Question PaperInternational Finance and Trade – I (221) : January 2005

Section A : Basic Concepts (30 Marks)

This section consists of questions with serial number 1 - 30. Answer all questions. Each question carries one mark. Maximum time for answering Section A is 30 Minutes.

1. Under the gold standard, the loss of gold and reduction in the money supply in the deficit country may lead to

(a) An increase in its interest rate and a capital inflow(b) An increase in its interest rate and a capital outflow(c) A decrease in its interest rate and a capital inflow(d) A decrease in its interest rate and a capital outflow(e) Capital outflow only.

< Answer >

2. The following are the exchange rates quoted in Singapore

S$/Euro : 2.0118/21S$/US$ : 1.7384/86

The synthetic rates of US $/Euro are

(a) 1.1572/73 (b) 1.1571/74 (c) 0.8640/41 (d) 0.8639/42 (e) 3.4977/79.

< Answer >

3. According to the law of comparative advantage, a country can benefit from trade

(a) If it can produce the good in another country at a lower cost than in its own country(b) If it has an absolute advantage or disadvantage in the production of all goods(c) If it exports more than it imports(d) If its resources and technology are superior to those of other countries(e) If it imports more than it exports.

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4. The current interest rates are as under:

Year 1 2 3

Interest Rate 5% 6% 7%

The expected 1 year rate after 2 years is r12 and expected 2 years rate after 1 year is r21, then which of the following is true?

(a) r12 = 8% r21 = 7 % (b) r12 = 8% r21 = 8%(c) r12 = 9% r21 = 7% (d) r12 = 9% r21 = 9%(e) r12 = 9% r21 = 8%.

< Answer >

5. A crawling peg system is a

(a) Fixed exchange rate system (b) Floating exchange rate system

(c) Hybrid of fixed and flexible exchange rate system(d) Currency board system (e) Free float system.

< Answer >

6. To ensure that there is no three point arbitrage, the relationship among the rates of three currencies should conform to

I.bid ask

ask

1S(C / B) S(A / C) 1

S(A / B)

II.

ask

ask

S(A / B)

S(C / B)³ S (A/C)bid

III. S (A/B)bid ask ask

1 1

S(C / B) S(A / C)

1(a) Only (I) above (b) Only (II) above (c) Only (III) above(d) Both (I) and (III) above (e) Both (II) and (III) above.

< Answer >

7. ‘J curve’ occurs because

(a) Elasticity of demand for imports is greater in the short run than in the long run(b) Elasticity of supply for exports is greater in the long run than in the short run(c) Elasticity of supply for exports is greater in the short run than in the long run(d) Long run and short run trade elasticities are equal(e) Elasticity of demand for export is greater in the short run than in the long run.

< Answer >

8. In a swap-out deal, the foreign currency is

(a) Bought both spot and forward(b) Sold both spot and forward(c) Sold spot and bought forward(d) Sold forward with different maturities(e) Bought forward with different maturities.

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9. If the Euro is quoted $ 1.1410 today and the inflation rates are 2% in Euro-zone and 3% in USA, what should be the $/Euro quote after 3 months?

(a) $ 1.1382/Euro (b) $ 1.1438/Euro (c) $ 1.1522/Euro(d) $ 1.1300/Euro (e) $ 1.1466/Euro.

< Answer >

10. A country may be able to correct its persistent (long-term) Balance of Payments deficit by

(a) Reducing the barriers on imported goods(b) Reducing its official reserves(c) Expanding its national income(d) Reducing the international value of its currency (e) Increasing the international value of its currency.

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11. Which of the following statements is not true with respect to SDRs?

(a) SDRs are reserves created by IMF and allocated to member countries(b) SDRs are only used to cover current account deficit(c) Interest is paid to those who hold SDRs and by those who draw down their SDRs(d) The interest rate of SDRs is based on average money market rates in major countries(e) The value of SDR represents the weighted average value of dollar, pounds, euro, and yen.

< Answer >

12. Which of the following is/are not (an) underlying assumption(s) of purchasing power parity?

(a) Goods can move freely across the globe(b) Capital can move freely across the globe(c) There are no tariff on goods(d) There are no transaction costs involved in the buying and selling of goods(e) There are no transportation cost.

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13. A private arrangement between lending banks and a borrower is called a

(a) Syndicated loan (b) Depository loan(c) Club loan (d) Shelf registration (e) Euro loan.

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14. Samurai bond is a bond

(a) Denominated in yen and issued outside Japan(b) Denominated in a currency other than yen and issued to the public in Japan(c) Denominated in yen and issued under Private placement by non-Japanese borrowers in Japan(d) Denominated in yen and issued by non-Japanese borrowers to the public in Japan(e) Denominated in yen and issued by Japanese borrower in US.

< Answer >

15. The relationship between the spot and forward exchange rates between a pair of currencies is brought about principally through

(a) The Fisher effect (b) Purchasing power parity(c) Covered interest rate arbitrage (d) Uncovered interest rate arbitrage(e) The law of one price.

< Answer >

16. Which of the following import licenses are exempted from payment of basic custom duty, surcharge, additional customs duty anti dumping duty and safeguard duty?

(a) Regular license (b) Advance license (c) Open general license(d) Special import license (e) Canalized items.

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17. In which of the following cases of international commercial terms, the seller has to bear the maximum obligation, like risk costs including duties, taxes and charges of delivering the goods thereto, cleared for importation?

(a) Delivered ex ship(b) Delivered unpaid (c) Delivered duty paid(d) EXW Ex works (e) CIF cost insurance & freight.

< Answer >

18. The method which is based on the premise that exposure is linked to the maturity of the assets or liability & hence does not give importance to its nature is called

(a) Current / Non current method (b) Monetary / Non monetary method(c) Temporal method (d) Current rate method(e) Historical exchange rate method.

< Answer >

19. Netting is

I. One of the advantages of centralized cash management. II. An internal hedging techniques.III. Applicable only to large companies.

(a) Only (I) above (b) Only (II) above (c) Both (I) and (II) above(d) Both (I) and (III) above (e) All (I), (II) and (III) above.

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20. Which of the following not an assumption of international CAPM?

(a) There are no restrictions on foreign investments(b) All the currencies of the world are completely convertible(c) Purchasing power parity holds good(d) International capital markets are not perfectly integrated(e) Purely domestic portfolio would be below the efficiency frontier.

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21. The discount rate used in the APV method to calculate the benefit due to increased borrowing capacity if the probability of positive cash flows is low, is

(a) Market rate of interest in home country(b) Market rate of interest in host country(c) Nominal risk free rate of interest in home country(d) Nominal risk free rate of interest in host country(e) Cost of capital for the parent company.

< Answer >

22. Interest rate parity implies that

(a) Interest rate should change by an equal amount but in the opposite direction, to the difference in inflation rates between two countries

(b) In the long run real interest rate between two countries will be equal(c) Nominal interest rates in each country are equal to the required real rates plus compensation for

expected inflation(d) The interest rates between two countries start in equilibrium any change in the differential rate

of inflation between the two countries tend to offset over the long-term by an equal but opposite change in the spot exchange rate

(e) The difference in interest rates in different currencies for securities of similar risk and maturity should be consistent with the forward rate discount or premium for the foreign currency.

< Answer >

23. Two important practical differences between the monetary/non-monetary method and the current rate method of translation is found in their treatment of

(a) Inventories and fixed assets (b) Cash and accounts receivable(c) Fixed assets and owner’s equity (d) Issued share capital and retained earnings(e) Monetary assets.

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24. Bank of the Middle East, Dubai is maintaining an account with SBI Mumbai. SBI Mumbai calls this account as

(a) Nostro account (b) Vostro account (c) Loro account(d) Mirror account (e) Shadow account.

< Answer >

25. Due to the consolidation of international operations the potential for an increase or a decrease in the net worth and reported net income caused by a change in exchange rates, is called

(a) Economic exposure (b) Operation exposure (c) Translation exposure

(d) Strategic exposure (e) Exchange rate exposure.

< Answer >

26. Which of the following statements submitted by Authorized Dealer to RBI, is used for compilation of India’s Balance of Payments statements?

(a) GR forms (b) XOS statement (c) BEF statement(d) R – returns (e) Pro forma invoice.

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27. Which of the following is a non tariff barrier in international trade?

(a) Export duty (b) Ad valorem duty (c) Embargo(d) Transit duty (e) Countervailing duty.

< Answer >

28. In march 1991, Argentina, Brazil, Paraguay and Uruguay decided to form a common market for goods, services, capital and labor by the name of

(a) NAFTB (b) ASEAN (c) MERCOSUR(d) EEC (European economic community) (e) UNCTAP.

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29. Which of the following is not the reason for not using normal NPV in international projects as appraisal criteria?

(a) Blocked funds (b) Restrictions on repatriation (c) Taxability of cash flows (d) Brand Equity(e) Exchange rate movements.

< Answer >

30. If the identical product or service can be sold in two different markets, no restrictions exist on the sale, and transportation costs of moving the product between markets are zero, the product’s price should be the same in both the markets. This theory is called:

(a) The law of one price (b) The Fisher effect (c) Market parity theory(d) Purchasing power parity (e) Efficient Market Theory.

< Answer >

END OF SECTION A

Section B : Problems (50 Marks)

This section consists of questions with serial number 1 – 5. Answer all questions. Marks are indicated against each question. Detailed workings should form part of your answer. Do not spend more than 110 - 120 minutes on Section B.

1. Somya Electronics imported goods from Japan on July 1st 2004, and an amount of JP ¥ 10 million was to be paid on 31st, December 2004. The treasury manager collected the following exchange rates on July 01, 2004 from the bank.

Mumbai Rs./$ Spot 45.86 /886 months forward 46.00/03

Hong Kong JP ¥/ $ Spot 108/108.506 months forward 110/110.60

Though forward quotation for yen was available, the treasury manager purchased spot $ in Mumbai and converted $ into JP ¥ in Hong Kong using 6 months forward rate. The Rs./$ spot rate on 31 st December, 2004 turned out to be 46.24 /26.

You are required to calculate the loss or gain in the strategy adopted by the treasury manager by comparing the actual cash flow of the transaction with the notional cash flow involved in the forward cover for Yen.

(8 marks) < Answer >

2. On January 01, 2004, an importer has borrowed rupee for one year at 6% for purchasing dollar. During the year, inflation rates in US and India were 2% and 7%, respectively.

He observed the following $/ Rs. Quotes

On 01.01.2004 : Exchange rate on the date of availing the loan - $0.0218/Rs.

On 31.12.2004 : Exchange rate on the date of repaying the loan - $ 0.0200/Rs.

You are required to calculate the importer’s real cost of borrowing rupees in dollar terms for the year.

(10 marks) < Answer >

3. An industrial unit in Bangalore exports its goods to Australia at a price of AUD 500 per unit. The company imports components from Germany and the cost of components for each unit is 200 Euro. The company executed an order for the supply of 2000 units on January 01, 2005 and also paid for the imported components on the same date. The company’s variable costs per unit are Rs. 1250 and the allocable fixed costs of the company are Rs. 10, 00,000. The exchange rates as on 01.01.05 are as follows-

Spot Rs./AUD 33/33.04

Rs./Euro 56.49/56.56

Treasury manager who is observing the movements of exchange rates on a day to day basis, has expected that the rupee would appreciate against AUD $ and depreciate against Euro.

He has estimated the following rates for 31st June 2005.

Spot Rs./AUD 32.15/32.21

Rs./Euro 57.27/57.32

You are required to find out:

a. The change in profitability due to transaction exposure for the supply of 2000 units.

b. By how many units should the company increases its sales so as to maintain the current profit level for the proposed shipment in the last week of June 05.

(5 + 3 = 8 marks) < Answer >

4. Following are the covered after-tax lending and borrowing rates for three units of a Multinational Corporation located in the United States, Singapore and India.

Lending (%) Borrowing (%)

United States

Singapore

India

4.5

3.5

4.6

5

4

5.4

Currently, the Singapore and India units owe $2 million and $ 3 million, respectively to their US parent. The Singapore unit also has $ 1 million in receivables from its India affiliate. The timing of these payments can be changed by up to 60 days in either direction. If US Parent is in deficit of funds, while both the Singapore and India subsidiaries have surplus cash available, you are required to:

a. Determine the MNC’s optimal leading and lagging strategies

b. Calculate the net profit impact of these adjustments

c. Indicate the change in the MNC’s optimal strategy, if the US parent has surplus cash available.

(2 + 3 + 2 = 7 marks) < Answer >

5. Ponytail Fashion exported ready-made garments to Hong Kong under an irrevocable letter of credit and negotiated at sight bill for HKD 100000 with his banker on Jan 01, 2004. Exchange rates in the inter-bank market of Mumbai and Singapore are quoted as under on January 01, 2004.

Mumbai: Rs. / $ Spot 45.54 / 691 month forward 30 / 35 2 month forward 62 / 65

3 month forward 80 / 81

Singapore: HKD / $ Spot 7.7940/421 month forward 20 / 222 month forward 52/ 553 month forward 70 / 75

As there were some discrepancies in the documents, the bill remained unpaid till February 19, 2004. The foreign currency amount was reversed on the 30th day from the due date that was on February 19, 2004 by the exporter’s bank as per FEDAI rules. The following exchange rates prevailed in the market on February 19, 2004.

Mumbai: Rs. / $ Spot 45.14 / 28

1 month forward 4/5

Singapore: HKD/$ Spot 7.7700/15

1 month forward 20 / 25

Note: Transit period is 25 days

Exchange margin required is 0.10% for buying as well as selling rates.

The exporter pays interest on post shipment credit at 10% p.a.

The exporter pays interest on overdue export credit at 12% p.a.

Exchange rate is to be rounded off to the four decimal places.

You are required to compute:

a. The exchange rate quoted to the exporter.

b. The interest amount recovered from the exporter.

c. The overdue interest amount recovered from the exporter.

d. The amount outstanding in the books of accounts of the exporter’s bank.

(3 + 2 + 2 + 3 = 10 marks) < Answer >

6. National City Bank observes the following interest rates and exchange rates information.

Interest rates $ - 4.5% – 5%

Euro – 4%- 4.3%

Current rate $/Euro 1.22840 / 1.22890

Expected rate after fortnight $/Euro 1.23170 / 1.23220

Miss Rachna, a treasury manager thinks that the forward rates are not correctly reflecting the interest rate differential between two currencies. How can she take advantage of her view?

(7 marks) < Answer >

END OF SECTION B

Section C : Applied Theory (20 Marks)

This section consists of questions with serial number 7 - 8. Answer all questions. Marks are indicated against each question. Do not spend more than 25 -30 minutes on section C.

7. With the opening up of the doors of the economies around the globe, the corporates are able to have access to international markets to procure funds, both in the form of equity and debt. What are the various debt instruments in the international financial markets? Describe them briefly.

(10 marks) < Answer >

8. Payments for exports are open to risks even at the best of the times. To mitigate the risks faced by the exporter, Export Credit Guarantee Corporation of India (ECGC) has been established. What are the various functions of ECGC and what are the various covers provided by ECGC? Discuss in brief.

(10 marks) < Answer >

END OF SECTION C

END OF QUESTION PAPER

Suggested AnswersInternational Finance and Trade – I (221) : January 2005

Section A : Basic Concepts1. Answer : (a) < TOP >

Reason : Under the gold standard, the loss of gold and reduction in the money supply in the deficit country may lead to an increase in its interest rate and a capital inflow

2. Answer : (b)

Reason : The synthetic rates of US $/Euro are

(US $/Euro)bid = (US$/S$)bid (S$/Euro)bid

=bid

ask

1(S$ / Euro)

(S$ / US$)

=

12.0118

1.7386

= 1.1571.

Similarly (US$/Euro)ask =

12.0121

1.7384

= 1.1574.

US$/Euro = 1.1571/74.

< TOP >

3. Answer : (b)

Reason : According to the law of comparative advantage (LCA) a country can benefit from trade, if it has an absolute advantage or disadvantage in the production of all goods. Option a is wrong because LCA is concerned with producing goods in ones own country. Options (c) and (e) are wrong because LCA trade benefits are independent of net trade flow. Option (d) is wrong because LCA states trade benefits can be realized even when the reverse is true. Therefore, correct answer is (b).

< TOP >

4. Answer : (e)

Reason : r1 = 5%, r2 = 6%, r3 = 7%

(1 + r3)3 = (1 + r2)2 (1 + r12)

or, (1.07)3 = (1.06)2 (1 + r12)

or, r12 =

3

2

(1.07)1

(1.06)

= 9%

(1 + r3)3 = (1 + r1) (1 + r21)2

or, (1.07)3 = (1.05)(1 + r21)2

or, (1 + r21)2 =

3(1.07)(1.05)

= 1.1667

r21 = 8%

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5. Answer : (c)

Reason : A crawling peg system is a hybrid of fixed and flexible exchange rate system. Under this system the value of a currency is fixed in terms of a reference currency and this peg itself keeps changing in accordance with the underlying economic fundamentals, by letting the market forces play a role in determining the exchange rate.

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6. Answer : (c)

Reason : To ensure that there is no three point arbitrage the relationship among the rates of three currencies should conform to

S (A/B)bid S (B/C)bid S (C/A)bid 1

or, S (A/B)bid askask )C/A(S

1

)B/C(S

1

1

and S (A/B)ask S(B/C)ask S(C/A)ask ³ 1

in alternative (a) S(A/C)ask is not a correct term, it should be S(A/C)bid for no arbitrage and in alternative (b) if S(C/B)ask term is S(C/B)bid then it will also give the no arbitrage condition

Hence, the other two options under (a) and (b) do not satisfy the no arbitrage relationship.

And give rise to three point arbitrage.

Hence, the correct answer is (c).

< TOP >

7. Answer : (b) < TOP >

Reason : ‘J’ curve occurs because Elasticity of supply for exports is greater for long run than for short run options in (a), (c), (d) and (e) are not correct.

8. Answer : (c)

Reason : In a swap-out deal, the foreign currency is sold spot and bought forward. Options in (a), (b), (d) and (e) are not correct.

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9. Answer : (b)

Reason : Reason :

0.031

4 1.14100.02

14

= $ 1.1438/Euro.

< TOP >

10. Answer : (d)

Reason : A country may be able to correct its persistent (long term) Balance of Payments deficit by reducing the international value of its currency. This takes place by devaluation. As a result of this exports would be more competitive and imports would be more costlier. By this the Balance of Payments deficit gets corrected.

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11. Answer : (b)

Reason : It is not correct to say that SDRs are only used to cover current account deficit.

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12. Answer : (b)

Reason : Option (b) is not assumption of purchasing power parity (PPP).

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13. Answer : (c)

Reason : A private arrangement between lending banks and a borrower is called a club loan.

< TOP >

14. Answer : (d)

Reason : Samurai bond is a bond denominated in yen and issued by non-Japanese borrowers to the public in Japan.

< TOP >

15. Answer : (c)

Reason : The relationship between the spot and forward exchange rates between a pair of currencies is brought about principally through covered interest arbitrage. The fisher effect says that the real interest rates are equal across different countries. Purchasing power parity says that the exchange rate between two countries currencies is determined by the respective price levels in the two countries. Correct answer is (c).

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16. Answer : (b)

Reason: Advanced License are exempted from payment of basic custom duty, surcharge, additional customs duty anti dumping duty and safeguard duty.

< TOP >

17. Answer : (c)

Reason : In Delivered duty paid (DDP), the seller has to bear the maximum obligation, like risk costs including duties, taxes and charges of delivering the goods thereto, cleared for importation.

Delivered duty paid means that the seller fulfills his obligation to deliver when the goods have been made available at the named place in the country of importation.

< TOP >

18. Answer : (a)

Reason : Current /non current method is based on the premise that exposure is linked to the maturity of the assets or liability & hence does not give importance to its nature.

< TOP >

19. Answer : (e)

Reason : Netting is

i. One of the advantages of centralized cash management.

ii An internal hedging techniques.

iii. Applicable only to large companies.

< TOP >

Hence option (e) is the answer.

20. Answer : (c)

Reason : Purchasing power parity holds goods, is not an assumption for international CAPM.

< TOP >

21. Answer : (a)

Reason : The discount rate used in the APV method to calculate the benefit due to increased borrowing capacity if the probability of positive cash flows is low, is market rate of interest in home country. Options in (b), (c), (d) and (e) are not correct.

< TOP >

22. Answer : (e)

Reason : Interest rate parity (IRS) implies that the difference in interest rates in different currencies for securities of similar risk and maturity should be consistent with the forward rate discount or premium for the foreign currency.

< TOP >

23. Answer : (a)

Reason : Two important practical differences between the monetary/non monetary method and the current rate method of translation is found in their treatment of inventories and fixed assets.

< TOP >

24. Answer : (b)

Reason : Vostro account means ‘your account with us’. SBI Mumbai calls the account maintained by Bank of the Middle East Dubai as Vostro account.

Nostro account means ‘our account with you’. If SBI maintains account with the Bank of the Middle East, SBI calls it as Nostro account. Conversely Bank of the Middle East calls it as Vostro account in this case, from their point of view.

LORO account means ‘their account with you’. For example SBI and British Bank of the Middle East maintain their account with Citi Bank NewYork and SBI refers the nostro account of British Bank of the Middle East with Citi Bank as LORO account of British Bank of the Middle East.

< TOP >

25. Answer : (c)

Reason : The potential for an increase or decrease in the parents net worth and reported net income caused by a change in exchange rates, since the last consolidation of international operations is a reflection of Translation exposure.

< TOP >

26. Answer : (d)

Reason : Authorized Dealers (ADs) have to submit R returns to RBI for compilation of BOP statement.

< TOP >

27. Answer : (c)

Reason : Embargo is a non tariff barriers in international trade , rest are the tariff barriers.

< TOP >

28. Answer : (c)

Reason : In march 1991, Argentina, Brazil, Paraguay and Uruguay decided to form a common market for goods, services, capital and labor by the name of MERCOSUR.

< TOP >

29. Answer : (d)

Reason : Brand equity is not the reason for not using normal NPV in international projects as appraisal criteria.

< TOP >

30. Answer : (a)

Reason : The law of one price theory holds that If the identical product or service can be sold in two different markets, no restrictions exist on the sale, and transportation costs of moving the product between markets are zero, the product’s price should be the same in both the markets.

< TOP >

Section B : Problems

1. Here we have to compare the notional cash outflow for the forward rate of yen and the actual cash outflow involved in rupees against forward purchase of yen for dollars in Hong kong and spot purchase of dollars in Mumbai for rupees.

Rs./JP ¥ 6 month forward rate

Bid rate = 46/110.60 = 41.5913

Ask rate = 46.03/110 = 41.8454

Hence, Rs./JP ¥ 6 month forward rate = 41.5913/41.8454

i. If the company purchases JP ¥ forward against rupees in Mumbai the company pays = Rs.4184545.

ii. Amount of US dollars to be paid on due date by purchase of JP¥ 10 million

=

100,00,000

110 = $ 90909.0909

Cash outflows in rupees against purchase of dollars in Mumbai on Dec. 31, 2004

= 90909.09 46.26 = Rs.4205454.503

iii. The company had loss = Rs. 4205454.503 – 4184545 = Rs.20909.5

(Since the company paid more in the strategy adopted by the treasury manager).< TOP >

2. Exchange rate on Jan 1, 2004 was Rs.1 – 0.0218 $

Exchange rate on 31st Dec. 2004 was Rs.1– 0.0200/$

Interest rates for rupee loan = 6%

The amount borrowed in rupee which is equivalent to 1$ = Rs. 1/ 0.0218 = Rs. 45.87

The loan amount to be repaid which includes both principal and interest in rupee terms

= Rs. 45.87( 1.06) = Rs. 48.622

Since exchange rate on 31st Dec. 2004 was Rs. 1 = $ 0.0200

The nominal loan amount to be repaid in terms of dollar = Rs. 48.622(0.0200) = $ 0.97244

Therefore for each $ worth of rupee borrowed at the beginning of the year , its costs only 0.97244 $ to repay the principal and interest.

Hence the nominal dollar cost of borrowing rupee

= loan repayment in dollar terms – initial loan amt. in dollar terms /Initial loan amt. in dollar terms.

=

$0.97244 $10.02756 2.75%

$1

since inflation rate in US is 2%

The loan amount to be repaid in real terms in dollar = 0.97244/1.02= 0.95337.

The real dollar cost borrowing rupee

= loan repayment in real terms in dollar – initial loan amt./Initial loan amount

=

$0.95337 $10.04663 4.66%

$1

< TOP >

3. The Company’s existing profits can be calculated as follows

sales – 2000x500x33 = 330,00,000

Less - Variable costs –2000 200 56.56 = 2,26,24,000

1250 2000 = 25,00,000

Fixed cost = 10,00,000

Profit = 68,76,000

After the Rupee appreciation against AUD$ and depreciation against euro, the company’s profitability for 2000 units will be

Sales : 2000 500 32.15 = Rs.32150,000

Less- Variable cost : 2000 200 57.32 = Rs. 2,29,28,000

2000 1250 = Rs. 25,00,000

Fixed cost Rs. 10,00,000

Rs.2,64,28,000

57,22,000

Decrease in profit = 68,76,000 – 57,22,000 = Rs. 11,54,000

Let the number of units that need to be sold for keeping the profits at pre appreciation level be X.

Then , 6876,000 = [500 32.15 X] – [(1250 X) + (200 57.32X) + 10,00,000]

6876,000 = [16075X – (1250X + 11464X + 10,00,000)]

6876,000 + 10,00,000 = 16075X – 12714X

7876000 = 3361X

Therefore X = 2343.350 or, 2343 units.

The company should increase its existing supply from 2000 to 2343 to maintain the current profit level of Rs. 6876000.

< TOP >

4. a. Both Singapore and India subsidiaries (which have surplus cash) should speed up their payments to the US parent(which is in deficit of cash), since the borrowing rate (5%) in US is more than the lending rates in Singapore (3.5%) and India (4.6%). However, the Indian unit should lag its payments to its Singapore affiliate, since lending rate in Singapore (3.5%) is less than the lending rate in India (4.6%).

b. Speeding up the payments by Singapore and India subsidiaries to the US parent:

The US parent reduces its borrowings by $5,000,000, when it receives funds 60 days earlier from its affiliates.

Therefore, the interest savings by the US parent = $5,000,000 (5/100) (60/360) = $ 41666.67.

Since both Singapore and India affiliates are paying 60 days earlier to their US parent, the available cash with them will be reduced by $2 million and $3 million respectively.

Therefore,

The interest foregone by Singapore affiliate = $2,000,000 (3.5/100) (60/360) = $ 11666.67

The interest foregone by India affiliate = $3,000,000 (4.6/100) (60/360) = $ 23000

The net savings from this transaction =

Interest saving by the US parent – Interest foregone by Singapore and Indian affiliates

= $41666.67 – ($11666.67+ $ 23,000) = $7000

Lagging the payment by Indian subsidiary to its Singapore affiliate:

Cash available with India subsidiary will be more by $1,000,000, when it lags the payment by 60 days

Interest earned by it = $1,000,000 (4.6/100) (60/360) = $ 7666.67

Interest foregone by Singapore affiliate = $1,000,000 (3.5/100) (60/360) = $ 5,833.33

The net savings from this transaction =$7666.67 – $ 5833.33 = $ 1833.34.

c. If the US parent has surplus cash, Singapore subsidiary should lead its payments to the US parent, since lending rate in US(4.5%) is more than the lending rate in Singapore(3.5%). However, Indian subsidiary should lag the payment to the US parent, since lending rate in US(4.5%) is less than the lending rate in india (4.6%).

Similarly Indian subsidiary should lag the payment to its Singapore affiliate, since interest rate in India (4.6%)is more than the lending rate in Singapore (3.5%).

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5. (a) The bank has to quote bill buying rate to the exporter

Dollar is at Premium against rupee. Since this is a buying rate, the transit period will be rounded off to the higher month and one month forward Rs. / $ buying rate is to be taken

Rs. / $ – One month forward buying rate (45.54 + 0.30) : 45.84000

Less exchange margin at 0.10% : 0.04584

45.79416 (round off to 45.7942).

Dollar is at premium against Hong Kong dollar. Since this is a selling rate, the transit period will be rounded off to the higher month and one month forward HKD/$ selling rate is to be taken

HKD/ $ Spot selling rate : 7.7942

Add premium for one month : 0.0022

7.7964

Bill buying rate for Rs. / HKD =

45.7942

7.7964 = Rs.5.873762 (Rounded off to Rs.5.8738.)

(b) Interest amount recovered from the exporter

=

100000 x 5.8738 x 25 x10

36500

= Rs.4023.150

(c) Overdue interest amount recovered from the exporter

=

100000 x 5.8738 x 30x12

36500

= Rs5793.33.

(d) Export bills remaining unpaid for a period of 30 days after the transit period in case of demand bills (drawn at sight basis), the foreign currency amount shall be reversed from the export bills purchased portfolio on the 30th day. In case, 30th happens to be a holiday or Saturday, it shall be reversed/crystallized on the next working day. The rate applicable to such reversal shall be the ready TT selling rate. In the given problem, the bill amount in foreign currency is crystallized into rupees by computing the TT selling rate of February 19, 2004 and exchange margin of 0.1% is to be added (as required in the problem).

Rs/HKD selling rate = (Rs/$) ask

1

(HKD / $)bid

= 45.28

1

7.7700

= 5.8275.

Add exchange margin at 0.1% = 0.0058275

–––––––

5.8333693 (round off to 5.8334)

Amount paid to the exporter at 5.8738 (100000 5.8738) = 587380

Deduct the difference in rates (5.8334 – 5.8738)100000 = 4040

Amount out standing in the books of accounts of the exporter’s bank 583340

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6. If treasury manager borrows 10 million dollar amount to the period after a fortnight with interest at 5%pa.

= 10000000 (1 + .05/24)

= 10020833.33$.

Convert 10 million $ into euro at 1.22890$/euro and invest at 4% pa for a fortnight.

Inflow of Euro with interest =

10000000

1.22890 x (1 + .04/24)

= Euro 8150920.878.

Convert Euro into $ at 1.23170 $/Euro.

= 8150920.878 x 1.23170

= 10039489.25$.

Repay the loan with interest

Gain = 10039489.25 – 10020833.33

= 18655.92$.

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Section C: Applied Theory

7. Following are the various Debt instruments:

i. Eurobonds

ii. Foreign bonds

iii. Euro notes.

i. Eurobonds: The bonds issued in the Euro market referred to as Euro-bonds. Typically, a Euro bond is issued outside the country in which it is denominated. It is like any other Euro instrument and through international syndication and underwriting, the paper is sold without any limit of geographical boundaries. Eurobonds are generally listed on world’s stock exchange, usually on the Luxembourg stock Exchange.

There are also equity related bonds like convertibles or bonds with equity warrants. Zero coupon bonds were issued capitalizing on the tax treatment.

Bond issue structures can be of two types Fixed rate bonds and Floating rate bonds.

Fixed-rate Bonds/Straight Debt Bonds : Straight Debt Bonds are fixed interest bearing securities which are redeemable at face value.

Floating Rate Notes (FRNs) - FRNs can be described as a bond issue with a maturity period varying from 5-7 years having varying coupon rates – either pegged to another security or re-fixed at periodic intervals. Conventionally, the paper is referred to as notes and not as bonds. The spreads or margin on these notes will be above 6 months LIBOR for Eurodollar deposits.

FRNs have thus been restructured into the following types:

Flip-flop FRNs : The investors have the option to convert the paper into flat interest paying instrument at the end of a particular period.

Mismatch FRNs : These notes have semi-annual interest payments though the actual rate is fixed monthly.

Mini-max FRNs: These notes include both minimum and maximum coupons. The investors will earn a minimum rate as well as a maximum rate on these notes.

Capped FRNs : An interest rate cap is given over which the borrower is not required to service the notes, even if Libor goes above that level.

VRN-structured FRNs: These represent long-dated paper with variable interest spreads.

Perpetual FRNs: These notes which are irredeemable are also known as perpetual floaters or undated issues.

ii. Foreign Bonds

These are relatively lesser known bonds issued by foreign entities for raising medium to long-term financing from domestic money centers in their domestic currencies.

a. Yankee Bonds : These are US dollar denominated issues by foreign borrowers (usually foreign governments or entities, supranationals and highly rated corporate borrowers) in the US bond markets.

b. Samurai Bonds : These are bonds issued by non-Japanese borrowers in the domestic Japanese markets. Borrowers are supranationals and have at least a minimum investment grade rating (A rated). The maturities range between 3-20 years.

c. Bulldog bonds : These are sterling denominated foreign bonds which are raised in the UK domestic securities market. The maturity of these bonds will be either for very short periods (5 years) or for very long maturities (25 years and above). Bonds with intermediate maturity periods are rare.

d. Shibosai Bonds: These are the privately placed bonds issued in the Japanese markets. The qualifying criteria is less stringent as compared to Samurai or Euro Yen bonds. Shibosai bonds are offered to a different market segment that consists of institutional investors.

iii. Euronotes

Euronotes as a concept is different from syndicated bank credit and is different from Eurobonds in terms of

its structure and maturity period. Euronotes command the price of a short-term instrument usually a few basis points over LIBOR and in many instances at sub-LIBOR levels. The documentation formalities are minimal (unlike in the case of syndicated credits or bond issues) and cost savings can be achieved on that score too. The funding instrument in the form of Euronotes possess flexibility and can be tailored to suit the specific requirements of different types of borrowers. These are numerous applications of basic concepts of Euronotes. These may be categorized under the following heads.

a. Commercial Paper : These are short-term unsecured promissory notes which repay a fixed amount on a certain future date.

b. Note Issuance Facilities (NIFs) : The currency involved is mostly US dollars. A NIF is a medium-term legally binding commitment under which a borrower can issue short-term paper, of up to one year.

c. Medium-Term Notes (MTNs): MTNs are defined as sequentially issued fixed interest securities which have a maturity of over one year.

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8. Major Functions of the ECGC are

To provide a range of credit risk insurance covers to exporters against loss in export of goods and services

To offer guarantees to banks and financial institutions to enable exporters obtain better facilities from them.

ECGC also helps exporters by

Providing insurance protection to exporters against payment risks Providing guidance in export related activities Providing information on creditworthiness of overseas buyers Providing information on about 180 countries with its own credit ratings Making it easy to obtain export finance from banks/financial institutions Assisting exporters in recovering bad debts.

The covers issued by ECGC can be divided into four groups:

i. Standard Policy issued to exporters to protect them against payment risks involved in exports on short-term credit and small exporter’s policy issued for the same purpose to exporters with small exports.The Standard Policy is a whole turnover policy designed to provide a continuing insurance for the regular flow of an exporter’s shipments of raw materials, consumer goods and consumer durables for which credit period does not exceed 180 days. Contracts for export of capital goods or turnkey projects or construction works or rendering services abroad are not of repetitive nature and they involve medium/long-term credits. Such transactions are, therefore, insured by ECGC on a case-to-case basis under specific policies.Shipments (Comprehensive Risks) Policy, which is commonly known as the Standard Policy, is ideally suited to cover risks in respect of goods exported on short-term credit, i.e., credit not exceeding 180 days. This policy covers both commercial and political risks from the date of shipment.Risks covered under the PolicyUnder the Shipments (Comprehensive Risks) Policy, the Corporation covers, from the date of shipment, the following risks:a. Commercial Risks:

Insolvency of the buyer Failure of the buyer to make the payment due within a specified period, normally 4 months from

the due date. Buyer’s failure to accept the goods, subject to certain conditions.

b. Political Risks: Imposition of restriction by the government of the buyer’s country of any government action

which may block or delay the transfer of payment made by the buyer. War, civil war, revolution or civil disturbances in the buyer’s country. New import restrictions or cancellation of a valid import license. Interruption of diversion of voyage outside India resulting in payment of additional freight or

insurance charges which cannot be recovered from the buyer. Any other cause of loss occurring outside India, not normally insured by general insurers, and

beyond the control of both the exporter and the buyer.

ii. Specific Policies designed to protect Indian firms against payment risks of loss involved ina. Export on deferred terms of payment.b. Services rendered to foreign parties, andc. Construction works and turnkey projects undertaken abroad.

iii. Financial guarantees issued to banks in India to protect them from risks of loss involved in extending financial support to exporters at the pre-shipment as well as post-shipment stages; and

To meet the varying needs of exporters, the Corporation has evolved the following types of Guarantees:

a. Packing Credit Guarantee

b. Export Production Finance Guarantee

c. Post-shipment Export Credit Guarantee

d. Export Finance Guarantee

e. Export Performance Guarantee; and

f. Export Finance (Overseas Lending) Guarantee.

a. Packing Credit Guarantee

Any loan given to an exporter for the manufacture, processing, purchasing or packing of goods meant for export against a firm order or Letter of Credit qualifies for Packing Credit Guarantee. Pre-shipment advances given by banks to parties who enter into contracts for export of services or for construction works abroad, to meet preliminary expenses in connection with such contracts are also eligible for cover under the Guarantee.

The Guarantee is issued for a period of 12 months against a proposal made for the purpose and covers all the advances that may be made by the bank during the period to a given exporter within an approved limit. The bank is required to submit monthly declarations of advances and repayments and to pay premium every month.

To banks which undertake to obtain cover for packing credit advances granted to all its customers on all-India basis, the corporation issues Whole Turnover Packing Credit Guarantee (WTPCG).

b. Export Production Finance Guarantee

The purpose of this Guarantee is to enable banks to sanction advances of the pre-shipment stage to the full extent of cost of production when it exceeds the free on board (f.o.b.) value of the contract/order, the differences representing incentives receivable. The extent of cover and the premium rate are similar to those of Packing Credit Guarantee. Banks having WTPPCG are eligible for concessionary premium rate and higher percentage of cover.

c. Post-Shipment Export Credit Guarantee:

Post-shipment finance given to exporters by banks through purchase, negotiation or discount of export bills or advances against such bills qualifies for this guarantee. It is necessary, however, that the exporter concerned should hold suitable policy of ECGC to cover the overseas credit risks.

d. Export Finance Guarantee

The Guarantee covers post-shipment advances granted by banks to exporters against export incentive receivable in the form of cash assistance, duty drawback, etc.

Banks having WTPSG are eligible for concessionary premium rate and higher percentage of cover.

e. Export Performance Guarantee

Exporters are often called upon to execute bonds duly guaranteed by an Indian Bank at various stages of export business. An exporter who desires to quote for a foreign tender may have to furnish a bank guarantee for the bid bond. If he wins the contract, he may have to furnish bank guarantees to foreign buyers to ensure due performance or against advance payment or in lieu of retention money or to a foreign bank in case he has to raise overseas finance for his contract.

An export proposition may be frustrated if the exporter’s bank is unwilling to issue the guarantee. The Export Performance Guarantee is aimed at meeting such situations. The guarantee to the bank is issued to protect the bank against losses that it may suffer on account of guarantees given by it on behalf of exporters. This protection is intended to encourage bank to give guarantees on a liberal basis for export purposes.

f. Export Finance (Overseas Lending) Guarantee

If a bank financing an overseas project provides a foreign currency loan to the contractor, it can protect

itself from the risk of non-payment by the contractor by obtaining Export Finance (Overseas Lending) guarantee.

iv. Special Schemes, viz. Transfer Guarantee meant to protect banks which add confirmation to Letters of Credit opened by foreign banks. Insurance cover for Buyer’s Credit, Line of Credit, Overseas Investment Insurance and Exchange Fluctuation Risk Insurance.

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