Finance Acharya Jatin Nagpal 10A.

1 Krivii Eduspace

Ch 10A - Forex
Index - Main Questions Ques Number
Cross rates & application of cross rates 1–5
Foreign investment 6
Arbitrage (Triangular arbitrage and Covered Interest Arbitrage) 7–8
Forward premium & Discount 9 – 10
Hedging using forward Contact 11 – 15
Should you avail credit or Not? 16 – 18
Leading and Lagging 19
Money Market operations (MMO) 20 – 21
Fate of forward contracts 22 – 26
Nostro, Vostro, Loro 27
Exposure calculation 28 – 30
International Cash Management 31 – 33
Discrete Questions 34 – 35

Index - Additional Questions Ques Number

Basics 1
Arbitrage (Triangular arbitrage and Covered Interest Arbitrage) 2–4
Forward premium & Discount 5–7
Should you avail credit or Not? 8
Fate of forward contracts 9
Nostro, Vostro, Loro 10 – 11
Discrete Questions 12
Low Probability Unique Questions
- Geographical arbitrage when rates of different locations are given 13
- Cost under FR vs MMO vs Unhedged “when Tax rate is given” 14
- Bifurcating difference due to time factor vs currency fluctuation 15
- Calculating Cash inflow when “Transit and usance” period is given 16
Simplified AFM Ques Bank 10A.2 Forex

Main Questions
Cross rates & application of cross rates

Squaring off existing trade using Cross rate

# Ques 1 – Trigarta {SM TYK}
Trigarta ltd. had entered into a cross currency deal and had sold US$ 10 Lacs against € at US $
= € 1.4400 for spot delivery. However, during the day the market became volatile and Trigarta in
compliance with the managements’ guidelines had to square up the position when quotes were:
Spot US$ 1 INR 31.4300 / 4500
Spot US$ 1 € 1.4400 / 4450
What will be the gain or loss in the transaction in terms of ₹?
Ans: Step 1: calculating profit/loss in Euro €
Sold $10 L: 10 L x 1.440 = 14,40,000
Bought $10 L: 10 L x 1.4450 = 14,45,000
Gain/(loss) = (€5,000)

• Loss in ₹ terms = € 5.000 x 21.8403 (WN 1) = ₹1,09,201.5

WN 1: ₹/€ = ₹ x $ = 31.43 x 1 – 31.45 x 1 = 21.7509 – 21.8403

$ € 1.4450 1.440

Squaring off existing trade using Cross rate

# Ques 2 – Tripura {SM TYK, N20 Exam (Old), N24 MTP 1}
You sold Hong Kong Dollar 1,00,00,000 value spot to Mrs. Tripura at ₹ 5.70 & covered yourself in
London market on the same day, when the exchange rates were:
• US$ 1 = H.K.$ 7.5880 - 7.5920
• Local inter-bank market rates for US$ were → Spot US$ 1 = ₹ 42.70 - 42.85
Calculate cover rate and ascertain the profit or loss in the transaction. Ignore brokerage.
Ans: Bank (Dealer) covers itself by buying from inter-bank market at market Ask rate.
Rupee – Dollar selling rate ₹ 42.85
Dollar – Hong Kong Dollar HK $ 7.5880
Finance Acharya Jatin Nagpal 10A.3 Krivii Eduspace
Rupee – Hong Kong cross rate = ₹ 42.85 / 7.5880 ₹ 5.6471

Profit / Loss to the Bank

Amount received from customer (1 crore × 5.70) = ₹ 5,70,00,000
(-) Amount paid on cover deal (1 crore × 5.6471) = ₹ 5,64,71,000
= Profit to Bank = ₹ 5,29,000

Comparing cross rates on 2 diff. dates to calculate P&L

# Ques 3 – Sarayu {SM TYK, N18 RTP (New), N19 RTP (Old), M24 MTP 2}
On Jan.28, 2005 Sarayu requested a bank to remit Singapore Dollar SGD 25,00,000 under an
irrevocable LC. However, due to bank strikes, the bank could effect’s the remittance only on Feb.4,
2005. The inter-bank market rates were as follows:
28th Jan. 4th Feb.
Bombay US 1 ₹ 45.85 /45.90 45.91 / 45.97
London Pound 1 $ 1.7840 / 1.7850 1.7765 /1.7775
London Pound 1 SG $ 3.1575 / 3.1590 3.1380 /3.1390

The bank wants to retain an exchange margin of 0.125%. How much does the customer stand to gain
or loss due to the delay? (Calculate rate in multiples of 0.001).
Ans: ₹ = ₹ x $ x £
SGD $ £ SGD

• Ask rate on 28th Jan. = 45.90 x 1.7850 x 1 /3.1575 = ₹25.8931/SGD

• Effective rate = 25.8931 + 0.125% = ₹25.9806 / SGD

• Ask rate on 4th Feb. = 45.97 x 1.7775 x 1/3.1380 = ₹26.0394 / SGD

• Effective rate = 26.0394 + 0.125% = ₹26.0719 / SGD

• Loss to customer = (26.0719 – 25.9806) x 25 lacs = ₹228250

Selecting Optimum cross rate to square off existing trade

# Ques 4 – Parikshit {SM TYK, N20 RTP (Old), N20 MTP 1 (Old)}
You, a foreign exchange dealer of Parikshit Bank, are informed that your bank has sold a T.T. on
Copenhagen for Danish Kroner 10,00,000 at the rate of Danish Kroner 1 = ₹6.5150. you are the
transaction either in London or New York market. The rates on required to cover that date is as
Simplified AFM Ques Bank 10A.4 Forex
under:
Mumbai – London ₹74.3000 – ₹74.3200
Mumbai – New York ₹49.2500 – ₹49.2625
London – Copenhagen DKK 11.4200 – DKK 11.4350
New York – Copenhagen DKK 07.5670 – DKK 07.5840

In which market will you cover the transaction, London, or New York, and what will be the exchange
profit or loss on the transaction? Ignore brokerages.
Ans: Amount realized on DKK sale @ ₹6.515 = ₹ 65,15,000

# Option 1 – Cover in London

• Buy DKK at London = 10,00,000/11.42 = £ 87,565.67
• Buy $ at 1$ = ₹74.32 = 87,565.67 x 74.32 = ₹ 65,07,881
» Profit = ₹65,15,000 – 65,07,881 = ₹ 7,119

# Option 2 – Cover in New York

• Buy DKK at New York = 10,00,000/7.567 = $ 1,32,152.77
• Buy $ at 1$ = ₹49.2625 = 1,32,152.77 x 49.2625 = ₹ 65,10,176
» Profit = ₹65,15,000 – ₹65,10,176 = ₹ 4,824

Decision :- Buy from London as it leads to higher profit.

Calculating Forward rate using Cross rate + Swap points + exchange margin
# Ques 5 – Nitya {SM TYK, M18 Exam (Old), N20 RTP (Old)}
An Importer customer of Nitya Bank wishes to book a forward contract with your bank on 3 rd Sep
for sale to him of SGD5,00,000 to be delivered on 30th October. The spot rate on 3rd Sep are:
USD/INR = 49.3700/3800 and USD/SGD = 1.7058/68.
The swap points are:
USD/₹ USD/SGD
Spot/Sep. 0300/0400 1st month forward 48/49
Spot/Oct. 1100/1300 2nd month forward 96/97
Spot/Nov. 1900/2200 3rd month forward 138/140
Spot/Dec. 2700/3100
Spot/Jan. 3500/4000
Calculate the rate to be quoted to the Importer by assuming an exchange of 5 paisa.
Finance Acharya Jatin Nagpal 10A.5 Krivii Eduspace
Ans: ₹/SGD Forward ask rate = ₹x$ = 49.56 / 1.7154 = 28.8912
$ SGD

• Hence, applicable forward rate for Importer = ₹28.8912/SGD

WN 1: ₹/$ Oct FR (ask) = SR + Swap points + ₹ commission

= 49.3800 + 0.1300 + 0.05 = ₹49.56/$

WN 2: SGD/$ Oct. FR = SR + Swap points

= (1.7058 + 0.0096) – (1.7068 + 0.0097)
= 1.7154 – 1.7165

• $/SGD Oct. FR = 1/1.7165 – 1/1.7154

Foreign investment

Finding Indifferent return (b/w HC & FC)

# Ques 6 – Nandi
With the relaxation of investment norms in India in international market up to $ 2,50,000, Mr. Nandi
wants to hedge himself against the risk of declining Indian economy and weakening of Indian Rupee
during last few years decided to diversify into international market. Accordingly, he invested a sum
of ₹1.58 crore on 1.1.2001 in Standard & Poor Index. On 1.1.2002 he sold his investment.
The other relevant data is given below:
1.1.2001 1.1.2002
Index of Stock Market in India 7395 ?
Standard & Poor Index 2028 1919
Exchange Rate 62.00/62.25 67.25/67.50
(i) Determine the return for a US investor.
(ii) Determine return of Mr. Nandi of holding period.
(iii) Determine the value of Index of Stock Market in India as on 1.1.2002 at which Mr. Nandi would be
indifferent between investment in Standard & Poor Index & Indian Stok Market.
Ans: Return on S&P = 1919 – 2028 = –5.375%
2028
• Return on $ = 67.25 – 62.25 = 8.032%
62.25
Simplified AFM Ques Bank 10A.6 Forex

• Effective return = (1 + S&P return) (1 + $ return) – 1

= (1 – 0.05375) (1 + 0.08032) – 1 = 0.02225 or 2.225%

(i) Return for US investor = S&P return = -5.375%

(ii) Return of Mr. Nandi = Effective return = 2.225%
(iii) For Indifference → Nifty return should be equal to Effective return on foreign investment i.e. 2.225%

• Hence, Closing value of Nifty = 7395 + 2.225% = 7560 approx.

Triangular Arbitrage

Basic Triangular Arbitrage (No bid-ask rates / commission etc.)

# Ques 7 – Maharathi {SM TYK, N20 Exam (New), N20 RTP (New), N24 MTP 2}
Following are the spot exchange rates quoted at three different forex markets:
USD/INR 48.30 in Mumbai
GBP/INR 77.52 in London
GBP/USD 1.6231 in New York

Maharathi has USD 1,00,000 assuming that there is no transaction cost, explain whether there is any
arbitrage gain possible from the quoted spot exchange rates.
Ans: Rough Analysis (Show in exam “Only if time allows”)
• £ Price in Direct market $ 1.6231
• £ Price in Indirect market: $/£ = ₹/£ x $/₹ = 77.52 x 1/48.30 $ 1.605
• Decision: Buy £ indirectly ($ → ₹ → £) and then sell it in Direct market (£ → $)

» Main Answer:
Step 1 – Buy £ Indirectly ($ → ₹ → £)
• Sell $ 1,00,000 to get ₹ = 1,00,000 x 48.30 ₹ 48,30,000
• Sell ₹ 48.30 Lacs to get £ = 48,30,000 x 1/77.52 £ 62,306.50

Step 2 – Sell £ Directly (£ → $)

• Sell £ to get $ = 62,306.50 x 1.6231 $ 1,01,130
» Arbitrage profit = $1,01,130 – $1,00,000 $ 1,130
Finance Acharya Jatin Nagpal 10A.7 Krivii Eduspace
Covered Interest Arbitrage (CIA)

Basic CIA (No bid-ask rates / No Separate deposit – borrowing rates)

# Ques 8 – Sushumna {SM TYK, M18 Exam (New), N18 Exam (Old)}
₹/$ Spot rate = ₹48.0123
180 days Forward rate = ₹48.8190
Annualised interest rate for 6 months- ₹ = 12%
Annualised interest rate for 6 months- US $ = 8%

Is there any arbitrage possibility? If yes then how Mrs. Sushumna an arbitrageur can take advantage
of the situation, if she is willing to borrow ₹40,00,000 or US $83,312. Further should arbitrageur
go for Covered Interest Rate Arbitrage if she has forecasted the spot rates 180 days hence as:
Future rate for 1 US $ Probability
₹48.7600 25%
₹48.8000 60%
₹48.8200 15%
Ans: Today
• Borrow $88,312 from US and Invest in India. ₹ Invested today = 83,312 x 48.013 = ₹40 lacs

After 3-months
A ₹ investment value = 40 L (1 + 0.12 x6/12) = ₹ 42,40,000
B $ repayment = 83,312 (1 + 0.08 x 6/12) = $ 86,644.48
C ₹ at forward rate = 86,644.48 x 48.819 = ₹ 42,29,897
D ₹ at Expected spot rate = 86,644.48 x 48.793 = ₹ 42,27,644

E Arbitrage profit
- at forward rate =A–C= ₹ 10,103
- at Expected rate = A – D = ₹ 12,356

Decision - It is better to go for “Uncovered arbitrage” as it leads to higher arbitrage profit.

However, unlike covered arbitrage it may lead to significant risk of exchange rate fluctuation.

WN 1: Expected spot rate = {48.76 x 0.25} + {48.8 x 0.6} + {48.82 x 0.15} = 48.793
Simplified AFM Ques Bank 10A.8 Forex
Forward premium & Discount

Selecting Optimum invoicing currency for Export & Import

# Ques 9 – XP Pharma {Jul 21 Exam (New), N23 MTP 2}
XP Pharma Ltd., has acquired an export order for ₹10 million for formulations to a European co.
The Co. has also planned to import bulk drugs worth ₹ 5 million from a Co. in UK. The proceeds of
exports will be realized in 3 months from now and the payments for imports will be due after six
months from now. The invoicing of these exports and imports can be done in any currency i.e., Dollar,
Euro or Pounds sterling at company's choice. The following market quotes are available.
Spot Rate Annualised Premium
₹/$ 67.10/67.20 $ - 7%
₹ /Euro 63.15/63.20 Euro - 6%
₹ /Pound 88.65/88.75 Pound - 5%
Advice the co. about invoicing in which currency. Calculation should be up to three decimal places.
Ans: (i) Proceeds of Exports in INR = ₹ 10 Million
Position of Inflow under three currencies will be as follows:

# Invoice at SR Expected rate after 3m Conversion in INR after 3m

$ 100L / 67.10 = $149031.297 67.10 (1 + 0.07/4) = ₹68.27 68.27 x 149031.297 = ₹1,01,74,367
€ 100L / 63.15 = €1,58,353.127 63.15 (1 + 0.06/4) = ₹64.10 64.10 x 158353.127 = ₹1,01,50,435
£ 100L/88.65 = £1,12,803.158 88.65 (1 + 0.05/4) = ₹89.76 89.76 x 112803.158 = ₹1,01,25,211

(ii) Payment of Import in INR = ₹ 5 Million

Position of outflow under three currencies will be as follows:

# Invoice at SR Expected rate after 6m INR after 6 months

$ 50L / 67.20 = $74404.762 67.20 (1 + 0.07/2) = ₹69.55 69.55 x 74404.762 = ₹51,74,851
€ 50L/ 63.20 = €79,113.924 ₹63.20 (1 + 0.06/2) = ₹65.10 65.10 x 79,113.924 = ₹51,50,316
£ 50L/88.75 = £56,338.028 ₹88.75 (1 + 0.05/2) = ₹90.97 90.97 x 56,338.028 = ₹51,25,070

Advice: Since cash inflow is highest (1,01,74,367) in case of $ hence invoicing for Export should be
in $. However, cash outflow is least (51,25,070) in case of £ the invoicing for import should be in £.

Effective cost of loan = Interest cost (after TDS adjustment) + Currency Premium
# Ques 10 – Chalo Chalo {N19 Exam (Old)}
Finance Acharya Jatin Nagpal 10A.9 Krivii Eduspace
A German subsidiary of a US based MNC “Chalo Chalo ltd.” has to mobilize 100000 Euro's working
capital for the next 12 months. It has the following options:
Loan from German Bank: @ 5% p.a.
Loan from US Parent Bank: @ 4% p.a.
Loan from Swiss Bank: @ 3% p.a.
Banks in Germany charge an additional 0.25% p.a. towards loan servicing. Loans from outside
Germany attract withholding tax of 8% on interest payments. If the interest rates given above are
market determined, examine which loan is the most attractive using interest rate differential.
Ans: Net Cost under each of the Options is as follows:
(i) Loan from German Bank = 5% + 0.25% = 5.25%

(ii) Loan from US Parent Bank

• Effective Rate of Interest = 4% / (1 – 0.08) 4.35%
• Premium on US$: (1.05 / 1.04) – 1 0.96%
» Net cost: 5.31%

(iii) Loan from Swiss Bank

• Effective Rate of Interest = 3% / (1 – 0.08) 3.26%
• Premium on US$: (1.05 / 1.03) – 1 1.94%
» Net cost: 5.20%

# Comment - Thus, loan from Swiss Bank is the best option as the Total Outflow including Interest is
Less i.e. €105200

Hedging using forward Contact

V. Basic – Using FR to hedge outflow

# Ques 11 – Anahita {SM TYK, M23 RTP}
Anahita Co have taken a 6-month loan from their foreign collaboration for $ 2 million, interest
payable on maturity is at LIBOR plus 1.0%. Current 6-month LIBOR for USD is 2% p.a. and for INR
is 6% p.a. Enquiries regarding Exchange rate with their bank elicit the following data:
• Spot USD 1 ₹ 48.5275
• 6 Months forward ₹ 48.4575

(i) What would be their total commitment in Rupees, if they enter, into a forward contract?
Simplified AFM Ques Bank 10A.10 Forex
(ii) Will you advise the company to enter, into a forward contract? Explain giving Reasons.
Ans: Effective Interest rate = USD LIBOR + 1% = 2% + 1% = 3% p.a.
Amount payable after 6-months = 2 Mn x (1 + 0.03 x 6/12) = $ 2.03 million

(i) ₹ outflow under forward contract = 2.03 million x 48.4575 = ₹ 9,83,68,725

(ii) Since, Forward rate (48.4575) < Spot rate (48.5275), ⸫ it is advisable to enter, into a forward contract.

Covering Trnx @ FR vs Expected SR

# Ques 12 - Suger Pine {SM TYK, Dec 21 Exam (New)}
Suger Pine ltd. operating in Japan has today effected sales to an Indian company, the payment being
due 3 months from the date of invoice. The invoice amount is 108 lakhs yen. At today's spot rate,
it is equivalent to ₹ 30 lakhs. It is anticipated that the exchange rate will decline by 10% over the
3 months period and in order to protect the yen payments, the importer proposes to take appropriate
action in the foreign exchange market. The 3 months forward rate is presently quoted as 3.3 yen
per rupee. You are required to calculate the expected loss and to show how it can be hedged by a
forward contract.
Ans: Calculation of rates
• ¥/₹ Spot rate (SR) = ¥108L / ₹30L ¥ 3.6 / ₹
• Expected SR after 3 months = 3.6 x 0.9 ¥ 3.24 / ₹
• 3 months Forward rate (FR) ¥ 3.3 / ₹

Particulars Without Forward With Forward contract

Present cost of 108 lakhs yen ₹ 30L ₹ 30L
Cost after 3 months: ₹ 33.33L (108L / 3.24) ₹ 32.73L (108L / 3.3)
Expected exchange loss ₹ 3.33L ₹ 2.73L

» Loss under forward < Loss under expected rate. Hence, taking forward contract is suggested.

Net cost of Forward contract = FR + FV of Premium charged by bank

# Ques 13 – Kalyani {SM TYK, N20 Exam (New), Dec 21 Exam (New), M23 MTP 1, N24 RTP}
Kalyani Ltd. is considering hedging its foreign exchange risk. It has made a purchase on 1st July,
2016 for which it has to make a payment of US$ 60,000 on Dec 31, 2016. The present. exchange
rate is 1 US $ = ₹ 65. It can purchase forward 1 $ at ₹ 64. The company will have to make an
upfront premium @ 2% of the forward amount purchased. The cost of funds to the co. is 12% p.a.
Finance Acharya Jatin Nagpal 10A.11 Krivii Eduspace

(i) Compute the profit/loss the co. will make if it hedges its foreign exchange risk with the exchange rate
on 31st Dec, 2016 as: (a) ₹ 68 per US $ (b) ₹ 62 per US $
(ii) Should the co. hedge its exposure if the probability distribution of expected USD Spot rate for
31 Dec, 16 is as follows:
Exchange rate 61 64 66 68
Probability 0.25 0.4 0.15 0.2

Alternatively, part (ii) can also be written as:

Advise the co. a suitable cover for its risk, if it can hedge its position with the following expected rate
of USD in foreign exchange market on 1st July 2020:
Exchange rate 61 64 66 68
Probability 0.25 0.4 0.15 0.2
A: Calculating cost of hedging Amount ₹
A. Forward premium = $60,000 x 64 x 2% 76,800
B. Interest for 6 months = 76,800 x 12% x 6/12 4,608
C. Total hedging cost = A + B 81,408
D. Amount to be paid for US$ 60,000 @ ₹ 64 38,40,000
E. Total cost under forward cover = C + D 39,21,408

(i) Net P&L if forward cover is taken (i) ₹68/$ (ii) ₹62/$
A. Cost @ Spot rate = 60,000 x SR 40,80,000 37,20,000
B. Cost under forward cover (39,21,408) (39,21,408)
C. Net gain = B – A 1,58,592 (2,01,408)

(ii) Unhedged vs Hedged position

• Total expected outflow if exposure is not hedged = 60,000 x 64.35 (WN 1) ₹ 38,61,000
• Cost under forward cover ₹ 39,21,408
• Since expected cashflow is less in case of unhedged position company should opt for the same.

WN 1: Expected SR on 31 Dec, 2016 = {61×0.25} + {64×0.4} + {66×0.15} + {68×0.2} = ₹ 64.35 / $

Expected loss @ FR vs Expected SR vs Actual SR

# Ques 14 – Nalini {SM TYK, N18 RTP (Old), M24 RTP}
Nalini Ltd., an Indian company has an export exposure of JPY 10,000,000 receivable August 31, 2014.
Simplified AFM Ques Bank 10A.12 Forex
Japanese Yen (JPY) is not directly quoted against Indian Rupee.
Current spot rates Forward rates for August 2014
INR/US $ = ₹ 62.22 INR/US $ = ₹ 66.50
JPY/US$ = JPY 102.34 JPY/US$ = JPY 110.35

It is estimated that Japanese Yen will depreciate to 124 level and Indian Rupee to depreciate
against US $ to ₹ 65. Required:
i) Calculate the expected loss, if the hedging is not done. How the position will change, if the firm
takes forward cover?
ii) Is the decision to take forward cover justified if the spot rates on August 31, 2014 are:
INR/US $ = ₹ 66.25
JPY/US$ = JPY 110.85
Ans: ₹/¥ SR on date of export = ₹/$ x $/¥ = 62.22/102.34 = ¥0.6080
Expected Rate of ¥ for Aug = ₹ 0.5242 (₹65/¥124)
Forward Rate of ¥ for Aug = ₹ 0.6026 (₹ 66.50/¥110.35)

i) Calculation of expected loss @ Expected SR & @ Forward rate

A. Export value as on today = ₹0.608 × ¥10Mn ₹ 60,80,000
B. Receivable at expected SR (₹0.5242 × ¥10Mn) ₹ 52,42,000
C. Loss at expected rate (C = A – B) ₹ 8,38,000
D. Receivable under Forward (₹0.6026 × ¥10Mn) ₹ 60,26,000
E. Loss under forward contract (E = A – D) ₹ 54,000

By taking forward cover loss is reduced to ₹ 54,000.

ii) Actual Rate of ¥ on August 2014 = ₹ 0.5977 (₹66.25/¥110.85)

A. Export value as on today = ₹0.608 × ¥10Mn ₹ 60,80,000
B. Amount at SR as on 31 Aug = ₹0.5977 × ¥10Mn = ₹ 59,77,000
C. Loss (C = A – B) ₹ 1,03,000

The decision to take forward cover is still justified.

Calculating Contribution to sales ratio to decide on “Forward vs Expected SR”

# Ques 15 – Shikhandi {SM TYK, N19 Exam (New)}
Following information relates to Shikhandi Ltd. Which manufactures some parts of an Electronics
Finance Acharya Jatin Nagpal 10A.13 Krivii Eduspace
device which are exported to USA, Japan & Europe on 90 days credit terms.
Cost and Sales Information: Japan USA Europe
Variable cost per unit ₹ 225 ₹ 395 ₹ 510
Export sale price per unit ¥ 650 $ 10.23 € 11.99
Sale Receipts due in 3 months ¥ 78,00,000 $ 1,02,300 € 95,920

Other Info: ¥/₹ US $/₹ €/₹

Spot market 2.417-2.437 0.0214–0.0217 0.0177-0.0180
3-m forward 2.397-2.427 0.0213–0.0216 0.0176–0.0178
3-m expected SR 2.423-2.459 0.02144 – 0.02156 0.0177 – 0.0179

Advice by calculating contribution to sales ratio whether the co. should take forward contract or not.
Ans: Total contribution (I) When risk is hedged (II) When risk is not hedged
A. Total receipts (WN 1 & 2) 1,33,38,719 1,32,75,578
B. Total variable cost (WN 3) 1,07,30,000 1,07,30,000
C. Contribution = A - B 26,08,719 25,45,578
D. Contribution ratio = C/A x 100 19.56% 19.17%

WN 1: Total receipt when risk is hedged

• Sum due ¥ 78,00,000 $ 1,02,300 €95,920
• 3-m Forward ask rate 2.427 0.0216 0.0178
» Rupee value of receipts ₹ 32,13,844 ₹ 47,36,111 ₹ 53,88,764

• Total receipts = 32,13,844 + 47,36,111 + 53,88,764 = ₹1,33,38,719

WN 2: Total receipt when risk is not hedged

• Sum due ¥ 78,00,000 $ 1,02,300 € 95,920
• 3-m Forward ask rate 2.427 0.0216 0.0178
» Rupee value of receipts ₹ 31,72,021 ₹ 47,44,898 ₹ 53,58,659

• Total receipts = 31,72,021 + 47,44,898 + 53,58,659 = ₹ 1,32,75,578

WN 3: Calculating total variable cost

• Sum due ¥ 78,00,000 $ 1,02,300 € 95,920
÷ Unit input price ¥ 650 $ 10.23 € 11.99
Simplified AFM Ques Bank 10A.14 Forex
= Unit sold 12,000 10,000 8,000
× Variable cost PU ₹ 225 ₹ 395 ₹ 510
» Variable cost ₹ 27 Lacs ₹ 39.5 Lacs ₹ 40.80 Lacs

• Total cost = 27,00,000 + 39,50,000 + 40,80,000 = ₹ 1,07,30,000

Decision – Co. should hedge its foreign currency exchange risk as it leads to higher contribution to
sales ratio.

Should you avail credit or Not?

Avail credit from Supplier vs Loan from bank

# Ques 16 – Ramya {SM TYK, N22 MTP 1}
Ramya Ltd. has imported goods to the extent of US$ 1 crore. The payment terms are 60 days
interest-free credit. For additional credit of 30 days, interest at the rate of 7.75% p.a. will be charged.

The banker of Ramya Ltd. has offered a 30 days loan at the rate of 9.5% p.a. Their quote for the
foreign exchange is as follows:
Spot rate INR/US$ 62.50
60 days forward rate INR/US$ 63.15
90 days forward rate INR/US$ 63.45

Which one of the following options would be better?

i) Pay the supplier on 60th day and avail bank loan for 30 days.
ii) Avail the supplier's offer of 90 days credit.
Ans: (i) Option 1 - Pay the supplier in 60 days
Outflow in ₹ = $1 crore x ₹63.15/$ ₹ 63.15 crore
(+) Interest for 30 days = 63.15(1+ 0.095×30/360) ₹ 0.50 crore
= Total Outflow in ₹ ₹ 63.65 crore

ii) Option 2 - Availing supplier’s offer of 90 days credit

Amount Payable $ 1.0000 crore
(+) Interest for 30 days @ 7.75% p.a. $ 0.00646 crore
= Total Outflow in USD $ 1.00646 crore
₹ Outflow @ FR = 1.00646 crore × 63.45 ₹ 63.86 crore
Finance Acharya Jatin Nagpal 10A.15 Krivii Eduspace

Outflow under Option 1 (63.65) < Outflow under option 2.

Hence, supplier should be paid in 60 days by availing bank loan.

Loan from Local bank vs Loan from Foreign bank using LC (by paying commission for LC)
# Ques 17 – Alert {SM TYK, N19 RTP (Old), M22 Exam, M23 RTP}
Alert ltd. Is planning to import a multi-purpose machine (asset) from Japan at a cost 3,400 Lakhs
YEN. The company can avail loans at 18% interest per annum with quarterly rests or compounding,
with which it can import the machine (asset), from India. However, there is an offer from Tokyo
branch of an India Based bank extending credit of 180 days at 2% p.a. in Tokyo itself against
opening of an irrevocable letter of credit.

Other information:
• Present Exchange rate ₹ 100 = 340 YEN
• 180 day’s forward rate ₹ 100 = 335 YEN
• Commission charges for letter of credit is 2% per 12 months in INDIA to be payable today.

(i) Advise whether the offer from the foreign branch should be accepted? Take 365 Days in a year.
(ii) Based on the present market condition company is not interested to take the risk of currency
fluctuations and wanted to hedge with an additional expense of ₹25 lacs. If so, what is your advice
to the company?
Ans: Calculation total cost under each of the options
# Option 1 – Take loan from India (in Lacs)
• Loan amount = ¥ 3400L x 1/3.4 ₹ 1000
• Repayment amount = 1000L x (1 + 0.18/4)2 ₹ 1092.025

# Option 2 – Take loan of ¥3400 Lacs from Tokyo (in Lacs)

A. ¥ Repayable after 6 months = 3400 (1 + 0.02 × 180/365) ¥ 3433.53
B. Equivalent amount in ₹ = 3433.53 / 3.35 ₹ 1025
C. Future value of commission paid (WN 1) ₹ 10.92
D. Total ₹ payable = B + C ₹ 1035.92

(i) Decision -> Loan from Tokyo is preferred due to lower outflow.

(ii) Loss due to forward rate (as compared to spot rate) = 1025 – 1000 = ₹ 25 lacs
Simplified AFM Ques Bank 10A.16 Forex
• Hence, if an alternative hedging option is available at an additional cost of 25 lacs, then the co. can
select that option. Because forward contract is also resulting in increased outflow by same amount.

# WN 1: Future value of commision

• Commission payable on LC = (3400 x 1/3.4) x 2% x 6/12 ₹ 10 Lacs
• FV of commission payable = 10 L x (1 + 0.18/4)2 ₹ 10.92 Lacs

• LC will be taken in terms of HC i.e. ₹ in this case. ₹ equivalent of ¥3400 = ₹1000 L. (i.e., 3400 x 1/3.4).
• Since commission is paid today (whereas all other payments are after 6-m), ⸫ we’ll calculate the FV
of commission after 6-m.

Pay Immediately vs later when “Surplus cash” is available with the co.
# Ques 18 – Radha {Dec 21 RTP (Old)}
Radha Ltd. has imported goods to the extent of US$ 8 Million. The payment terms are as under:
i) 1% discount if full amount is paid immediately or
ii) 60 days interest free credit. However, in case of a further delay up to 30 days, interest at the
rate of 8% p.a. will be charged for additional days after 60 days. The Co. has ₹25 Lakh available
and for remaining it has an offer from bank for a loan up to 90 days @ 9.0% p.a.

The quotes for ₹/$ are as follows:

Spot Rate (buying) ₹ 66.98
60 days Forward Rate (buying) ₹67.16
90 days Forward Rate (buying) ₹68.03

Advise which of the following options would be better for the Co.
i) Pay immediately after utilizing cash available and for balance amount take 90 days loan from bank.
ii) Pay the supplier on 60th day and avail bank’s loan (after utilizing cash) for 30 days.
iii) Avail supplier offer of 90 days credit and utilize cash available.

Further presume that the cash available with the Co. will fetch a return of 4% p.a. in India till it is
utilized. Assume year has 360 days. Ignore Taxation.
Ans: Pay immediately (in Lacs)
$ to be paid = 80 x 0.99 $ 79.2
• ₹ required today = 79.2 x 66.98 ₹ 5304.816
(-) Available cash balance (₹ 25)
Finance Acharya Jatin Nagpal 10A.17 Krivii Eduspace
= ₹ borrowing required today ₹ 5279.816
(+) Interest on ₹ borrowing for 90 days @ 9% p.a. ₹ 118.80
Total ₹ outflow after 90 days ₹ 5398.616

ii) Pay in 60 days (in lacs)

$ to be paid $80
• ₹ required = 80 x 67.16 ₹ 5372.8
(-) Available cash balance = 25 (1 + 0.04 x 60/360) (₹ 25.167)
= ₹ borrowing required today ₹ 5347.633
(+) Interest on ₹ borrowing for 30 days @ 9% p.a. ₹ 40.107
Total ₹ outflow after 90 days = ₹ 5387.74

iii) Pay in 90 days (in lacs)

$ to be paid = 80(1 + 0.08 x 30/360) $ 80.533
• ₹ required = 80.533 x 68.03 ₹ 5478.66
(-) Available cash balance = 25 (1 + 0.04 x 90/360) (₹ 25.25)
Total ₹ outflow after 90 days ₹ 5453.41

Leading and Lagging

Netting off exposure (via Leading / Lagging) vs Covering them separately

# Ques 19 - NP and Co {SM TYK}
NP and Co. has imported goods for US $ 7,00,000. The amount is payable after three months. The
company has also exported goods for US $ 4,50,000 and this amount is receivable in two months.
For receivable amount a forward contract is already taken at ₹ 48.90.
The market rates for Rupee and Dollar are as under:
Spot ₹ 48.50/70
Two months 25/30 points
Three months 40/45 points

Company wants to cover the risk and it has two options as under :
(I) To cover payables in the forward market and
(II) To lag the receivables by one month and cover the risk only for the net amount. No interest for
delaying the receivables is earned.
» Evaluate both the options if the cost of Rupee Funds is 12%. Which option is preferable?
Simplified AFM Ques Bank 10A.18 Forex
Ans: (I) Cover payable and receivable in forward Market
• Amount payable after 3 months $7,00,000
• Forward Rate ₹ 48.45
(A) Payable Amount (₹) ₹ 3,39,15,000
• Amount receivable after 2 months $ 4,50,000
• Forward Rate ₹ 48.90
(B) Receivable Amount (₹) ₹ 2,20,05,000
(C) Interest @ 12% p.a. for 1 month ₹ 2,20,050
» Net Amount Payable in (₹) (A)–(B)–(C) ₹ 1,16,89,950

(II) The forward contract for receivable was already booked. It shall be cancelled if we lag the
receivables. Accordingly, profit/ loss on cancellation of contract shall also be adjusted.
• Amount Payable ($) $7,00,000
• Amount receivable after 3 months $ 4,50,000
• Net Amount payable $2,50,000
• Applicable Rate ₹ 48.45
(A) Amount payable in (₹) ₹ 1,21,12,500
(B) Profit on cancellation of Forward contract = (48.90 – 48.30) × 4,50,000 ₹ 2,70,000
(C) Net amount payable in (₹) = (A) + (B) ₹ 1,18,42,500

Conclusion - Cover payable and receivables in forward market as it leads to lower outflow.

Note: In the question it has not been clearly mentioned that whether quotes given for 2 and 3
months (in points terms) are premium points or direct quotes. Although above solution is based on
the assumption that these are direct quotes, but students can also consider them as premium points
and solve the question accordingly.

Money Market operations (MMO)

MMO with separate Bid-ask rates & Deposit-Loan rates

# Ques 20 – Nirjalla {SM TYK, M19 RTP (New), N19 Exam (Old), M24 RTP}
Nirjalla ltd is a UK based company. Invoice amount is $350000. Credit period is three months.
Some additional info is as below:
$/£ Exchange rates in London Deposit rate Loan rate
Spot Rate = 1.5865 – 1.5905 $ = 7% $ = 9%
Finance Acharya Jatin Nagpal 10A.19 Krivii Eduspace
3m Forward Rate = 1.6100 – 1.6140 £ = 5% £ = 8%

Compute and show how a money market hedge can be put in place. Compare and contrast the
outcome with a forward contract.
Ans: (a) £ inflow under forward = $ 350000 x 1 = £ 2,16,852.54
1.6140

(b) Under money market operation (MMO)

• Borrow PV of receivable = $ 350000 $ 3,42,298.29
1 + 0.09×3/12
• Convert in £ today = 342298.29 x 1.5905 £ 2,15,214.27
• Future value of £ = 2,15,214.27 x (1 + 0.05×3/12) £ 2,17,904,45

→ Note – Settlement of $ Loan

• Repayment of $ loan = $3,42,298.29 x (1 + 0.09×3/12) $ 3,50,000
• This will be settled using $3,50,000 receivable after 3-months.

# Conclusion – receivable under MMO (£ 2,17,904.45) > receivable under forward contract
(£ 2,16,852.54). So, prefer MMO.

MMO for Payable & receivable vs Forward cover

# Ques 21 - Columbus Surgical {SM TYK}
Columbus Surgical Inc. is based in US, has recently imported surgical raw materials from the UK and
has been invoiced for £4,80,000, payable in 3 months. It has also exported surgical goods to India
and France.
The Indian customer has been invoiced for £1,38,000, payable in 3 months, and the French customer
has been invoiced for €5,90,000,payable in 4-months.

Current spot and forward rates are as follows :

£/$ Spot 0.9830 – 0.9850
£/$ Three months forward 0.9520 – 0.9545

$/€ Spot 1.8890 – 1.8920

$/€ Four months forward 1.9510 – 1.9540
Simplified AFM Ques Bank 10A.20 Forex
Current money market rates are as follows :
UK : 10.0% - 12.0% p.a.
France : 14.0% - 16.0% p.a.
USA : 11.5% - 13.0% p.a.
You as are required to show how the company can hedge its foreign exchange exposure using
Forward markets and Money markets hedge and suggest which is the best hedging technique
Ans: Net payable in 3-months = £4,80,000 – £1,38,000 £ 3,42,000
- Net receivable in 4-months € 5,90,000

→ Using Forward rates

• 3-months payable = £ 3,42,000/0.952 $ 3,59,244
• 4-months receivable = € 5,90,000 x 1.9510 $ 11,51,090

→ Using Money market operations (MMO) for payable

• Invest PV of payable = £3,42,000 £ 3,33,659
(1 + 0.10 x 3/12)
• Borrow equivalent $ today = 3,39,659/0.983 $ 3,39,429
• Repay $ borrowing = 3,39,429 x (1+0.13 x3/12) $ 3,50,460

Note: The payable of £ 3,42,000 will be settled using the investment proceeds after 3 months.

→ Using MMO for receivable

• Borrow PV of receivable = €5,90,000 € 5,60,127
(1 + 0.16 x4/12)
• Convert in $ and invest = 5,60,127 x 1.8890 $ 10,58,080
• Investment value after 4-m = 10,58,080 × (1 + 0.115 x 4/12) $ 10,98,640

Note: The receivable of € 5,90,000 will be used to settle the borrowing after 4 months.

→ Conclusion
• For payable -> Use MMO (as outflow is less under MMO)
• For receivable -> Use forward (as inflow is more under forward)
Finance Acharya Jatin Nagpal 10A.21 Krivii Eduspace
Fate of forward contracts – Delivery, Cancellation, Extension etc.

Cancellation before Due date [using Cross rates + Swap points + Ex margin]
# Ques 22 – Balarama {SM TYK, N23 MTP 2}
Balarama bank enters, into a forward purchase TT covering an export bill of Swiss francs 1,00,000
at ₹32.4000 due 25th April and covered itself for same delivery in the local inter- bank market at
₹32.4200. However, on 25th March exporter sought for cancellation of the contract as the tenor of
the bill is changed. In Singapore market, Swiss Francs were quoted against dollars as under:
Spot CHF 1 USD 1 = Sw. Fcs. 1.5076/1.5120
One month forward 1.5150 / 1.5160
Two months forward 1.5250 / 1.5270
Three months forward 1.5415 / 1.5445

and in the interbank market US dollars were quoted as under:

Spot CHF 1 USD 1 = ₹49.4302 / .4455
Swap Points
Spot/April 4100 / 4200
Spot/May 4300 / 4400
Spot/June 4500 / 4600
Cal. cancellation charges payable by customer if exchange margin is 0.10% on buying and selling.
Ans: Customer has earlier sold forward. Now, to cancel he must purchase forward, i.e., Bank’s ask rate for
April forward shall apply.

(i) ₹ / $ Forward rate for April

Spot Selling Rate ₹ 49.4455
(+) Premium for April ₹ 00.4200
₹ 49.8655
(+) Exchange Margin @ 0.10%* ₹ 00.0499
₹ 49.9154

(ii) ₹ / SF forward rate = ₹/$ x $/SF = 49.9154 x 1/1.5150 ₹ 32.9474

Rounded off to: ₹ 32.9475

(iii) Gain/(loss) to customer

• Sold forward : 1,00,000 x 32.4 ₹ 32,40,000
Simplified AFM Ques Bank 10A.22 Forex
• Bought forward : 1,00,000 x 32.9475 ₹ 32,94,750
• Gain/(loss) (₹ 54,750)
Hence, Cancellation charges of ₹54,750 shall be paid by the customer.

Cancellation on Due date [with Ex margin]

# Ques 23 – Saraswati bank {SM Illus}
On the 15 Jan 2015 you as a banker of Saraswati bank booked a forward contract for US $ 250,000
for your import customer deliverable on 15 March 2015 at ₹65.3450. On due date customer request,
you to cancel the contract. On this date quotation of US$ in the Inter-bank market is as follows:
Spot ₹65.2900/2975 per US$
Spot/April 3000/3100
Spot/May 6000/6100
Cancellation Charges = ₹100. Exchange margin = 0.10%.
Calculate cancellation charges payable by customer.
Ans: Gain/(loss) to Bank (Amount in ₹)
A. Sold forward : 2,50,000 x 65.3450 1,63,36,250
B. Bought forward : 2,50,000 x 65.2250 1,63,06,250
C. Gain/(loss) = A – B 30,000
D. Flat cancellation charges 100
E. Total charges to be paid by customer = C + D 30,100

WN 1: Rate applicable to customer = Spot Bid rate – 0.1% margin = 65.29 – 0.1% = 65.2247
rounded off to = 65.2250

Extension On due date [with Ex margin]

# Ques 24 – Satyaki {SM TYK}
Satyaki, an importer requests his bank to extend the forward contract for US$ 20,000 which is due
to maturity of 30th October, 2010, for a further period of 3 months. He agrees to pay the required
margin money for such extensions of the contract.

Contracted Rule – US$ 1 = ₹ 42.32

The US Dollar quoted on 30-10-2010: spot = 41.5000/41.5200
3 months’ $ premium = 0.87% / 0.93%

Margin money for buying and selling rate is 0.075% and 0.20% respectively. Compute:
Finance Acharya Jatin Nagpal 10A.23 Krivii Eduspace
(i) The cost to the importer in respect of the extension of the forward contract, and
(ii) The rate of new forward contract
Ans: Existing contract cannot be extended. It must be 1st squared off and a new contract will be entered.

i) Squaring off existing contract

A. Sold forward = 20,000 x 41.4700 (WN 1) ₹ 8,29,400
B. Buy forward = 20,000 x 42.3200 ₹ 8,46,400
C. Gain/(loss) on cancellation (₹ 17,000)

WN 1: Rate at which contract is sold = Bank’s bid rate – Commission = 41.50 – 0.075% = 41.4689
rounded off to 41.4700.

ii) Rate at which new forward contract will be purchased = (Spot ask rate + premium) + Commission
= (41.52 + 0.93%) + 0.2% = ₹ 41.9900 / $

Early delivery
# Ques 25 – BNP Bank {SM Illus, N18 Exam (New), M19 Exam (New), N23 MTP 1}
On 1 Oct, 2015 Mr. X an exporter enters a forward contract with a BNP bank to sell US $1 Lac on
31 Dec, 2015 at ₹65.40/$. However, due to the request of the importer, Mr. X received amount on 28
Nov, 2015. Mr. X requested the bank take delivery of the remittance on 30 Nov, 2015 i.e. before due
date. The inter- banking rates on 28 Nov, 2015 was as follows:
Spot ₹65.22/65.27
1 Month Premium 10/15
If the bank agrees to take early delivery, then what will be net inflow to Mr. X assuming, that the
prevailing Prime lending rate is 18%. Take 365 days in a year.
Ans: Amount payable on 30 Nov (Amount in ₹)
• Buy $1,00,000 at agreed rate of ₹65.40 65,40,000
(-) Swap loss (WN 1) (20,000)
(-) Interest on outlay of funds (WN 2) (275)
» Net amount paid to customer 65,19,725

WN 1: Swap loss calculation

• Sell $ at SR today ₹ 65.22
• Buy Forward today ₹ 65.42
• Swap loss ₹ 00.20
Simplified AFM Ques Bank 10A.24 Forex
• Total swap loss = 0.20 x 1,00,000 (20,000)

WN 2: Interest on outlay of funds

Bank outflow today = 1,00,000 x 65.40 65,40,000
Bank inflow today = 1,00,000 x 65.22 65,22,000
Bank’s Net outflow 18,000
• Interest charged = 18,000 x 18% x 31/365 ₹275

Late delivery / Cancellation / Extension

# Ques 26 – Eklavya {SM Illus, M18 RTP (New), M18 Exam (Old),
N20 Exam (Old), Dec 21 MTP 1 (Old), M23 MTP 1, N23 Exam}
An Importer booked a forward contract with Eklavya bank on 10th,April for US $ 2,00,000 due on
10th June @ ₹64.4000. The bank covered its position in the market at ₹64.2800. The exchange rate
for Dollar in the inter-bank market on 10th June & 13th June were:
10th June 13th June
Spot US $ 1 = ₹ 63.8000 / 8200 ₹ 63.6800 / 7200
Forward Rates: June ₹ 63.9200 / 9500 ₹ 63.8000 / 8500
July ₹ 64.0500 / 0900 ₹ 63.9300 / 9900
August ₹ 64.3000 / 3500 ₹ 64.1800 / 2500
Sept. ₹ 64.6000 / 6600 ₹ 64.4800 / 5600
Exchange margin 0.10% and interest on outlay of funds @ 12%. The Importer requested on 14th June
for extension of contract with due date on 10th August.
Rates rounded to 4 decimals in multiples of 0.0025. Take 360 days. On 10th June, Bank Swaps by
selling spot & buying one month forward.
Calculate how the bank will react if on 14th June:
(a) Customer requests to Cancel the contract. Calculate
(i) Cancellation rate
(iii) Total cancellation charges / Total cost of customer
(b) Customer requests to execute the contract
(c) Customer requests to extend the contract with due date to fall on 10th August.
Ans: (a) Customer Requests cancellation
i) Cancellation rate (rate @ which customer will sell) = 63.6800 – 0.1% = 63.6163
• Rounded off: 61.6175
Finance Acharya Jatin Nagpal 10A.25 Krivii Eduspace
(ii) Amount payable by customer as per FEDAI rules (amount in ₹)
Loss on Squaring off i.e. Exchange difference (WN 1) 156,500
Swap loss (WN 2) 30,000
Interest on outlay of funds (WN 3) 96
» Net amount paid by customer ₹1,86,596

WN 1: Exchange difference i.e. Squaring off the contract

• Customer bought future at 64.4000
• Customer sold spot at 63.6175
» Total loss to customer = 0.7825 x 200,000 ₹156,500

Customer selling rate = 63.5800 – 0.1% = 63.6163. Rounded off to 63.6175.

WN 2: Swap loss
Bank sell spot at 63.80
Bank Buy 1-m forward 63.95
» Total Swap loss = 0.15 x 200,000 ₹30,000

WN 3: Interest on outlay of funds

Bank outflow today (buy $ from interbank market) 64.28
Bank inflow today = Sold $ at spot rate 63.80
» Bank’s Net outflow = (64.28 – 63.80) x 200,000 ₹96,000
• Interest charged for 3 days = 96,000 x 12% x 3/360 ₹96

(b) Customer requests to execute the contract

• Cancellation charges of ₹1,86,596 as computed above will be recovered.
• The contract will be executed at the spot TT selling rate calculated as follows:
» ₹ / $ interbank spot selling rate + Exchange margin = 63.7200 + 0.10% = 63.7837 r/o to 63.7850.

(c) Customer requests to extend the contract

• Cancellation charges of ₹1,86,596 as computed above will be recovered.
• A new contract for August can be entered at following rate:
» ₹ / $ FR for August + Exchange margin = 64.2500 + 0.1% = 64.3143 r/o to ₹ 64.3150 / $.
Simplified AFM Ques Bank 10A.26 Forex
ADDITIONAL NOTES: QUESTION VARIATIONS
Sometimes ques may give some additional rates as well, like “Rates as on 15th June are as follows…”
These unrequired rates are given to confuse students. Ignore them like your crush ignores you :p

Nostro, Vostro, Loro

Meeting required closing balance in Nostro A/c and Exchange position A/c
# Ques 27 – Shridhara {SM TYK, SM Illus, N18 Exam (New), N24 RTP}
Shridhara as a dealer in foreign exchange have following position in Swiss Francs on 31 Oct, 2009:
Swiss Francs
Balance in the Nostro A/c Credit 1,00,000
Opening Position Overbought 50,000
Purchased a bill on Zurich 80,000
Sold forward TT 60,000
Forward purchase contract cancelled 30,000
Remitted by TT 75,000
Draft on Zurich cancelled 30,000

What steps would you take, if you are required to maintain a credit Balance of Swiss Francs 30,000
in the Nostro A/c and keep as overbought position on Swiss Francs 10,000?
Ans: Particulars Nostro A/c Exchange position A/c (CHF)
Opening Balance 1,00,000 50,000
Purchase Bill on Zurich - 80,000
Sold forward TT - (60,000)
Forward purchase Cancelled - (30,000)
Remitted by TT (75,000) (75,000)
Draft on Zurich Cancelled - 30,000
Closing balance before adjustments 25,000 (5,000)
# Adjustments
Buy Spot 5,000 Nil
Buy forward 10,000
Closing Balance 30,000 10,000

» Thus buying 5,000 CHF spot and selling 10,000 CHF forward will maintain the req. closing balance.
Finance Acharya Jatin Nagpal 10A.27 Krivii Eduspace
Exposure calculation

Calculating Transaction Exposure

# Ques 28 – Shanti {Dec 21 MTP 1 (Old)}
Shanti exported 200 piece of designer jewellery to USA at $200 each. To manufacture and design
this jewellery she imported raw material for Japan of the Cost JP¥ 6000 For each piece. The labour
cost and variable overhead incurred in producing each piece of jewellery is ₹1,300 and ₹650
respectively. Suppose spot rates are:
INR/US$ ₹65.00 – ₹66.00
JP¥/US$ JP¥ 115 – JP¥ 120
Shanti is expecting that by the time the export remittance is recovered and payment of export is
made the expected spot rates are likely to be as follows:
INR/US$ ₹68.90 – ₹69.25
JP¥/US$ JP¥105 - JP¥ 112
You are required to calculate the resultant transaction exposure.
Ans: Particulars At spot rate At expected rate
Sale price 200 x 65 = 13,000 200 x 68.9 = 13780
(-) Material (WN 2) (3443.46) (3957.12)
(-) Labour (1300) (1300)
(-) Variable o/hs (650) (650)
= Profit per unit 7606.54 7872.88
× No. of units 200 200
» Total Profit 15,21,308 15,74,576

» Transaction exposure = Profit @ spot rate - Profit at changed rates = 15,74,576 – 15,21,308 = ₹53,268

WN1: Calculating ₹/¥ Ask rate

Before: ₹/¥ = ₹ x $ = 66 x 1 = 0.57391
$ ¥ 115
After: ₹/¥ = 69.25 x 1 = 0.65952
105
WN 2: Material cost
Before = 6000 x 0.57391 = 3443.46
After = 6000 x 0.65952 = 3957.12
Simplified AFM Ques Bank 10A.28 Forex
Calculating Transaction exposure + Operating Exposure
# Ques 29 - Omega Electronics {SM TYK}
M/S Omega Electronics Ltd. exports air conditioners to Germany by importing all the components
from Singapore. The Co. is exporting 2,400 units at a price of Euro 500 per unit. The cost of imported
components is $800 per unit. The fixed cost and other variables cost per unit are ₹1,000 and
₹1,500 respectively. The cash flow in foreign currencies is due in six months.
Current exchange rates: ₹/Euro = 51.50/55 ₹/S$ = 27.20/25
After six months the exchange rates turn out as: ₹/Euro = 52.00/05 ₹/S$ = 27.70/75

(1) You are required to calculate loss/gain due to transaction exposure.

(2) Based on the following additional information calculate the loss/gain due to transaction and
operating exposure if the contracted price of air conditioner is ₹25,000: The current exchange rate
changes to → ₹/Euro = 51.75/80 ₹/S$ = 27.10/15
• Price elasticity of demand is estimated to be 1.5
• Payments and receipts are to be settled at the end of six months.
Ans: (i) Particulars Current rates New rate (₹ lacs)
Revenue : 500 x 2400 x (51.50 / 52) 618 624
(-) Material : 800 x 2400 x (27.25 / 27.5) (523.2) (532.8)
(-) Fixed cost: 1000 x 2400 (24) (24)
(-) Variable cost : 1500 x 2400 (36) (36)
» Total Profit 0.348 0.312

• Loss due to transaction exposure = 0.348 – 0.312 = ₹0.036 crore i.e ₹3,60,000.

(2) New rates

Particulars (₹) Current rates (a) 2400units (b) 2417*units
Revenue : 25,000 x (2400 / 2400 / 2417) 600L 600L 604.25L
(-) Material : 800 x 27.15 x 2400 (521.28L)
800 x 27.75 x 2400 (532.8L)
800 x 27.75 x 2417 (536.574L)
(-) Fixed cost: 1000 x 2400 (24L) (24L) (24L)
(-) Variable cost: 1500 x 2400 (36L) (36L)
1500 x 2417 (36.255L)
» Total profit: 18.72L 7.2L 7.421L
Finance Acharya Jatin Nagpal 10A.29 Krivii Eduspace
• Loss due to transaction exposure = Profit at spot rates (-) profit at changed rates
= 18.72 – 7.2 = ₹11.52 lacs.

• Loss due to operating exposure = Profit @ SR (-) Profit @ changed rate after changed demand
= 18.72 – 7.421 = ₹11.299 lacs.

WN 1: Calculating new demand due to change in price (for customer)

• Earlier price/unit in € = 25000/51.50 € 485.437
• New price/unit in € = 25000/51.75 € 483.092
• % Decrease in price = {485.437 – 483.092} / 485.437 0.483%
» % Increase in demand = % fall in price x Price elasticity = 0.483% x 1.5 = 0.7245%
» New units demand = 2400 + 0.7245% ~2417 units

Calculating Exposure using Swap points

# Ques 30 – Kunti {SM TYK, N19 RTP (Old)}
Following are details of cash inflows and outflows in foreign currency of Kunti Co. an Indian export
firm:
Currency Inflow Outflow Spot Rate Forward rate
US$ 4 crore 2 crore 48.01 48.82
French Franc 2 crore 0.8 crore 7.450 8.120
UK£ 3 crore 2 crore 75.57 75.98
Japanese YEN 1.5 crore 2.5 crore 3.200 2.400
(i) Determine the net exposure of each foreign currency in terms of ₹.
(ii) Are any of the exposure positions offsetting to some extent?
Ans: Currency Inflow Outflow Net Inflow Swap points Net Exposure (in crores)
US $ 4 2 2 0.81 1.62
FF 2 0.8 1.2 0.67 0.804
UK £ 3 2 1 0.41 0.41
¥ 1.5 2.5 -1 -0.80 0.80

ii) Japanese yen exposure is being offset by better forward rate.

Note 1: Swap points = Forward rate – Spot rate

Note 2: Net Exposure = Net inflow x Swap points
Simplified AFM Ques Bank 10A.30 Forex
International Cash Management

Selecting ideal investment currency for maximum gains

# Ques 31 – Manvantar {SM TYK, M18 RTP (New), M19 Exam (Old), Dec 21 RTP (Old), N23 MTP 1}
Manvantar bank’s London office has surplus funds of USD 5,00,000 for a period of 3 months. The
cost of the funds to the bank is 4% p.a. It proposes to invest these funds in London, New York or
Frankfurt and obtain the best yield, without any exchange risk to the bank. Following rates of interest
are available at the 3 centres for investment of domestic funds there at for 3 months period:
London 5 % p.a.
New York 8% p.a.
Frankfurt 3% p.a.

The market rates in London for US dollars and Euro are as under:
London on New York London on Frankfurt
Spot 1.5350/90 1.8260/90
1 month 15/18 60/55
2 months 30/35 95/90
3 months 80/85 145/140

At which centre, will be investment be made & what will be the net gain (to the nearest pound) to
the bank on the invested funds?
Ans: Faculty Note 1: London on New York means => $/£
London on Frankfurt means => €/£
Faculty Note 2: Question mentioned that “London office” has surplus funds. But these funds are lying in
“US$” and not “£”.

# WN 1 – Spot rates
• $/£ = 1.5350 – 1.5390 £/$ = 1/1.5390 – 1/1.5350
• €/£ = 1.8260 – 1.8290 £/€ = 1/1.8290 – 1/1.8260

• €/$ = £/$ x €/£ = {1/1.5390 x 1.8260} – {1/1.5350 x 1.8290} = 1.1865 – 1.1915

• $/€ = 1/1.1915 – 1.1865

# WN 2 - Three months Forward rates

• $/£ FR = {1.5350 + 0.0080} - {1.5390 + 0.0085} = 1.5430 – 1.5475
Finance Acharya Jatin Nagpal 10A.31 Krivii Eduspace
• £/$ FR = 1/1.5475 – 1/1.5430

• €/£ FR = {1.8260 – 0.0145} - {1.8290 – 0.0140} = 1.8115 – 1.8150

• £/€ FR = 1/1.8150 – 1/1.8115

# WN 3 –Cost of funds to the bank = 4%

• Initial Amount + Interest thereon = $5L + $5,000 $ 5,05,000
• Equivalent amount of £ required to pay the above sum ($ 5,05,000/1.5430*) £ 3,27,285
* Due to conservative outlook.

(i) If investment is made at New York

• Net interest earned = $ 5,00,000 x (8% - 4%) x 3/12 $ 5,000
• Equivalent amount in £ 3 months = $ 5,000/ 1.5475 £ 3,231

(ii) Particulars London Frankfurt

A. Invest today $ 5,00,000 $5,00,000
B. in local Currency (using SR) 5L/1.5390 = £ 3,24,886 5L x 1.1865 = € 5,93,250
C. Interest rate in local currency 5% 3%
D. 3 months Interest £ 4,061 € 4,449
E. Balance after 3 months £ 3,28,947 € 5,97,699
F. Equivalent £ £ 3,28,947 5,97,699 x 1/1.8150 = £ 3,29,332
G. Less: Outflow in £ (WN 3) £ 3,27,285 £ 3,27,285
H. Arbitrage profit £ 1,662 £ 2,047

Maximum profit is earned if investment is made in New York. Hence it should be opted.

Acting Independently vs Immediate Cash pooling

# Ques 32 – Ambalika {N18 RTP (Old), N23 RTP}
Suppose you are a treasure of Ambalika plc in the UK. It has two overseas subsidiaries, one based
in Amsterdam and one in Switzerland. The Dutch subsidiaries has surplus Euros in the amount of
7,25,000 which it does not need for the next three months but which will be needed at the end of
that period (91 days). The Swiss subsidiaries has a surplus of Swiss Francs in the amount of
9,98,077 that, again, it will need on day 91. The Ambalika plc.in UK has a net balance of £75,000
that is not needed for the foreseeable future .Given the rates below, what is the advantage of
swapping Euros and Swiss Franc into Sterling?
Simplified AFM Ques Bank 10A.32 Forex
Spot rate (€) £0.6858 – 0.6869
91 days Pts. 0.0037 – 0.0040
Spot rate (£) CHF2.3295 – 2.3326
91 days Pts 0.0242 – 0.0228

Interest ates for the deposits:

Amount of currency 91 days Interest rate % p.a.
£ € CHF
0 – 1,00,000 1 ¼ 0
1,00,001 – 5,00,000 2 1.5 ¼
5,00,001 – 10,00,000 4 2 1/2
Over 10,00,000 5.375 3 1
Note: - Assume 360 days a year.
Ans: Amount after 91-days when acting Independently (i.e., w/o Swapping)
# In Local Currency in £
€ 7,25,000(1 + 0.02 x 91/360) = €7,28,665 5,02,415
CHF 9,98,077(1 + 0.005 x 91/360) = CHF9,99,338 4,32,651
£ 75,000(1 + 0.01 x 91/360) = £75,190 75,190
Total : 10,10,256

(b) Immediate Cash pooling i.e. Swap to Sterling

£ amount today in £
€ : 7.25 x 0.6858 4,97,205
CHF : 9.98077/2.3326 4,27,882
£: 75,000
Total : 10,00,087
(+) 1-m £ Interest : 10,00,087 x 5.375% x 91/360 13,588
10,13,675

* Net gain due to sterling swap = 10,13,675 – 10,10,256 = £3,419

WN 1: Forward rate = Spot rate ± Swap Points = 0.6858 + 0.0037 – 0.6869 + 0.0040 = 0.6895 – 0.6909

• CHF/£ FR = (2.3295 – 0.0242) – (2.3326 – 0.0228) = 2.3053 – 2.3098

Finance Acharya Jatin Nagpal 10A.33 Krivii Eduspace
Investment in Risky index vs Investment in Safe Govt. securities
# Ques 33 – Amba {N18 Exam (Old), N20 Exam (New), N20 MTP 1 (New), M23 Exam}
Amba Ltd. an Indian MNC is executing a plant in Sri Lanka. It has raised ₹400 billion. Half of the
amount will be required after 6months’ time. It is looking an opportunity to invest this amount on
1st April 2020 for a period of six months. It is considering two underlying proposals:
Market Japan USA
Nature of investment Index Fund (JPY) Treasury Bill (USD)
Dividend (in billions) 25 -
Income from Stock lending (in billions) 11.9276 -
Discount on initial investment at the end 2% -
Interest - 5% p.a.
Exchange Rate (1st April 2020) JPY/INR 1.58 USD/INR 0.014
Exchange Rate (30th Sep. 2020) JPY/INR 1.57 USD/INR 0.013
You, as an Investment Manager, is required to suggest the best course of option.
Ans: (i) Investing ₹200 Billions in Japan (Option 1) JPY (Billions)
JPY invested = 200 x 1.58 316
+ Dividend 25
+ Income from Stock lending 11.9276
(-) Discount on initial investment: 316 x 2% (6.32)
» JPY after 6-months 346.6076
• Equivalent ₹ = 346.6076/1.57 ₹ 220.769

(ii) Investing ₹200 Billion in US (Option 2) ($ Billions)

USD Investment : 200 x 0.014 2.8
(+) Interest : 2.8 x 5% x 6/12 0.07
Total $ receivable after 6- months 2.87
• Equivalent ₹ = 2.87 x 1/0.013 ₹ 220.769

Decision - The gain amount is same in both the cases so the company is indifferent. However,
Treasury Bills are risk free, so investment in Treasury Bills (USA) is suggested.
Simplified AFM Ques Bank 10A.34 Forex
Discrete Questions

Competitive Quote selection

# Ques 34 – Vyasa {SM TYK, M23 MTP 2}
You have following quotes from Bank Vyasa & Bank Vipasa
Bank Vyasa Bank Vipasa
SPOT USD / CHF 1.4650 /55 USD / CHF 1.4653 /60
3 months 5/10
6 months 10/15
SPOT GBP / USD 1.7645 /60 GBP / USD 1.7640 /50
3 months 25/20
6 months 35/25
(i) How much min. CHF amount you have to pay for 1 million GBP spot?
(ii) Considering the quotes from Bank Vyasa only , for GBP /CHF what are the Implied Swap points for
spot over 3 months?
Ans: Quote selection → We will obviously select the bank more competitive rate.
• For USD/CHF → Bank Vyasa @ 1.4650/55.
• For GBP/USD → Bank Vipasa @ 1.7640/50.

• GBP/CHF SR (i.e. CHF) = CHF x $ = 1.4650 x 1.7640 – 1.4655 x 1.7650 = 2.58426 – 2.58661
£ $ £

(i) 1 million GBP = CHF 2.58661 x 1 million = CHF 25,86,610.

(ii) Considering quotes from bank Vyasa only

• Spot CHF/£ = 1.4650 x 1.7645 – 1.4655 x 1.7660 = 2.5850 - 2.5881
• 3-m FR CHF/£ = 1.4655 x 1.7620 – 1.4665 x 1.7640 = 2.5822 - 2.5869

* Swap points
Spot rate = 2.5850 - 2.5881
3-m FR = 2.5822 - 2.5869
= 0.0028 - 0.0012
⸫ Swap points are = 28/12.
Finance Acharya Jatin Nagpal 10A.35 Krivii Eduspace
Finding rate of “Indifference” between ₹ & $ borrowing + Calculating Forward rates
# Ques 35 – Ashwatthama {N18 Exam (New), N20 MTP 1 (Old)}
Ashwatthama Ltd. obtains the following quotes (₹/$)
Spot 35.90/36.10
3-months forward rate: 36.00/36.25
6-months forward rate: 36.10/36.40
The co. needs $ funds for 6 months. Determine whether the company should borrow in $ or ₹.

Interest rates are :

3-Month’s interest rate : ₹ = 12% $ = 6%
6-Month’s interest rate : ₹ = 11.50% $ = 5.5%
Also determine what should be the rate of interest after 3-months to make the company indifferent
between 3-months borrowing and 6-months borrowing in the case of:
(i) ₹ borrowing (ii) $ borrowing
Ans: Let amount of funds required be $1000. (Faculty Note: You can assume any amount)

(i) $ Borrowing
$ outflow after 6-m = $1000 x (1 + 0.055×6/12) $ 1027.5
Equivalent ₹ outflow = 1027.5 x 36.40 ₹ 37,401

(ii) ₹ borrowing
Required ₹ borrowing today = $1000 x 36.10 ₹ 36,100
₹ outflow after 6-m = 36,100 x (1 + 0.1150×6/12) ₹ 38,175.75

• Decision: Prefer $ borrowing and enter in 6-m forward contract.

(iii) Calculating 3 x 6 Forward rate (i.e. 3-m forward rate after 3-m).
a. $ Forward rate
• (1 + 0.05 x 3/12) (1 + $ FR) = (1 + 0.055 x 6/12)
• $ FR = 1.2315% for 3-months or 4.926% p.a.

b. ₹ Forward rate
• (1 + 0.12 x 3/12) (1 + ₹ FR) = (1 + 0.1150 x 6/12)
• ₹ FR = 2.67% for 3-months or 10.68% p.a.
Simplified AFM Ques Bank 10A.36 Forex

Additional Questions
Basics

V. Basic currency conversion + Decision: Convert today or later

# Ques 1 – Ugrasena {SM TYK, M19 RTP (Old), N22 Exam}
The following two ways quotes appear in Foreign Exchange Market:
Spot 2-Months Forward
₹/US $ ₹46.00 / ₹46.25 ₹47.00/₹47.50
Required:
(i) How many $ should Ugrasena sell to get ₹25 Lakhs after 2 months?
(ii) How many Rupees is the firm required to pay to obtain US$ 2,00,000 in the spot market?
(iii) Assume the firm has $69,000 in current Account earning no interest. ROI on Rupee Investment is
10% p.a. Should the firm encash the US $ now (lead) or two months later (lag)?
Ans: (i) $ Required to get ₹25 lacs = 25L x 1/47 $ 53,191.4893
(ii) ₹ required to get $2L = $2L x 46.25 ₹ 92,50,000

(iii) Lag receivable or encash now

A. If $ are converted today
• ₹ received today: 69,000 x 46 ₹ 31,74,000
• 2 months interest: 31,74,000 x 10% x 2/12 ₹ 52,900
» Total: ₹ 32,26,900
B. If $ are converted after 2-months
₹ received after 2-months: 69,000 x 47 = ₹ 32,43,000

Decision – The firm should lag and should encash after 2 months.

Triangular Arbitrage

Triangular arbitrage under Bid-ask spread + Exchange commision

# Ques 2 – Mahamaya
Following are the spot exchange rates quoted at three different forex markets:
Finance Acharya Jatin Nagpal 10A.37 Krivii Eduspace
USD/INR 59.25 / 59.35 in Mumbai
GBP/INR 102.50 / 103.00 in London
GBP/USD 1.70 / 1.72 in New York

Mahamaya has USD 1,00,00,000. The bank wishes to retain an exchange margin of 0.125%.
Explain whether there is any arbitrage gain possible from the quoted spot exchanges rates.
Ans: Rough (No need to show in exam) – Write down all the quotes for easy reference
₹/$ = 59.25 - 59.35 $/₹ = 1/59.35 - 1/59.25
₹/£ = 102.50 - 103 £/₹ = 1/103 - 1/102.50
$/£ = 1.70 - 1.72 £/$ = 1/1.72 - 1/1.70

• Cross rate of $/£ = ₹/$ x $/₹ = 102.50 x 1/59.35 – 103 x 1/59.25 = 1.7270 - 1.734

» Rough Analysis (Show in exam “Only if time allows”)

• £ Price in Direct market $ 1.70 - 1.72
• £ Price in Indirect market (cross market) $ 1.7270 - 1.7384
• Decision: Buy £ directly ($ → £) and then sell it in indirect market (£ → ₹ → $)

» Main Answer:
Step 1 – Buy £ Directly ($ → £)
Sell $ to buy £ = $ 1 crore x {1/1.72 – 0.125%} £ 58,06,686

Step 2 – Sell £ Indirectly (£ → ₹ → $)

• Sell £ 58,06,686 to get ₹ = 58,06,686 x {102.50 - 0.125%} ₹ 59,44,42,060
• Sell ₹ 59,44,42,060 to get $ = 59,44,42,060 x {1/59.35 – 0.125%} $ 1,00,03,353

» Hence arbitrage profit = $1,00,03,353 - $1,00,00,000 = $3353.

Notes: -
1. Students answer may differ due to rounding off.
2. Here, we use exploited the mispricing between $/£. Student may choose to exploit any other pair.
3. The above answer is sufficient for 4-5 marks questions. However, in case the question is asked for
6 marks or more, then also show effective rate of each transaction separately.
Ex: Rate applicable when selling $1 crore = 1/1.72 – 0.125% = £ 0.5806686 / $
Simplified AFM Ques Bank 10A.38 Forex
Covered Interest Arbitrage (CIA)

CIA under Bid-ask spread + Separate deposit-borrowing rates

# Ques 3 – Choka
Spot Rate 1$= ₹45.36 - ₹45.45
3 Month Forward Rate 1$= ₹46.00 - ₹46.10
Interest Rate: India USA
Borrowing 8% 5%
Deposit 6% 4%
Mr. Choka, an arbitrageur, wants to construct an arbitrager using above information. Calculate
Covered Interest Arbitrage Profit?
Ans: ROUGH ANALYSIS (NO NEED TO SHOW IN EXAM)
• $ Forward premium = {46.10 / 45.45 – 1} x 12/3 5.72%
• Return if invested in India 6%
• Return if invested in US = Rf$ + $ Premium = 4% + 5.72% 9.72%
• Return in US > Return in India. So borrow from India & Invest in US.

IN EXAM START FROM HERE:

Today
Borrow ₹10,000 from India & invest in US.
$ Invested today = ₹10,000/45.45 $ 220.022

- After 3-months
$ Investment value = 220.022(1 + 0.04x3/12) $ 222.22
₹ at forward rate = 222.22 x 46 ₹ 10,222.12
Repay ₹ borrowing = 10,000 (1 + 0.08 x3/12) (₹ 10,200)
=> Arbitrage profit ₹ 22.12

CIA when continuously compounded rate is given

# Ques 4 – Gandharv
The risk-free rate of interest rate in USA is 8% p.a. and in UK is 5% p.a. The spot exchange rate
between US $ and UK £ is 1$ = £0.75. Assuming that interest is compounded on daily basis then at
which forward rate of 2 year there will be no opportunity for arbitrage. Further, show how Gandharv,
an investor could make risk-less profit, if two year forward price is 1$ = 0.85 £.
Given e-0.06 = 0.9413 & e-0.16 = 0852, e0.16 = 1.1735, e-0.1 = 0.9051
Finance Acharya Jatin Nagpal 10A.39 Krivii Eduspace
Ans: £/$ 2-year forward rate = SR eUKrf x 2
eUSrf x 2
= SR e(UKrf – Usrf) x 2
= 0.75 e(0.05 – 0.08) x 2 = 0.75 e-0.06 = £0.706/$

- Arbitrage if prevailing $ forward rate = £0.85

• Sell 2-year $ forward at £0.85/$.
• Invest 1$ today for two-years.
• Borrow equivalent £ for $ investment = 0.75 £

- After 2-years
• $ investment value = 1 e0.08 x 2 = 1 x e0.16 = $1.1735
• Sell $ at forward rate & get £ = 1.1735 x 0.85 = £0.997475
• £ loan repayment = 0.75 x e0.05 x 2 = 0.75 x e0.10
= 0.75 x 1 = 0.75 x 1 = £0.828638
e-0.10 0.9051

• Arbitrage profit = £0.997475 – £0.828638 = £0.168837 per $

Forward premium & Discount

Finding missing entries using Forward rate concepts

# Ques 5 – Savitri {N23 RTP}
The following table reflect interest rates for the US $ & French Francs. The spot exchange rate is
7.05 francs per dollars. Miss Savitri has requested you to complete the missing entries.
3-m 6-m 1-year
$ Interest Rate (effective rate) 11.5% 12.25% ?
Franc Interest Rate (effective rate) 19.5% ? 20%
Forward Franc per Dollar ? ? 7.5200
Forward discount per Franc % per year ? -6.3 ?
Ans: FR (3-months) = SR (1 + rf FF)1/4 = 7.05 (1.195)1/4 → 1$ = FF 7.173
(1 + rf $)1/4 (1.115)1/4

(ii) $/FF = 1/7.05 = 0.14184 $/FF

FR = 1/7.173 = 0.13941 $/FF
Simplified AFM Ques Bank 10A.40 Forex
⸫ Discount = 0.13941 – 0.14184 x 12 = -6.853% p.a.
0.14184 3

(iii) FR (1-year) = SR (1 + rf FF)

(1 + rf $)

• 7.52 = 7.05 (1.20)

(1 + rf $)

• 1 + rf $ = 1.125
• rf $ = 0.125 or 12.5% p.a.

iii) Discount = 6.3% p.a. i.e., 3.15% for 6-months.

• $ = FF 7.05
» FR ($ after 6-m) = 7.05 + 3.15% = FF 7.272075

iv) FR (6m) = SR (1 + rf FF)1/2

(1 + rf $)1/2

• 7.272075 = 7.05 (1 + rf FF)1/2

(1.1225)1/2

• 7.272075 x (1.1225)1/2 = 7.05 (1 + rf FF)1/2

• 1.0928546 = (1 + rf FF)1/2

Squaring both side

• (1.0928546)2 = [(1 + rf FF)1/2]2
• 1.9433 = 1 + rf FF
• 0.19433 = rf FF → 19.433%

Calculating Forward premium + Using IRPT to calculate Fair FR

# Ques 6 – True Blue Cosmetics
True Blue Cosmetics Ltd.is an old-line producer of cosmetics products made up of herbals. Their
products are popular in India and all over the world but are more popular in Europe. The company
invoice in Indian Rupee when it exports to guard itself against the fluctuation in exchange rate.
Finance Acharya Jatin Nagpal 10A.41 Krivii Eduspace
As the company is enjoying monopoly position, the buyer normally never objected to such invoices.
However, recently, an order has been received from a whole-seller of France for FFr 80,00,000. The
other conditions of the order are as follows:
(a) The delivery shall be made within 3 months;
(b) The invoice should be FFr.

Since, Company is not interesting in losing this contract only because of practice of invoicing in
Indian Rupee. The Export Manager Mr. E approached the banker of Company seeking their guidance
and further course of action. The banker provided following information to Mr. E
(a) Spot rate 1FFr = ₹6.60;
(b) Forward of (90 days) of 1 FFr = ₹6.50
(c) Interest rate in India is 9% p.a. and in France 12% p.a. Mr. E entered in forward contract with
banker for 90 days to sell FFr at above mentioned rate. When the matter came for consideration
before Mr. A Accounts Manager of company, he approaches you.
You as a Forex Consultant is required to comment on:
(i) Whether an arbitrage opportunity exist or not.
(ii) Whether the action taken by Mr. E is correct and if bank agrees for negotiation of rate, then at what
forward rate company should sell FFr to Bank.
Ans: (i) Calculating premium /discount of FF
= Forward rate – Spot rate x 12
Spot rate months

= 6.50 – 6.60 x 12 = -6.06%

6.60 3

• Interest rate differential between 2 countries = 12% - 9% = 3% p.a.

• Implied discount (6.06%) ≠ Interest differential (3%). Therefore, arbitrage opportunity exists.

(ii) Correct forward rate as per IRPT

₹/FF forward rate = SR (1 + ₹ interest)
(1 + FF interest)

= 6.60 x (1 + 0.09 x 3/12) = ₹6.552/FF

(1 + 0.12 x3/12)
Simplified AFM Ques Bank 10A.42 Forex
P&L using FR vs Expected SR
# Ques 7 – Indraprastha {SM TYK}
Indraprastha Ltd. of U.K. has exported goods with Can $5,00,000 receivable in 6-months.The exporter
wants to hedge the receipt in the forward market. The following information is available:
Spot Exchange Rate Can $2.5/£
Interest rate in U.K. 12%
Interest rate in Canada 15%
The forward rates truly reflect the interest rates differential. Find out the gain/loss to U.K. exporter
if Can $ spot rates: (i) Declines 2% (ii) Gains 4%
Ans: Cad$/£ FR = SR (1 + Cad. Interest rate x 6/12) = 2.5 (1 + 0.15 x 6/12) = Cad $2.535/£
(1 + UK Interest rate x 6/12) (1 + 0.12 x 6/12)

Calculating Gain/(Loss) (i) £ = Cad $2.55 (ii) £ = Cad $2.4

(i.e., 2.5 x 1.02) (2.5 x 0.96)
• Receipt at FR: 5,00,000 ÷ 2.535 £1,97,239 £1,97,239
• Receipt at SR: 5,00,000 ÷ 2.55 or 2.4 £1,96,078 £2,08,333
Gain/(Loss): £1,161 (£11,094)

Should you avail credit or Not?

Avail credit from Supplier vs Loan from bank

# Ques 8 – Gibraltar {SM TYK, N19 RTP (New), N20 MTP 1 (New)}
Gibraltar ltd has imported 5,000 bottles of shampoo at landed cost in Mumbai of US$ 20 each. The
company has the choice for paying for the goods immediately or in 3-month time. Has a clean
overdraft limited where 14% p.a. rate of interest is charged calculate which of the following method
would be cheaper to Gibraltar Ltd.
(i) Pay in 3 months with the interest @ 10% and cover risk forward for 3 months
(ii) Settle now at a current spot rate and pay interest of the overdraft for 3 months.
The rates are as follows
Mumbai ₹/$ Spot 60.25-60.55
3 Month Swap 35/25
Ans: Amount payable = 5,000 x $ 20 = $1,00,000
• Forward rate (FR) = SR ± Swap points = {60.25 – 0.35} – {60.55 – 0.25} = 59.90 – 60.30
Finance Acharya Jatin Nagpal 10A.43 Krivii Eduspace
(i) Pay in 3-months: ₹ in Lacs
Payment to supplier: $1L (1 + 0.1 x 3/12) x 60.3 61.8075

(ii) Settle now: ₹ in Lacs

Payment to supplier: $ 1 L x 60.55 60.55
+ Interest @ 14% p.a.: 60.55 x 14% x 3/12 2.11925
Total = 62.66925

- Clearly, paying supplier in 3-months is a better option.

Fate of forward contracts

Extension on Due date (Cancel existing + Enter into new contract)

# Ques 9 – Uttara {SM Illus}
Suppose you are a Banker and Uttara, one of your export Customer has booked a US $ 1,00,000
forward sale contract for 2 months with you at the rate of ₹62.5200 & simultaneously you covered
yourself in the inter-bank market at ₹62.5900. However, on due date, after 2 months your customer
comes to you and requests for cancellation of the contract and requests for extension of the contract
by one month. On this date quotation for US $ in the market was as follows:
Spot ₹62.7200/ 62.6800
1 month forward ₹62.6400/ 62.7400.
Determine the extension charges payable by the customer assuming exchange margin of 0.10% on
buying as well as selling.
Note: In this ques the Ask rate (67.68) < Bid rate (67.72). This is technically impossible. It is
simply a typing mistake in the ques. Students MUST consider the correct quote while attempting
ques.
Ans: For Extension
• A contract cannot be extended as such. For extension, the customer must cancel the existing contract
and enter a new 1-m Forward.

=> Gain/(loss) to customer

Sold forward: 1,00,000 x 62.52 ₹ 62,52,000
Bought forward: 1,00,000 x 62.7825 (WN 1) ₹ 62,78,250
Gain/(loss) = ₹ 26,250
Simplified AFM Ques Bank 10A.44 Forex
Hence, cancellation charges of ₹26,250 shall be paid by the customer.

WN 1: Applicable rate = Spot ask rate + 0.1% = 62.72 + 0.1% = 62.7827 rounded off to ₹62.7825.

(ii) Applicable rate for new contact = 1- month forward bid rate – 0.1% margin
= 62.64 - 0.1% x 62.64 = 62.5774, rounded off to ₹62.5775

Nostro, Vostro, Loro

V. Basic cross rate calculation

# Ques 10 – Xover {SM TYK, M19 RTP (Old)}
Xover Bank, Amsterdam, wants to purchase Rupee 25 million against £ for funding their Nostro A/c.
Calculate the amount of £,s credited. Ongoing inter-bank rates per $, ₹61.3625/3700 & per £ is $
1.5260/70.
Ans: ₹/£ = ₹/$ x $/£ = 61.3625 x 1.5260 - 61.3700 x 1.5270 = 93.6392 – 93.7120
£ required = 25 million / 93.6392 = £2,66,982.20

V.V. Basic currency conversion

# Ques 11 – ABN Amro {SM TYK}
ABN-Amro bank, Amsterdam, wants to purchase ₹15 million against US $ for funding their Vostro
account with Canara Bank, New Delhi. Assuming the inter-bank rates of US $ is ₹51.3625/3700, what
would be the rate Canara Bank would quote to ABN-Amro bank? Further, if the deal is struck, what
would be the equivalent US $ amount.
Ans: Applicable rate = ₹51.3625/$
Equivalent $ amount = ₹15 million x 1 = $292,041.86
51.3625

Discrete Questions

Broken swap points

# Ques 12 – Atulya {SM TYK, N22 RTP}
On April 3, 2016, Atulya bank quotes the following:
Spot exchange Rate (US$ 1) INR 66.2525 INR 67.5945
2 months swap points 70 90
3 months swap points 160 186
Finance Acharya Jatin Nagpal 10A.45 Krivii Eduspace
In a spot transaction, delivery is made after two days.
Assume spot date is April 5, 2016.
Assume 1 swap point = 0.0001.
(i) Ascertain swap points for 2 months and 15 days. (For June 20, 2016).
(ii) Determine foreign exchange rate for June 20, 2016 and
(iii) Compute the annual rate of premium/discount of US $ on INR, on an average rate.
Ans: Swap point for 2-m 15 days
Bid = 70 + (160 – 70) x 15 = 115
30
Ask = 90 + (186 – 90) x 15 = 138
30
⸫ Swap points for 2 months 15 days = 115/138

ii) FR for 20th June, 2016.

SR 66.2525 67.5945
Swap points 115 138
Forward rate 66.2640 67.6083

iii) Spot Rate 66.2525 67.5945

2.5 M FR 66.2640 67.6083
Average 66.2583 66.6014
Premium (Swap points) 0.0115 0.0138

⸫ Premium (%) p.a. 0.0115 x 12 0.0138 x 12

66.2583 2.5 66.6014 2.5
= 0.083% = 0.098%

Alternate view
Average spot rate = (66.2525 + 67.5945) / 2 = 66.9235
Average 2.5 m FR =(66.2640 + 67.6083) / 2 = 66.9362

⸫ Premium = 66.9362 – 66.9235 x 12 = 0.091% p.a.

66.9235 2.5
Simplified AFM Ques Bank 10A.46 Forex
Low Probability Unique Questions

Geographical arbitrage when rates of different locations are given

# Ques 13 - Bharat Silk
Bharat Silk Ltd., an established exporter of silk materials, has a surplus of US$20 million as on
31st May, 2015. The banker of the company informs the following exchange rates that are quoted at
three different forex markets:

GBP/INR 99.10 at London

INR/GBP 0.01 at London
USD/INR 64.10 at Mumbai
INR/USD 0.02 at Mumbai
USD/GBP 0.65 at New York
GBP/USD 1.5530 at New York
Assuming that there are no transaction costs, advice the company how to avail the arbitrage gain
from the above quoted spot exchange rates.
Ans: Krack chart – We have $20 million surplus. We have “rotate” it in a manner to generate arbitrage
gain. How to do it?
Simple → Whenever selling any currency, sell at highest possible rate.
Whenever buying --> Buy at lowest rate.

2 Also, it will be better to first write ratio in standard form. (You can do this step in rough).
- London : ₹/£ = 99.10
£/₹ = 0.01 i.e. ₹/£ = 1/0.01 = ₹100/£
- Mumbai : ₹/$ = 64.10
$/₹ = 0.02 i.e. ₹/$ = 1/0.02 = 50
- New York: £/$ = 0.65 i.e. $/£ = 1/0.65 = 1.5384
$/£ = 1.5530
Finance Acharya Jatin Nagpal 10A.47 Krivii Eduspace
In exam start from here -
• Sell $ at Mumbai : $20 Mn x 64.10 ₹ 1282 Mn
• Sell ₹ at London : ₹1282 /99.10 £ 12.93643 Mn
• Sell £ at New York :£12.93643 x 1.5530 $ 20.0027 Mn
• Profit = $20.09027 Mn - $20 Mn $ 0.09027 Mn i.e., $90,270

Cost under Forward cover vs MMO vs Unhedged ‘when Tax rate is given’
# Ques 14 – Dhrishtadyumna
On 1/3/1979, Dhrishtadyumna. bought from a foreign firm electronic equipment that will require the
payment of LC 9,00,000 on May 31,1979. The spot rate on March 1, 1979, is LC 10 per $, the expected
future spot rate is LC 8 per $, and the ninety days forward rate is LC 9 per $. The US interest rate
is 12%, and the foreign interest rate is 8%. Tax rate for both countries is 40%. The Co. is considering
three alternatives to deal with the risk of exchange rate fluctuations.
(a) To enter forward market to buy LC 9,00,000 at the 90 days forward rate in effect on May 31, 1979.
(b) To borrow an amount in $ to buy the LC at the current spot rate. This money is to be invested in
government Securities of the foreign country; with the interest income, it will equal LC 9,00,000
on 31 May, 1979.
(c) To wait until May 31, 1979, and buy LCs at whatever spot rate prevails at that time.
Which alternative should the Co. Follow in order to minimise its cost of meeting the future payment
in LCs? Explain.
Ans: Forward Cover
• $ if paid today = 9,00,000/10 $ 90,000
• $ if paid under forward cover = 9,00,000/9 $ 1,00,000
= Extra exp. incurred under forward cover = 100000 – 90000 $ 10,000
(-) Tax saving on this $10,000 = 10,000 x 40% $ 4,000
= Cost (net of tax) = $1,00,000 - $4,000 $ 96,000

(b) Cost under MMO

• Interest rate on investment (net of tax) = 8% x (1 – 0.4) = 4.8%
• Invest PV of LC 9,00,000 for 3m = 9,00,000 / (1 + 0.048×3/12) LC 8,89,328

# Borrow in $ an amount equivalent to LC 8,89,328 today.

• Borrow $ for 3m @ 12% p.a. = 8,89,328 / 10 $ 88,932.8
• $ Repaid = 88,932.8 + 88,932.8 x 12%(1 – 0.4) x 3/12 $ 90,534
Simplified AFM Ques Bank 10A.48 Forex
c) If Uncovered (i.e. pay at SR after 3-months)
• $ if paid today = 9,00,000/9 $ 90,000
• $ if paid at expected spot rate = 9,00,000/8 $ 1,12,500
» Extra exp. incurred under forward cover = 1,12,500 – 90,000 $ 22,500
• Tax saving on this $22,500 = 22500 x 40% $ 9,000
» Cost (Net of tax) = $1,12,500 - $9,000 $ 1,03,500

Bifurcating difference due to time factor vs currency fluctuation

# Ques 15 – Satyavati
Satyavati Ltd. purchased 1 lacs Mark’s worth of machines (asset) from a firm in Dortmund, Germany.
The value of the dollar in terms of the mark has been decreasing. The firm in Dortmund offers 2/10,
net 90 terms. The spot rate prevailing for 10 days for the mark is Dollar 0.55. the 90 days forward
rate is dollar 0.56.
(a) Compute the $ cost of paying the account within 10 days.
(b) Compute the $ cost of buying a forward contract to liquidate the account in 90 days.
(c) The differential between part (a) and part (b) is the result of the time value of money (the discount
for --prepayment) and protection from currency value fluctuation. Determine the magnitude of each
of these components.
Ans: (i) If paid within 10 days = (1,00,000 x 0.98) x 0.55 $53,900
(ii) Pay in 90 days = 1,00,000 x 0.56 $56,000
(iii) Difference between (i) and (ii) = 56,000 – 53,900 = $2,100.

• Difference due to discount i.e. time factor = (1,00,000 – 98,000) x 0.56 $1,120
• Balance difference is due to currency fluctuation = 2,100 – 1,120 $980

Calculating Cash inflow when “Transit and usance” period is given

# Ques 16 - Sky products
M/s. Sky products Ltd., of Mumbai, an exporter of sea foods has submitted a 60 days bill for EUR
5,00,000 drawn under an irrevocable Letter of Credit for negotiation. The company has desired to
keep 50% of the bill amount under the Exchange Earners Foreign Currency Account (EEFC). The
rates for ₹/USD and USD/EUR in inter-bank market are quoted as follows:
₹/USD USD/EUR
Spot 67.8000-67.8100 1.0775 - 1.8000
1-month forward 10/11 Paise 0.20/0.25 Cents
2 months forward 21/22 Paise 0.40/0.45 Cents
Finance Acharya Jatin Nagpal 10A.49 Krivii Eduspace
3 months forward 32/33 Paise 0.70/0.75 Cents
Transit Period is 20 days. Interest on post shipment credit is 8% p.a. Exchange Margin is 0.1%.
Assume 365 days in a year.
You are required to calculate:
(i) Exchange rate quoted to the company
(ii) Cash inflow to the company
(iii) Interest amount to be paid to bank by the company.
Ans: Note: Transit and usance period is 80 days. It will be rounded off to the lower of months and @
months forward bid rate is to be taken:

(i) Exchange rate quoted = 2 months (60 days) Forward Bid rate of ₹ / EUR
• ₹ Forward rate = ₹ x $ = 67.9420 x 1.0815 = 73.4793 …(refer WN 1 & WN 2)
€ $ €

(ii) Cash inflow

• Amount of Export Bill EUR 5,00,000
Less: EEFC EUR 2,50,000
EUR 2,50,000
• Cash inflow in ₹ = 2,50,000 x 73.4793 ₹ 1,83,69,825

(iii) Interest for 80 days @ 8% = 1,83,69,825 x 8% x 80/365 ₹ 3,22,101

# WN 1 – ₹ / $ forward bid rate

• ₹/USD ₹ 67.8000
+ Premium for 2 months ₹ 0.2100
₹ 68.0100
(-) Exchange margin @ 0.1% ₹ 0.0680
= Bid rate for USD ₹ 67.9420

# WN 2 - $ / € Forward bid rate

• USD/EUR USD 1.0775
+ Add: Premium USD 0.0040
USD 1.0815