Practice Set 2

International Finance (Prof. K Parmeshwaram)

4^TH NOVEMBER 2010

1. One of the leading oil companies in India wanted to remit USD 124 mn towards their oil import payment. They want to raise a loan from the international market for 90 days. They have both the options of borrowing in USD or JPY. From the following data, find out the best option. The company would like to cover their foreign currency exposure. (360 days in a calendar year).

	Spot	Forward differentials for 90 days	Interest rates
USD/INR	44.50/51	40/41	USD 2.5%
USD/JPY	80.50/60	20/10	JPY 2.25%

Working: There are two options for the client.

Either to avail loan in USD or JPY. There are two methods of working:

i. Find out the interest outflow in both the cases:

Interest for USD loan will be: $775,000

Interest for JPY loan in USD terms: $ 1,163,368

Please check when the loan is raised in JPY, you will raise a loan in JPY and convert this Yen loan into USD at 80.60.Becasue market has to sell USD for your import remittance.

At the time of repayment of the loan you have to buy back the Yen from the market at 80.50- 0.20 = 80.30. Please note Yen has appreciated on FWD, which is not favour of the client

ii. Compare both the interest rates of borrowing i.e., USD and JPY and add the forward differentials for JPY loan. USD is at discount against JPY. Hence, JPY is at stronger. The actual discount can be worked out on annualised percentage basis. It will become easier for you to compare the cost of the borrowing in both the cases and decide.

1. Cost of USD borrowing: 2.5%

2. Cost of JPY borrowing; (2.25 +0.4899 =2.7399%)

Working for annualised forward discount 0.4899% is given below)

a. Interest 2.25%

b. FWD differentials: (selling USD and buying JPY from the market- Market will quote 80.50-0.20 = 80.30)

i. Discount for 80.50 for 6 months 0.20

ii. Discount for 100 for one year:

= 0.20 x100/80.50 x 12/6

= 0.4989%

Hence borrowin in USD will be cheaper.

2. One of the UK firms has 90 days receivable of EUR 50mn (inward remittance in EUR). They would like to convert this EURO into GBP. This company has access to domestic as well as offshore markets. Inter -bank market rates are: ( 360 days in a calendar year)

GBP/EUR 1.1310/15

90 days FWD differentials 30/40

Money market: Bid/offer

Interest rate for GBP 2.25/2.50

Interest rate for EUR 3.25/3.50

a. By booking forward contract how much GBP the firm will receive. FWD rate will be 1.1355 - will get GBP 44033465.43

b. If the firm wants to opt for money market route will it be a better option than booking forward contract. FWD rate on money market operation will be at 1.1350. and will get 44052863

Please work out and find out the better option.

Comments: Quote is in GBP/EUR. Base currency is in GBP. The question is how much GBP we will get.

Through money market operation, we will get more GBP>

3. One of the leading software companies have short-term surplus of USD 5 mn for 20 days. If they keep this amount with one of the US based bank in Current account, they may get interest @1.5% p.a.

Other option will be to invest the amount in short term fixed deposit for one month and earn yield of 2.5% p.a.

If the company avails overdraft facility for 10 days, the Bank will charge interest of 4.25% p.a.

As a treasurer, you can decide to either keep the amount in Current account or invest for one month. Please work out the best option. (360 days in a calendar year).

Second option will be better: will get USD 347.23 more

4. Your company has branches in the following centers. Inter branch transactions are given below. Please try netting possibility through USD.

		London	Frankfurt	New York	Singapore
		Payable	Payable	Payable	payable
London	Receivable	Xxx	GBP 25	GBP 50	GBP 25
Frankfurt	Receivable	EUR 50	xxx	EUR 20	EUR 40
New York	Receivable	USD 40	USD 30	xxx	USD 20
Singapore	Receivable	SGD 30	SGD 40	SGD 60	xxx
Conversion rate decided by the parent office
GBP/USD		1.6000
EUR/USD		1.4000
USD/SGD		1.2500

New York will pay $52 to Frankfurt. & $14 to London

Singapore will $12 to London.

5. Leveraging forward contracts

With the following information, please work out the portion of your exposure to be covered under Forward contract to achieve the budgeted rate:

Exposure –

Export Receivable GBP 5 mn – 3 months (Due in the month of – Feb 2011).

Spot GBP/USD 1.6150

3 month FWD rate quoted by the market 1.6125

Budgeted rate 1.6100

Forex market view on movement of the currency in the range between

1.6000 – 1.6200

80% to be booked and 20% exposure can be kept open.

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