hastened by June 30,2006. As per the Ministry of Commerce, India would also be able to draw up a list of 90 special


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products that would lie outside the purview of the tariff reduction formula and would also enablethe Indian farmers to protect their crucial crops from global competition. With all this in place,the Indian industry would stand to benefit as the developed countries decided to reduce theduties on products that are of interest to the developing countries.

Problems (50 Marks)

This section consists of questions with serial number 1 5.



Detailed workings should form part of your answer.

Do not spend more than 110 - 120 minutes on Section B.

1On 02.01.2006 M/s Sportsfolio Private Ltd., a Unit in Santacruz Exports Processing Zone,Mumbai, opened an L.C. for USD 100,000 for import of machinery from USA. As per the termsof LC, the last date for shipment is 15.02.2006 and negotiation is 28.02.2006. On 01.02.2006the Finance Manager of the company booked a forward contract with option for delivery from17.02.2006 to 16.03.2006, when the ongoing market rates were:

As on 01.02.2006

Spot Rate Rs./$ 44.08/44.10

Forward 1-Month 03/05



The machinery could not be shipped due to non-availability of ship to carry the consignment toMumbai. The Finance Manager was on leave and no decision was taken for extension of LC aswell as extension of forward sale contract. The bank has cancelled the contract on 31.03.2006as per FEDAI Rules.

The ongoing rates on 31.03.2006 are as follows:

Spot Rate Rs./$ 44.50 / 44.52




Additional information:

(i) Rs./$ Spot TT rates on 16.03.2006 is Rs.44.46/44.48


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(ii) Interest rate applicable on outlay of funds is 12% p.a.

You are required to calculate:

a. The forward rate quoted by the bank on 01.02.2006.

b. The cancellation charges payable by Sportsfolio.

c. The interest amount payable on outlay of funds.

(4 + 4 + 3 = 11 marks)< Answer >

2Indian Remedies Ltd., a leading drug manufacturing company based at Gurgaon is planning toinvest in a bulk drug manufacturing unit in Malaysia. After the initial appraisal of the projectusing the Adjusted Present Value (APV) technique, the firm arrives at a negative NPV of Rs.500million. The Government of Malaysia evince interest to encourage the investment, in the form ofarranging a concessional loan of US$ 200 million as the project is expected to create 3,000 jobsdirectly and indirectly. The principal of concessional loan has to be repaid in four equal

installments, commencing at the end of third year and interest to be repaid annually. Thefinancial institutions are charging 9% interest for similar type of loans in Malaysia. The currentexchange rate is Rs.44.62/$.

You are required to find out the interest rate on concessional loan to make the project viable

(10 marks)< Answer >

3Consider the following exchange rates :

US $ Equivalent

US Market

Singapore Dollar (S$) Spot0.6330/33

3 month forward0.6357/60

Euro () Spot1.2818/21

3 month forward

1.2898/01

Equivalent Singapore $


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Singapore Market

Euro () Spot2.0379/82

You are required to

a. Verify whether there is a possibility of triangular arbitrage to exploit the difference betweenS$-Euro cross rates in the U.S. market and the S$-Euro rates in the Singapore market. Indicateclearly which currency you would buy/sell and in which market.

If you have $1 million, calculate the profit or loss from the triangular arbitrage.

b. Compute what is the 3-month risk less interest rate in the U.S. (expressed as effective annualrate), if risk less rate of interest in the Singapore market for 3-month is 3.25% p.a.compounded annually?

(6 + 5 = 11 marks)< Answer >

4A Finance company in Mumbai proposes to invest rupee funds equivalent to 10 million for oneyear in London market. The return on investment over the period of investment will be 8%. Thecurrent exchange rates are as follows:

Rs./Spot53.15/53.20

1- year forward53.25/53.30

A foreign bank has agreed to offer 10 million at a rate of Rs.53.10/ and swap the sameamount at Rs.53.20/ after one year. The rupee cost of the funds to the company is 7%.

You are required to calculate the actual returns earned under forward cover and swap deal andsuggest the company whether it should go for the simple forward cover or accept the foreignbanks offer.

(8 marks)< Answer >

5Kwality Oils Ltd., an exporter of coconut oil in Kochi has submitted a 45 days bill for Can$600,000 drawn under an irrevocable LC for negotiation. The company asked its banker to retain

50% of the bill amount under EEFC (Exchange Earners Foreign Currency) account.

The rates for US$ in the inter-bank market are quoted as under:

As on 04.04.2006

Rs./US$ Spot 44.51 / 44.61

1-month forward 08/09


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2-months forward 16/17

3-months forward 26/27

US$ is quoted in the Montreal market as under:

Spot: Can $/US$ 1.1671 /1.1675

1- month forward 19 / 17

2- months forward 28 / 26

3- months forward 36 / 34

Additional information:

(i) Transit period is 15 days

(ii) Interest on post-shipment credit is 8.5%

(iii) Exchange margin required is 0.1%

You are required to compute

a. Exchange rate quoted to the company.

b. The rupee inflow to the company.

(7 + 3 = 10 marks)< Answer >

END OF SECTION B

Section C : Applied Theory (20 Marks)




Do not spend more than 25 -30 minutes on section C.

6There are four methods to translate the financial statements of a foreign entity into domesticcurrency. Discuss those four methods.

(10 marks)

< Answer >

7For India to increase its share in the global trade a comprehensive view is needed to be takenfor the overall development of the economy. Explain briefly the highlights of the Foreign TradePolicy 2004-2009.

Section B : Problems

1.


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a. Computation of Forward Rate at which the Forward Sale contract was booked by the bank on01.02.2006

(Rs./$) Spot Ask Rate 44.10

Ask rate for 17.02.2006 {(44.10) + (0.05 X) = 44.129 44.13

Ask rate for 16.03.06 {(44.15) + (0.08 X) = 44.189 44.19

The rate quoted should be higher of above two rates i.e. Rs.44.19/$.

b. Cancellation charges payable by the customer +/- Exchange difference:

Forward Sale contract will be cancelled at the spot TT buying rate of Rs/$ prevailing on16.03.2006, the last day for taking delivery under the contract.

Bank bought $ under cancellation Rs. 44.46

Bank sold the dollar under original contract Rs. 44.19

Exchange difference payable per dollar by customer Rs. 0.27

Exchange difference for $100,000 payable by customer is Rs.27,000 + Rs.100 towardscancellation charges

c. Interest on outlay of funds:

On 16.03.2006, due to the inability of the customer to take delivery of the currency undercontract

the bank was forced to execute the contract by purchasing $100,000 at Rs.44.46/$ from themarket, the difference being 0.27 per 1$ and the total amount involved is Rs.27,000 and theinterest payable works out as Rs.133.15( @ 12% for 15 days).< TOP >

2.Let the interest rate on concessional loan be r"

YearPrincipal

OutstandingRepaymentInterestTotal repayment

1

200--200r200r

2.200

200r200r


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3.20050200r200r + 50

4.15050150r150r + 50

5.10050100r100r + 50

650

5050r50r +50

Present value of repayments

= 200r X PVIF (9% 1) + 200r X PVIF (9% 2) + (200r + 50) X PVIF (9% 3)

+ (150r+50 ) XPVIF (9% 4) + (100r + 50) X PVIF ( (9% 5) + (50r +50) X PVIF (9% 6)

= (200r x 0.9174) + ( 200r x 0.8417) + (200r + 50) ( 0.7722) + (150r + 50) ( 0.7084)

+ (100r + 50 ) ( 0.6499) + (50r + 50) (0.5963)

= 183.48r + 168.34r + ( 154.44r +38.61) + (106.26r + 35.42) + (64.99r + 32.50) + (29.82r +29.82)

= 707.33r + 136.35

If the project is to be accepted APV = 0

So, [ 200 (707.33r + 136.35)] x 44.62 = 500


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Or, [ 63.65 707.33r ] =

Or, 707.33r = 63.65 11.206

Or, r = = 7.41%.

So the interest on the concessional loan should be less than 7.41% to make the project viable.< TOP >

3.a. In the U.S. market the cross rate of S $/Euro is:

(S$/)bid = (S$/$)bid ($/)bid = ($/)bid = = 2.0240

(S$/)ask = (S$/$)ask ($/)ask = ($/)ask = = 2.0254

Cross rates: S$/ 2.0240/2.0254

Spot rate: S$/ 2.0379/2.0382

Since synthetic ask rate is lower than the actual bid rate there is possibility of three pointarbitrage.

Thus, Euro is cheaper in the US market and worth more in Singapore. Therefore, we can buyEuro in the US, sell Euro in Singapore for Singapore $. Which we will sell in the US to convertback into US$. The triangular arbitrage will be implemented as follows:

First we buy euro for $1,000,000 in US.

Thus we get Euro 1,000,000 = 779,970.36

Then we sell this 779,970.36 in Singapore market for S$

Thus we get S$ = 779,970.36 2.0379 = S$ 1,589,501.60

Finally we sell this S$ in US market for dollars = 1,589,501.60 0.6330 = $1,006,154.51

Profit from the trasaction = 1,006,154.51 - 1,000,000 = $ 6,154.51.

b. 3 month risk less rate in Singapore

=

= 0.8028%

By interest rate Parity.

Or, 1+ rus =

rus = 0.01233 for 3 months

Effective annual rate = (1 + 0.01233)4 1 = 1.05024 1 = 5.024%.< TOP >


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4.Rupee out flow at spot rate for acquiring 10 million 10 53.20 = Rs.532 million

Rupee cost of funds = 532 0.07 = 37.24 million

Return from Investment = 10 0.08 million

= 0.80 million

Total inflow = 10 + 0.80 = 10.80 million

Rupee inflow if covered through forward market = 10.80 53.25

= Rs.575.10 million

Net gain = 575.10 [500 + 37.24] = Rs.37.86 million.

Return = , say 7.12%.

If the company accepts foreign banks offer:

Initial rupee outflow = 10 m 53.10

= 531.00 million

Rupee cost of funds = 531.00 0.07 = 37.17 million

Out of the total investment matured, 10 million is to be paid back to foreign bank and will payRs. 53.20/ and rest 0.80 million can be sold through forward cover @ Rs. 53.25/.

Rupee inflow from swap deal = 10m 53.20 = Rs.532 million

Rupee inflow from forward cover = 0.80m 53.25 = Rs.42.60 million

Total rupee inflow after one year = 532 + 42.60 = Rs.574.60 million

Net gain = 574.60 (531.00 + 37.17)

= 574.60 568.17 = Rs.6.43 million

Return =

The finance company should reject the banks offer, as the return is less.< TOP >

5.(i) Exchange Rate quoted to the Company:

Usance of the bill and transit period come to 60 days i.e. two months.

US$/Rs. Spot rate = 44.51

Add: Premium for two months = + 0.16

= 44.67

Less: Exchange Margin. 0.1% = +0.0445

Bill Buying rate for US$ = 44.6255


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In the Montreal Market US$ is quoted at discount, dollar selling rate for 2 months is

Can.$/US $ spot ask rate = 1.1675

Less : Discount for two months = (-) 0.0026

Can.$/US$ ask rate = 1.1649

Can.$ Bill buying rate : (Rs/US$)bid

=

= 38.3084

Exchange Rate quoted to company = Rs./Can.$ 38.3084.

ii. Rupee Inflow to the Company:

Can. $ 3,00,000 @ Rs. 38.3084, the exporter will receive 1,14,92,520

Less: Interest for 45 days Usance period + 15 days transit period

@ 8.5% p.a (-) 1,62,810

Net Cash inflow to the Company Rs.1,13,29,710< TOP >

Section C: Applied Theory

6.There are four methods which guide the translation of the financial statements of a foreignentity, whether independent or integrated. These are

Current/Non-Current method

Monetary/Non-monetary method

Temporal method

Current rate method

For understanding these methods, we need to first understand a few terms:

Historical exchange rate: It is the rate at which a transaction was actually settled. For example,the rate which was used to convert the domestic currency into the foreign currency for settlingthe payment for a machinery bought by the company. In cases where no actual currencyconversion takes place, it is the rate prevailing at the time the original transaction took place.

For example, if the machinery in the above example was bought by a foreign subsidiary, therewould have been no conversion of currency. In that case, the historical rate would have beenthe rate prevailing when the machinery was bought.

Current or closing exchange rate: It is the rate prevailing on the date of translation of accounts.

Average rate: It is the average of the rates prevailing over a certain period of time.

CURRENT/NON-CURRENT METHOD


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This method is based on the premise that exposure is linked to the maturity of the asset orliability and hence, does not give importance to its nature. It advocates the conversion of allcurrent assets and liabilities at the closing rate, and all non-current assets and liabilities at thehistorical rate. All items of income and expenditure are required to be converted at the averagerate for the relevant period, except those items that are related to non-current assets andliabilities. All such items (like depreciation) are to be converted at the same rate as the relatedasset or liability.

As the non-current assets and liabilities are converted at the historical rate, this method resultsin only the current assets and liabilities being exposed to exchange rate movements. Hence,when the foreign subsidiary has a positive working capital, the parent company books anexchange gain on depreciation of the domestic currency, and an exchange loss on itsappreciation. Conversely, when the foreign subsidiary has a negative working capital, the parentcompany would book an exchange loss on depreciation of the domestic currency, and anexchange gain on its appreciation.

MONETARY/NON-MONETARY METHOD

This method emphasizes the nature of the item rather than its maturity. It classifies assets andliabilities into monetary and non-monetary. Monetary items are money held and assets andliabilities to be received or paid in fixed or determinable amounts of money. Under this method,

the monetary assets and liabilities (like cash, accounts receivables, accounts payable) aretranslated at the closing rate, and the non-monetary items (like inventory, building aretranslated at the historical rate). Items of the income statement are translated at the averagerate, except for those related to the non-monetary items (like depreciation and cost of rawmaterial consumed). These are translated at the rate at which the corresponding non-monetaryasset or liability is translated. This differentiation between the items of the income statementmay lead to some mismatches. For example, while sales are translated at the average rate, apart of cost of goods sold (to be specific, cost of raw materials consumed) may get reflected atthe historical rate.

TEMPORAL METHOD

This method classifies items on the basis of whether they are valued at historical basis or onmarket price basis. All the items of the balance sheet that are valued on historical cost basis are

translated at the historical rate, and those which are valued on current value (or realizablevalue) are valued at the closing rate. Effectively, this method is a modification of themonetary/non-monetary method, as the monetary assets and liabilities get converted at theclosing rate, with the non-monetary items getting converted at the historical cost. Themodification lies in the fact that under the temporal method, the inventory gets converted at theclosing rate despite being a non-monetary item, if it is valued in the balance sheet at therealizable value. Under this method, the income statement items are also translated in the sameway as under the monetary/ non-monetary method.

CURRENT RATE METHOD

Under this method, all assets, liabilities, incomes and expenditures are translated at the currentor closing rate. The idea is to retain the relationship (ratios) between various items of thebalance sheet and income statement.

< TOP >

7.FOREIGN TRADE POLICY 2004-2009

For India to become a major player in world trade, an all encompassing , comprehensive viewsneed to be taken for the overall development of the countrys foreign trade. While increase inexports is of vital importance, we have also to facilitate those imports, which are required tostimulate our economy. Coherence and consistency among trade and other economic policies isimportant for maximizing the contribution of such policies to development. Thus, while


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incorporating the existing practice of enunciating an annual trade policy, it is necessary to gomuch beyond and take an integrated approach to the developmental requirements of Indiasforeign trade.

The principal objectives of the foreign trade policy are:

i. To double our percentage share of global merchandise trade with in the next five years.

ii. To stimulate sustained economic growth by providing access to essential raw materials,intermediates, components, consumables and capital goods required for augmenting productionand providing services.

iii. To enhance the technological strength and efficiency of Indian agriculture, industry andservices, thereby improving their competitive strength while generating new employmentopportunities and to encourage the attainment of internationally accepted standards of quality.

iv. To provide consumers with good quality goods and services at internationally competitiveprices while at the same time creating a level playing field for the domestic producers.

The first National Foreign Trade Policy for the period 2004-09 incorporating the export andimport policy for the period 2002-07 came into force with effect from 1st September, 2004 and

shall remain in force up to 31st August, 2009. The Policy has for the first time tried to integratethe trade policy with the process of Country's Economic development.

The be new trade policy replaces the five-year Export-Import Policy of 2002-07. The mostimportant factor that proves the similarity between the new and existing policy is the implicationof WTO agreement and the Free Trade Agreement between India and other countries.

The new initiatives announced for agriculture and other thrust areas such as handicrafts, handlooms, gems and jewelry, and leather and footwear are appreciable.

Further, in the new trade policy export-oriented units will be exempted from the service tax andbiotechnology parks in the country would get all the facilities of 100% export-oriented units. Inaddition to the above, the government has liberalized the EPCG benefits, the permission totransfer capital equipment to group companies, the extension of duty-free entitlement benefits

to some more sectors, duty relief on fuel consumed by exporting units, and determination todouble exports and keep a special focus on agriculture, all as a part of focusing on the newpolicy.

Foreign Trade Policy (2004-2009) Highlights

1. Strategy

It is for the first time that a comprehensive Foreign Trade Policy is being notified. The ForeignTrade Policy takes an integrated view of the overall development of India's foreign trade.

The objective of the Foreign Trade Policy is two-fold:

i. To double India's percentage share of global merchandise trade by 2009; and

ii. To act as an effective instrument of economic growth by giving a thrust to employmentgeneration, especially in semi-urban and rural areas.

The key strategies are:

i. Unshackling of controls;

ii. Creating an atmosphere of trust and transparency;


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iii. Simplifying procedures and bringing down transaction costs;

iv. Adopting the fundamental principle that duties and levies should not be exported;

v. Identifying and nurturing different special focus areas to facilitate development of India as aglobal hub for manufacturing, trading and services.

Foreign Trade Policy

2. Special Focus Initiatives

Sectors with significant export prospects coupled with potential for employment generation insemi-urban and rural areas have been identified as thrust sectors, and specific sectoralstrategies have been prepared. Further sectoral initiatives in other sectors will be announcedfrom time to time. For the present, Special Focus Initiatives have been prepared for Agriculture,Handicrafts, Handlooms, Gems & Jewelry and Leather and Footwear sectors.

The threshold limit of designated. Towns of Export Excellence is reduced from Rs.I ,000 crore toRs.250 crore in these thrust sectors.

3. Package for Agriculture

The Special Focus Initiative for Agriculture includes:

A new scheme called Vishesh Krishi Upaj Yojana has been introduced to boost exports of fruits,vegetables, flowers, minor forest produce and their value added products.Duty free import ofcapital goods under EPCG scheme.

Capital goods imported under EPCG for agriculture permitted to be installed anywhere in theAgri Export Zone.

ASIDE funds to be utilized for development for Agri Export Zones also. Import of seeds, bulbs,tubers and planting material has been liberalized. Export of plant portions, derivatives and

extracts has been liberalized with a view to promote export of medicinal plants and herbalproducts.

4. Gems & Jewelry

Duty free import of consumables for metals other' than; gold and platinum allowed up to 2% ofFOB value of exports.

Duty free re-import entitlement for rejected jewelry allowed up to 2% of FOB value of exports.

Duty free import of commercial samples of jewelry increased to Rs.I lakh. Import of gold of 18carat and above shall be allowed under'. the replenishment scheme.

5. Handlooms & Handicrafts

Duty free import of trimmings and embellishments for Handlooms and Handicrafts sectorsincreased to 5% of FOB value of exports.

Import of trimmings and embellishments and samples shall be exempt from CVD.

Handicraft Export Promotion Council authorized to import trimmings, embellishments andsamples for small manufacturers.

A new Handicraft Special Economic Zone shall be established.


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6. Leather & Footwear

Duty free entitlements of import trimmings, embellishments and footwear components forleather industry increased to 3% of FOB value of exports. Duty free import of specified items forleather sector increased to 5% of FOB value of exports. Machinery and equipment for EffluentTreatment Plants for leather industry shall be exempt from Customs Duty.

7. Export Promotion Schemes

a. Target Plus

A new scheme to accelerate growth of exports called Target Plus has been introduced. Exporterswho have achieved a quantum growth in exports would be entitled to for duty free credit basedon incremental exports substantially higher than the general actual export target fixed. Rewardswill be granted based on a tiered approach. For incremental growth of over 20%, 25% and100%, the duty free credits would be 5%, 10% and 15% of FOB value of incremental exports.

b. Vishesh Krishi Upaj Yojana

Another new scheme called Vishesh Krishi Upaj Yojan (Special Agricultural Produce Scheme) has

been introduced to boost exports of fruits, vegetables, flowers, minor forest produce and theirvalue added products. Export of these products shall qualify for duty free credit entitlementequivalent to 5% of FOB value of exports. The entitlement is freely transferable and can be usedfor import of a variety of inputs and goods.

c. Served from India Scheme

To accelerate growth in export of services so as to create a powerful and unique "Served fromIndia" brand instantly recognized and respected the world over; the earlier DFEC scheme forservices has been revamped and re-cast into the Served from India scheme. Individual serviceproviders who earn foreign exchange of at least Rs.5 lakhs, and other service providers whoearn foreign exchange of at least Rs.I0 lakhs will be eligible for a duty credit entitlement of 10%of total foreign exchange earned by them. In the case of standalone restaurants, the entitlementshall be 20%, whereas in the case of hotels, it shall be 5%. Hotels and Restaurants can use

their duty credit entitlement for import of food items and alcoholic beverages.

d. EPCG

Additional flexibility for fulfillment of export obligation under EPCG scheme in order to reducedifficulties of exporters of goods and services.

Technological upgradation under EPCG scheme has been facilitated and incentivized.

Transfer of capital goods to group companies and managed hotels now permitted under EPCG.

In case of movable capital goods in the service sector, the requirement of installation certificatefrom Central Excise has been done away with.

Export obligation for specified projects shall be calculated based on concessional dutypermitted to them. This would improve the viability of such projects.

e. DFRC

Import of fuel under DFRC entitlement shall be allowed to transfer to marketing agenciesauthorized by the Ministry of Petroleum and Natural Gas.

f. DEPB


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The DEPB scheme would be continued until replaced by a new scheme to be drawn up inconsultation with exporters.

Income tax benefits on plant and machinery shall be extended to DT A units, which convert toEOUs.

Import of capital goods shall be on self-certification basis for EOUs.

For EOUs engaged in Textile & Garments manufacture leftover materials and fabrics up to 2% ofClF value or quantity of import shall be allowed to be disposed off on payment of duty ontransaction value only.

Minimum investment criteria shall not apply to Brass Hardware and Handmade Jewelry EOUs(this facility already exists for Handicrafts, Agriculture, Floriculture, Aquaculture, AnimalHusbandry, IT and Services). .

8. New Status Holder Categorization

A new rationalized scheme of categorization of status holders as Star Export Houses has beenintroduced as under:

Category Total performance over three years

Star Export Houses shall be eligible for a number of privileges including fast-track clearanceprocedures, exemption from furnishing of Bank Guarantee, eligibility for consideration underTarget Plus Scheme, etc.

9. EOUs

EOUs shall be exempted from Service Tax in proportion to their exported goods and services.

EOUs shall be permitted to retain 100% of export earnings in EEFC accounts.

Income tax benefits on plant and machinery shall be extended to DTA units, which convert toEOUs.

Import of capital goods shall be on self-certification basis for EOUs.

For EOUs engaged in Textile and Garments manufacture leftover materials and fabrics up to2% of CIF value or quantity of import shall be allowed to be disposed off on payment of duty ontransaction value only.

10. Free Trade and Warehousing Zone

A New scheme to establish Free Trade and Warehousing Zone has beenintroduced to createtrade-related infrastructure to facilitate the import and export of goods and services withfreedom to carry out trade transactions in free currency. This is aimed at making India into aglobal trading-hub. Units in the FTWZs would qualify for all other benefits as applicable for SEZunits.

11. Services Export Promotion Council

An exclusive Services Export Promotion Council shall be set up in order to map opportunities forkey services in key markets, and develop strategic market access programs, including brandbuilding, in co-ordination with sectoral players and recognized nodal bodies of the servicesindustry.

12. Common Facilities Center


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Government shall promote the establishment of Common Facility Centers for use by homebased service providers, particularly in areas like Engineering and Architectural design, Multi-media operations, software developers etc., in State and District-level towns, to draw in a vastmultitude of home-based professionals into the services export arena.

13. Procedural Simplification & Rationalization Measures

Import of second-hand capital goods shall be permitted without any age restrictions.

Minimum depreciated value for plant and machinery to be re-located into India has beenreduced from Rs.50 crores to Rs.25 crores.

All exporters with minimum turnover of Rs.5 crores and good track record shall be exempt fromfurnishing Bank Guarantee in any of the schemes, so as to reduce their transactional costs.

All goods and services exported, including those from DT A units, shall be exempt from ServiceTax.

Validity of all licenses/entitlements issued under various schemes has been increased to auniform 24 months.

Number of returns and forms to be filed has been reduced. This process shall be continued inconsultation with Customs & Excise.

Enhanced delegation of powers to Zonal and Regional offices of DGFT for speedy and lesscumbersome disposal of matters.

Time bound introduction of Electronic Data Interface (EDI) for export transactions. 75% of allexport transactions to be on EDI within six months.

14. Pragati Maidan

In order to show case our industrial and trade prowess to its best advantage and leverageexisting facilities, Pragati Maidan will be transformed into a world-class complex. There shall bestate-of-the-art, environmentally controJled, visitor friendly exhibition areas and marts. A huge

Convention Center to accommodate 10,000 delegates with flexible hall spaces, auditoria andmeeting rooms with high-tech equipment, as well as multi-level car parking for 9,000 vehicleswill be developed within the envelope of Pragati Maidan.

15. Legal Aid

Financial assistance would be provided to deserving exporters, on the

recommendation of Export Promotion Councils, for meeting the costs of legal expensesconnected with trade-related matters.

16. Grievance Redressal

A new mechanism for grievance redressal has been formulated and put into place by a

Government Resolution to facilitate speedy redressal of grievances of trade and industry.

17. Quality Policy

DGFT shall be a business-driven, transparent, corporate-oriented organization.

Exporters can file digitally signed applications and use Electronic Fund Transfer Mechanism forpaying application fees.

All DGFT offices shall be connected via a central server making application processing faster.


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DGFT HQ has obtained ISO 9000 certification by standardizing and automating procedures.

18. Board of Trade

The Board of Trade shall be revamped and given a clear and dynamic role. An eminent person orexpert on trade policy shall be nominated as President of the Board of Trade, which shall have aSecretariat and separate Budget

Head, and will be serviced by the Department of commerce.

International Financial management

Q.1 Answer the following questions:

(a) Define exposure, differentiating between accounting and economic exposure.

(b) Describe at least three circumstances under which economic exposure is likely to exist.

(c ) Of What relevance are the International Fisher effect and purchasing power panty to you answer to parts

(a) and (b)

(d) What is exchange risk as disinter form exposure?

Q.2 The principal problem in analyzing different form of export financing is the distribution of risk between

the exporter and the importer. Analyze the following export financing instruments in this respect:

1. Confirmed revocable letter of credit

2. Confirmed irrevocable letter of credit

3. Open account credit

4. Time draft D/A

5. Cash in advance

6. Consignment

Q.3 (a) What risks confront dealers in the foreign exchange market?

(b) an investor wishes to buy French spot (at $0.10

IN Rs.5.5880) and sell French francs forward for 180 days (at $0.10

IN Rs.5.5886)

Q.4 Todays high interest rates put a premium on careful management of cash and marketable securities.

(a) What techniques are available to an MNC with operating subsidiaries in many countries to economize on

these short term assets?

(b) What acre the advantages and disadvantages of centralizing the cash management function?

(c ) What can the firm do to enhance the advantages and reduce the disadvantages described in part (b) ?

Q.5 The experiences of fixed exchange rate systems and target zone arrangements have not been entirely

satisfactory.

(a) What lessons can be drawn form the breakdown of the Breton woods system?


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(b) What lessons can be draws form the exchange rate experiences of the European Monetary system?

Q.1 (a) The international economy is fast Turing into a borderless global village. Critically examine.

(b) What is the impact of devaluation on foreign investment? How is foreign direct investment different form

imitational capital movements in general?

Q.2 (a) Explain the functions and role of the world Bank IDA and IFC. How do they differ form each other?

(b) How effective has the regulation of international financial system been? Discuss with suitable examples.

Q.3 what are the various kinds of foreign exchange exposures? If you are a finance manager of

anIndia software Multinational Company how would you measure the possible translation exposure, if Re.

devalues by 5% against $

Q.4 what is a political risk? How is it forecasted? Do you think management of political risk is very crucial for

successful foreign direct investment decision? If yes how? Given some examples of recent political risks inthe India context.

Q.5 (a) What are important techniques of exposure management which may be internally adopted by a

multinational firm?

(b) Spot U.K /Rs. is 1 = Rs.68.90 day sincerest rates in Indiana and U.K money markets are 10% and 6%

respectively. What is the expected /Rupee 90 days forward rate?

Q.6 (a) In which countries or currencies would you like to retain a higher proportion of your earnings for

reinvestment? Explain with reasons

(b) Write a brief note highlighting special problems of developing countries in financing foreign trade. Alsoindicate possible ways out.

Q.7 What is the difference between foreign direct investment and portfolio investment? To what extent is the

building up of separate investment strategies justified by such difference?

Q.1(a) What is the primary goal of multinational companies? Why is stockholders wealth maximisation more

important than profit maximisation?

(b) Who do volatile exchange rates exist?

Q.2 (a) A countrys current account balance is equal to its private savings surplus minus its government

budget deficit. Assume that a country has a current account surplus of $10,000.00

IN Rs.557,926.71 a government budget deficit of $1,500.00

IN Rs.83,689.01 and private savings of $12,000.00

IN Rs.669,512.06. what is the country private investment? Is the country saving more or less than is needed

to finance its private investment and budget deficit?

(b) Most developing countries have incurred huge balance of payments deficits for many years. What

alternatives are available to these countries for dealing with their balance of payments problems?


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Q.3 (a) Discuss some causes of deviations form purchasing power parity.

(b) The exchange rate for Japanese Yen is $0.00

IN Rs.0.0069 per years and a call option has a strike price of $0.00

IN Rs.0.0065. an investor has two call options. If the investor exercises, the call options how much profit

would be realized.

Q.4 (a) What is the basic purpose of economic exposure management?

(b) A.U.S Company has a singly wholly owned affiliate in Japan. This affiliate has exposed assets of Y500

million and exposed liabilities of Y 800 Million. The exchange rate appreciates form Y 150 per dollar to Y 100

per dollar.

1. what is the amount fo net exposure?

2. What is the amount of the transaction gain or loss

Q.5 (a) What is the role of a factor in foreign trade? How can a factor aid an exporter?

(b) What are bills of lading and how do they facilitate trade financing?

Q.6 (a) Explain the theory of comparative advantage as a motive for foreign trade. What is the logic behind

third- theory?

(b) Comment on the flow of foreign direct investment in India since 1991.

Q.7 (a) Explain the globalisation of financial markets.

(b) Why has the Euro-currency market grown so rapidly?Q.1(a) Identify the factors which are to be taken into consideration by the countries, which see to make use

of foreign capital on their terms.

(b) The international economy is fast turning into a borderless global economy. Critically analyse in relation

to international financial System.

Q.2 Prepare a Balance of Payment (BoP) Statement with the following data. Show clearly, sub-balance such

as trade balance. Current account balance and capital account balance etc. in the statement.

(a) UFL Ltd. of USA invests in India. Rs.30, 00,000 to modernize its Indian Subsidiary.

(b) A tourist form South Africa buys souvenir worth Rs. 30,000 to carry with him. He also paid hotel and

travel bills of Rs. 50,000 to a travel agency.

( c) UFL Ltd. remitted Rs. 50,000 as dividends to its parent company in USA.

(d) The Indian subsidiary of UFL Ltd. sold a part of its production in other Asia countries for Rs. 10,00,000.

UFL also borrowed Rs. 20,00,000 to be paid in 6 month) form the British money market for meeting it

immediate liquidity needs.

(e) An Indian company buys a machine for Rs. 10,00,000 form Germany. 60% of the payment is made

immediately and the balance to be made after 3 years.


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(f) An Indian subsidiary of French company borrowed Rs. 5,00,000 form the Indian Public to invest for the

modernization.

Q.3 (a) What do you mean by Foreign Exchange Market? Discuss the role played by the main participants in

this market.

(b) Explain briefly and illustrate with an example the chain method of marking out cross rates.

Q.4 Explain the need for foreign exchange exposure management. Discuss the various external exposure

management techniques thistle used to manage the exchange risk.

Q.5 (a) Define Letter of Credit explain the explain the various forms of Letters of Credit. Which one is more

popular and Why?

(b) Explain briefly the different types of policies offered by she Export Credit Guarantee to provide cover for

Uestion Paper Ift

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