JOSEPH’S COLLEGE OF COMMERCE (AUTONOMOUS)

End Semester Examinations – OCTOBER 2014

MIB –III semester

FOREIGN EXCHANGE MANAGEMENT

Duration: 3 Hrs Max. Marks: 100

SECTION – A

Answer any SEVEN Each carries 5 marks. (7 x 5 = 35)

What are the features of a foreign exchange market?
Write a note on Foreign Exchange Dealers Association of India (FEDAI).
Explain BOP theory of exchange rate determination.
Briefly explain the various techniques of forecasting.
Suppose that the current spot exchange rate is €0.80/$ and the three-month forward exchange rate is €0.7813/$. The three-month interest rate is 5.6 percent per annum in the United States and 5.40 percent per annum in France. Assume that you can borrow up to $1,000,000 or €800,000.
Show how to realize a certain profit via covered interest arbitrage, assuming that you want to realize profit in terms of U.S. dollars. Also determine the size of your arbitrage profit.
Assume that you want to realize profit in terms of Euros. Show the covered arbitrage process and determine the arbitrage profit in Euros.
Assume that locational arbitrage ensures that spot exchange rates are properly aligned. Also assume that you believe in purchasing power parity. The spot rate of the British pound is $1.80. The spot rate of the Swiss franc is 0.3 pounds. You expect that the one-year inflation rate is 7 percent in the U.K., 5 percent in Switzerland, and 1 percent in the U.S. The one-year interest rate is 6% in the U.K., 2% in Switzerland, and 4% in the U.S. What is your expected spot rate of the Swiss franc in one year with respect to the U.S. dollar? Show your work.
Explain the different forms of Natural hedges or Internal hedging strategies
An Indian importer imports goods worth $62,500. He expects an appreciation of pound. So he goes for hedging the risk. The currency market has the following data:

(a) Spot rate on the date of the contract Rs. 68,00/£

(b) Three month forward rate Rs. 68.50/£

(d) Strike rate in a three-month put option Rs. 68.80/£ with 5% premium

(e) Spot rate on the date of payment/maturity Rs. 68.90/£

Will he go for a hedge? If so, which of the options he will select?

Write a note on interest rate caps and floors.
Briefly explain currency swaps.

Section – B

Answer any THREE questions. Each carries 15 marks. (3 x 15 = 45)
You plan to visit Geneva, Switzerland in three months to attend an international business conference. You expect to incur the total cost of SF 5,000 for lodging, meals and transportation during your stay. As of today, the spot exchange rate is $0.60/SF and the three-month forward rate is $0.63/SF. You can buy the three-month call option on SF with the exercise rate of $0.64/SF for the premium of $0.05 per SF. Assume that your expected future spot exchange rate is the same as the forward rate. The three-month interest rate is 6 percent per annum in the United States and 4 percent per annum in Switzerland.

(a) Calculate your expected dollar cost of buying SF 5,000 if you choose to hedge via call option on SF.

(b) Calculate the future dollar cost of meeting this SF obligation if you decide to hedge using a forward contract.

(d) Illustrate the future dollar costs of meeting the SF payable against the future spot exchange rate under both the options and forward market hedges.

Write a note on the following: Each carries 5 marks
Interest rate collars
Interest rate corridors
Forward rate agreements (FRA’s)
A) Explain the trading Process, Pricing and credit risk involved in currency futures market (7 Marks)
B) Explain the broad features of currency options market and also elucidate on the various types of options and hedging in currency options market. (8 Marks)
The one-year risk-free interest rate in Mexico is 10%. The one-year risk-free rate in the U.S. is 2%. Assume that interest rate parity exists. The spot rate of the Mexican peso is $.14.
What is the forward rate premium?
What is the one-year forward rate of the peso?
Based on the international Fisher effect, what is the expected change in the spot rate over the next year?
If the spot rate changes as expected according to the IFE, what will be the spot rate in one year?
Compare your answers to (b) and (d) and explain the relationship.

Boston Co. will receive 1 million Euros in one year from selling exports. It did not hedge this future transaction. Boston believes that the future value of the euro will be determined by purchasing power parity (PPP). It expects that inflation in countries using the euro will be 12% next year, while inflation in the U.S. will be 7% next year. Today the spot rate of the euro is $1.46, and the one-year forward rate is $1.50.

Estimate the amount of U.S. dollars that Boston will receive in one year when converting its euro receivables into U.S. dollars.
Today, the spot rate of the Hong Kong dollar is pegged at $.13. Boston believes that the Hong Kong dollar will remain pegged to the dollar for the next year. If Boston Co. decides to convert its 1 million Euros into Hong Kong dollars instead of U.S. dollars at the end of one year, estimate the amount of Hong Kong dollars that Boston will receive in one year when converting its euro receivables into Hong Kong dollars.

Section – C

Compulsory Case study. (1 x 20 = 20)

16.

A Bank’s customer requests the bank to purchase a 30 days sight bill for Swiss Franc 5,00,000. USD/INR is quoted in the interbank market as follows:

USD/INR Spot – 42.2800/2875

1 Month – 1700/1750

2 Month – 3500/3550

3 Month – 5500/5550

The Swiss Franc is quoted in the Singapore market as follows:

USD/CHF Spot – 1.4250/4375

1 Month – 50/55

2 Month – 105/110

3 Month – 155/160

What rate will the bank quote to the customer given the following additional information?

Exchange margin 0.10%
Transit period is 20 Days
Rate of interest is 10% p.a.
Commission on export bill Rs. 500

What is the Rupee amount payable to the customer? (15 MARKS)

b) If a bank in India gives a quotation for USD as follows TT rates for INR 100 is USD 12.65/12.75. What amount in Rupees will the bank recover from the customer to remit USD 25,000 to New York? (5 MARKS)

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