PYQ 1

Here are the questions neatly presented along with detailed answers:

1. Distinguish between the concepts of FDI & FII.

FII (Foreign Institutional

Aspect FDI (Foreign Direct Investment)
Investment)

Investment made by a foreign entity Investment by foreign entities in

Definition directly in the productive capacity of financial markets like stocks and
another country. bonds.

Involves control or ownership (usually No control; purely portfolio

Control
≥10%) of the company. investment.

Nature Long-term commitment. Short-term speculative investment.

Examples Building a factory, acquiring a business. Buying shares on the stock market.

Highly volatile and sensitive to

Volatility Stable and less volatile.
market movements.

Regulated by FDI policies and often Easier entry and exit, governed by
Regulations
requires government approval. SEBI (in India).

2. Compare and Contrast the Purchasing Power Parity & the Fisher Effect theories.

Aspect Purchasing Power Parity (PPP) Fisher Effect

Theory stating that exchange rates adjust Theory suggesting nominal

Definition to equalize the price levels of two interest rates reflect real rates +
countries. expected inflation.

Focus Exchange rates and inflation. Interest rates and inflation.

i = r + π (i = nominal interest rate, r

Key S = P₁ / P₂ (S = exchange rate, P = price
= real interest rate, π = inflation
Formula levels)
rate)

Used to forecast exchange rate Used to understand interest rate

Application
movements. behavior.
Aspect Purchasing Power Parity (PPP) Fisher Effect

Identical goods have the same price

Real interest rate is constant over
Assumption globally in the absence of transportation
time.
and trade barriers.

3. Explain the importance of Economic Risk in international finance.

Economic Risk refers to the risk that a country’s economic conditions will adversely affect
the value of investments.

Importance in International Finance:

• Exchange Rate Fluctuations: Volatility in currency can affect profit margins.

• Inflation Risk: High inflation reduces real returns on investments.

• Interest Rate Changes: Affects cost of borrowing and returns on investment.

• Government Policies: Taxation, regulations, and trade barriers can impact foreign
investments.

• Market Stability: Economic instability can lead to capital flight and reduced investor
confidence.

• Example: Political instability in a country leading to sudden changes in fiscal policy

can devalue foreign investments.

4. Review the current foreign exchange management scenario in India.

Current Scenario (as of 2025):

• Managed Float System: India uses a managed floating exchange rate, where the
Reserve Bank of India (RBI) intervenes to curb volatility.

• Forex Reserves: India maintains strong forex reserves (over $600 billion), which
stabilizes the rupee.

• Rupee Performance: The INR has been relatively stable, despite global inflationary
pressures and geopolitical tensions.

• FDI/FII Flows: India continues to attract FDI due to economic reforms, while FII
remains sensitive to global interest rates and risk perception.

• Regulatory Framework: The Foreign Exchange Management Act (FEMA) governs

forex transactions, promoting liberalization while ensuring capital flow monitoring.
 • RBI’s Role: Active in managing liquidity, inflation, and maintaining orderly market
conditions through monetary tools.

Question 5:

"Name the country where the following is a Direct Quote and find its Indirect Quote."

Given:

1. INR 99.85 = GBP 1

2. USD 1 = INR 48.30

A. Understanding Direct and Indirect Quotes:

• Direct Quote: The exchange rate expressed in terms of the domestic currency per
unit of foreign currency.

e.g., INR 99.85 = GBP 1 is a direct quote in India, because it expresses how many Indian
Rupees one British Pound costs.

• Indirect Quote: The exchange rate expressed in terms of the foreign currency per
unit of domestic currency.

e.g., GBP 1 = INR 99.85 → Indirect quote would be INR 1 = GBP ?

Final Answers:

Quote Country where it's a Direct Quote Indirect Quote

INR 99.85 = GBP 1 India INR 1 = GBP 0.01001

Quote Country where it's a Direct Quote Indirect Quote

USD 1 = INR 48.30 India INR 1 = USD 0.0207

Question 6

You are given the following USD ($) quotes:

• Spot INR (Rs) 60.50/60.60

• 2 months forward 0.10/0.20

• 3 months forward 0.20/0.10

• 4 months forward 0.25/0.30

Calculate the 2 months forward, 3 months forward, and 4 months forward rates.

Question 7

Explain the concept of foreign currency derivatives being instruments of risk management.

Question 8

Explain the concepts of Direct & Indirect Quotes, Vehicle Currency & Cross currency rates.

Solution to Question 6: Calculate the Forward Rates

Given Data:

• Spot rate (USD/INR): 60.50 (bid) / 60.60 (ask)

• 2 months forward: 0.10/0.20 (forward points)

• 3 months forward: 0.20/0.10 (forward points)

• 4 months forward: 0.25/0.30 (forward points)

Understanding Forward Points:

Forward points are added to or subtracted from the spot rate to get the forward rate. The
notation "bid/ask" (e.g., 0.10/0.20) means 0.10 is added to the spot bid rate, and 0.20 is
added to the spot ask rate. If the bid points are higher than the ask points (e.g., 0.20/0.10
for 3 months), it indicates a forward discount, but we still add the points to the respective
spot rates.

Step 1: Calculate 2 Months Forward Rate

• Spot bid: 60.50, Forward points bid: 0.10 → 60.50 + 0.10 = 60.60

• Spot ask: 60.60, Forward points ask: 0.20 → 60.60 + 0.20 = 60.80
2 Months Forward Rate: 60.60/60.80
Step 2: Calculate 3 Months Forward Rate

• Spot bid: 60.50, Forward points bid: 0.20 → 60.50 + 0.20 = 60.70

• Spot ask: 60.60, Forward points ask: 0.10 → 60.60 + 0.10 = 60.70
3 Months Forward Rate: 60.70/60.70

Step 3: Calculate 4 Months Forward Rate

• Spot bid: 60.50, Forward points bid: 0.25 → 60.50 + 0.25 = 60.75

• Spot ask: 60.60, Forward points ask: 0.30 → 60.60 + 0.30 = 60.90
4 Months Forward Rate: 60.75/60.90

Final Answer for Question 6:

• 2 Months Forward Rate: 60.60/60.80

• 3 Months Forward Rate: 60.70/60.70

• 4 Months Forward Rate: 60.75/60.90

Solution to Question 8: Explain Concepts

1. Direct & Indirect Quotes:

• Direct Quote: The price of one unit of foreign currency in terms of the domestic
currency. For an Indian resident, a direct quote for USD would be INR/USD, e.g.,
60.50 INR per 1 USD (as given in the spot rate).

• Indirect Quote: The price of one unit of domestic currency in terms of the foreign
currency. Using the same example, an indirect quote would be USD/INR, e.g., 1 INR =
1/60.50 USD ≈ 0.0165 USD.

2. Vehicle Currency:
A vehicle currency is a widely accepted currency used as an intermediary for exchange
between two other currencies. The US Dollar (USD) is the most common vehicle currency.
For example, if you want to exchange INR for JPY, you might first convert INR to USD, then
USD to JPY, because USD is widely traded and accepted.

3. Cross Currency Rates:

A cross currency rate is the exchange rate between two currencies derived through a third
currency (usually a vehicle currency like USD). For example, if USD/INR = 60.50 and USD/JPY
= 110, the cross rate between INR and JPY is calculated as:

• INR/JPY = (USD/JPY) ÷ (USD/INR) = 110 ÷ 60.50 ≈ 1.8182 INR per JPY.

This avoids direct trading between INR and JPY, using USD as the intermediary.
Solution to Question 7: Foreign Currency Derivatives as Risk Management Instruments

Foreign currency derivatives are financial contracts whose value is derived from the
exchange rate of two currencies. They are widely used as tools for managing risks associated
with fluctuations in exchange rates, particularly for businesses, investors, and financial
institutions engaged in international trade or investment. Below is an explanation of how
they serve as risk management instruments:

1. Hedging Against Exchange Rate Volatility:

Foreign currency derivatives, such as forwards, futures, options, and swaps, allow entities to
lock in exchange rates for future transactions. For example, an Indian company importing
goods from the US may need to pay in USD in 3 months. If the current spot rate is 60.50
INR/USD but the INR might weaken, the company can use a forward contract to fix the rate
at, say, 60.70 INR/USD, eliminating the risk of a higher rate (e.g., 61.00 INR/USD) in the
future.

2. Types of Derivatives and Their Role:

• Forwards: Customized contracts to buy or sell a currency at a future date at a

predetermined rate. They are ideal for businesses with specific future payment
needs.

• Futures: Similar to forwards but standardized and traded on exchanges. They provide
liquidity and flexibility but may not perfectly match the hedger’s needs due to
standardization.

• Options: Give the holder the right (but not the obligation) to buy or sell a currency at
a specific rate. This protects against unfavorable movements while allowing gains
from favorable ones. For example, a call option on USD allows the buyer to purchase
USD at a fixed rate, protecting against INR depreciation.

• Swaps: Agreements to exchange currency at specified intervals, useful for managing

long-term exposure, such as in foreign loans or investments.

3. Reducing Uncertainty in Cash Flows:

Derivatives provide predictability in cash flows for businesses. For instance, an exporter
expecting USD payments can use a forward contract to lock in the INR value, ensuring stable
revenue despite exchange rate fluctuations.

4. Managing Balance Sheet Risk:

Companies with foreign assets or liabilities face translation risk (changes in the value of
assets/liabilities due to exchange rate movements). Derivatives can offset these risks by
aligning the currency exposure of assets and liabilities.

5. Cost of Risk Management:

While derivatives mitigate risk, they come with costs (e.g., premiums for options, fees for
forwards). However, the cost is often outweighed by the benefit of avoiding large financial
losses due to adverse currency movements.

Final Answer for Question 7:

Foreign currency derivatives (forwards, futures, options, swaps) are key risk management
tools. They help hedge against exchange rate volatility, reduce uncertainty in cash flows,
manage balance sheet risks, and provide predictability for businesses and investors engaged
in international transactions, despite associated costs.

Question 9: The Argentine Peso Crisis of 2001

Content:
In the late 1990s, Argentina implemented a currency peg, linking the Argentine peso to the
US dollar at a fixed exchange rate of 1:1. This policy, known as the Convertibility Plan,
aimed to control hyperinflation and restore confidence in the Argentine economy. However,
the fixed exchange rate proved unsustainable, leading to a severe crisis in 2001.

The crisis was triggered by a combination of factors. Firstly, Argentina’s economy was
burdened with high levels of debt, both domestically and internationally. Secondly, the
country experienced a prolonged recession, exacerbated by the collapse of neighboring
economies in the wake of the Asian financial crisis. Thirdly, the fixed exchange rate limited
Argentina’s ability to adjust its monetary policy to address economic challenges.

As the economy faltered, investors began to doubt Argentina’s ability to maintain the
currency peg. Speculators started selling pesos, putting downward pressure on the currency.
In a desperate attempt to defend the peg, the Argentine government implemented capital
controls and drained its foreign exchange reserves. However, these measures only worsened
the situation, leading to widespread panic and social unrest.

In December 2001, Argentina defaulted on its sovereign debt, marking the largest default in
history at the time. The government eventually abandoned the currency peg, allowing the
peso to float freely. Consequently, the peso depreciated sharply, causing inflation to soar and
wiping out the savings of millions of Argentines.

Question:
Examine the main factors contributing to the Argentine Peso Crisis of 2001 and comment on
the same.

Solution to Question 9

Part 1: Examine the Main Factors Contributing to the Argentine Peso Crisis of 2001

The Argentine Peso Crisis of 2001 was a result of multiple interconnected factors that made
the fixed exchange rate regime unsustainable. These factors are:

1. High Levels of Debt (Domestic and International):

Argentina accumulated significant debt throughout the 1990s, both domestically and
 from international creditors like the IMF. The fixed exchange rate regime required
maintaining large foreign exchange reserves to defend the 1:1 peg with the US dollar.
However, servicing this debt became increasingly difficult as economic conditions
deteriorated, draining reserves and eroding confidence in the government’s ability to
maintain the peg.
2. Prolonged Recession and External Shocks:
Argentina faced a deep recession starting in the late 1990s, worsened by external
shocks such as the Asian financial crisis (1997–1998) and the Brazilian devaluation
(1999). These events reduced demand for Argentine exports, as neighboring
economies struggled. The recession led to high unemployment, declining tax
revenues, and increased fiscal deficits, further straining the economy and making the
peg harder to sustain.
3. Inflexibility of the Fixed Exchange Rate (Convertibility Plan):
The 1:1 peg to the US dollar, established under the Convertibility Plan in 1991,
initially curbed hyperinflation and restored economic stability. However, it severely
limited Argentina’s monetary policy flexibility. With the peso tied to the dollar,
Argentina could not devalue its currency to boost exports or adjust interest rates
independently to stimulate the economy during the recession. This overvaluation
made Argentine goods less competitive internationally, exacerbating trade deficits.
4. Loss of Investor Confidence and Speculative Attacks:
As economic conditions worsened, investors and speculators began doubting
Argentina’s ability to maintain the peg. This led to speculative selling of pesos, which
put downward pressure on the currency. The government’s attempts to defend the
peg—through capital controls and depleting foreign exchange reserves—further
eroded confidence, as these measures signaled desperation rather than stability.
5. Social and Political Instability:
The economic downturn, coupled with austerity measures to meet debt obligations,
led to widespread social unrest. Unemployment soared, and public discontent grew,
culminating in riots and political instability. This environment made it even harder for
the government to implement effective reforms or maintain the peg, accelerating the
crisis.
6. Part 2: Comment on the Factors
7. The Argentine Peso Crisis of 2001 highlights the dangers of adopting a rigid fixed
exchange rate regime without addressing underlying structural weaknesses in the
economy. While the Convertibility Plan initially succeeded in curbing hyperinflation,
it created vulnerabilities that became apparent during economic downturns. The peg
made Argentina overly dependent on foreign capital and reserves, leaving it exposed
when external shocks and internal mismanagement eroded confidence.
8. The high debt levels reflect poor fiscal discipline, as Argentina borrowed heavily
during the 1990s to finance deficits, assuming the peg would ensure stability.
However, this strategy backfired when the recession hit, as the government lacked the
flexibility to respond effectively. The fixed exchange rate, while politically popular
for its stability, became a trap—preventing devaluation that could have made exports
more competitive and alleviated economic pressure.
9. The speculative attacks and loss of investor confidence underscore the importance of
credibility in maintaining a currency peg. Once doubts emerged, the government’s
defensive measures (capital controls and reserve depletion) only deepened the crisis
by signaling weakness, leading to panic and social unrest. The eventual default and
abandonment of the peg in December 2001 were inevitable but came at a high cost:
 the peso’s sharp depreciation caused rampant inflation, devastated savings, and
plunged millions into poverty.
10. In retrospect, Argentina could have mitigated the crisis by adopting a more flexible
exchange rate regime earlier, coupled with stricter fiscal policies to manage debt. The
crisis serves as a cautionary tale for countries considering currency pegs, emphasizing
the need for robust economic fundamentals, policy flexibility, and proactive measures
to maintain investor confidence.

PYQ 2

Section A (20 Marks)

Instruction: Attempt any four questions out of five. Each question carries 5 marks.
(Note: Since you’ve requested to attempt all, I’ll solve all five questions.)

Question 1

Explain the benefits of international financial management for a multinational corporation.

Question 2

Explain with examples: American quote and European quote.

Question 3

Name five Indian companies who have issued ADRs since the beginning of FY 2017-18.

Question 4

Briefly explain the concept in relation to the theory of Interest-rate Parity with adequate
example(s).

Question 5

Explain the major roles of RBI in the foreign exchange market.

Solutions

Solution to Question 1: Benefits of International Financial Management for a Multinational

Corporation

International financial management (IFM) involves managing financial operations across

borders, which is crucial for a multinational corporation (MNC). The key benefits are:

1. Access to Global Capital Markets: IFM enables MNCs to raise funds in international
markets where capital may be cheaper or more accessible. For example, an MNC can
issue bonds in Europe at lower interest rates than in its home country.
 2. Risk Diversification: Operating in multiple countries reduces exposure to country-
specific risks (e.g., economic downturns, political instability). An MNC with
operations in both the US and Asia can offset losses in one region with gains in
another.

3. Currency Risk Management: IFM helps MNCs manage foreign exchange risk through
hedging tools like forwards and options. For instance, a US-based MNC expecting
payments in EUR can use a forward contract to lock in the exchange rate, protecting
against EUR depreciation.

4. Optimizing Cash Flows: IFM allows MNCs to manage cash flows efficiently across
subsidiaries. For example, an MNC can use transfer pricing or lead/lag payments to
shift funds to subsidiaries in need, minimizing tax liabilities and maximizing liquidity.

5. Exploiting Market Opportunities: IFM helps MNCs take advantage of arbitrage

opportunities, such as differences in interest rates or currency valuations across
countries, to enhance profitability.

Final Answer: IFM benefits an MNC by providing access to global capital, diversifying risks,
managing currency exposure, optimizing cash flows, and exploiting market opportunities,
ensuring financial stability and growth.

Solution to Question 2: American Quote and European Quote with Examples

These terms refer to how exchange rates are quoted in the foreign exchange market:

• American Quote (Direct Quote): This is the amount of domestic currency required to
buy one unit of foreign currency. For a US resident, an American quote for the euro
(EUR) would be expressed as USD/EUR.
Example: If the exchange rate is 1.20 USD/EUR, it means 1 EUR costs 1.20 USD.

• European Quote (Indirect Quote): This is the amount of foreign currency required to
buy one unit of domestic currency. For a US resident, a European quote for the euro
would be expressed as EUR/USD.
Example: If the exchange rate is 0.8333 EUR/USD, it means 1 USD buys 0.8333 EUR
(this is the reciprocal of the American quote: 1 ÷ 1.20 = 0.8333).

Final Answer: An American quote is the domestic currency per unit of foreign currency (e.g.,
1.20 USD/EUR), while a European quote is the foreign currency per unit of domestic
currency (e.g., 0.8333 EUR/USD).

Solution to Question 3: Five Indian Companies That Issued ADRs Since FY 2017-18
American Depositary Receipts (ADRs) allow US investors to buy shares of foreign companies.
Indian companies have been issuing ADRs for years, but the question asks for those that
issued ADRs starting from FY 2017-18 (April 2017 onward). Based on my knowledge:

1. Wipro Limited: Wipro has had an ADR program since 2000, but it continued to be
active in the US market during and after FY 2017-18.

2. Infosys Limited: Infosys, with an existing ADR program since 1999, remained active in
issuing ADRs post-2017.

3. ICICI Bank: ICICI Bank’s ADR program, ongoing since 2000, was active during this
period.

4. HDFC Bank: HDFC Bank has had an ADR program since 2001 and continued to
maintain it after 2017.

5. Tata Motors: Tata Motors, with an ADR program since 2004, was also active in the US
market during this timeframe.

Note: The question asks for companies that “issued ADRs since the beginning of FY 2017-
18,” which could imply new issuances. However, no major Indian companies launched new
ADR programs after April 2017, as the trend shifted toward other instruments like global
bonds. The companies listed above had existing ADR programs that remained active, which
aligns with the question’s intent in an academic context.

Final Answer: Five Indian companies with active ADRs since FY 2017-18 are Wipro, Infosys,
ICICI Bank, HDFC Bank, and Tata Motors.

Solution to Question 4: Concept of Interest-Rate Parity with Examples

Interest-Rate Parity (IRP): IRP is a theory in international finance that links interest rates,
spot exchange rates, and forward exchange rates. It states that the difference in interest
rates between two countries should equal the difference between the spot and forward
exchange rates, ensuring no arbitrage opportunities.

Formula (Covered IRP):

The 1-year forward rate is 72.17 INR/USD. This reflects the higher interest rate in India,
leading to a forward discount on INR.

Explanation: IRP ensures that an investor cannot profit by borrowing in a low-interest-rate

country (US), converting to a high-interest-rate currency (INR), investing, and hedging with a
forward contract. The forward rate adjusts to offset the interest rate differential.

Final Answer: Interest-rate parity links interest rates and exchange rates, ensuring no
arbitrage. For example, with a spot rate of 75 USD/INR, a US interest rate of 2%, and an
Indian rate of 6%, the 1-year forward rate is 72.17 INR/USD, reflecting the interest rate
differential.

Solution to Question 5: Major Roles of RBI in the Foreign Exchange Market

The Reserve Bank of India (RBI) plays a critical role in regulating and stabilizing India’s foreign
exchange market. Its major roles are:
 1. Exchange Rate Management: The RBI intervenes in the forex market to manage the
INR’s value, ensuring stability. For example, if the INR depreciates sharply, the RBI
may sell USD from its reserves to support the INR.

2. Regulation of Forex Transactions: The RBI sets guidelines under the Foreign
Exchange Management Act (FEMA) to control forex transactions, such as limits on
remittances and foreign investments, ensuring compliance and preventing misuse.

3. Maintaining Forex Reserves: The RBI maintains foreign exchange reserves to meet
external obligations and stabilize the INR during crises. For instance, it builds reserves
during periods of INR appreciation to use during depreciation.

4. Facilitating External Trade and Payments: The RBI ensures smooth forex operations
for trade by licensing authorized dealers (banks) to handle forex transactions,
supporting importers and exporters.

5. Controlling Speculation: The RBI monitors speculative activities in the forex market
and may impose restrictions, such as margin requirements on currency derivatives,
to prevent excessive volatility.

Final Answer: The RBI manages exchange rates, regulates forex transactions, maintains
reserves, facilitates trade, and controls speculation to ensure stability in India’s foreign
exchange market.

Section B (16 Marks)

Instruction: Attempt any two questions out of three. Each question carries 8 marks.
(Note: As requested, I’ll solve all three questions.)

Question 6

(a) Briefly explain the meaning of currency arbitrage.

(b) Explain how an arbitrage may be performed if in India SBI quotes EUR 1 = INR
70.70/72.20 and in Germany Deutsche Bank quotes INR 1 = EUR 0.01368/0.01379.

Question 7

(a) Given the following quotations from London, calculate direct quotes:
USD/GBP = 1.3000/1.3050, EUR/GBP = 1.1720/1.1770.
(b) Find the possible cross rates from the following quotes:
GBP/USD = 0.7663, GBP/EUR = 0.8496.

Question 8

Suppose the US and Canada produce only one commodity, i.e., wheat. If the price of wheat
per unit is $3.25 in the US and C$4.10 in Canada:
(a) Calculate the $:C$ spot rate, according to the law of one price.
(b) If wheat price is expected to rise to $3.35 in the US and C$4.30 in Canada, then 1-year
$:C$ forward rate should be?

Section C (14 Marks)

Instruction: Compulsory question.

Question 9

A Swiss exporter expects to receive $1,000,000 after 3 months. The exporter has collected
the following information:

• Spot (SrF/$): 1.48/1.52

• 3-month forward (SrF/$): 1.52/1.58

• 3-month LIBOR: SrF – 4% and $ – 3%

(a) What is meant by hedging in finance?

(b) Why should a non-financial services organization always try to hedge its foreign currency
exposure?
(c) Suppose the exporter decides to use either money market or forward market to cover the
exposure, what will the net position after 3 months in each of these markets, respectively?

Solutions

Solution to Question 6: Currency Arbitrage

(a) Meaning of Currency Arbitrage:

Currency arbitrage is the practice of exploiting price differences in exchange rates across
markets to make a profit with no risk. It involves simultaneously buying and selling a
currency in different markets where the exchange rates are misaligned, taking advantage of
the discrepancy until the rates equalize.

(b) Arbitrage Opportunity with Given Quotes:

• SBI (India): EUR 1 = INR 70.70/72.20 (bid/ask)

o Buying EUR: 72.20 INR (ask)

o Selling EUR: 70.70 INR (bid)

• Deutsche Bank (Germany): INR 1 = EUR 0.01368/0.01379 (bid/ask)

o Buying INR: EUR 0.01368 (bid)

o Selling INR: EUR 0.01379 (ask)

 o Converting to EUR/INR:

▪ EUR 1 = INR (1 ÷ 0.01379) / (1 ÷ 0.01368) = INR 72.52/73.10

Step 1: Identify the Opportunity:

• In India, buy EUR for 72.20 INR (SBI ask).

• In Germany, sell EUR for 73.10 INR (Deutsche Bank bid: 1 ÷ 0.01368).

• Profit per EUR = 73.10 – 72.20 = 0.90 INR.

Step 2: Arbitrage Process:

• Start with 72.20 INR in India, buy 1 EUR from SBI.

• Sell 1 EUR in Germany, receive 73.10 INR from Deutsche Bank.

• Net profit: 0.90 INR per EUR, risk-free.

Final Answer:
(a) Currency arbitrage is profiting from exchange rate differences across markets.
(b) Buy EUR in India for 72.20 INR, sell in Germany for 73.10 INR, earning 0.90 INR profit per
EUR.

Solution to Question 7: Direct Quotes and Cross Rates

(a) Calculate Direct Quotes (GBP as Base):

Given:

• USD/GBP = 1.3000/1.3050 (1 GBP = 1.3000 USD bid, 1.3050 USD ask)

• EUR/GBP = 1.1720/1.1770 (1 GBP = 1.1720 EUR bid, 1.1770 EUR ask)

These are already direct quotes for GBP (amount of foreign currency per GBP):

• Direct Quote for USD/GBP: 1.3000/1.3050

• Direct Quote for EUR/GBP: 1.1720/1.1770

Note: The question asks for direct quotes, and since these quotes are already in the form of
foreign currency per GBP (direct for a UK resident), no further calculation is needed.

(b) Calculate Cross Rates:

Given:

• GBP/USD = 0.7663 (1 USD = 0.7663 GBP)

• GBP/EUR = 0.8496 (1 EUR = 0.8496 GBP)

Cross Rate USD/EUR:

 • 1 USD = 0.7663 GBP, 1 EUR = 0.8496 GBP.

• USD/EUR = (GBP/EUR) ÷ (GBP/USD) = 0.8496 ÷ 0.7663 = 1.1088.

• So, 1 USD = 1.1088 EUR.

Cross Rate EUR/USD:

• EUR/USD = (GBP/USD) ÷ (GBP/EUR) = 0.7663 ÷ 0.8496 = 0.9020.

• So, 1 EUR = 0.9020 USD.

Final Answer:
(a) Direct quotes: USD/GBP = 1.3000/1.3050, EUR/GBP = 1.1720/1.1770.
(b) Cross rates: USD/EUR = 1.1088, EUR/USD = 0.9020.

Solution to Question 8: Law of One Price and Forward Rate

(a) Calculate USD/CAD Spot Rate (Law of One Price):

• Price of wheat: $3.25 in the US, C$4.10 in Canada.

• Law of one price: The price of a commodity should be the same globally when
adjusted for exchange rates.

• USD/CAD spot rate = Price in USD ÷ Price in CAD = 3.25 ÷ 4.10 = 0.7927.

• So, 1 USD = 0.7927 CAD.

(b) Calculate 1-Year Forward Rate:

• Future price of wheat: $3.35 in the US, C$4.30 in Canada.

• Using the law of one price for the future:

• USD/CAD forward rate = 3.35 ÷ 4.30 = 0.7791.

• So, 1-year forward rate: 1 USD = 0.7791 CAD.

Final Answer:
(a) Spot rate: USD/CAD = 0.7927.
(b) 1-year forward rate: USD/CAD = 0.7791.

Solution to Question 9: Hedging and Net Position

(a) Meaning of Hedging in Finance:

Hedging is a risk management strategy used to offset potential losses from adverse price
movements. In finance, it involves taking a position in one market (e.g., forwards, options) to
counterbalance risks in another (e.g., currency exposure), ensuring more predictable
outcomes.

(b) Why Non-Financial Organizations Hedge Forex Exposure:

Non-financial organizations, like exporters, face currency risk from exchange rate
fluctuations, which can impact profits and cash flows. Hedging ensures:

• Stability: Locks in rates to avoid losses from currency depreciation.

• Predictability: Helps plan budgets and pricing without forex uncertainty.

• Risk Mitigation: Protects against sudden market shocks, ensuring financial stability.

(c) Net Position After Hedging (Money Market vs. Forward Market):

• Given Data:

o Spot (SrF/$): 1.48/1.52

o 3-month forward (SrF/$): 1.52/1.58

o 3-month LIBOR: SrF 4%, USD 3%

o Exporter expects $1,000,000 in 3 months.

o 3-month rates: SrF 4% ÷ 4 = 1%, USD 3% ÷ 4 = 0.75%.

Forward Market Hedge:

• Sell $1,000,000 forward at the forward bid rate (1.52 SrF/$).

• After 3 months, receive: $1,000,000 × 1.52 = 1,520,000 SrF.

• Net Position: 1,520,000 SrF (locked in, no interest rate impact).

Money Market Hedge:

 •

• Net Position: 1,523,772 SrF.

Final Answer:
(a) Hedging offsets financial risks by taking counterbalancing positions.
(b) Non-financial firms hedge forex exposure for stability, predictability, and risk mitigation.
(c) Forward market: 1,520,000 SrF; Money market: 1,523,772 SrF.

INTERNAL EXAM

Q1 (Within 50 Words Each)

1(a)

Explain the meaning and scope of International Finance.

1(b)

Discuss the key factors that determine international exchange rates.

Q2 (Within 300 Words Each)

2(a)

Explain the importance of the global business environment in international finance.

2(b)
Explain the concepts of Direct and Indirect Exchange Rates with examples. Suppose a
company operates internationally and made a profit of 20 million euros. Convert this profit,
10 million yen, and 20 bitcoins. Given exchange rates:

• 1 USD = 0.00002 Bitcoin

• 1 USD = 1.35 Canadian Dollar

• 1 USD = 0.93 Euro

• 1 USD = 149.44 Japanese Yen

Calculate the profit in USD.

2(c)

Recall the concept and importance of Sovereign rating of countries.

2(d)

Identify names of the respective countries where the following is a direct quote and find the
Indirect quote for that country:

• INR 99.85 = GBP 1

• GBP 1 = USD 1.6549

• INR 60.16 = USD 1

2(e)

Note: This appears incomplete as it only lists exchange rates (INR 99.85 = GBP 1, GBP 1 =
USD 1.6549, INR 60.16 = USD 1) without a question. Since it’s labeled as a separate part, I’ll
assume it’s a continuation of 2(d) and focus on 2(a) to 2(d) unless further clarification is
provided.

Solutions

Q1(a): Meaning and Scope of International Finance (Within 50 Words)

International Finance deals with financial interactions between countries, focusing on

exchange rates, foreign investments, and global trade. Its scope includes managing currency
risks, international capital flows, balance of payments, and global financial markets, ensuring
economic stability and facilitating cross-border transactions for businesses and
governments.
Word Count: 47

Q1(b): Key Factors Determining International Exchange Rates (Within 50 Words)

Exchange rates are influenced by interest rates, inflation, and economic growth. Political
stability, trade balances, and market speculation also play roles. For example, higher interest
rates attract foreign capital, strengthening a currency, while trade deficits or political unrest
can weaken it, impacting global trade and investment.
Word Count: 48

Q2(a): Importance of Global Business Environment in International Finance (Within 300

Words)

The global business environment significantly influences international finance by shaping the
conditions under which financial transactions occur across borders. It encompasses
economic, political, legal, cultural, and technological factors that affect exchange rates,
investment decisions, and risk management for multinational corporations and
governments.

Economically, global growth rates, inflation, and interest rate differentials drive capital flows
and exchange rate fluctuations. For instance, if the US Federal Reserve raises interest rates,
the USD often strengthens, attracting foreign investment and impacting international
borrowing costs. Political stability is equally critical; countries with stable governments, like
Germany, are seen as safe havens, reducing currency risk, while political turmoil, as seen in
Venezuela, can lead to currency devaluation and capital flight. Legal frameworks, including
trade agreements and tax policies, also influence financial strategies. For example, favorable
trade agreements like the USMCA can boost cross-border investments by reducing tariffs.

Cultural factors affect consumer behavior and market entry strategies, impacting financial
planning. A company entering Japan must adapt to local business practices, influencing its
financial operations. Technological advancements, such as fintech innovations, have
revolutionized international finance by enabling faster cross-border payments and real-time
currency hedging, reducing transaction costs and risks.

The global business environment also affects risk management in international finance.
Currency volatility, driven by global events like Brexit, requires firms to use hedging tools like
forwards or options to mitigate losses. Additionally, understanding the global environment
helps firms exploit opportunities, such as arbitrage or accessing cheaper capital in foreign
markets.

In summary, the global business environment shapes the strategies and risks in international
finance by influencing economic conditions, political stability, legal frameworks, cultural
norms, and technological advancements, ensuring firms can navigate challenges and
capitalize on global opportunities effectively.
Word Count: 275
Q2(b): Concepts of Direct and Indirect Exchange Rates, and Profit Conversion (Within 300
Words)

Direct and Indirect Exchange Rates:

A direct exchange rate expresses the amount of domestic currency needed to buy one unit
of foreign currency. For a US resident, a direct quote for the euro is 0.93 USD/EUR (1 EUR =
0.93 USD). An indirect exchange rate shows the amount of foreign currency per unit of
domestic currency. For the same US resident, the indirect quote is EUR/USD = 1.0753 (1 USD
= 1.0753 EUR, calculated as 1 ÷ 0.93).

Profit Conversion:
Given:

• 1 USD = 0.00002 Bitcoin

• 1 USD = 1.35 CAD

• 1 USD = 0.93 EUR

• 1 USD = 149.44 JPY

• Profit: 20 million EUR, 10 million JPY, 20 Bitcoins

1. Convert EUR to USD:

o 1 EUR = 0.93 USD (given as 1 USD = 0.93 EUR, but interpreting as direct quote
for consistency).

o If 1 USD = 0.93 EUR, then 1 EUR = 1 ÷ 0.93 = 1.0753 USD.

o 20 million EUR × 1.0753 = 21,506,000 USD.

2. Convert JPY to USD:

o 1 USD = 149.44 JPY, so 1 JPY = 1 ÷ 149.44 = 0.00669 USD.

o 10 million JPY × 0.00669 = 66,900 USD.

3. Convert Bitcoins to USD:

o 1 USD = 0.00002 Bitcoin, so 1 Bitcoin = 1 ÷ 0.00002 = 50,000 USD.

o 20 Bitcoins × 50,000 = 1,000,000 USD.

Total Profit in USD:

• 21,506,000 (EUR) + 66,900 (JPY) + 1,000,000 (Bitcoin) = 22,572,900 USD.

Final Answer:
Direct rate: domestic per foreign unit (e.g., 0.93 USD/EUR); Indirect: foreign per domestic
(e.g., 1.0753 EUR/USD). Total profit: 22,572,900 USD.
Word Count: 264

Q2(c): Concept and Importance of Sovereign Rating of Countries (Within 300 Words)

Concept of Sovereign Rating:

A sovereign rating is an assessment of a country’s creditworthiness, reflecting its ability to
repay debt obligations. Assigned by agencies like S&P, Moody’s, and Fitch, it evaluates
economic, political, and financial factors. Ratings range from investment-grade (e.g., AAA,
highest) to speculative (e.g., BB or lower). For instance, a country with a strong economy like
the US often gets an AAA rating, while a country with fiscal challenges, like Argentina, might
be rated lower, indicating higher default risk.

Importance of Sovereign Rating:

Sovereign ratings play a critical role in international finance. First, they guide investors by
signaling the risk of lending to a government. A high rating, such as Germany’s AAA, attracts
foreign investment at lower interest rates, as it indicates low default risk. Conversely, a lower
rating, like Greece’s BB during its debt crisis, increases borrowing costs due to perceived risk,
impacting the country’s ability to finance deficits.

Second, sovereign ratings influence a country’s access to global capital markets. A

downgrade can lead to capital outflows, as seen with South Africa in 2017 when its rating
dropped to junk status, causing currency depreciation and higher borrowing costs. Third,
ratings affect foreign direct investment (FDI); investors prefer countries with stable ratings
for long-term projects, ensuring economic growth.

Additionally, sovereign ratings impact currency stability. A downgrade often weakens a

currency due to reduced investor confidence, affecting trade balances. For governments,
ratings provide a benchmark for fiscal discipline, encouraging reforms to improve
creditworthiness.

In summary, sovereign ratings assess a country’s credit risk, influencing investor confidence,
borrowing costs, market access, FDI, and currency stability, while guiding policymakers
toward sustainable economic practices.
Word Count: 268

Q2(d): Identify Countries and Calculate Indirect Quotes (Within 300 Words)

Identify Countries for Direct Quotes:

• INR 99.85 = GBP 1: This is a direct quote for India (INR per GBP). The country is India.
 • GBP 1 = USD 1.6549: This is a direct quote for the UK (GBP per USD). The country is
the UK.

• INR 60.16 = USD 1: This is a direct quote for India (INR per USD). The country is India.

Calculate Indirect Quotes:

• For India (INR 99.85 = GBP 1):

o Direct: 1 GBP = 99.85 INR.

o Indirect (GBP/INR): 1 INR = 1 ÷ 99.85 = 0.010015 GBP.

o Indirect quote: 0.010015 GBP/INR.

• For the UK (GBP 1 = USD 1.6549):

o Direct: 1 GBP = 1.6549 USD.

o Indirect (USD/GBP): 1 USD = 1 ÷ 1.6549 = 0.6043 GBP.

o Indirect quote: 0.6043 GBP/USD.

• For India (INR 60.16 = USD 1):

o Direct: 1 USD = 60.16 INR.

o Indirect (USD/INR): 1 INR = 1 ÷ 60.16 = 0.01662 USD.

o Indirect quote: 0.01662 USD/INR.

Summary:
A direct quote expresses the domestic currency per unit of foreign currency for a resident of
that country, while an indirect quote expresses the foreign currency per unit of domestic
currency. For India, INR 99.85/GBP and INR 60.16/USD are direct quotes, with indirect
quotes as 0.010015 GBP/INR and 0.01662 USD/INR, respectively. For the UK, GBP 1/USD
1.6549 is a direct quote, with the indirect quote as 0.6043 GBP/USD. These conversions help
in understanding exchange rates from the perspective of the domestic currency, aiding in
international financial transactions and comparisons.

Explanation of Direct and Indirect Exchange Rates with Examples

Direct Exchange Rate:

A direct exchange rate expresses the amount of domestic currency required to buy one unit
of foreign currency, from the perspective of a resident in the domestic country. It’s also
called a direct quote.
Example: For an Indian resident, if 1 USD = 83.50 INR, this is a direct quote. It means 1 US
dollar costs 83.50 Indian rupees.
Indirect Exchange Rate:
An indirect exchange rate shows the amount of foreign currency that can be obtained for
one unit of domestic currency, again from the perspective of a domestic resident. It’s also
called an indirect quote.
Example: Using the same rate, for an Indian resident, the indirect quote is 1 INR = 1 ÷ 83.50
= 0.01198 USD. This means 1 Indian rupee buys 0.01198 US dollars.

Another Example for Clarity:

For a US resident:

• Direct quote: 1 EUR = 1.08 USD (1 euro costs 1.08 US dollars).

• Indirect quote: 1 USD = 1 ÷ 1.08 = 0.9259 EUR (1 US dollar buys 0.9259 euros).

Final Answer:
A direct exchange rate is the domestic currency per unit of foreign currency (e.g., 1 USD =
83.50 INR for India). An indirect exchange rate is the foreign currency per unit of domestic
currency (e.g., 1 INR = 0.01198 USD).

TEACHER’S NOTE
Determinants of Exchange Rates – Simplified Explanation
Exchange rates are influenced by several key factors, each affecting the demand and supply
of a currency. Here’s a clearer breakdown of the determinants mentioned in the image:

1. Changes in Tastes (Preferences for Foreign Goods)

 • Example: If Japanese cars (like the Toyota Prius) become popular in the U.S.,
Americans need more Yen (¥) to buy them.
• Effect: Increased demand for the Yen → Yen appreciates (strengthens) against the
U.S. Dollar (USD).

2. Relative Real Interest Rates

• Example: If U.S. interest rates rise, foreign investors want to save or invest in the U.S.
to earn higher returns.
• Effect: Increased demand for USD → USD appreciates.

3. Relative Income Changes

• Example: If Europe enters a recession, Europeans earn less and reduce spending on
U.S. goods.
• Effect: Lower demand for USD → USD depreciates (weakens) against the Euro (€).

4. Relative Price Changes (Inflation Differences)

• Example: If China experiences high inflation, Chinese goods become more expensive.
• Effect: Lower global demand for Chinese Renminbi (¥) → Renminbi depreciates.

5. Speculation (Market Expectations)

• Example: If traders expect the USD to rise against the Euro, they buy USD now to
profit later.
• Effect: Increased demand for USD → USD appreciates.
The Market for Currency – Simplified Explanation
This graph illustrates how the exchange rate (the price of one currency in terms of another)
is determined by supply and demand in the foreign exchange market. Here, we’re looking at
the market for British pounds (£) priced in U.S. dollars ($).

1. The Supply of Pounds (Upward Sloping Curve)

• Why? When the dollar price of pounds rises (e.g., from 1to1to2 per £1), British
buyers get more dollars per pound, making U.S. goods cheaper for them.
• Effect: British consumers and businesses supply more pounds to buy more U.S.
goods (e.g., iPhones, American cars).
• Example: If £1 = 2insteadof2insteadof1, a $100 American jacket costs £50 instead of
£100 → British importers supply more pounds to buy more U.S. goods.

2. The Demand for Pounds (Downward Sloping Curve)

• Why? When the dollar price of pounds falls (e.g., from 2to2to1 per £1), British goods
become cheaper for Americans.
• Effect: Americans demand more pounds to buy more British goods (e.g., tea, luxury
cars).
 • Example: If £1 = 1insteadof1insteadof2, a £100 British sweater
costs 100insteadof100insteadof200 → Americans demand more pounds to buy more
British goods.

3. Equilibrium Exchange Rate

• The point where supply and demand curves intersect sets the market exchange rate.
• Example: If equilibrium is at £1 = $1.50, this means:
o British suppliers are willing to exchange pounds for dollars at this rate.
o American buyers are willing to pay this rate to get pounds.

Key Takeaways:
1. Stronger Dollar (fewer dollars per pound) → Cheaper British goods for Americans
→ Higher demand for pounds.
2. Weaker Dollar (more dollars per pound) → Cheaper U.S. goods for the British
→ Higher supply of pounds.
3. Exchange rates adjust based on trade flows, investment, and speculation.
To find the GBP/AUD exchange rate (how many Australian dollars (AUD) one British pound
(GBP) can buy), we'll use the given GBP/USD and AUD/USD rates. Here's the step-by-step
process:

Given Data:
Currency Pair Bid Ask

GBP/USD 0.9891 0.9894

AUD/USD 1.2287 1.2289

Step 1: Understand the Quotes

• Bid: The price at which the market buys the base currency (left) and sells the quote
currency (right).
• Ask: The price at which the market sells the base currency and buys the quote
currency.
For GBP/AUD, we need to derive the rate using the USD as the intermediary.

Final Cross Rate:

Currency Pair Bid Ask

GBP/AUD 0.8050 0.8053

Solution: Calculating the Forward Rate for USD/INR Payment on 31st Oct

Given:

1. Spot Rate (USD/INR):

o Bid (Bank buys USD): Rs. 45.8500

o Ask (Bank sells USD): Rs. 45.8600

2. Forward Premium for October (to be added to spot):

o Bid (Premium for bank's bid side): 0.5400

o Ask (Premium for bank's ask side): 0.5450

3. Exchange Margin: 0.125% (added to the bank's selling rate).

4. Rounding Rule: Last two digits in multiples of 25 paise (i.e., 0.25, 0.50, 0.75).

Step 1: Calculate Forward Ask Rate (Bank Sells USD)

Since you are importing (buying USD), the bank will quote its selling rate (Ask).

Forward Ask Rate=Spot Ask+Forward Ask Premium+Exchange MarginForward Ask Rate=Spot

Ask+Forward Ask Premium+Exchange Margin
 1. Spot Ask (Bank sells USD):

45.860045.8600

2. Add October Forward Ask Premium:

45.8600+0.5450=46.4050

3. Add Exchange Margin (0.125% of 46.4050):

0.125%×46.4050=0.0580

46.4050+0.0580=46.4630

4. Round to Nearest 25 Paise:

o 46.4630 → The last two digits (0.63) must be rounded to the nearest 0.25.

o 0.63 is between 0.50 and 0.75, so we round up to 0.75.

Final Forward Ask Rate=46.4750

Step 2: Total Cost in INR for USD 100,000

100,000×46.4750=Rs. 4,647,500

Final Answer:

• Forward Rate Quoted by Bank: Rs. 46.4750 per USD

• Total Payment Due on 31st Oct: Rs. 4,647,500

BENEFITS OF FDI TO HOST COUNTRIES

• Resource transfer effects

• Employment effects
• BOP effects
• Effect on competition and Growth
• Revenue to Government
• Less volatility
COSTS OF FDI TO HOST COUNTRIES
• Adverse effects on Competition
• Adverse effects on BOP
• National sovereignty and autonomy
• Capital intensive technology
BENEFITS OF FDI TO HOME COUNTRIES
• BOP benefits
• Employment effects
• Acquisition of skills
COSTS OF FDI TO HOME COUNTRIES
• BOP effects in three ways:
Capital A/C-Initial capital outflow
Current A/C-More Imports
Current A/C-Less Exports
• Employment Effects
FACTORS INFLUENCING EXCHANGE RATE
Cross Currency Rate
A currency quote not expressed in terms of USD is known as across rate. All dominant and
frequently traded currencies are translated in terms of USD. However, certain transactions
may be such that they do not contain the dollar component at all. In such cases, the
currency quotes are required to be expressed at a rate relative to one another to facilitate
that exchange.
Let us look at an example (as under) -
A manufacturer in Germany wants to obtain certain automobile parts from a supplier in
Australia. The supplier only accepts payment in Australian Dollars (AUD). Therefore, the
German manufacturer will be compulsorily required to convert EUR to AUD to close the
contract. The amount payable to the Australian Supplier is AUD 350,000.
The following quotes are quoted by the exchange.
EUR/USD 1.1670-1.1674
USD/AUD 1.3561-1.3570
The German manufacturer needs to convert EUR to AUD to pay AUD 350,000 to the
Australian supplier. Since the bank provides EUR/USD and USD/AUD rates, we must
calculate the cross rate (EUR/AUD).

Given Exchange Rates:

1. EUR/USD:

o Bid (Bank buys EUR): 1.1670

o Ask (Bank sells EUR): 1.1674

2. USD/AUD:

o Bid (Bank buys USD): 1.3561

o Ask (Bank sells USD): 1.3570

FIBA ASSIGNMENT NUMERICALS

Step 1: Determine if Forward USD is at Premium or Discount

• Rule:

o If forward margins increase (higher bid/ask than spot), the foreign currency
(USD) is at a premium.

o If margins decrease, USD is at a discount.

• Observation:

o Forward margins are positive and rising (e.g., 1-month: 28/29 → 6-month:
137/140).

o Conclusion: USD is trading at a forward premium against INR.

Reason:
The USD is more expensive in the future, indicating higher demand or lower supply of USD
in forward markets.

Step 2: Calculate Outright Forward Rates

Forward rates are derived by adding the forward margins to the spot rate (since USD is at a
premium).

Formula:

Forward Bid=Spot Bid+Forward Bid Margin (in INR)Forward Bid=Spot Bid+Forward Bid Mar
gin (in INR)Forward Ask=Spot Ask+Forward Ask Margin (in INR)Forward Ask=Spot Ask+For
ward Ask Margin (in INR)

Calculations:

1. 1-Month Forward:

o Bid: 64.91+0.28=65.19
 o Ask: 64.92+0.29=65.21

o Rate: 65.19/65.21

2. 2-Months Forward:

o Bid: 64.91+0.53=65.44

o Ask: 64.92+0.55=65.47

o Rate: 65.44/65.47

3. 3-Months Forward:

o Bid: 64.91+0.75=65.66

o Ask: 64.92+0.77=65.69

o Rate: 65.66/65.69

4. 6-Months Forward:

o Bid: 64.91+1.37=66.28

o Ask: 64.92+1.40=66.32

o Rate: 66.28/66.32

Key Takeaways:

1. USD is at a Premium:

o Forward rates are higher than spot rates, indicating INR depreciation
expectations.

2. Bid-Ask Spread Widens:

o Longer tenures have larger spreads (e.g., 6-month: 4 paise vs. 1-month: 2
paise), reflecting higher uncertainty.

3. Implications for Trade:

o An Indian importer paying USD in 6 months will pay Rs. 66.32 per USD (vs.
spot Rs. 64.92), increasing costs.

o Exporters receiving USD in the future gain from higher INR/USD rates

QUESTION 2:

Calculate the forward points –

Euro 1 = US $ 1.40, Interest rate differential is 6%. For 90 days forward calculate the
forward points.

Spot rate = 1.40. Int. differential = 6%

Forward period = 90 days (no. in a year to be taken 360 days).

Please use the formulae –

Step 1: Plug in the Values

Forward Points=(1.40×0.06×90)360×100Forward Points=360(1.40×0.06×90)×100

Step 2: Simplify the Calculation

1. Numerator:

1.40×0.06×90=7.561.40×0.06×90=7.56

2. Denominator:

360360

3. Divide and Multiply by 100:

7.56360×100=0.021×100=2.1 points3607.56×100=0.021×100=2.1 points

Interpretation:

• Forward Points = 2.1

o This means the forward rate adjusts the spot rate by 0.0021 (since 1 point =
0.0001).

Forward Rate Calculation:

• If the interest rate differential favors the Euro (EUR) (higher interest rates in the
Eurozone), the Euro trades at a forward premium.

• Forward Rate = Spot Rate + Forward Points (in decimals)

1.40+0.0021=1.40211.40+0.0021=1.4021

(Note: If the USD had higher interest rates, the Euro would trade at a discount, and points
would be subtracted.)
Key Takeaways:

1. Forward Points Reflect Interest Rate Differentials:

o A 6% higher annual interest rate in the Eurozone leads to a 0.21%

premium for EUR over 90 days.

2. Practical Use:

o Banks quote forward rates by adding/subtracting points to the spot rate

based on this formula.

3. Hedging Implication:

o A company locking in a 90-day forward contract would exchange EUR

at 1.4021 USD instead of the spot rate (1.40).

Step 1: Derive the Cross Rate Formula

To find JPY/INR, we can use the two given rates as follows:

JPY/INR=USD/INRUSD/JPYJPY/INR=USD/JPYUSD/INR

This works because the USD cancels out in the numerator and denominator.

Step 2: Plug in the Values

JPY/INR=45.17112.35=0.40204JPY/INR=112.3545.17=0.40204

Interpretation:

• 1 JPY = 0.40204 INR

• Alternatively, 1 INR = 1 / 0.40204 = 2.4873 JPY (though this is not asked).

Step 3: Match with Given Options

The calculated rate (0.40204) matches option:

 • c) 0.40204

Verification: Alternative Approach

To ensure correctness, let’s reverse the calculation:

• If 1 JPY = 0.40204 INR, then:

112.35 JPY=112.35×0.40204=45.17 INR112.35JPY=112.35×0.40204=45.17INR

This confirms that 1 USD = 45.17 INR, aligning with the given data

Q. Calculate the Inverse Quote, Mid Rate, Spread and Spread percentage from the following
data –

EUR USD = 1.5610/1.5700

A. EUR/USD = 1.5610/1.5700
(Where 1.5610 is the Bid price and 1.5700 is the Ask price)

1. Inverse Quote (USD/EUR):

To find how many EUR 1 USD can buy:

• Inverse Bid = 1/Ask = 1/1.5700 = 0.6369

• Inverse Ask = 1/Bid = 1/1.5610 = 0.6406

Inverse Quote: USD/EUR = 0.6369/0.6406

2. Mid Rate:

Mid Rate = (Bid + Ask)/2

= (1.5610 + 1.5700)/2
= 3.1310/2
= 1.5655

3. Spread:

Spread = Ask - Bid

= 1.5700 - 1.5610
= 0.0090

4. Spread Percentage:

Spread % = (Spread/Mid Rate) × 100

= (0.0090/1.5655) × 100
= 0.575% (approximately 0.57%)
INTRODUCTION

A. The Currency Market: where money denominated in one currency is

bought and sold with money denominated in another currency
B. International Trade and Capital Transactions:
▪ facilitated with the ability to transfer purchasing power
between countries
C. Location
▪ [Link]-type: no specific location
▪ [Link] trades by phone,
▪ telex, or SWIFT
▪ SWIFT: Society for Worldwide Interbank Financial
Telecommunications

PARTICIPANTS IN THE FOREIGN EXCHANGE MARKET

[Link] at 2 Levels

[Link] Level (95%)

-major banks

[Link] Level

-business customers

Two Types of Currency Markets

[Link] Market:

-immediate transaction

-recorded by 2nd business day

[Link] Market:

-transactions take place at a specified future date

Participants by Market

1. Spot Market

[Link] banks

[Link]

[Link] of commercial and central banks

[Link] Market

[Link]

[Link]

[Link]

[Link]

[Link] TRADING

[Link] Trading

-genuine screen-based market

[Link]:

[Link] cost of trading

[Link] traders’ oligopoly of information

[Link] liquidity

THE SPOT MARKET

[Link] QUOTATIONS

[Link]

[Link] major newspapers

[Link] currencies have four different quotes:

[Link] price

b.30-day

c.90-day

d.180-day

[Link] of Quotation

[Link] interbank dollar trades:

 [Link] terms

example: $.5838/dm

[Link] terms

example: Peso1.713/$

[Link] nonbank customers:

Direct quote

gives the home currency price of one unit of foreign currency.

EXAMPLE:dm0.25/FF

[Link] Costs

1. Bid-Ask Spread

used to calculate the fee

charged by the bank

Bid = the price at which the bank is willing to buy

Ask = the price it will sellthe currency

[Link] Arbitrage

[Link] cross rates differ from one financial center to another, and profit opportunities exist.

[Link] cheap in one int’l market, sell at a higher price in another

[Link] of Available Information

[Link] Date Value Date:

[Link] monies are due

2.2nd Working day after date of original transaction.

[Link] Risk

[Link] = middlemen

[Link] risk of adverse

exchange rate moves.

[Link] uncertainty about future exchange rate requires

1.) Demand for higher risk

premium
2.)Bankers widen bid-ask spread

[Link]

A. Definition of a Forward Contract

an agreement between a bank and a customer to deliver a specified amount of currency

against another currency at a specified future date and at a fixed exchange rate.

2. Purpose of a Forward:

Hedging

the act of reducing exchange rate risk.

[Link] Rate Quotations

1. Two Methods:

[Link] Rate: quoted to commercial customers.

[Link] Rate: quoted in the

interbank market as a discount or premium.

Direct/American Quotation

The most common way of stating a foreign exchange quotation is in terms of the number of
units of home Currency needed to buy one unit of foreign Currency. This is known as the
Direct Quote.

Direct Quotations are also known as American quotes. The prices of Currency Futures
Contracts traded on the Chicago Mercantile Exchange are quoted using the Direct method.
Direct exchange rate quotations are most frequently used by banks in dealing with their non-
bank customers.

Direct quotation: 1 foreign Currency unit = x home Currency units

India quotes its exchange rates in terms of the amount of rupees that can be exchanged for
one unit of foreign Currency. For example, if the Indian rupee is the home Currency and the
foreign Currency is the dollar, then the exchange rate between the rupee and the dollar
might be stated as:

$ 1/` 83.1100

This means that for one Dollar, one can buy 83.1100 Rupees.

If the home Currency is dollar, a Direct quotation of the exchange rate between dollar and
the Euro is:

1.0/$1.32421,

indicating that the dollar cost of one Euro is $1.32421.

Indirect/European Quotation

Indirect quotations refer to the Price of foreign Currency in terms of one unit of home
Currency.

In this method, also known as the European Terms, the rate is quoted in terms of the
number of units of the foreign Currency for one unit of the domestic Currency.

Indirect quotation: 1 home Currency unit = x foreign Currency units

For example, an Indirect quotation, for the exchange rate between the dollar and the rupee
will be ` 1/$.0201572/, indicating that one rupee can purchase .0202572 dollars.

Both Direct and Indirect quotes are in use. In the US, it is common to use the Direct Quote
for domestic business. For international business, banks generally use European Terms.
Transactions where the exchange of currencies takes place two days after the date of the
contact are known as the Spot transactions. The rate of exchange effective for the spot
transaction is known as the spot rate and the market for such transactions is known as the
spot market.

This requires the immediate delivery or exchange of currencies on the spot i.e. within 48
hours. For instance, if the contract is made on Monday, the delivery should take place on
Wednesday. If Wednesday is a holiday, the delivery will take place on the next day, i.e.,
Thursday.

Rupee payment is also made on the same day the foreign currency is received. It is
estimated that about 90 per cent of spot transactions are carried out exclusively for banks.
The rest are meant for covering the orders of the clients of banks, which are essentially
enterprises. This market functions continuously, round the clock. As a matter of fact, certain
length of time is necessary for completing the orders of payment and accounting operations
due to time differences between different time zones across the globe.

According to a Bank of International Settlements (BIS) estimate, the daily volume of spot
exchange transactions is about 50 per cent of the total transactions of exchange markets.
London market is the first market of the world not only in terms of the volume but also in
terms of diversity of currencies traded. The New York market trades, by and large, US Dollar
(75 per cent of the total), Euro, Yen, British Pound, Swiss Franc, Canadian Dollar, Australian
and New Zealand Dollar only.

Currency forward market involves transactions in which the exchange of currencies takes
places at a specified future date, subsequent to the spot date known as a forward
transaction. The forward transaction can be for delivery at a pre-agreed future point in time
at a specified price.

So we can say it is an agreement between two parties, requiring the delivery at some
specified future date of a specified amount of foreign currency by one of the parties,
against payment in domestic currency to the other party, at the price agreed upon in the
contract. The rate of exchange applicable to the forward contract is called the forward
exchange rate and the market for forward transactions is known as the forward market.

Forward market transactions are meant to be settled on a future date as specified in the
contract. Though forward rates are quoted just like spot rates, but actual delivery of
currencies takes place much later, on a date in future.

Forward exchange facilities, obviously, are of immense help to exporters and importers as
they can cover the risks arising out of exchange rate fluctuations by entering into an
appropriate forward exchange contract.

Forward Margin/Swap points: With reference to its relationship with spot rate, the forward
rate may be at par, discount or premium.

Forward rate may be the same as the spot rate for the currency. Then it is said to be ‘at par‘
with the spot rate. But this rarely happens. More often the forward rate for a currency may
be costlier or cheaper than its spot rate. The difference between the forward rate and the
spot rate is known as the forward margin or swap points.

If the forward margin is at premium, the foreign currency will be costlier under forward rate
than under the spot rate. The forward rate for a currency, say the dollar, is said to be at
premium with respect to the spot rate when one dollar buys more units of another
currency, say rupee, in the forward than in the spot rate on a per annum basis.

If the forward margin is at discount, the foreign currency will be cheaper for forward delivery
than for spot delivery. The forward rate for a currency, say the dollar, is said to be at
discount with respect to the spot rate when one dollar buys fewer rupees in the forward
than in the spot [Link] discount is also usually expressed as a percentage deviation
from the spot rate on a per annum basis.

Under direct quotation, premium is added to spot rate to arrive at the forward rate. This is
done for both purchase and sale transactions. Discount is deducted from the spot rate to
arrive at the forward rate.
The forward exchange rate is determined mostly be the demand for and supply of forward
exchange. Naturally when the demand for forward exchange exceeds its supply, the forward
rate will be quoted at a premium and conversely, when the supply of forward exchange
exceeds the demand for it, the rate will be quoted at discount. When the supply is
equivalent to the demand for forward exchange, the forward rate will tend to be at par.

Futures, Options and Swaps are called derivatives because they derive their value from the
underlying exchange rates.

Futures market is a standardised version of a forward contract that is publicly traded on a

futures exchange. Like a forward contract it includes price and the time in the future to
buy or sell an asset. In terms of currency market it is a contract to deliver or take delivery of
a given amount of currency on a specific future date at a price fixed on the date of the
contractor A transaction involving the exchange of two currencies at a rate agreed on the
date of the contract for value or delivery (cash settlement) at some time in the future (more
than two business days later). Like a forward contract a future contract is executed at a later
date but a future contract is different from forward contract in many respects. The major
distinguishing features are: Standardisation, Organised exchanges, Minimum variation,
Clearinghouse, Margins, and Marking to market.

Unlike forward contracts which are custom made, a future contract has a standardized
contract size and maturity date/s. Futures can traded only on an organized exchange and
they are traded competitively. Margins are not required in respect of a forward contract but
margins are required from all participants in the futures market and an initial margin must
be deposited into a collateral account to establish a future position.

Options: An option is a contract or financial instrument that gives holder the right, not the
obligation, to sell or buy a given quantity of an asset as a specified price at a specified future
date. An option to buy the underlying asset is known as a call option and an option to sell
the underlying asset is known as a put option. Buying or selling the underlying asset via the
option is known as exercising the option. The stated price paid (or received) is known as the
exercise or strike price. The buyer of an option is known as the holder of the option or long
position and the seller of an option is known as the writer of the option, or the short
position. The price for the option is known as premium.

Types of options: With reference to their exercise characteristics, there are two types of
options, American and European.

An European option can is exercised only at the maturity or expiration date of the contract,
whereas an American option can be exercised at any time during the contract.

Currency Options are derivative instruments that give a choice to a foreign exchange market
operator to buy or sell a foreign currency on or up to a date (maturity date) at a specified
rate (strike price).
Swaps, as the term suggests, are simply the instruments that permit exchange of two
streams of cashflows in two different currencies. The term swap in currency market terms
can be understood as simultaneous sale of spot currency for the forward purchase of the
same currencyor the purchase of spot for the forward sale of the same currency. The spot is
swapped against forward.

Operations consisting of a simultaneous sale or purchase of spot currency accompanied by a

purchase or sale, respectively of the same currency for forward delivery are technically
known as swaps or double deals as the spot currency is swapped against forward.
Commercial banks who conduct forward exchange business may resort to a swap operation
to adjust their fund position.

Arbitrage

Arbitrage is the simultaneous buying and selling of foreign currencies with intention of
making profits from the difference between the exchange rate prevailing at the same time in
different markets

Dealersare basically involved in buying currencies when they are low and selling them when
they are high.

Dealers operations are wholesaleand majority of their transactions are interbank in nature
although, once in a while, they may deal with corporates and central banks. They have low
transaction costs as well as thin spreads which reflect their long experience in exchange risk
management as well as the intense competition among banks.

Dealers at the retaillevel cater to needs of customers willing to buy or sell foreign exchange
for education, travel and tourism purposes. The spread is wide in these transactions and this
constitutes a very small portion of total trade.

Exchange brokers/ Brokers: Are not authorized to take a position on the market. Their job is
to find a buyer and a seller for the same amount for the given currencies. Their
remuneration is in the form of brokerage. They are constantly in liaison with banks and in
search of counterparties.

A large portion of foreign exchange transactions is conducted through brokers. While they
tend to specialize in certain currencies, they virtually handle all major currencies. Brokers
exist because they lower the dealers' costs, reduce their risks and provide anonymity. In
interbank trade, brokers charge a small commission of around 0.01 per cent of the
transaction amount. In illiquid currency dealings, they charge higher commissions. Payment
of commission is split between trading parties. Banks are able to avoid undesirable positions
with the help of brokers.

In India, banks may deal directly or through recognized exchange brokers. Accredited
exchange brokers are permitted to contract exchange business on behalf of authorized
dealers in foreign exchange only upon the understanding that they will conform to the rates,
rules and conditions laid down by the Foreign Exchanges Dealers ‘Association of India’
(FEDAI). All contracts must bear the clause subject to the Rules and Regulations of the
FEDAI.

Arbitrageursmake gains by discovering price discrepancies that allow them to buy cheap and
sell dear. Their operations are risk-free, in a free and open market, the scope for currency
arbitrage tends to be low and it is, by and large, accessible only to dealer banks. Unlike
arbitrageurs, speculators expose themselves to risk. Speculationgives rise to financial
transactions that develop when an individual's expectations differ from the expectations of
the market. Speculators transact in foreign exchange primarily because of an anticipated but
uncertain gain as a result of an exchange rate change. An open position denominated in
foreign currency constitutes speculation. Banks or corporates, when they accept either a net
asset or a net liability in foreign currency, are indulging in speculation.

Speculators are classified as bulls and bears. A bull expects a currency to become more
expensive in the future. He buys the currency either Spot or Forward today in the belief that
he can sell it at a higher price in the future. Bulls take a long position in the particular
currency.A bear expects a particular currency to become cheaper in the future. He sells either
Spot or Forward today in the hope of buying it back at a cheaper rate in the future. Bears
take a short position on a particular currency.

Central Banks participate to control their money supply, interest rate and inflation in order
to stabilize the home money market. Central banks intervene in the market to reduce
fluctuations of the domestic currency and to ensure an exchange rate compatible with the
requirements of the national economy. Their objective is not to make profit out of these
interventions but to influence the value of national currency in the interest of country's
economic well being. For example, if rupee shows signs of depreciating, central bank may
release (sell) a certain amount of foreign currency. This increased supply of foreign currency
will halt the depreciation of rupee. The reverse operation may be done to stop rupee from
appreciation.

Commercial banks are intermediaries between seekers and suppliers of currency. The role of
banks is to enable their clients to change one currency into another. Also, they operate on
these markets to make a profit through speculation and the process of arbitrage. Big
commercial banks serve as market-makers. They simultaneously quote, bid and ask prices,
indicating their willingness to buy and sell foreign currencies at quoted rates.

The purchases and sales by large commercial banks seldom match, leading to large variation
in their holdings of foreign currencies exposing them to exchange risk. When they assume
the risk deliberately, they act as speculators. However, banks prefer to keep their exposure
low and not get into unduly large speculations. Banks communicate between themselves
through a network of telephones, faxes and the means of communications supplied by
Reuters, Telerate, Bloomberg etc. Commercial banks also participate on behalf of corporates
who trade with other corporates based out of different countries.

SETTLEMENT OFTRANSACTIONS

Foreign exchange markets make extensive use of the latest developments in

telecommunications for transmitting as well settling foreign exchange transaction. Banks use
the exclusive network SWIFT to communicate messages and settle the transactions at
electronic clearing houses such as CHIPS at New York.

SWIFT: SWIFT is a acronym for Society for Worldwide Interbank Financial

Telecommunications, a co-operative society owned by about 250 banks in Europe and North
America and registered as a co-operative society in Brussels, Belgium. It is a communications
network for international financial market transactions linking effectively more than 25,000
financial institutions throughout the world who have been allotted bank identified codes.
The messages are transmitted from country to country via central interconnected operating
centers located in Amsterdam and Virginia. The member countries are connected to the
centre through regional processors in each country. The local banks in each country reach
the regional processors through the national networks.

The SWIFT System enables the member banks to transact among themselves quickly (i)
international payments (ii) Statements (iii) other messages connected with international
banking. Transmission of messages takes place within seconds, and therefore this method is
economical as well as time saving. Selected banks in India have become members of SWIFT
like Bank of India, Allahabad Bank, Andhra Bank, Bank of Baroda, Bank of Maharashtra,
CanaraBank, Central Bank of India, Dena Bank, Indian Bank, HDFC Bank Limited, Export
Import Bank of India, ICICI Bank Limited, Reserve Bank of India, State Bank of India,
Syndicate Bank, UCO Band, Yes Bank Limited etc.. The regional processing centre is situated
at Mumbai.

CHIPS: CHIPS stands for Clearing House Interbank Payment [Link] is an electronic
payment system owned by 12 private commercial banks constituting the New York Clearing
House Association. A CHIP began its operations in 1971 and has grown to be the world‘s
largest payment system. Foreign exchange and Euro dollar transactions are settled through
CHIPS. It provides the mechanism for settlement every day of payment and receipts of
numerous dollar transactions among member banks at New York, without the need for
physical exchange of cheques/funds for each such transaction.

FACTORS DETERMINING SPOT EXCHANGE RATES

Balance of Payments: Balance of Payments represents the demand for and supply of
foreign exchange which ultimately determine the value of the currency. Exports, both visible
and invisible, represent the supply side for foreign exchange. Imports, visible and invisible,
create demand for foreign exchange. Put differently, export from the country creates
demand for the currency of the country in the foreign exchange market. Conversely,
imports into the country will increase the supply of the currency of the country in the
foreign exchange market.

Inflation: Inflation in the country would increase the domestic prices of the commodities.
With increase in prices exports may dwindle because the price may not be competitive. With
the decrease in exports the demand for the currency would also decline;this in turn would
result in the decline of external value of the currency. It may be noted that unit is the
relative rate of inflation in the two countries that cause changes in exchange rates.

If, for instance, both India and the USA experience 10% inflation, the exchange rate between
rupee and dollar will remain the same. If inflation in India is 15% and in the USA it is 10%,
the increase in prices would be higher in India than it is in the USA. Therefore, the rupee will
depreciate in value relative to US dollar.

Interest rate: The interest rate has a great influence on the short –term movement of
capital. When the interest rate of a country rises, it attracts short term funds from other
countries. This would increase the demand for the currency of the home country and hence
its value. Rising of interest rate may be adopted by a country due to tight money conditions
or as a deliberate attempt to attract foreign investment. The effect of an increase in interest
rate is to strengthen the currency of the country through larger inflow of investment and
reduction in the outflow of investments by the residents of the country.
 Provision of Hedging Facilities: The other important function of the foreign exchange
market is to provide hedging facilities. Hedging refers to covering of foreign trade risks, and
it provides a mechanism to exporters and importers to guard themselves against losses
arising from fluctuations in exchange rates.
On March 17, 2025, the People's Bank of China suddenly announced that the digital RMB
(Renminbi, Chinese Yuan) cross-border settlement system will be fully connected to the ten
ASEAN countries and six Middle Eastern countries, which means that 38% of the world's
trade volume will bypass the SWIFT system dominated by the US dollar and directly enter
the "digital RMB moment". This financial game, which The Economist called the "Bretton
Woods System 2.0 Outpost Battle", is rewriting the underlying code of the global economy
with blockchain technology.

While the SWIFT system is still struggling with the 3-5 day delay in cross-border payments,
the digital currency bridge developed by China has compressed the clearing speed to 7
seconds. In the first test between Hong Kong and Abu Dhabi, a company paid a Middle
Eastern supplier through digital RMB. The funds no longer went through six intermediary
banks, but were received in real time through a distributed ledger, and the handling fee
dropped by 98%. This "lightning payment" capability makes the traditional clearing system
dominated by the US dollar instantly look clumsy.

What makes the West even more frightened is the technical moat of China's digital currency.
The blockchain technology used by the digital RMB not only makes transactions traceable,
but also automatically enforces anti-money laundering rules. In the China-Indonesia "Two
Countries, Two Parks" project, Industrial Bank used digital RMB to complete the first cross-
border payment, which took only 8 seconds from order confirmation to funds arrival, 100
times more efficient than traditional methods. This technical advantage has enabled 23
central banks around the world to actively join the digital currency bridge test, among which
Middle Eastern energy traders have reduced settlement costs by 75%.

The deep impact of this technological revolution lies in the reconstruction of financial
sovereignty. When the United States tried to sanction Iran with SWIFT, China had already
built a closed loop of RMB payments in Southeast Asia. Data shows that the cross-border
RMB settlement volume of ASEAN countries exceeded 5.8 trillion yuan in 2024, an increase
of 120% over 2021. Six countries including Malaysia and Singapore have included RMB in
their foreign exchange reserves, and Thailand has completed the first oil settlement with
digital RMB. This wave of "de-dollarization" made the Bank for International Settlements
exclaim: "China is defining the rules of the game in the era of digital currency."

But what really shocked the world was China's strategic layout. Digital RMB is not only a
payment tool, but also a technical carrier of the "Belt and Road" strategy. In projects such as
the China-Laos Railway and the Jakarta-Bandung High-Speed Railway, the digital RMB is
deeply integrated with Beidou navigation and quantum communication to build a "Digital
Silk Road". When European car companies use digital RMB to settle freight through the
Arctic route, China is using blockchain technology to increase trade efficiency by 400%. This
virtual-real strategy makes the US dollar hegemony feel a systemic threat for the first time.
Today, 87% of countries in the world have completed the adaptation of the digital RMB
system, and the scale of cross-border payments has exceeded 1.2 trillion US dollars. While
the United States is still debating whether digital currency threatens the status of the US
dollar, China has quietly built a digital payment network covering 200 countries. This silent
financial revolution is not only about monetary sovereignty, but also determines who can
control the lifeline of the future global economy!
If interest rate parity is violated, then an arbitrage opportunity exists. The simplest example
of this is what would happen if the forward rate was the same as the spot rate, but the
interest rates were different, than investors would:

1. Borrow in the currency with the lower rate.

2. Convert the cash at spot rates.

3. Enter a forward contract to convert the cash plus the expected interest at the same rate.

4. Invest the money at the higher rate.

5. Convert back through the forward contract.

6. Repay the principal and the interest, knowing the latter will be less than the interest
received.