Ca Final SFM Forex Summary
Ca Final SFM Forex Summary
Ca Final SFM Forex Summary
LOS 1 : Introduction
Globalization of Business
Raising of Capital from International Capital Markets or easy excess to External Commercial
Borrowings for companies.
Open Economy to Foreign Investments, Exports, Imports and making investments in Indian Economy
like Infrastructure sector, medical science, etc.
Participations of FII’s in Indian capital markets.
Trade tie-ups between countries.
Different countries have different currencies and the different currencies have different values, so there
is a need of the rule for currency conversions for Global Business and Investments.
1. Loans(ECB)
2. Investments (Bonds & Equity)
3. Export & Import
Foreign Exchange Risk
Note :
In India, Foreign Exchange Market is regulated by RBI.
Example:
Foreign Currency: Any currency other than home currency will be a Foreign Currency
Example:
Ask Rate: Rate at which bank SELLS left hand side currency.
Example: 1$ = ` 65
Explanation:
Bank buys 1$ at ` 65.
Bank sells 1$ at ` 65.
Two-way Quote: [when Bid and Ask Rate are separately given]
Example:
1$ = ` 62 ---------------------------------------- ` 65
Left Hand Side Bid Rate / Bank Buying Ask Rate/ Bank Selling
Currency rate of left hand currency rate of left hand currency
Note:
Difference between Bid & Ask rate represents Profit Margin for the bank.
Quotation/ Bid & Ask rate or Exchange Rate is always quoted from the point of view of bank.
8.3
Direct Quote can be converted into indirect quote by taking the reciprocal of direct quote.
𝟏
IDQ =
𝐃𝐐
Case 2: Two-way Quote [When bid & ask rates are separately given]
Direct Quote (DQ) can be converted into Indirect Quote (IDQ) by taking the reciprocal of direct quote
and switching the position.
Solution:
1 Re. = −
. .
OR 1 Re. = 0.02090 --- 0.02116 (2nd Quote)
8.4
Conversion Rules :
Which currency is given in the question, we need that currency in the LHS
of the quote.
Forward rate: Rate used for buying & selling of foreign currency at some future Date i.e. Forward rate
is the rate contracted today for exchange of currencies at a specified future date.
SR => 1$ = ` 45
FR => 1$ = ` 50
In the above quote $ is at Premium.
𝑭𝑹 𝑺𝑹 𝟏𝟐
× × 100
𝑺𝑹 𝐅𝐨𝐫𝐰𝐚𝐫𝐝 𝐏𝐞𝐫𝐢𝐨𝐝
Conclusion:
If one currency is at a premium, then another currency must be at a discount. However, the rate of
premium may not be equal to the rate of discount.
On account of base effect, premium is slightly higher than the discount.
LOS 8 : Calculation of Forward Rate when Spot Rate & Premium or Discount is given
Example :
SR 1$ = ` 48.50
8.5
$ is at premium = 5%
Calculate FR?
Solution:
FR 1$ = ` 48.50 (1 + 0.05)
1$ = ` 50.925
Example:
Solution:
Swap Point should be Added or Deducted from the last decimal point in the Reverse Order.
Premium Add Swap Points
Discount Less Swap Points
Example: Example:
SR 1$ = 45.4500 ---- 45.4580 SR 1£ = $ 1.4510 ---- 1.4620
2 months Swap Point = 30/42 1 months Swap Point = 55/44
Calculate Forward Rate? Calculate Forward Rate?
8.6
Solution: Solution:
1$ = 45.4500 ---- 45.4580 1£ = $ 1.4510 ---- 1.4620
+ 00.0030 ---- 00.0042 (-) 0.0055 ---- 0.0044
FR 1$ = 45.4530 ---- 45.4622 FR 1£ = $ 1.4455 ---- 1.4576
One path will result in profit while the other path will result in Loss.
8.7
SR =
PPPT is also applicable in case of inflation. Suppose Inflation Rate of India is IRs and in US is I$ Forward
Rate 1$ = ` F. Now as per PPPT, we have after 1 year:
X (1+ I`) = y (1+ I$ ) × FR
( )
FR =
( $)
FR = SR ×
$
Case1: When Period is less than 1 Year. Case2: When Period is more than 1 Year.
𝐅𝐑 (𝐑𝐬./$) 𝟏 𝐏𝐞𝐫𝐢𝐨𝐝𝐢𝐜 𝐈𝐧𝐟𝐥𝐚𝐭𝐢𝐨𝐧 𝐑𝐚𝐭𝐞 ( 𝐑𝐬.) 𝐧
= 𝐅𝐑 (𝐑𝐬./$) 𝟏 𝐈𝐧𝐟𝐥𝐚𝐭𝐢𝐨𝐧 𝐑𝐚𝐭𝐞 (𝐑𝐬.)
𝐒𝐑 (𝐑𝐬./$) 𝟏 𝐏𝐞𝐫𝐢𝐨𝐝𝐢𝐜 𝐈𝐧𝐟𝐥𝐚𝐭𝐢𝐨𝐧 𝐑𝐚𝐭𝐞 ( $ ) = 𝐧
𝐒𝐑 (𝐑𝐬./$) 𝟏 𝐈𝐧𝐟𝐥𝐚𝐭𝐢𝐨𝐧 𝐑𝐚𝐭𝐞 ($)
Note:
Note:
Determination of Premium or Discount with the help of Interest Rate: If Interest rate of a country is
higher, than the currency of that country will be at a discount in future and vice-versa.
If IRPT holds, arbitrage is not possible. In that case, it doesn’t matter whether you invest in domestic
country or foreign country, your rate of return will be same.
Type 1 Type 2
When Bid and Ask rates are same. If Bid & Ask rates are given separately.
When Investment & Borrowing rates are same in Investment & Borrowing rate of a given currency is
one country. separately given.
# (Short – cut is available) # (Hit & Trial method is used)
When Investment opportunity in any two given countries are different, covered Interest Arbitrage is
possible.
When IRPT is not applicable, then covered interest arbitrage will be applicable.
The rule is to “ Borrow from one country & Invest in another Country ”.
Suppose Interest Rate of India is INT` And USA is INT$. Spot Rate is 1$ = ` SR, Forward Rate => 1$
= ` FR
Let assume Investor is having ` A for investment
Option 1: When investor invest ` A in India:
Amount of ` Received after one year
A1 = A (1 + INT`)
Option 2: When investor invest ` A in USA:
Amount of Equivalent ` Received after one year
𝐀
A2 = [ $ (1 + INT$)] × FR
𝐒𝐑
IF A1 = A2 IF A1 > A2 IF A1 < A2
No arbitrage opportunity. Arbitrage Opportunity is Possible. Arbitrage opportunity is possible.
Arbitrager should invest in India Arbitrager should invest in USA
(Home Country) & borrow from USA (Foreign Country) & borrow from
(Foreign Country) India (Home Country)
Note:
If in 1st try we have arbitrage profit, then no need to solve 2nd case.
If in 1st try we have arbitrage loss, then 2nd case must be solved.
8.9
Step 1: Borrow in Foreign Currency: Amount of borrowing should be such that Amount Borrowed
+Interest on it becomes equal to the amount to be received.
Step 2: Convert the borrowed foreign currency into home currency by using spot Rate.
Step 3: Invest this home currency amount for the required period.
Step 4: Pay the borrowed amount of foreign currency with interest using the amount to be received in
foreign currency. [May be Ignored]
8.10
Step 1: Invest in Foreign currency. Amount of investment should be such that, “Amount Invested +
Interest on it” becomes equal to amount to be paid
Step 2: Borrow in Home Currency, equivalent amount which is to be invested in foreign currency using
Spot rate.
Step 3: Pay the borrowed amount with interest in Home Currency on Maturity.
Step 4: Pay the outstanding amount with the amount received from investment. [May be ignored]
Solution:
Step 1: Compute all cash inflows & outflows arising in foreign currency.
Step 2: Convert these cash Inflows & outflows into home currency by using appropriate exchange rates
(i.e. Forward Rate) (Calculate through Swap Point or IRPT)
Step 3: Compute a suitable discount rate.
Step 4: Compute Home Currency (NPV)
Step 1: Compute all cash inflows & outflows arising in foreign currency.
Step 2: Compute a suitable discount rate ( RADR).
Step 3: Compute Foreign Currency (NPV)
Step 4: Convert foreign currency NPV into Home currency by using Spot Rate
Note:
Discount Rate to be used should be risk-adjusted discount rate (RADR), Since foreign project involves
risk.
Case 1 Cancelled before expiry Forward Rate prevailing as on today for expiry
Case 2 Cancelled on expiry Spot Rate of expiry
Case 3 Cancelled after expiry Spot Rate of the date when customer contracted with the bank.
Case 4 Automatic Cancellation Spot Rate prevailing on 15th day i.e. when grace period ends.
8.12
Settlement of Profit/Loss:
Case 1 Cancelled on or before expiry Customer will be eligible for both profit/Loss.
Case 2 Cancelled after expiry or automatic Customer will be eligible only for Loss
cancellation
Step 2: Entering into a new forward contract for the extended period.
b) Interest on Outlay of Funds: It might be possible early delivery request of a customer may result in
outlay of funds. In such bank shall charge from the customer at a rate not less than prime lending rate
for the period of early delivery to the original due date. However, if there is an inflow of funds the
bank at its discretion may pass on interest to the customer at the rate applicable to term deposits for
the same period.
8.13
Example:
Example:
Long Position
Short Position
Note: First we will decide which currency will buy or which currency we will sell then check the currency
on the LHS of the quotation & then accordingly decide Long Position & Short Position
𝐕𝐚𝐥𝐮𝐞 𝐨𝐟 𝐏𝐨𝐬𝐢𝐭𝐢𝐨𝐧 £ $
No. of Lots = = =
𝐕𝐚𝐥𝐮𝐞 𝐨𝐟 𝐨𝐧𝐞 𝐂𝐨𝐧𝐭𝐫𝐚𝐜𝐭 £ £
Note: Convert exposure amount in the same currency as of Lot Size/Contract Size & it will be converted
at CONTRACT RATE.
8.16
Note: First we will decide which currency will buy or which currency we will sell then check the currency
on the LHS of the quotation & then accordingly decide Long Call & Long Put
8.17
𝐕𝐚𝐥𝐮𝐞 𝐨𝐟 𝐏𝐨𝐬𝐢𝐭𝐢𝐨𝐧 $
No. of Lots = = =17.35 or 17 lots
𝐕𝐚𝐥𝐮𝐞 𝐨𝐟 𝐨𝐧𝐞 𝐂𝐨𝐧𝐭𝐫𝐚𝐜𝐭 $
Note: Convert exposure amount in the same currency as of Lot Size/Contract Size & it will be converted
at CONTRACT RATE.
Step 3: Now the UNHEDGE POSITION should be hedge through forward market as there is no lot size
requirement under forward market.
Step 4: Calculation of Option Premium paid as on today with opportunity cost on it.
Equation:
𝐅𝐑 (𝐑𝐬./$)–𝐒𝐑(𝐑𝐬./$) 𝟏𝟐
× × 100 = Interest Rate (`) – Interest Rate($)
𝐒𝐑 𝐅𝐨𝐫𝐰𝐚𝐫𝐝 𝐏𝐞𝐫𝐢𝐨𝐝
This is a current account maintained by a domestic bank/dealer with a foreign bank in foreign currency.
Example: Current account of SBI bank (an Indian Bank) with swizz bank in Swizz Franc. (CHF) is a Nostro
account.
This is a current account maintained by a foreign bank with a domestic bank/dealer in Rupee currency.
Example: Current account of Swizz bank in India with SBI bank in Rupee (`) currency
This is a current account maintained by one domestic bank on behalf of other domestic bank in foreign
bank in a foreign currency.
In other words, Loro account is a Nostro account for one bank who opened the bank and Loro account for
other bank who refers first one account.
Example: SBI opened Current account with swizz bank. If PNB refers that account of SBI for its
correspondence, then it is called Loro account for PNB and it is Nostro account for SBI.
Note:
8.19
SPOT purchase/sale of CHF affects both exchange position as well as Nostro account.
However, forward purchase/sale affects only the exchange position.