Forex

Practice Problems
Section A(ICAI Modified)
 Strategic Financial Management

CROSS RATE APPLICATION

PROBLEM - 1
Walgreens Boots Alliance sold Omani Rial 3,22,500 value spot to your customer
at `167.43 per OMR & covered yourself in Uk stock exchange on the same day,
when the exchange rates were
GBP 1 = OMR 0.4901 0.4941
Local inter bank market rates for GBP were
Spot GBP 1 = ` 80.71 80.86

Calculate cover rate and ascertain the profit or loss in the transaction. Ignore
brokerage.

Solution :

The bank (Dealer) covers itself by buying from the market at market selling rate.

Rupee – GBP selling rate ` 80.86

Omani Rial – GBP OMR 0.4901
Rupee – Hong Kong cross rate ` 80.86 /0.4901
` 164.9867

Profit / Loss to the Bank

Amount received from customer (3,22,500 × 167.43) ` 539,96,175

Amount paid on cover deal (3,22,500 × 164.9867) ` 532,08,211
Profit to Bank ` 7,87,964

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 Forex-Practice Problems

FORWARD COVER

PROBLEM - 2

HDIL Ltd. is a listed real estate development company in India, with significant
operations in the Mumbai Metropolitan Region has an export exposure of HKD
12,00,000 payable August 31, 2014. Hong Kong Dollar (HKD) is not directly quoted
against Indian Rupee.

The current spot rates are:

INR/GBP ` 82.05
HKD/GBP HKD 9.93

It is estimated that Hong Kong Dollar will depreciate to 10.89 level and Indian Rupee
to depreciate against GBP to ` 84.83.

Forward rates for August 2014 are

INR/ GBP ` 86.33

HKD /GBP HKD 10.77

Required:

i. Calculate the expected loss, if the hedging is not done. How the position
will change, if the firm takes forward cover?

ii. If the spot rates on August 31, 2014 are:

INR/ GBP = ` 82.09
HKD /GBP = HKD 9.99

Is the decision to take forward cover justified?

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Solution :

Since the direct quote for ¥ and ` is not available it will be calculated by cross
exchange rate as follows:
`/GBP x GBP/HKD = `/HKD
82.05/9.93 = 8.2628
Spot rate on date of export 1HKD = ` 8.2628
Expected Rate of HKD for August 2014 = ` 7.7897 (` 84.83/HKD 10.89)
Forward Rate of HKD for August 2014 = ` 8.0158 (` 86.33/HKD 10.77)
i. Calculation of expected loss without hedging
Value of export at the time of export (` 8.2628 x HKD 12,00,000) `99,15,360
Estimated payment to be received on Aug. 2014
(` 7.7897 x HKD 12,00,000) ` 93,47,640
Loss ` 5,67,720

Hedging of loss under Forward Cover

` Value of export at the time of export (` 8.2628 x HKD 12,00,000) `99,15,360

Payment to be received under Forward Cover
(` 8.0158 x HKD 12,00,000) ` 96,18,960
Loss ` 2,96,400

By taking forward cover loss is reduced to ` 2,96,400.

ii. Actual Rate of HKD on August 2014 = ` 8.2172 (` 82.09/HKD 9.99)

Value of export at the time of export (` 8.2628 x HKD 12,00,000) `99,15,360

Estimated payment to be received on Aug. 2014
(` 8.2172 x HKD 12,00,000) ` 98,60,640
Loss ` 54,720

The decision to take forward cover is not justified because loss under forward cover
was bigger i.e., ` 2,96,400

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 Forex-Practice Problems

PROBLEM - 3

A company is considering hedging its foreign exchange risk. It has made a

purchase on 1st. January, 2008 for which it has to make a payment of British
Pound GBP 73,500 on September 30, 2008. The present exchange rate is 1 GBP
£ = ` 82.3953. It can purchase forward 1 1 GBP £ at `81.5375. The company will
have to make a upfront premium of 2% of the forward amount purchased. The
cost of funds to the company is 11% per annum and the rate of corporate tax is 45%.
Ignore taxation. Consider the following situations and compute the Profit/Loss
the company will make if it hedges its foreign exchange risk:

i. If the exchange rate on September 30, 2008 is ` 84.5000 per £.

ii. If the exchange rate on September 30, 2008 is ` 83.0000 per £.

Solution :

`
Present Exchange Rate `82.3953 = 1 GBP
If company purchases £ 73,500 forward premium is £ 73,500 × 81.5375 × 2% 119860
Interest on `119860 for 9 months at 11% 9888
Total hedging cost 129748
If exchange rate is `84.50/GBP
Then gain (`84.5000 – `81.5375) for £ 73,500 217744
Less: Hedging cost 129748
Net gain 87996
If £ = `83.0000
Then gain (83.00 - 81.5375) for £ 73,500 107494
Less: Hedging Cost 129748
Net Loss (22254)

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 Strategic Financial Management

PROBLEM - 4

ABC Ltd. of USA has exported goods worth Can $ 3,90,000 receivable in 9 months.
The exporter wants to hedge the receipt in the forward market. The following
information is available:

Spot Exchange Rate ` 64.56/$

Interest Rate in USA 1.25%
Interest Rate In Indian 8%

The forward rates truly reflect the interest rates differential. Find out the
gain/loss to USA exporter if Indian ` spot rates (i) declines 1.5%, (ii) gains 5.5% or
(iii) remains unchanged over next 6 months.

Solution :

Forward Rate

64.56[{1+(0.08) 9/12}/{1+(0.0125)  9/12}] = `67.7980

i. If spot rate decline by 1.5%

Spot Rate = ` 64.56x 1.015 =`65.5284/$

$
` receipt as per Forward Rate ($ 3,90,000  `67.7980) 26441220
` receipt as per exp Spot Rate ($ 3,90,000  `65.5284) 25556076
Profit due to forward contract 885144

ii. If spot rate gains by 5.5%

Spot Rate = ` 64.56x 0.945=`61.0092/$

$
` receipt as per Forward Rate ($ 3,90,000  `67.7980) 26441220
` receipt as per exp Spot Rate ($ 3,90,000 `61.0092) 23793588
Profit due to forward contract 2647632

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 Forex-Practice Problems

iii. If spot rate remains unchanged

$
` receipt as per Forward Rate ($ 3,90,000  `67.7980) 26441220
` receipt as per exp Spot Rate ($ 3,90,000 `64.56) 25178400
Profit due to forward contract 1262820

PROBLEM - 5

Dreher Brewery, a company operating in Hungary is a landlocked country in Central

Europe, has today effected sales to an Indian FMCG company, the payment being
due 6 months from the date of invoice. The invoice amount is 227 lakhs Hungarian
Forint (HUF). At today's spot rate, it is equivalent to ` 53.92 lakhs. It is anticipated
that the exchange rate will decline by 11% over the 6 months period and in order
to protect the HUF payments, the importer proposes to take appropriate action
in the foreign exchange market. The 6 months forward rate is presently quoted as
3.91 HUF per rupee. You are required to calculate the expected loss and to show how
it can be hedged by a forward contract.

Solution :

Spot rate of ` 1 against HUF = 227 lakhs HUF/` 53.92 lakhs = 4.21 HUF
6 months forward rate of Re. 1 against yen = 3.91 HUF
Anticipated decline in Exchange rate = 11%.
Expected spot rate after 6 months = 4.21 HUF – 11% of 4.21
= 4.21 HUF – 0.46 HUF
= 3.75 HUF per rupee
` (in lakhs)
Present cost of 227 lakhs HUF 53.92
Cost after 6 months: 227 lakhs HUF / 3.75 HUF 60.53
Expected exchange loss 6.61

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 Strategic Financial Management

If the expected exchange rate risk is hedged by a Forward contract:

Present cost 53.92
Cost after 6 months if forward contract is taken 227 lakhs HUF / 3.91 HUF 58.06
Expected loss 4.14

Suggestion: If the exchange rate risk is not covered with forward contract, the
expected exchange loss is ` 6.61 lakhs. This could be reduced to ` 4.14 lakhs if it
is covered with Forward contract. Hence, taking forward contract is suggested.

PROBLEM - 6

Ford India Private Limited is a wholly owned subsidiary of the Ford Motor Company
in India. The vehicles and engines use as an integral parts import from Ford
Motor Company of Canada Ltd. And the Ford Motor Company of Canada Ltd.
invoiced the sales to the Indian company, the payment being due three months
from the date of invoice. The invoice amount is $ 11,250 and at todays spot rate
of $0.015 per `.1, is equivalent to ` 7,50,000.

It is anticipated that the exchange rate will decline by 10% over the three
months period and in order to protect the dollar proceeds, the importer
proposes to take appropriate action through foreign exchange market. The three
months forward rate is quoted as $0.0145 per ` 1.

You are required to calculate the expected loss and to show, how it can be
hedged by forward contract.

Solution :

Calculation of the expected loss due to foreign exchange rate fluctuation

Present Cost
US $11,250 @ today spot rate of US $0.015 per Re. 1 ` 7,50,000
Cost after 3 months
US $11,250 @ expected spot rate of US $0.0135 per Re. 1 ` 8,33,333
(Refer to working note)
Expected loss `83,333

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 Forex-Practice Problems

Forward cover is available today at 1 Re. = US $0.0145 for 3 months

If we take forward cover now for payment after 3 months net amount to be paid is
(US $ 11,250/0.0145) = ` 7,75,862
Hence, by forward contract the company can cover `57,471 (`83,333 – `25,862) i.e.
about 69% [(57,471/83,333)  100] of the expected loss.

Working Note:

Expected spot rate after 3 months

It is anticipated by the company that the exchange rate will decline by 10%
over the three months period. The expected rate will be
Present rate - 10% of the present rate.
= US $ 0.015 – 10% of US $ 0.015
= US $ 0.0135

Alternatively, the expected rate may also be calculated as follows:

= US $ 0.015  90/100 = US $ 0.0135

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 Strategic Financial Management

FX SWAP

PROBLEM - 7

Energy Drilling Company an Australian Company has a won a contract in Russia

for drilling oil field. The project will require an initial investment of 4700 RUB
Million. The oil field along with equipments will be sold to Russian Government
for 7700 RUB Million in one year time. Since the Russian Government will pay for
the amount in RUB the company is worried about exposure due exchange rate
volatility.

You are required to:

i. Construct a swap that will help the Energy Drilling Company to reduce the
exchange rate risk.

ii. Assuming that Russian Government offers a swap at spot rate which is
1AUD = 44.89 RUB in one year, then should the company should opt for this
option or should it just do nothing. The spot rate after one year is expected to
be 1AUD = 48.89 RUB. Further you may also assume that the Energy Drilling
Company can also take a AUD loan at 5% p.a.

Solution :

i. The following swap arrangement can be entered by Energy Drilling Company.

a. Swap a AUD loan today at an agreed rate with any party to obtain
Russian Ruble to make initial investment.
b. After one year swap back the Russian Ruble with AUD at the agreed rate. In
such case the company is exposed only on the profit earned from the project.

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 Forex-Practice Problems

ii. With the swap

Year 0 Year 1
(Million (Million
AUD) AUD)
Buy RUB 4700 Million at spot rate of 1AUD = 44.89 RUB (104.70) --------
Swap 4700 Million back at agreed rate of 44.89 RUB ------ 104.70
Sell 3000 RUB Million at 1 AUD= 48.89 RUB ------ 61.36
Interest on AUD loan @5% for one year ----- (5.24)
(104.70) 160.82
Net result is a net receipt of AUD 56.12 million.
Without the swap

Year 0 Year 1
(Million (Million
AUD) AUD)
Buy RUB 4700 Million at spot rate of 1AUD = 44.89 RUB (104.70) --------
Sell 7700RUB Million at 48.89 RUB ------ 157.50
Interest on AUD loan @5% for one year ------ (5.24)
(104.70) 152.26
Net result is a net receipt of AUD 47.56 million.
Decision: Since the net receipt is higher in swap option the company should opt
for the same.

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 Strategic Financial Management

IPR EQUATION

PROBLEM - 8

On 1st April, 180 days interest rate in the PHP and NPR are 9.18 per cent and
10 per cent per annum respectively. The NPR/PHP spot rate is 0.4844. What would
be the forward rate for NPR for delivery on 30th September?

Solution :

PHP NPR
Spot 0.4844 1.000
Interest rate p.a. 9.18% 10%
Interest for 180 days 0.0219 0.0493
Amount after 180 days 0.5063 1.0493
Hence forward rate 0.5063 0.4863
1.0493

OR

  91  
0.6560  1   0.065  
  365  
Forward rate  = 0.6592
  91  
1   0.045  
  365  

Forward Rate = 0.4844 ´ [{1+ (0.10180/365)}/{1+(0.0918180/365)}]

= 0.4863

PROBLEM - 9

On April 1, 3 months interest rate in the € and ¥ are 4% and 7% per annum
respectively. The € /¥ spot rate is 0.00787. What would be the forward rate for ¥ for
delivery on 30th June?

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 Forex-Practice Problems

Solution :

As per interest rate parity

 1  in A 
S1  S0  
 1  in B 

= 0.00787[{1+ (0.043/12)}/{1+(0.073/12}]
= 0.00787 × 0.09926
= € /¥ 0.00781

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 Strategic Financial Management

CIA

PROBLEM - 10

Following are the rates quoted at National Stock Exchange (NSE) for Canadian Dollar:

CAD/` 49.87/97 Interest Rates India Canada

3 m Forward 35/85 3 months 8% 5%
6 m Forward 65/90 6 months 10% 8%

Verify whether there is any scope for covered interest arbitrage if you borrow
rupees.

Solution :

Particulars Option I (3 mths) Option II (6mths)

Amount borrowed 100000 100000
Pound obtained by converting at spot rate 100000/49.97 100000/49.97
= 2001.20 = 2001.20
Invest pound for the period 1.25% 4%
Amount of pound received at the end 2001.20 × 1.0125 2001.20× 1.04
Of the period = 2026.215 = 2081.248
Convert pounds to ` At forward rate 2026.215× 50.22 2081.248 × 50.52
= 1,01,757 = 1,05,145
Amount of Re. Loan to be repaid 100000 × 1.02 100000 × 1.05
= 102000 = 105000

There is no arbitrage opportunity on 3 months but on 6 months there is an arbitrage

opportunity.

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 Forex-Practice Problems

PROBLEM - 11

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 is interest is compounded on daily basis then at which forward
rate of 2 year there will be no opportunity for arbitrage.
Further, show how an investor could make risk-less profit, if two year forward price is
1 $ = 0.85 £. Given e0.-06 = 0.9413 & e-0.16 = 0.852, e0.16 = 1.1735, e-0.1 = 0.9051

Solution :

2 year Forward Rate will be calculated as follows:

F  Se uk us 
r r t

Where F = Forward Rate

S = Spot Rate
rUK = Risk Free Rate in UK
rUS = Risk Free Rate in US
t = Time
Accordingly,

F  0.75e 
0.050.08 2

= 0.75 х 0.9413
= 0.706
Thus,
1 US $ = £ 0.706
If forward rate is 1 UK $ = 0.85$ then an arbitrage opportunity exists. Take
following steps.
a. Should borrow UK £
b. Buy US $
c. Enter into a short forward contract on US $

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 Strategic Financial Management

Accordingly,

The riskless profit would be

a. Say borrow £ 0.706e-(0.05)(2) = £ 0.639 and invest in UK for 2 years.
b. Now buy US $ at US $ 1e-(0.08)2 = US $ 0.852, so that after two year it can be used
to close out the position.
c. After two year the investment in US $ will become US $ 0.852 e(0.08)(2)
= US $ 0.852 х 1.1735 = 1 US $.
d. Sell this US $ for £ 0.85 and repay loan of £ 0.639 along with interest i.e £ 0.706.
Thus arbitrage profit will be US$ 0.85 – US$ 0.706 = 0.144 $.

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 Forex-Practice Problems

FC VS MMC

PROBLEM - 12

Barclays is a British multinational bank and financial services company headquartered

in London. It is a universal bank with operations in retail, wholesale and investment
banking. Barclays provides financial services across the Globe. The Company raised
an invoice amount is ¥6,77,500. Credit period is three months. Exchange rates in
London are :

Spot Rate (¥/£) 145.4967 – 145.5007

3-month Forward Rate (¥/£) 148.7859 – 148.7890

Rates of interest in Money Market :

Deposit Loan
¥ 9% 11%
£ 5% 8%

Compute and show how a money market hedge can be put in place. Compare
and contrast the outcome with a forward contract.

Solution :

Identify: Foreign currency is an asset. Amount ¥6,77,500.

Create: ¥ Liability.
Borrow: In ¥. The borrowing rate is 11% per annum or 2.75% per quarter.
Amount to be borrowed: ¥6,77,500 / 1.0275 = ¥6,59,367.40
Convert: Sell ¥ and buy £. The relevant rate is the Ask rate, namely, ¥145.5007 per £,
(Note: This is an indirect quote). Amount of £s received on conversion is
4531.71 (¥6,59,367.40/¥145.5007).
Invest: £ 4531.71 will be invested at 5% for 3 months and get £ 4588.36
Settle: The liability of ¥6,59,367.40 at interest of 2.75 per cent quarter matures to
¥6,77,500 receivable from customer.
Using forward rate, amount receivable is = ¥6,77,500/ 148.7890 = £4553.43

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 Strategic Financial Management

Amount received through money market hedge = £ 4588.36

Gain = £ 4588.36 – £4553.43 = £34.93
So, money market hedge is beneficial for the exporter.

PROBLEM - 13

Bhawal Steel Agency, are engaged in the manufacturing, supplying, exporting

and importing of a wide range of Stainless Steel products. etc from Brazil and
Slovak Republic and exports such products to Singapore and Australia after
processing. The company has receivables of SGD3,50,000 and payables of
AUD$2,45,00 three months from now. The following rates exchanges rates are
available in the market:

Exchanges Rates ` / SGD ` /AUD$

Spot 46.9580 - 47.0080 49.6825 – 49.7025
Three month forward 47.0680 – 47.0880 49.7225 – 49.7425

The current rates (per annum) are as under

Maturity Rupee (%) SGD(%) AUD$(%)

3 months 7.00/8.00 3.00/3.20 5.00/5.20

The company is considering to cover the cover the exposure either through the
forward market money market. You are required to advise the company as to which
alternative should be better for covering both the payable and receivable.

Solution :

Receivable- SGD 3,50,000 3 month

Alternative - I forward cover :

Sell SGD 3,50,000 3m forward @ 47.0680
Inflow after 3 months = 3,50,000 × `47.0680
=`164,73,800

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 Forex-Practice Problems

Alternative -II Money market cover (Borrow- sell-invest)

Step I Borrow the PV of SGD 3,50,000 at 3.20%
∴ PV of SGD = SGD 3,50,000/1.008
= SGD 3,47,222
Step II Sell SGD 3,47,222 @ 46.9580
Getting = SGD 3,47,222 × `46.9580/SGD
= `163,04,861
Step III Invest ` 163,04,861 @ 7% i.e. 1.75%
Inflow =163,04,861 × 1.0175
=`165,90,196
Since ` inflow is higher in alternative II, Firm should choose money market cover.
Payable AUD 2,45,000 after 3 months
Alternative - I forward cover :
Buy AUD 2,45,000 for 3 month forward at 49.7425
So, outflow after 3 month = `49.7425 × AUD 2,45,000
`121,86,913
Alternative II Money market Cover (Invest- Buy- Borrow)
Step I : Invest the PV of $ 100,000 @5/4 i.e., 1.25%
AUD 245,000
1.0125
AUD 2,41,975
Step II : Buy AUD 2,41,975 spot at `49.7025
Requiring [2,41,975 × `49.7025]
`120,26,778
Step III : Borrow `1,20,26,778 at 8/4 i.e., 2%
So outflow after 3 month `120,26,778 × 1.02
=`122,67,313
Since Rupee outflow is lower under alternative I forward cover is recommended.

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 Strategic Financial Management

PROBLEM - 14

Techinfo Ltd. Has imported specialty computer equipments worth US$ 250,000 from
a company in US. The amount due for the imports is payable after 3 months.
Mr. Garg, the treasury manager of Techinfo has collected the following market
quotes:

Exchange rates:
Sport Rs./$ 47.15/47.30
Forward 3 month 55/60

Interest rates(p.a.):
Dollar (3 months) 6.00%/6.50%
Rupee (3 months) 10.00%/11.00%

The supplier of the equipments has offered a discount of $5000 if the payable
is settled at the current date. Mr.Garg is reviewing the following alternatives to
settle the payable:
i. Cover through forward market.
ii. Cover through money market.
iii. Avail the cash discount of $5000 by taking a bridge loan at 9% p.a. from a lending
institution.

Solution :

Spot Rs./$ 47.15/47.30

3m forward 47.70/47.90
Forward market cover:
Rupee outflow after 3 month = 250,000×47.90
=Rs.119.75 lakh.
Money market cover:
As the company has to pay dollar 3 months hence, so it will borrow in rupees,
convert into dollar at spot and invest in dollar.
Dollar amount to be invested today

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 Forex-Practice Problems

$250,000
  $246, 305.42
0.06
1
4
∴ Rupee amount to be borrowed today
=$246,305.42 × 47.30 = Rs. 116.50 lakh
∴ Rupee outflow after 3 months
0.11
= 116.50  1+ 
=Rs.119.70 lakh.
 4 
Availing cash discount
Amount to be paid if cash discount is availed = $245,000
Rupee equivalent of $ 245,000 at the spot rate = 245,000 × 47.30 = Rs. 115.89 lakh
∴ Rupee outflow after 3 months
 0.09 
=115.89  1+ = Rs.118.50 lakhs
 4 
So it is better to avail cash discount as the outflow is minimum in this case

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FOREIGN CURRENCY EXPOSURE

PROBLEM - 15

Bharat Electronics Limited in Bangalore exports space vehicles to Belgium by

importing all the components from south Korea. Imports are invoiced in Hong Kong
dollars and exports in Euro. The company is exporting 6000 unit at a pries of Euro 165
per unit. The cost of imported components is HK$ 75. The fixed cost and other
variable costs per unit per unit are `1200 and `2500 respectively. The cash flows in
foreign currencies are due in six months. The current exchange rates are as follows :
`/Euro : 59.60/62
`/HK$ : 5.96/5.98
After six months the exchanges rates (at the time of receipts and payments of foreign
currency) turn out as follows :
`/Euro : 60.30/32
`/HK$ : 6.23/25
You are required to :
i. Calculate the loss/gain due to the transaction exposure.
ii. Based on the following additional information, calculate the loss/gain due to
transaction and operating exposure if the life contracted price of washing
marching is `9500.
 The current exchange rates change to
`/Euro : 59.85/87
`/HK$ : 6.00/02
 Price elasticity of demand of the product in Germany is estimated as 2.5.
 Payment and receipts are to be settled/received at the end of six months.

Solution :

i. Firm faces the following transaction exposure

receivable = 6000 × 165 = ∈ 990,000
payable = 6000 × 75 = HK $ 4,50,000

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∴Gain in Euro receivable = 6,93,000

9,90,000 ×[60.30-59.60]
Loss on HK $ payable = 1,21,500
HK $ 4,50,000 [6.25 - 5.98]
∴ Net gain due to transaction Exposure 5,71,500

ii. Step I
We are required to calculate the change in profit on account of transaction and
Economic exposure. Transaction exposure is still there relating to $ payable.
∴ $ payable = 6000 × $75 = HK$ 4,50,000
∴ loss due to transaction Exposure = `/HK$ (6.25 -6.02) × 450,000
= `1,03,500
Step II
Invoice price = `9500
9500
Euro equivalent price at the old currency rate = 159.40
59.60
9500
Euro equivalent price at the new current rate = = 158.73
59.85
159.40  158.73
% fall in price =  100  0.42%
159.40
Increase on demand = 0.42% × 2.5 = 1.05%
∴ New demand = 6000 + 1.05% of 6000 = 6063
old profit [Based on 6000 units and revised currency rates)
= 6000[`9500 - 75 × 6.02 - 2500] - 6000×1200 = 3,20,91,000
New profit [Based on 6063 units and exchange rate after 6 m]
= 6063[`9500 - 75×6.25 - 2500 ] - 6000 × 1200 = ` 3,23,98,969
So, Gain due transaction exposure & economic exposure
= 32398969 - 32091000
= 3,07,969
∴ Hence, Gain due to Economic exposure = `[3,07,969 + 1,03,500] = `4,11,469

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PROBLEM - 16

Pacific Leather Goods Ltd. an Indian manufacturer exports leather goods to USA. The
company is exporting 5000 units at a price of $60. The company has imported some
specialty chemicals from Europe to produce the export items. The cost of chemicals
per unit of leather good stands at Euro 10. The fixed overhead costs per unit comes
at Rs.250 and other variable overheads, including the freight cost, add upto Rs.1250
per unit. The payments for both exports and imports are due in six months.
The current exchange rate are as follows:
Rs./$ 46.90
Rs./Euro 40.40
After six months (at the time of settlement of payments) the exchange rate turns out
as follows:
Rs./$ 47.90
Rs./Euro 41.25
You are required to:
i. Calculate the loss/gain due to transaction exposure.
ii. Based on the following additional information calculate the losses/gains due
to transaction and operating exposure if the contracted export price per unit is
Rs.2700:
 The current exchange rate changes to
Rs./$ : 47.50
Rs./Euro : 40.80
 Price elasticity of demand for the company's product in the USA is estimated to
be 1.60.
 The payments are to be settled at the end of sixth month.

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 Forex-Practice Problems

Solution :

i. Profit at the current exchange rates

=5000[60×46.90-(10×40.40+250+1250)]
=500[2841-1904]
=5000×910=Rs.45.50 lakhs
Profit after the change in exchange rate
=5000[60×47.90-(10×41.25+250+1250)]
=5000[2874-1912.5]
=5000×961.5=Rs.48.075 lakhs
∴Gain due to transaction exposure
=48.075-45.50
=Rs.2.575 lakh.
ii. Profit based on new exchange rate
=5000[2700-(10×40.80+250+1250)] = Rs.39.60 lakh
Profit after change of exchange rate at the end of 6 month
=5000[2700-(10×41.25+250+1250)] = Rs.39.375 lakh
∴Decline in profit due to transaction exposure =39.60-39.375 = Rs.0.225 lakhs
2700
Current price of each unit in dollar term =  $57.57
46.90
2700
After the change in exchange price per unit in dollar term =  $56.84
47.50
57.57  56.84
∴% reduction in price =  1.27%
57.57
Increase in demand due to reduction in price =1.27×1.60 = 2.03%
Size of the increased order = 5000(1+0.0203)=5102 units
∴Profit
=5102[2700-(10×41.25+250+1250)]
=5102×787.5
=Rs.40.18 lakhs
∴Increase in profit due to operating exporter =40.18 - 39.60 = Rs.0.58 lakhs

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 Strategic Financial Management

LEADING, LAGGING, & NETTING

PROBLEM - 17

An Indian importer has a payable of £100,000. The seller has given the Indian
importer the following two options.
i. Pay immediately with a cash discount of 1% on the payable.
ii. Pay after. 3 months with interest at 4% P.a.
The borrowing rate for the importer in Rupees is 12% P.a. The following are the
exchange rates as on December 02,2002.
Rs/£ Spot 74.76/80
3 month 38/40
Which of the above two options is advisable for the importer?

Solution :

Payable £ 1,00,000
Option 1
Pay now, by availing a cash discount of 1%
Amount payable is £99,000
Borrow at 12% for 3 months
Amount to be borrowed=99,000 × 74.80 = 74,05,200
Rupee out flow after 3 months
 0.12 
=74,05,200  1+  =76,27,356
 4 

Option 2:
Pay after 3 months
Payment in foreign currency
 0.04 
=1,00,000   1    £ 1, 01, 000
 4 
Obtain forward cover for £ 1,01,000 at the rate of Rs. 75.20/£
Rupee outflow = 75,95,200
Option 2 is beneficial to the Indian importer as the rupee outflow is lower, by
Rs.32,156

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 Forex-Practice Problems

INTERNATIONAL WORKING CAPITAL MANAGEMENT

PROBLEM - 18

True view Ltd. a group of companies controlled from the United Kingdom includes
subsidiaries in India, Malaysia and the United States. As per the CFO's forecast
that , at the end of the June 2010 the position of inter-company is as follows:
i. The Indian subsidiary will be owned or will receive `1,44,38,100 by the Malaysian
subsidiary and will to owe or will pay the US subsidiary US$ 1,06,007.
ii. The Malaysian subsidiary will be owed or will receive MYR 14,43,800 by the US
subsidiary and will owe it or will pay US$ 80,000
Suppose you are head of central department of the group and you are required to
net off inter-company balances as far as possible and to issue instructions for
settlement of the net balance. For this purpose, the relevant exchange rates may be
assumed in term of £1 are US$ 1.415; MYR 10.215; `68.10. What are the net
payments to be made in respect of the above balances?

Solution :
India Malaysia US
India - `1,44,38,100 (US$ 1,06,007)
Malaysia (`1,44,38,100) - MYR 14,43,800
(US$ 80,000)
US US$ 1,06,007 MYR 14,43,800 -
US$ 80,000

Table showing conversion of above position into pound sterling

India £ Malaysia £ US £ Total £
India - 2,12,013 (74,917) 1,37,096
Malaysia (2,12,013) - 1,41,341
(56,537) (1,27,209)
US 74,917 (1,41,341)
56,537 - (9,887) NIL

Decision : Central treasury department will instruct the Malaysia subsidiary to pay
the Indian subsidiary.
£1,27,209 and the US subsidiary to pay the Indian subsidiary £9,887.

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 Strategic Financial Management

TRIANGULAR ARBITRAGE

PROBLEM - 19

Followings are the spot exchange rates quoted at three different forex markets:
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
The arbitrageur has USD1,00,00,000. Assuming that bank wishes to retain an
exchange margin of 0.125%, explain whether there is any arbitrage gain possible
from the quoted spot exchange rates.

Solution :

The arbitrageur can proceed as stated below to realize arbitrage gains.

i. Buy GBP at New York for USD USD 1,00,00,000
GBP/USD 1.72
Add: Exchange Margin @ 0.125% 0.002
1.722
Accordingly, GBP acquired in exchange of USD1,00,00,000 is GBP 58,07,200
ii. Sell these GBP at London Market and get INR
GBP/INR 102.50
Less: Exchange Margin@ 0.125% 0.13
102.37

INR on conversion of GBP (58,07,200 X 102.37) = INR 59,44,83,064

iii. Acquire USD by selling INR at Mumbai

USD/INR 59.35
Add: Exchange Margin @ 0.125% 0.07
59.42
59, 44, 83, 064
Accordingly, USD acquired in exchange of INR is USD 1,00,04,763
59.42

Net Gain (USD 1,00,04,763 - USD 1,00,00,000) = USD 4,763

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SANJAY SARAF SIR
 Forex-Practice Problems

FOREIGN CURRENCY ACCOUNT

PROBLEM - 20

You as a dealer in foreign exchange have the following position in Great British Pound
on 31st November, 2015 :
GBP
Balance in the Nostro A/c Credit 5,00,000
Opening Position Overbought 100,000
Purchased a bill on London 90,000
Sold forward TT 80,000
Forward purchase contract cancelled 40,000
Remitted by TT 125,000
Draft on London cancelled 60,000

What steps would you take, if you are required to maintain a credit Balance of GBP
80,000 in the Nostro A/c and keep as overbought position on GBP 40,000 ?

Solution :
A/c Statement (£)
Particulars Dr. Cr.
1. Op. Balance 5,00,000
2. Returned by TT 1,25,000
Total 1,25,000 5,00,000
Cl A/c Total 3,75,000

Position Statement (£)

Particulars Long Short

1. Op Position 1,00,000
2. Purchased a bill on London 90,000
3. Sold forward TT 80,000
4. Forward purchase contract cancelled 40,000
5. Resulted by TT 1,25,000
6. Draft on London Cancelled 60,000
Total 2,50,000 2,45,000

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 Strategic Financial Management

i.e. closing position £5,000

Target closing A/c Balance = £ 80,000 cr.
To achieve this, dealer should sell £ 2,95,000 spot. However this makes
Our position = 5,000 long and 2,95,000 short i.e. £ 2,90,000 short.
Target Position = £ 40,000 long.
So, to achieve this dealer should buy £ 3,30,000 forward.
Final suggestion 1, spot sale £ 2,95,000
2, Forward buy £ 3,30,000

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 Forex-Practice Problems

CANCELLATIONS AND EXTENSION OF FORWARD CONTRACTS

PROBLEM - 21
An Indian importer has a payable of C$ 5,00,000 due on 31.3.2002. On 01.01.2002,
the importer covers the payable through forward buying of C$ at Rs. 30.34 from his
banker.
On 3l-3-2002, he requests the banker to extend the contract till 30-4-2002. The
exchange rates as on 31-3-2002 are
Rs./C$ Spot 30.54/63
1 month forward 30.56/68

You are required to find out the net cash outflow for the importer.

Solution :
The bank must have bought C$5,00,000 in inter- bank market for delivering to the
importer on 31.3.2002. When, the importer requests for extension, the bank has to
take the delivery of C$ from inter-bank market and sell the same at the spot rate
and book a fresh forward contract at 30.68 for which bank will again cover it in the
inter-bank market. The customer enjoys gain/incurs loss in the spot market.
On 31.3.2002
Gain on selling C$ in the spot market
(30.54 - 30.34) × 5,00,000
Rs. 1,00,000
On 30.4.2002
Cash outflow on account of C$ bought at 30.68
in the forward market = 30.68 × 5,00.000 = 153,40,000
Less gain 1,00,000
Net cash outflow Rs. 152,40,000

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 Strategic Financial Management

PROBLEM - 22
An Indian software company had approached State Bank of India (SBI) for forward
sale of £100,000 delivery on May 31, 2001. The bank had quoted a rate of Rs.65.60/£
for the purchase of pound sterling from the customer. But on May 31st, the customer
informed the bank that it was not able to deliver the pound sterling as anticipated
receivable from London has not materialized and requested the bank to extend the
contract for delivery July 31st.
The following are the market quotes available on May 31, 2001:
Rs/£
Spot 66.60/65
1m forward 20/25
2m forward 41/46
3m forward 62/68
You are required to find out the extension charges payable by the software company.

Solution :
The forward purchase contract will be first cancelled at the spot rate.
Sterling bought from the customer under original contract at 65.60
Sterling sold to customer under cancellation contract at 66.65
Exchange difference per sterling payable by customer 1.05
Exchange difference for £ 100,000 is Rs.105,000 charges for cancellation :
Exchange difference Rs.105,000
(+) Flat charge Rs.100
Rs.105,100
The bank will book a fresh forward purchase of sterling on 31st July.
Spot buying rate for sterling 66.60
(+) Two month premium 0.41
Rs. 67.01
On extension of the forward contract, Rs.105,100 will be recovered as cancellation
charges from the customer and fresh contract will be booked at Rs.67.01

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 Forex-Practice Problems

INTERNATIONAL PROJECT APPRAISAL

PROBLEM - 23
OJ Ltd. Of UK is supplier of leather goods to retails in the UK and other Western
European countries. The company is considering entering into a joint venture with a
manufacturer in South America. The two companies will each own 50% of the limited
liability company JV(SA) & will share profits equally. £450,000 of the initial capital is
being provided by OJ Ltd. and the equivalent in South American collars (SA$) is being
provided by the foreign partner. The managers of the joint venture expect following
cash flows :
SA$ 000 Forward rates of exchange to the £ Sterling [SA$/£]
Year 1 4,250 10
Year 2 6,500 15
Year 3 8,350 21

For tax reasons JV(SA) the company to be formed for the joint venture, will be
registered in South America. Ignore taxation in your calculations Requirements :

Assume you are financial adviser retained by OJ Limited to advise on the proposed
joint venture.
i. Calculate NPV of the project under the two assumptions explained below. Use a
discount rate of 16% for both assumptions.
Assumption 1 : The South American country has exchange controls which
prohibit the payment of cash flows above 50% of the annual cash flows for the
first three years of the project. The accumulated balance can be repatriated at
the end of the third year.
Assumption 2 : The government of the South American country is considering
removing exchange controls and restriction on repatriation of profits. If this
happens all cash flows will be distributed to the partner companies at the end of
each year.

ii. Comment briefly on whether or not the joint venture should proceed based on
these calculations.

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 Strategic Financial Management

Solution :
i. With Exchange Controls
Year Profit O.J. 50% div. OJ Share PVF @ Present
After Share ER[£/$] in £000 16% Value
Tax 50% SA$ 000 £000
SA$000 SA$0000
0 - (450) 1.000 (450)
1 4,250 2,125 1,062 .1 106 0.862 91
2 6,500 3,250 1,625 .067 108 0.743 80
3 8,350 4,175 2,088 .0476 100 0.641 64
3 - - 4,775 .0476 227 0.641 146

Net Present Value (69)

Exchange controls removed and all earnings distributed as divide

Year Profit OJ Share ER[£/$] OJ Share PVF @ Present

After SA$0000 S in £000 16% Value
Tax flow
SA$000 £000
0 (450) (1.000) (450)
1 4,250 2,125 .1 212 0.862 183
2 6,500 3,250 .067 217 0.743 161
3 8,350 4,175 .0476 199 0.641 127
Net Present Value 21

ii. Decision :
If exchange controls exist in the South American Country the project has a
negative and NPV should not be undertaken.

If exchange control are removed then project may be undertaken as then the
project has a positive NPV. Investing in countries with a history of high inflation
and political volatility adds to the risk of the project and OJ Ltd. Should proceeds
with caution.

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