FOREX MANAGEMENT

FOREIGN EXCHANGE MANAGEMENT 1. FINANCIAL ARITHMETICS Direct and Indirect Quote 1.1. Identify whether the following are direct quote or indirect quote (London) also provide the corresponding indirect quote and direct quote. a. INR 68. 05 / £ b. ¥ 185 / £ c. £ 0.63 / $ 1.2. Identify whether the following are direct quote or indirect quote (as provided by IOB, Bangalore) and provide the corresponding indirect quote and direct quote. a) INR 1 = EUR 0.20 b) INR. 75.60 = £ 1 c) INR 18.4 = MYR 1 1.3. Identify whether the following are direct quote or indirect quote (New Delhi) also provide the corresponding indirect quote and direct quote. a. INR 5.50 / HK$1 b. ¥ 0.19 / INR1 c. INR 83.50 / £ d. €0.0175 / INR1 e. INR 12.50 / MYR1 f. INR 0.35 / ¥ 1.4. Following are the quotes available at an SBI, Mumbai as on 1st April 2010. a. INR 44.50 – 44.80 / US$ b. INR 67.50 - 68/€ c. INR 43.15 – 43.85 / CAD Convert the above quote into Indirect quote. 1.5. Identify the following quotes and convert them a. INR 69.5 / EUR (Lisbon) b. INR 22.50 / ZAR (Mumbai) c. INR 1.15/BHN (Thimpu) d. CNY 5.65 / USD (Guangzhou) Dr. J. Nelson Michael (2017). Foreign Exchange Management Exercises. Bangalore: Kristu 1 Jayanti College.

1.6. Identify the following quotes and convert them: a. EUR 0.012 / JPY (Tokyo) b. PLN 0.44 /SEK (Warsaw) c. TRY 2.83 / CHF (Istanbul) d. RUB 17.9 / BRL (Rio de Janeiro) e. AUD 1.35 / ILS (Tel Aviv) Spread 1.7. The prevailing quote for wholesale transactions by a commercial bank for the euro is $ 1.0876 / 78. What is the Spread? 1.8. Calculate percentage spread from the following quotes: a) INR 1.8000 – 2.1500/THB b) PHP 43.2000 – 44.3500/USD c) CAD 6.8500 – 6.9670/EUR 1.9. Given the following quotes: a) Identify the quotes as direct or indirect and convert them; b) Calculate the spread: i. INR 3.93 – 3.99 / MXN (Mexico City) ii. USD 2.64 – 2.68 / BHD (Bharain) iii. DKK 22.22 – 22.27 / KWD (Kuwait City) iv. NZD 1.563 – 1.584 / CHF (Wellington) 1.10. Given the following quotes: i) CNY 0.054 – 0.059 / JPY (Osaka) ii) EUR 0.2782 – 0.2991 / ILS (Lisbon) iii) THB 25.15 – 25.80 / AUD (Canberra) iv) ZAR 3.5000 – 3.5250 / BRL (Cape town) a) Calculate the Spread for quotes as given above (before conversion) b) Identify the quotes stated above as direct or indirect and convert them (KJC QP, 2016) 2

Forward Rate Differential 1.11. From the following exchange rates, a) Convert them into outright rates and indicate their spreads b) Calculate the premium or discount Spot 1-month 3-months 6-months INR/$ 45.6300/25 20/25 25/35 30/40 1.12. Calculate the spread and Forward rate differential (assume YOU are selling the USD) Spot 1-month 3-months 6-months ZAR/USD 10.4500/80 75/25 80/40 30/70 1.13. Calculate FRD (assuming that trader is buying HKD) Spot 3-months 6-months LKR/HKD 16.9100/9200 15/65 50/20 1.14. The Spot rate is INR 70/£. Calculate the forward discount and forward premium when forward rate is: i. INR 66.50 / £ ii. INR 73.50 / £ 1.15. You have called your foreign exchange trader and asked for quotation on the spot, one month, three month, and six month the trader has responded with the following $ 0.2479-81, 3/5, 8/7, 13/10. a. What does this mean in terms of $/€? b. If you wish to buy spot €, how much would you pay in $. c. If you wish to purchase spot US$, how much would you pay in €. d. What is the premium or discount for 1,3,6 month forward rate in annualized percentage(assume you are buying €) e. Calculate the forward premium/discount assuming you are selling €. 1.16. You have called your banker for quotation on the spot, one month, three month, and six month. The bank has responded as follows: INR 10.1012/55, 30/60, 45/25, 65/28 3

a. What does this mean in terms of INR/CNY? b. If you wish to buy spot CNY, how much would you pay in INR? c. If you wish to purchase spot INR, how much would you pay in CNY? d. What is the premium or discount for 1,3,6 month forward rate in annualized percentage(assume you are buying CNY) e. What is the value of the transaction of CNY 10,000 for an exporter? 1.17. A Russian Trader obtains the following quotes from her banker for RUB/CHF: Spot 2 m 4 m 6 m RUB/CHF 62.1205/70 80/40 50/25 40/20 a. What does this mean in terms of RUB/CHF? b. If the trader wishes to buy 4 month CHF, how much would she pay in RUB? c. At what rate will she Sell 6 month RUB? d. Calculate ‘p’ (assume the trader is selling CHF) e. What is the effect of FRD on interest rates? f. What is the value of the transaction of 2 months CHF 10,000 for an importer/ 1.18. Unique Inc. receives the following quotes for ZAR, one month, three month and six months from South African Bank: Spot 1 month 3 months 6 months LKR/ZAR: 12.1120/75 40/60 55/35 60/50 a) What does this mean in terms of LKR/ZAR? b) If Unique Inc has exported LKR 1,000,000 worth of equipment to South Africa, what is the value of the transaction in ZAR according to the 6 months rate? c) If Unique Inc wished to sell LKR three months forward, how much would it receive in ZAR? d) If it wished to buy ZAR six months forward, how much would it have to pay in LKR? e) Assuming that ZAR is being sold by the Unique Inc, find out the forward rate differentials for the three periods. f) What would the above quotes imply in respect of the return structure of interest rates in South Africa and Sri Lanka (assume Sri Lanka as home country)? Discuss the international parity relationship theory which deals with the above. If the forward rate is LKR 12. 05 / ZAR, after one year, what would happen to the interest rate in South Africa? 4

(KJC, QP) 1.19. A forex trader receives the following quotes for GBP, one month, three month and six months forward from a British Bank: Spot 1 month 3 months 6 months AED/GBP: AED 6.0301/92 78/41 65/25 36/69 a) Calculate the outright quotes for one, three, and six months b) If the trader wished to buy GBP three months forward, how much would she pay in AED? c) If she wished to purchase AED one month forward, how much would she have to pay in GBP? d) Assuming that GBP is being bought by the trader, find out the forward rate differentials for the three periods. e) What would the above quotes imply in interest rates in United Arab Emirates and UK? (Assume UAE as home country) Cross Rates 1.20. The $ : DM exchange rate is 1DM = $ 0.35 and DM : FFr exchange rate is 1FFr = DM 0.31.What is the FFr : $ exchange rate? 1.21. The USD/THB rate is: USD 0.2339/THB and the USD/INR exchange rate is: USD 0.2538/INR. What is the INR/THB exchange rate? (BU 2005) 1.22. Calculate the cross rate of INR / CAD from the following quotes: INR 56.040/USD CAD 4.256/USD 1.23. If the exchange rates were: INR 2.0020/THB and THB 26.0070/EUR, What is the INR/EUR exchange rate? 1.24. An importer has purchased from France goods worth FFR 50,000. There is no quote available for INR/FFR. The quotes available are: 5

i) USD = INR 45.05/10 ii) USD = FFR 5.1025/50 What is the value of this transaction in rupee terms? (BU 2005) 1.25. Calculate the cross rate from the following quotes: New Delhi: INR. 45.0010 – 45.0080/$ Paris: FFr 6.1025 – 6. 1050/$ 1.26. USD/INR Spot 48.75/80 2 month swap 12/20 JPY /USD Spot 125.50/126.10 2 month swap 20/15 Find INR/JPY 2 month outright. (BU 2007) 1.27. Calculate cross rates for the following situations: a) $1.5537-59/ £ € 0.1982-92 / $ What is the direct quote for Pound in terms of Euro? b) $ 2.0015-30 / £ $ 0.6965-70 / CHF What is the direct quote of CHF in terms of pounds c) $/£ = 1.5240 ¥/£ = 235.20 ¥/$ = ? d) €/£ = 2.5150 €/¥ = 205.80 ¥/£ = ? e) $£ = 1.5537-59 €$ = 0.1982-92 €/£ = ? f) $/£ = 2.0015-30 $/CHF =0.6965-70 £/CHF = ? 1.28. a). Find out the exchange rate between SEK/TRY from the following quotes: i. SEK 8.60 / CHF 6

ii. TRY 3.09 / CHF b). An importer has purchased goods from Oman worth OMR 100,000. There is no quote available for MYR/OMR. The quotes available are: i. MYR 3.08/35 / AUD ii. OMR 0.27/41 / AUD What is the value of this transaction in MYR terms? c). A trader in Moscow, wants to export goods to Mexico. She is interested to know the RUB / MXN exchange rate from the following: i. RUB 46.15 – 46.78 / SGD ii. SGD 0.085 – 0.096 / MXN 1.29. a). Find out the exchange rate USD/HKD from the following quotes: iii. USD 1.3752/EUR iv. HKD 10.6591/EUR b). An importer has purchased goods from Qatar worth QAR 100,000. There is no quote available for INR/QAR. The quotes available are: iii. INR 61.20/95 / USD iv. QAR 3.15/64 / USD What is the value of this transaction in rupee terms? c). A trader in Jerusalem, wants to export goods to Bahrain. She is interested to know the ILS / BHD exchange rate from the following: iii. ILS 2.1941 – 2.7832 / NZD iv. NZD 3.0049 – 3.3784 / BHD (KJC, QP, 2014) 7

2. INTERNATIONAL PARITY RELAITONSHIPS EXCHANGE RATE FORECASTING 2.1. The spot exchange rate for Swiss franc has changed from SFr 1.50/$ to SFr 1.20/$ has the SFr depreciated against US$? If the spot exchange rate for € changes from $1.18/€ to $1.03/€, has the US$ depreciated against €? 2.2. The spot exchange rate for Swiss franc from CHF 1.50/$ to CHF 1.20/$ has the CHF depreciated against US$? If the spot exchange rate from € declines from $1.18/€ to $1.03/€, has the US$ depreciated against €? PPP 2.3. In India, prices changed from INR 4500 to INR 5500 over a period of three years for the basket of goods. Whereas they changed from USD100 to USD 110 over the same period in USA. What was the initial exchange rate S0? What is the expected exchange rate after 3 years S3 ? 2.4. Inflation rates in UK and India are respectively 3% and 6% p.a. respectively. What is the expected exchange rate after one year, if it was INR 78/GBP at the beginning of the period? 2.5. Price indices in UK and USA are 125 and 200 respectively at the reference period (time zero). These indices change to 129 and 205 respectively after one year. Calculate the exchange rate after one year, given the reference exchange rate of USD 1.80/GBP. 2.6. The inflation rates in India and UK are 2.5% and 5.5% respectively. If the exchange rate at time zero is INR 79/GBP, calculate expected exchange rate a year later and also the appreciation/depreciation of GBP 2.7. The US inflation rate is expected to average about 4% annually while Indian interest rate is expected to average about 12% annually. If the current spot rate for Rupee is $0.0285, what is the expected spot rate in two years? 8

IRP & IFE 2.8. Six-month interest rates on INR and GBP are 8% and 5% pa respectively. The current exchange rate is INR 79/GBP. Estimate the exchange rate of INR/GBP 6 months later. 2.9. What is the essence of interest rate parity? The interest rate in US is 10% and in Japan the comparable rate is 7%.The spot rate for the ¥ is $ 0.003800. If the Interest rate parity holds ,what is 90 days forward rate? 2.10. If the spot rate is INR 57.00/USD, interest rate in India 9.5% and interest rate in US is 11.25%, What is the 180 day forward rate? 2.11. If the $ : ¥ spot rate is 1$ = ¥110 and interest rate in Tokyo & New York are 3% and 4% respectively. What is the expected $ : ¥ exchange rate one year hence? 2.12. If the $ : ¥ spot rate is 1$ = ¥110 and interest rate in Tokyo & New York are 3% and 4% respectively. What is the expected $ : ¥ exchange rate one year hence? 2.13. Suppose in July, the 1year interest rate is 12% on British pound and 9% on US $. If the current exchange rate is $1.63/£. What is expected future exchange rate in one year. Suppose a exchange in expectation regarding future US inflation causes the expected future spot rate to decline to $1.52 to $1. What should happen to US interest rate? 2.14. Exchange rate between INR and CHF is INR 33/CHF at the reference period and is found to be INR 33.40/CHF after 9 months. Nine month interest rate on INR is 8% pa. What should have been the CHF interest rate? 2.15. If the nominal rate of interest is 12% and the inflation is 5%, what is the real rate of return? 2.16. a) What is the essence of IRP? Six months interest rates on EUR and HKD are 8% and 9% p.a. respectively. The current exchange rate is HKD 9.89 / EUR. Estimate the exchange rate of HKD/EUR 6 months later. 9

b) Price indices in Canada and China are 125 and 200 at the time period zero. These indices change to 130 and 210 respectively after one year. Calculate the exchange rate after one year, given the exchange rate in time period zero as CNY 5.51/CAD. If the Exchange rate fluctuates to CNY 5.45, CNY 5.25, etc. What would happen to the inflation in China? c) Exchange rate between RUB and CHF is RUB 40.30/CHF at the reference period and is found to be RUB 40.90 / CHF after 9 months. Interest rate on RUB is 8% p.a. What should have been the CHF interest rate? (KJC, QP, 2014) 2.17.1. a) If the $ : ¥ spot rate is 1$ = ¥110 and interest rate in Tokyo & New York are 3% and 4% respectively, what is the expected $ : ¥ exchange rate one year hence? b) Price indices in Canada and Hongkong are 125 and 200 at the time period zero. These indices change to 130 and 210 respectively after one year. Calculate the exchange rate after one year, given the exchange rate in time period zero as HKD 5.51/CAD. If the Exchange rate fluctuates to HKD 5.45, HKD 5.25, etc. What would happen to the inflation in Hongkong? (KJC QP) 10

3. MULTI NATIONAL CAPITAL BUDGETING 3.1. Rayzone Corp presently has no existing business in Germany but is considering the establishment of a subsidiary there. The following information has been gathered to assess this project:  The initial investment required is DEM 50 million. Given the existing spot rate of $ 0.50 per mark, the initial investment in dollars is $ 25 million. In addition to the DEM 50 million initial investment on plant and equipment, DEM 20 million is needed for working capital and will be borrowed by the subsidiary from German bank. The German subsidiary of Rayzone Corp will pay interest only on the loan each year, at an interest of 14%. The loan principal is to be paid in 10 years.  The project will be terminated at the end of the 3rd year, when the subsidiary will be sold.  The price, demand and variable cost of the product in Germany are as follows: Year Price Demand Variable cost 1 DEM 500 40,000 units DEM 30 2 DEM 511 50,000 units DEM 35 3 DEM 530 60,000 units DEM 40  The fixed costs, such as overhead expenses are estimated to be DEM 6 million per year  The exchange rate of the mark is expected to be $ 0.52 at the end of year 1, $ 0.54 at the end of year 2 and $ 0.56 at the end of year 3  The German govt will impose an income tax of 30% on income. In addition it will impose a withholding tax of 10% on earnings remitted by the subsidiary. The US govt will not impose any additional tax.  All cash flows received by the subsidiary are to be sent to the parent at the end of each year.  The plant and equipment are depreciated over 10 years using the straight line method. Since plant and equipment are initially valued at DEM 50 million, the annual depreciation is DM 5 million. 11

 Rayzone requires 20% return on this project. Determine the NPV of the project. Should Rayzone accept the project? (KJC, 2012) 3.2. Barret corporation presently has no existing business in France but is considering the establishment of a subsidiary there. The following information is given to assess this project.  The initial investment required is FFr 60million. The existing spot rate is $ 0.20;the investment in $ is $12million. In addition to FFr 60million initial investment on plant and equipment, FFr 10million is needed for working capital and will be borrowed by the subsidiary from French Bank. The French subsidiary of Barret corporation will pay interest only on the loan each year at an interest of 10%. The loan principal is to be paid in 10years.  The project will be terminated at the end of year 3, when subsidiary will be sold.  The price, demand and variable cost of the product in France are as follows: YEAR PRICE(FFr) DEMAND VARIABLE COST(FFr) 1 600 40,000 25 2 650 50,000 30 3 700 60000 40  The fixed cost are estimated to be FFr 5million per year  The exchange rate of the French Franc is expected to be $0.22 at the end of year 1, $0.25 at the end of year 2 and $0.28 at the end of year 3.  The Government will impose a with holding tax of 10% on earnings remitted by the subsidiary. The U.S Government will allow a tax credit on remitted earnings and will not impose any additional taxes.  All cash flows received by the subsidiary are to be sent to the parent a company at the end of each year. The subsidiary will use its working capital to support ongoing operations.  The plant and equipment are depreciated over 10 years, using straight line depreciation method. Since the plant and equipment are initially valued at FFr 60million, the annual depreciation expenses is FFr 6million.  In three years, the subsidiary is to be sold .Barret corporation plans to let acquiring firm assume the existing French loan. The working capital will not be liquidated, will be used by the acquiring firm.  The required rate of return on this project is 15%. a. Determine the net present value of this project. Should Barret corporation accept this project? 12

b. Assume that Barret corporation provides the additional funds for the working capital so that the loan from the French government is not necessary. c. Would the NPV of this project from the parent’s perspective be more sensitive to exchange rate movements if the subsidiary used French financing to cover the working capital ? explain. d. Assume barret corporation uses the original proposed financing arrangements and that funds are blocked until the subsidiary is sold. The funds to be remitted are reinvested at a rate of 8%( after taxes) until the end of the year3. How is the project’s NPV affected? e. Assume that barret corporation decided t implement the project, using the original proposed financing arrangement ; also assume that after one year, a French firm offers barret corporation a price of $30million after taxes for the subsidiary, and have not changed. Should barret corporation divest the subsidiary? Explain? 3.3. What are the factors influencing Capital Budgeting decisions of MNCs? Analyse the following Case, Calculate the NPV and advice the MNC regarding their Capital Budgeting Decision. Axim Inc, London considers establishing a subsidiary in Malaysia. They present you with the following information regarding their project. They seek your assessment and advice:  The initial investment required is 300 million MYR. The existing spot rate is GBP 0.20 / MYR; In addition to 300 million MYR initial investments on plant and equipment 100 million MYR is needed for working capital and will be borrowed by the subsidiary of Axim and will pay interest only on the loan each year at an interest rate of 12.5%. The loan principal is to be paid in 10 years.  The project will be terminated at the end of the year 3, when subsidiary will be sold.  The demand, price, and variable cost of the product in Malaysia are as follows:- Particulars Year I Year II Year III Demand 72,000 80,000 85,000 Variable Cost (MYR) 125 135 145 Price (MYR) 900 1000 1050  The fixed costs are estimated to be 13.5 million MYR per year 13

 The exchange rates of the MYR is expected to be GBP 0.24 at the end of first year , GBP 0.21 at the end of second year and GB 0.19 at the end of third year.  The Malaysian government will impose an income tax of 33% on income. In addition it will impose a withholding tax of 15% on earnings remitted by the subsidiary. The UK government will allow a tax credit on remitted earnings and will not impose any additional taxes.  All cash flows received by the subsidiary are to be sent at the end of the year. The subsidiary will use its working capital to support ongoing operations  The plant and equipment are depreciated over 10 years, using WDV depreciation method at the rate of 8%.  In three years, subsidiary is to be sold. Axim plans to let the acquiring firm assume the existing Malaysian loan. The working capital will not be liquidated, but will be used by the acquiring firm.  Axim Inc. requires 20% ROI on this project. (KJC QP, 2016 – Case Study) 3.4. Shine Inc, Germany considers establishing a subsidiary in South Africa. The following information is given to assess this project.  The initial investment required is 100 million ZAR (South African Rand). The existing spot rate is EUR 0.08 / ZAR; In addition to 100 million ZAR initial investments on plant and equipments 40 million ZAR is needed for working capital and will be borrowed by the subsidiary of Shine and will pay interest only on the loan each year at an interest rate of 12%. The loan principal is to be paid in 10 years.  The project will be terminated at the end of the year 3, when subsidiary will be sold.  The price, demand, and variable cost of the product in South Africa are as follows:- Year Price (ZAR) Demand Variable Cost (ZAR) 1 950 50,000 90 2 1050 60,000 100 3 1150 70000 110  The fixed costs are estimated to be 12 million ZAR per year 14

 The exchange rates of the ZAR is expected to be EUR 0.085 at the end of year 1, EUR 0.09 at the end of year 2 and EUR 0.095 at the end of year 3.  The South African government will impose an income tax of 30% on income. In addition it will impose a with holding tax of 10% on earnings remitted by the subsidiary. The German government will allow a tax credit on remitted earnings and will not impose any additional taxes.  All cash flows received by the subsidiary are to be sent at the end of the year. The subsidiary will use its working capital to support ongoing operations  The plant and equipment are depreciated over 10 years, using WDV depreciation method. Since the plant and equipment are initially valued at 100 million ZAR, the annual depreciation expenses is 10 million ZAR.  In three years, subsidiary is to be sold. Shine plans to let the acquiring firm assume the existing South African loan. The working capital will not be liquidated, but will be used by the acquiring firm.  Shine corporation requires 20% ROI on this project. Determine the net present value of this project. Should Shine accept this project? What are the factors affecting the cashflow of Shine from its foreign subsidiary? (KJC, QP, 2014) 15

BoP Disequilibrium in Pakistan The ministry of finance, Pakistan is concerned about the problem of a deficit in the balance of payments that has lasted for many decades in the country. High payment balances of Pakistan have strengthened the foreign currency against the home currency (PKR) which makes imports of goods and services more expensive as compared to exports. This is also a cause for devaluation of the home currency (PKR) and a balance of payments deficit. What are all the factors influencing Pakistan’s balance of payments ? The current account balance and balance of trade with different economic factors have to be considered to understand the causes of disequilibrium in BoP. Research has found that imports, exports, foreign direct investment, workers remittances, inflation, gross domestic saving, and production capacity are the main economic factors that sway Pakistan s balance of payment and cause deficit. How can the government strategically manage disequilibrium in BoP? (Adapted from Gulzar, Saqib and Hui Xiao Feng (2010). A Study on the Problem of Deficit in the Balance of Payments: The Case of Pakistan. Interdisciplinary Journal of Contemporary Research in Business. Oct, 2 (6), p371.) a) What are the components of BoP? b) Enumerate the causes and effects of Disequilibrium in BoP as evident in the above case. c) Discuss the different measures to overcome disequilibrium in BoP that can be adopted by emerging economies like Pakistan. 16