FOREX MARKET

EXCHANGE RATE
DOMESTIC
CURRENCY
DIRECT QUOTE
INDIRECT QUOTE
LINK BETWEEN
DIRECT&INDIRECT
QUOTE

AMERICAN TERM
EUROPEAN TERM
BID
ASK
TWO WAY QUOTE
SPREAD
CONVERTING
TWOWAY QUOTE
Arbitrage
pgkrd

FOREX MARKET

CROSS RATE
SPOT RATE
FORWARD RATE
APPRECIATION
DEPRECIATON
COMPUTATION OF
APPRECIATION AND
DEPRECIATION

SWAP POINTS
FORWARD RATE,
PREMIUM AND
DISCOUNT

pgkrd

EXCHANGE RATE
THE PRICE OF ONE CURRENCY
VIEWED IN RELATION TO ANOTHER
CURRENCY IS CALLED EXCHANGE
RATE.
EXAMPLE- Re/$ 44.76 means
44.76=1USD

pgkrd

3. DIRECT QUOTE
X UNITS OF DOMESTIC CURRENCY
EQUAL ONE UNIT OF FOREIGN
CURRENCY.
EXAMPLE- Rs44.20 per USD IS A
DIRECT QUOTE FOR USD IN INDIA

pgkrd

4. INDIRECT QUOTE
THE DOMESTIC CURRENCY IS THE
COMMODITY WHICH IS BEING
BOUGHT AND SOLD.
COMMODITY COMES FIRST AND
PRICE NEXT.
EXAMPLE- Re1=.02 USD

pgkrd

5.CONVERTION (D TO I)
Q1.If $1 =INR 49.3180 ; then Rs 1= ? $
Q2.If 1 =INR 77.8435; then Rs 100=?
Q3.If INR 100= 1.5301 then 1= ?INR
Q4.If 100 =INR 63.5600 then INR 1=?
Q5.How many $ = 1; from above rates
Q 6: How many =$1; from above rates
Q7: How many = 1; from above rates
pgkrd

6. AMERICAN AND
EUROPEAN TERMS
AMERICAN TERM IS DIRECT.
EUROPEAN TERM INDIRECT.
EXAMPLE-THE RATE $ 1.5 PER POUND IS AN
AMERICAN TERM.
THE QUOTE $1= INR 45 IN EUROPEAN TERM.
? AMERICA OR EUROPE.
(a) 3.419$ PER QUWAITI DINAR- IN USA IT IS
A DIRECT MODE- AMERICAN TERMS.
EUROPEAN TERM- 1/AMRICAN TERM : .2925
KWD PER USD.
pgkrd

7. SOLVE

(a) 7.760 HKD PER $ in USA, Comment.

Express in American term
1HKD=0.128$ European term
0.128 $ =1HKD Indirect quote

pgkrd

ANSWERS
(a) PERSON IN AMERICA THE QUOTE IS
FOREIGN CURRENCY PER UNIT OF HOME
CURRENCY. HENSE IT IS INDIRECT MODEEUROPEAN TERM
THE AMERICAN TERM: 1/EUROPEAN TERM IS
1/7.760= .13 $ PER HKD(HONG-KONG)
DOLLAR.
(b)THE QUOTE IS NEITHER EUROPEAN NOR
IN AMERICAN TERM SINCE DOLLAR IS NOT
ONE OF THE PAIR OF CURRENCIES.
pgkrd

BID AND ASK

THE BANKS QUOTE OF BID AND ASK IS
FROM THE BANKERS PERSPECTIVE.
BID= BUY
ASK=SELL
IF THE BID RATE FOR USD IS 40 IT MEANS
THAT THE BANK IS READY TO BUY 1$ FOR
Rs.40
IF THE ASK RATE IS FOR USD IS 41, IT MEANS
THAT THE BANK IS (ASKING IF SOMEONE
WILL BUY) SELLING 1$ FOR Rs.41.
pgkrd

Three tier architecture

A) bottom tire- Money changers licenced
by RBI
B) Second tire-cooperative and
Commercial Bank licenced to maintain
accounts for NRI
C) TOP TIER- Authoried dealersScheduled Banks-full-fledged foreign
exchange business.
pgkrd

Two way quote

BID QUOTE AND ASK QUOTE

Ex: Re/$- 40.42 41.63
Rs.40.42-bid(buying)-( Bank point of view)
Rs.41.63-ask(selling)
Rs.40.42=1$ means the quote is in india
Yen33= Re.1 means the quote is in Japan
If you want to buy, if you have $, you will get
Rs.40.42
If you want to sell Rs. and buy $ you part with
Rs.41.63.
pgkrd

Spread
ASK MINUS BID=SPREAD
EX. 40-41
SPREAD=
Rs.41-40=Rs.1
Factors:a) Stability of the exchange rate
b) depth of the market-volume of
transaction
High volume(deep market)-narrow spread
Low volume (thin market)-wider spread
pgkrd

Problem
Indian would like to have travelers cheques:
GBP-STERLING 72.70-73.25
A) explain the quote
B) compute the spread
C) how much would you pay for purchasing 250
pounds in TCS?
D) If you have a balance of pounds 23 in
travellers cheques , how many rupees would you
receive if the bank in india quotes 73.65-73.92?
pgkrd

Answer

A)Bank buys at 72.70and Ask rate is 73.25

B)Spread=.55
C) 250*73.25=Rs.18312.50
D)Rs.23*73.65=Rs.1693.95
Note: in practice all forex transactions are
rounded off to a rupee ie Rs.1694

pgkrd

Converting two way quotes

Formula
Bid(Rs/$)=1/Ask($/Rs)or
Ask(Rs/$)=1/Bid ($/Rs)or
Take the inverse of each rate (bid and ask)
and switch them around.
Ex:INR/USD 40.25-41.35

1/40.25 1/41.35
USD/INR

=0.0248

=.02418
pgkrd

PROBLEM
CONSIDER THE FOLLOWING
QUOTATIONS IN MUMBAI
Rupee/UAE Dirham(AED)=12.69
Rupee/Swedish kroner(SEK)=5.49
Rupee/New Zealand Dollar(NZD)=25.35
Euro/INR=0.0198
Compute a)The quote for SEK/AED

b) Euro/NZD
pgkrd

Solutions
A)SEK/AED=SEK/INR*INR/AED=.18*12.6
9
=1 AED
B)
EURO/NZD=EURO/Re*Re/NZD=.0198*25
.35=.50

pgkrd

SPOT RATE
RATE OF EXCHANGE FOR IMMEDIATE
SETTLEMENT
IT IS SETTLED ON THE SECOND WORKING
DAY
SATURDAY AND SUNDAY ARE HOLIDAYS
EX:SPOT RATE:Rs./$40.35-41.36 SUPPOSING
YOU HAVE 124000 DOLLAR RECEIVED ON
THURSDAY THE BANK WILL SETTLE
124000*40.35=50,03,400 ON THE FOLLOWING
MONDAY.
pgkrd

FORWARD RATE
RATE CONTRACTED TODAY FOR
EXCHANGE OF CURRENCIES AT A
SPECIFIED FUTURE DATE
THERE IS A FORWARD BID AND
FORWARED ASK
CASH DELIVERY-ON THE SAME DAY
TOM DELIVERY-ON WORKING DAY ON
THE FOLLOWING DAY
pgkrd

APPRICIATION AND
DEPRECIATION
IF F>S IN A DIRECT QUOTE THE FOREIGN
CURRENCY IS APPRECIATING
Home depreciate
Indirect quote: Foreign depreciates and HOME
APPRECIATES
Ex: 1.
SPOT:
SGD .O370=Re 1
IN SINGAPORE ; FORWARD RATE THREE MONTHS
HENCE 0.0360
SGD APPRECIATES OR DEPRECIATES?
SPOT USD 1.5865= 1 POUND IN UK. FORWARD 1
MONTH 1.5833 .
?DEPRECIATE OR APPRICIATE
pgkrd

SWAP POINTS
DIFFRENCE BETWEEN SPOT BID AND
FORWARD BID OR SPOT ASK AND
FORWARD ASK
?DIFFRENCE BETWEEN SPREAD AND
SWAP POINTS

pgkrd

FORWARD RATE, PREMIUM

AND DISCOUNT
IF SWAP ASK> SWAP BID-FOREIGN
CURRENCY IS APPRECIATING HENCE
ADD SWAP POINTS
IF SWAP ASK <SWAP BID FOREIGN
CURRENCY IS DEPRECIATING. HENCE
DEDUCT THE SWAP POINTS.

pgkrd

Arbitrage
Act of buying currency in one market at
lower prices and selling it in another at
higher price.
It helps the arbitrageurs in the market to
earn profit without risk
It is a balancing operations that do not
allow the same currency to have varying
rates in different forex markets.
pgkrd

Types of arbitrage
Geographical
Triangular arbitrage

pgkrd

Geographical arbitrage
Different prices quoted in two geographical
markets for the same currency
Tokyo and London
1.Observe the following:
Rs/US $
London Rs.: 42.5730--42.61
Tokyo $: 42.6750 -- 42.6675
Can make money out of it?
pgkrd

 Buy at London market at 42.6100 and sell the

same at Tokyo market for Rs.42.6350.
Suppose you buy from London for 100 million
Rupees you can get 100 million /
42.61=$2,346,866.932
Sell $ 2,346,866.932 in Tokyo market at Rs.
42.6350 gives Rs.100,058,671.16
There are transaction costs involved.
Note: selling price of one market should be
higher than buying price of another market.
pgkrd

Exercise-2
The following are three quotes in three
forex markets
1$=Rs.48.3011 in Mumboi
1pound=Rs.77.1125 in London
1Pound=$1.6231 in Newyork.
Are there any arbitrage gains possible?
Assume there are no transaction costs
and the arbitrageaur has $1,000,000.
pgkrd

Answer-2
The cross rate between Mumboi and London
with respect to$/pound=77.1125/48.3011
=$1.5965/pound
But in newyork the price is quoted $1.6231
There is an opportunity to earn by buing indian
rupee in in Mumboi market and convert them
into pounds in London Market
Then convert pounds into dollors in NewYork
market.
pgkrd

Answer-2 continues
Rs.48.3011X 1 million
dollor=Rs.48,301,100
Pounds=48,301,100/77.1125=626,371.85
92
Dollors=626,371.8592X1.6231
=$1,016,664.164.
The gain=$16,664.164.
pgkrd

Exercise-3: arbitrage in forward

market
Determine arbitrage gain from the
following data:
Spot rate Rs.78.10/pound
3 month forward rate Rs.78.60/pound
3 month interest rates:
Rupees: 5%; British pound :9%
Assume Rs10 million borrowings or pound
200,000 as the case may be.
pgkrd

Answer-3
Since forward rate is higher than the spot
rate pound is at a premium.
Percentage premium = (78.6078.10)X12X100/(78.10X3)=2.56%
Interest rate differential =9%-5%=4%
This helps to borrow from Indian market
and invest today in pounds in the spot
market
pgkrd

Method -2
1.Borrow in Uk and invest such pounds after
converting them into rupees in India
2.After three months re convert the rupees
including the interest into pounds at forward
rate
3.Deduct the loan including interest from
step 2
If step-2 is more than step-3 there is a gain.
pgkrd

Exercise-4
Spot rate=78.10; interest rates India-5%;
interest rate in UK-9% (pounds); At what
forward rate the arbitrage is not possible?

pgkrd

Answer-4
Spot rate =78.10
Add: 4% premium for three month
period(78.10 X 4/100) X3/12=0.781
Forward rate= 78.10-0.781=77.319
What is the principle used?

pgkrd

Principle
The arbitrageur earns 4% extra interest to
pay 4% forward premium yielding him no
gain.

pgkrd

Exercise-5
Spot rate-78.10; forward rate for three
months-Rs.77.50; rate of interest for
pounds-6% for three months.Rate of
interest in India-5%. Is there any
arbitrage ?

pgkrd

Answer-5
The British pound is at a forward discount of
3.073% ie.(78.10-77.50)x 100/78.10x (12/3)100
Interest rate differential is 6%-5%=1%
There are arbitrage gain possibilities.
Borrow in UK 2,00,000 pounds at 6% and
convert them into Indian currency and invest
them in India at rate of 5%
The total amount is converted into pounds at
the forward rate
Net gain =1067.7419 pounds.
pgkrd

Exercise-6
A Ltd is planning to import a multipurpose machine
from Japan at a cost of 3400 lakh Yen.The company
can borrow at the rate of 18% per annum with
quarterly rests.However there is an offer from Tokyo
bran of Indian Bank extending credit of 180 days at
2% per annum against the opening of an irrevocable
letter of credit. Other information is as follows:
Spot rate for Rs.100=340 yen; 180 days forward rate
for Rs.100=345 yen; commission charges for letters
of credit are at 2% for 12 months.
Advise the company which mode of purchase is
better?
pgkrd

Answer-6

Borrowing
3400 lakhs yen
Borrowing in Indian rupee=Rs.1000 lakhs
Interest for the first 3 months= 45
Interest for the second quarter=47.025
Total cash outflow at the end of 6 months equals
to Rs.1092.025 lakhs.
If letter of credit is followed:
Borrowings 3400 lakhs yen
Interest for 6 months
34 yen
Commission charges 3400 x .02 x6/12=34
pgkrd

Answer-6 continues
Total payments =3468 lakhs yen
Conversion into indian rupees=1005.217
Conclusion:- Avail overseas offer

pgkrd

Exercise-7
Spot Rs.48/$ ;6 month interest rate: India7.5%Per annum; US interest rate-2% per
annum.what forward rate will no arbitrage
gain be possible?

pgkrd

Answer-7
Difference in rate-7.5%- 2%=5.5%p.a.
Spot rate
$48
Add: 5.5% premium for three months
(48x (5.5/100) x 3/12) =0.66
Forward rate
= 48.66/$

pgkrd

Exercise-8
Spot rate- Rs.48.5/$ ; 6 month forward
rate-Rs.48.90/$ ; Annualised interest on
US 6 month treasury bill 2.5%;
annualised interest on Indian 6-month
treasury bill-6.0%; what are the
transactions the trader will execute to
receive arbitrage gain?

pgkrd

Answer-8
Interest rate differential=6%-2.5%=3.5%pa
Premium of forward rate=(48.9048.5)/48.5x100 x(12/6)=1.65%
Since interest diferential is more than
premium forward arbitrage gain is
possible.

pgkrd

Exercise-9
Calculate cross currency rate between
Euro/pound(bid as well as ask)
Rs/Us $ Rs 48.35-48.90
Rs/Euro Rs.51.90-52.30
$/ Pound $ 1.49-1.50

pgkrd

Answer-9
Euro/Pound(bid)=Rs/Us $ x $/Pound x
Euro/Rs=48.35 x1.49 x 1/51.90
Euro/Pound(ask)=48.90 x 1.50 x1/52.30

pgkrd

Exercise-10
You are required to fill in the missing
figures and complete the table

1USD
1
pound
1Cana
di
1 Yen

US Poun
dolla d
r

Cana Yen
dian

Euro

1.0
-

1.525
9
1.0
- pgkrd
-

0.928
7
1.0

o.616
1
1.0
-

-----1.0
-

Answer-10

1USD
1 pound
1Canadi
1 Yen
1 Euro

US
dollar

Poun Canadi Yen

d
an

Euro

1.0
1.623
0.655
30.00
85
1.076
7

o.616
1
1.0
.4037
.0052
.6634

0.9287
1.5074
0.6086
0.0078
1.0

1.5259
2.4767
1.0
0.0129
1.6430
pgkrd

118.08
191.655
77.3838
1.0
127.145

Exercise-11
The following quotations are available to
you:
by a bank in New York $ 1.6012/Pound
By a bank in Paris
FFr4.9800/$
By a a bank in London Pound 0.1350/FFr
Is any triangular arbitrage possible?

pgkrd

Answer-11
From a direct quote of New York and
Paris, the cross rate for Pound/FFr is
Pound/FFr= Pound/$ x $/FFr= 1/1.6012
x1/4.9800
Or Pound/FFr =0.1254
Since in the direct quote the FFr in London
is pound 0.1350/FFr(different from
0.1254), triangular arbitrage is possible.
pgkrd

Answer-11
1/1.6012 x 1/ 4.9800=0.1254=Pound/FFr
Since in the direct quote the FFr in London
is 0.1350/FFr different from 0.1254,
triangular arbitrage is possible.

pgkrd

 Borrow in the country where the rate of

interest is low and invest in the country
where interest rate is high.

pgkrd

Exercise-12
On 1st April 3 months interest rate in the
US $ and Germany are 6.5% and 4.5%
per annum respectively.The USD/DM spot
rate is 0.6560. What would be the forward
rate for DM, for delivery on 30 th June?

pgkrd

Answer-12
Spot rate is US $ 0.6560/DM
Interest rate parity relationship S0=[1+imA]/
[1+inB
S0= Spot rate; S1= Future exchange rate
inA=Nominal interest in country A(USA)
inB= Nominal interest in country
B(Germany)
S1=0.6560{1+(0.065 x3/12)/1 +(0.045 x 3/12)}
= 0.6560 x (1.01625/1.01125) = USD 0.6592
$/DM
pgkrd

Exercise-13
Spot rate
47.88/$
3 month forward rate 48.28/$
3 month interest rates Re.7%
$ 11%
Is there any arbitrage gain?

pgkrd

Answer-13
3 month forward rate of dollar is higher than spot rate
implies that the dollar is at premium.

Premium(percentage)= (48.28-47.88) /
47.88x(12/3) x 100=3.34% per annum.
Interest rate differential=11%-7%=4%
Since interest rate differential is more than
premium percentage there are arbitrage
gain possible.
pgkrd

Exercise-14
On 1st April, 3 months interest rate in the
US and Germany are 4.5% and 6.5 % per
annum respectively. The $/DM spot rate is
0.6560. What would be the forward rate
for DM for delivery on 30th June?

pgkrd

 S1=0.6560{1+(0.045 x3/12)/1 +(0.065 x

3/12)}
= 0.6560 x ( 1.01125/1.01625)
= USD 0.652772 $/DM

pgkrd

Exercise-15
In International Monetary Market an
international forward bid for December, 15
on pound sterling is $ 1.2816 at the same
time that the price of IMM sterling future
for delivery on December,15 is $1.2806.
The contract size of pound sterling is
62,500. How could the dealer use
arbitrage in profit from this situation and
how much profit is earned?
pgkrd

Exercise-16
ABC Co. have taken 6-month loan from their foreign
collaborators for US Dollars 2 millions. Interest payable
on maturity is at LIBOR plus 1.0%. Current 6-month
LIBOR is 2%.
Enquiries regarding exchange rates with their bank elicit
the following information:
Spot USD 1
Rs. 48.5275
6 months forward
Rs.48.4575
1.What would be their total commitment in rupees, if they
enter into a forward contract?
2. Will you advise them to do so? Explain giving reasons.
pgkrd

Exercise-17
The United States Dollar is selling in India at
Rs.45.50. If the interest rate for 6 month
borrowing in India is 8% per annum and the
corresponding rate in USA is 2%.
1.Do you expect US dollar to be at premium or at
discount in the Indian forward market?
2.What is expected 6 month forward rate for United
States Dollar in India?
3. What is the rate of forward premium or discount?
pgkrd

Answer
Borrow in US at 2% and invest in India
Differential interest rate =8%-2%=6%
Since US interest rate is low dollar is at
premium.
Forward rate=45.50(1+[.04
x6/12)]=Rs.46.41

pgkrd

Exercise-18
A company operation 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 todays spot rate, it is
equivalent to $30 lakhs. It is anticipated that the
exchange will decline by 10% over 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.
pgkrd

Exercise-19
The following table shows interest rates
for the United States dollar and French
francs. The spot exchange rate is 7.05
franks per dollar. Complete the missing
entries:
3 months 6 months 1 year
Dollar interest rate
(annually compounded
Frank interest rate
(annually compounded)
Forward franc per dollar
Forward discount on franc
per cent per year

11 %
19 %
?
?

12 %
?
?
pgkrd
6.3%

?
20%
7.5200
?

Exercise-20

1)
2)

In march 2008, the multinational Industries makes the

following assessment of dollar rates per British pound to
prevail as on 1.9.08.
What is the expected spot rate for 1.9.2008?
If , as of March,2003, the 6 month forward rate is $1.80,
should the
firm sell forward
its pound receivables due in
$/pound
Probability
September, 2008?
1.6
1.7
1.8
1.9
2.0

0.15
0.20
0.25
0.20
0.20

pgkrd

Exercise-21

X Ltd. an Indian company has an export exposure of 10 million(100 lacs)

Yen, value September end. Yen is not directly quoted against Rupee.
The current spot rates are-USD/INR=41.79 and USD/JPY=129.75.

It is estimated that Yen will depreciate to 144 level and rupee to

depreciate against dollar to 43

Forward rate for September, 2008 USD/Yen =137.35 and

USD/INR=42.89.
You are required
i)
To calculate the expected loss if hedging is not done. How the position
will change with company taking forward cover?
ii)
If the spot rate on 30th September, 1998 was eventually
USD/Yen=137.85 and USD/INR=42.78, is the decision to take forward
cover justified?

pgkrd

Exercise-22

A company operating in a country having the dollar as its unit of currency

has today invoiced sales to an Indian company, the payment being due
three months from the date of invoice.The invoice amount is $13,750 and at
today spot rate of $0.0275 per Re.1, is equivalent to Rs.5,00,000.
It is anticipated that the exchange rate will decline by 5% over the three
month period and in order to protect the dollar proceeds, the importer
proposes to take appropriate action through foreign exchange market.
The three month forward rate is quoted as $0.0273 per Re.1
You are required to calculate the expected loss and to show, how it can be
hedged by forward contract.

pgkrd

Exercise-23

1)
2)
3)

Shoe Company sells to a wholesaler in Germany. The purchases price of

a shipment is 50,000 deutsche marks with term of 90 days. Upon
payment, Shoe Company will convert the DM to dollars. The present spot
rate for DM per dollar is 1.71, whereas the 90-day forward rate is 1.70.
You are required to calculate and explain:
If Shoe Company were to hedge its foreign exchange risk, what would it
do? What transactions are necessary?
Is the deutsche mark at a forward premium or at a forward discont?
What is implied differential in interest rates between the two countries?
(Use interest rate parity assumption)

pgkrd

Answer-23
Spot rate DM/US $ =1.71
If company receive payment then
50,000 x 1.71=

pgkrd

Exercise-24
A customer with whom the Bank had entered into 3
months forward purchase contract for Swiss Francs
10,000 at the rate of Rs.27.25 comes to the bank
after 2 months and requests cancellation of the
contract. On this date, the rates prevailing are:
Spot
CHF 1=27.30 27.35
One month forward Rs.27.45
27.52
What is the loss/gain to the customer on
cancellation?
(loss to the customer $2700 due to exchange
difference)
pgkrd