IF Solution

Document Sample
IF Solution Powered By Docstoc                        31st March I.F. Solution                     9833088336

(2 Hours)                                                                  [Total Marks : 60]

                                          Section I
Q.1) Explain in Brief
(a) Tax Haven
       A tax haven can be described as a country or a region which for both, residents and non-
residents has nominal or zero income tax rates.

The characteristics of such locations are:

   1. Both residents and non-residents enjoy very low income tax rates.

   2. They provide a very high degree of financial freedom combined with limited regulations
      whose enforcement is less stringent.

   3. They offer limited wholesale banking service to non-residents with near zero tax on

   4. The non-resident financial institutions located at such centres are not integrated with the
      financial system of the host country.

   5. They promise strict secrecy regarding financial transactions of non-resident bank

(b) Special Drawing Rights (SDR)
The SDR is an entitlement which provides the holder with a right to get access to foreign
currency of equivalent amount without any collateral security.
        SDRs created by the IMF were allocated to all member countries in the same ratio as the
quotas (subscriptions) paid by them for their membership. The main features of this instrument
are as follows:

    1. SDR’s are entitlements granted to member countries enabling them to draw from the
       IMF in addition to drawings against their quotas.

    2. SDR’s do not have any physical existence (artificial currency unit) and operate only
       through book entries with the IMF. A special account is set up for each member and the
       allocated SDR’s are credited to it. When a member needs to borrow against SDR’s they
       apply to the IMF for drawings. The IMF designates a surplus member country to fulfill
       the requirements of the borrowing country.

    3. The SDR is not a currency and there is no security to back its existence. The IMF does
       not undertake any liability against SDR operations. The SDR therefore is not a
       negotiable instrument.                         31st March I.F. Solution                     9833088336

(c) Vostro Account
        Demand deposit accounts, denominated in domestic currencies maintained by overseas
    banks with domestic banks are called VOSTRO accounts. Vostro means ‘your account with
    us’. Ex: If Barclays Bank, London has an INR account with Punjab National Bank, New
    Delhi then such an account would be called a VOSTRO account.

The FEDAI was set up in 1958 as an association of banks dealing in foreign exchange in India.

       Presently main functions of FEDAI are as follows:

      Frame guidelines and rules for Foreign Exchange Business.
      Training of Bank Personnel in the areas of Foreign Exchange Business.

      Accreditation of Foreign Exchange Brokers and periodic review of their operations. They
       also advise the RBI regarding licensing of new brokers.

      Announcement of ‘spot rate’ at the start of each trading day to ensure uniformity in
       settlement between different market participants.

   Hence FEDAI plays a Catalytic role for smooth functioning of the markets through closer co-
   ordination with the RBI.

(e) Petro-dollar
    The Organisation of Petroleum Exporting Countries (OPEC) was formed in 1960 at the
    Baghdad Conference in Iraq. This cartel has had a significant influence on crude oil /
    petroleum prices. The first major hike in petroleum prices was introduced in 1973. This event
    had a major impact on the flow of international funds. Most of the petroleum exporting
    countries had small economies with small capital absorbing power. The surplus funds
    generated by them were used for lending to the petroleum importing countries that were
    facing balance of payment deficits. Most of this recycling of funds was done through off-
    shore financial centers in various parts of the world. Since petroleum trading was invoiced in
    USD, these surplus funds generated out of petroleum sales and recycled between exporters
    and importers, were called Petro-Dollars.

a] Ans.
Step 1: Existence of Arbitrage
 F  S 43.2300  42.4210
   S           42.4210
        = 0.0191
 Rv  Rb n            12  8 6
          x                x
   100      12         100 12
                  =    0.0200                         31st March I.F. Solution          9833088336

Hence, Arbitrage exist
F  S Rv  Rb n
                x
  S       100      12
So borrowing in base currency USD & Invest in variable currency INR.

Step 2:
Let capital borrowed be 1 million USD
                         RT 
Amount payable  P x 1         
                         100 
                                  8    6
                  10,00,000 x 1
                                100 x 12 
                                         
                   10,00,000 x
                   = USD 10,40,000

Step 3:
(i) Convert USD into INR (spot)
= 10,00,000 x 42.4210

(ii) Invest INR
                         12 6 
= 10,00,000 x 42.4210 x 1  x 
                         100 12 
= 10,00,000 x 42.4210 x

(iii) Convert INR into USD (forward)
                        212      1
= 10,00,000 x 42.4210 x      x
                        200 43.2300
= USD 10,40,163.31

Step 4:
Arbitrage Gain = Amount Receivable – Amount Payable
               = 10,40,163.31 – 10,40,000
               = USD 163.31 or 163 per 1 million USD

Q.2 [b]
(iii) Ans.
The role of RBI in the exchange market is as follows:                          31st March I.F. Solution                     9833088336

 Monitoring and management of exchange rates without a pre-determined target rate or range
  with intermittent intervention as and when necessary has been the basis of the Managed Float
  system followed in India.

   A policy to build a higher level of foreign exchange reserves, which takes into account not
    only anticipated current account deficits but also liquidity requirements arising from
    unanticipated capital outflows.

   A judicious policy for management of capital account transactions, with progressive
    liberalisation of such transactions.

   Balancing the external economy represented by the exchange rate and the internal economy
    represented by interest rates, inflation, money supply, etc.

(v) Ans.
        Hedging can be defined as a process or mechanism of reducing, minimizing or
eliminating risk from a given transaction. A foreign exchange exposure is hedged or covered
when the company takes certain steps to insulate itself from the adverse effects of exchange rate
movements. The basic objective in hedging is to create a position in the foreign currency in the
direction opposite to the one that exists so that ultimately the balance or net effect becomes zero.
Hedging may be achieved through internal or external mechanisms.


    Exposure netting: Companies having has both receivables and payables in a foreign
    currency, need not hedge receivables and payables separately, but can do so for the net

    Denomination in local currency: The exchange risk can be completely avoided if the
    transaction is denominated in local currency. In such a the exchange risk will be borne by the
    opposite party to the transaction.

    Foreign currency accounts: In India as per the Exchange Earners Foreign Currency (EEFC)
    account scheme, persons receiving foreign currency are entitled to retain in foreign currency
    50% of the remittance received. The balance in this account can be used by the account
    holder for purposes permitted in the exchange control regulations, including payment for
    imports. Thus exchange risk is eliminated and the currency conversion cost can be avoided.

    Leads and legs: The manipulation of the timing of receipts and payments of foreign
    currency depending upon the expectations of change in currency values is known as leads
    and legs.

    A Derivative can be defined as “a transaction or a financial instrument which derives its
    value through some other asset or security.” Foreign Currency derivatives derive their values
    from the value of the underlying currency.                           31st March I.F. Solution                  9833088336

   Derivatives can be used for,

   a. hedging exchange rate risk

   b. speculation

   c. maximization of profits

   d. adjusting liquidity and hedging mismatched maturity risk ( interest rate risk)

   The commonly used foreign currency derivatives are:

   i)     Foreign currency forward contracts.
   ii)    Foreign currency swaps.
   iii)   Foreign currency Futures contracts.
   iv)    Foreign currency Option contracts.

                                           Section – II
a] Ans.
USD/CAD        1.1630 – 1.1650
Direct quote = Canada
                Ask  bid
Mid Rate 
               1.1650  1.1630
             = 1.1640

Spread        = Ask – Bid
              = 1.1650 – 1.1630
              = 0.0020 or 20 pips

% Spread                  x 100
                 Mid Rate
                       x 100
              = 0.1718%

Inverse quote
CAD / USDbid       
                       USD / CADask                       31st March I.F. Solution   9833088336

                = 0.8584

CAD / USDask    
                   USD / CADbid
                = 0.8598
CAD/USD        0.8584 – 0.8598

b] Ans.
USD/GBP        0.6542 – 0.6547
USD/CHF        1.5530 – 1.5535

                   x 1.5530
           = 2.3721

GBP/CHFAsk             x 1.5535
               = 2.3747

Derived GBP/CHF      2.3721 – 2.3747
Given GBP/CHF        2.3722 – 2.3745

Identified Bid =      2.3722
        Ask =         2.3745
.: Bid < Ask
Arbitrage does not exist.

a] Ans.
   USD/INR                  47.7000      47.7200
   (+) Premium (2m)          0.0240       0.0300
   2m fwd USD/INR           47.7240      47.7500
          F  S  12
AFM              x  x 100
          S  n                           31st March I.F. Solution                       9833088336

                47.7240  47.7000 12
     Bid rate                   x   x 100
                     47.7000       2
     = 0.3019 %
AFM bid rate is premium 0.3019%.

         F  S  12
AFM            x    x 100
         S  n
             47.7500  47.7200 12
 Askrate                     x   x 100
                  47.7200       2
           = 0.3772 %
AFM ask rate is premium 0.3772%.

   USD/INR                            47.7000           47.7200
  (+) Premium (1m, 10 days)            0.0160            0.0200
  2m fwd USD/INR                      47.7160           47.7400

                 240  0                 300  0
                        x 40                   x 40
                 60  0                   60  0
               = 160                  = 200

b] Ans.
Calculation of Interest Receivable
(a) Invest in INR 4 million
                    5.75 6 
     40,00,000 x 1       x   40,00,000
                    100 12 
    = INR 1,15,000

(b) Invest in USD
       40,00,000  4.25 6 
                x 1  x  x 45.20  40,00,000
         44.87      100 12 
    = INR 1,15,043.46

(c) Invest in GBP
       40,00,000  5.25 6 
                x 1  x  x 93.23  40,00,000
           93       100 12 
    = INR 1,15,152.15

Invest in currency GBP Since it results into highest interest i.e. INR 1,15,152.15                         31st March I.F. Solution                    9833088336

(a) Ans.
Role of ECB:
       The ECB has the mandate to administer the monetary policy of the 16 EU member
countries who have adopted the common currency EURO. These nations are collectively called

Objectives of ECB:

1. To ensure price stability within the Euro-zone through low inflation rates. (Ideally less than

2. To define and implement a common monetary policy.

3. To take care of the foreign currency reserves of the ESCB.

4. To promote smooth operation of the financial markets.

5. To maintain an exclusive right over issuance of Euro-banknotes and coins.

6. To maintain a stable financial system and monitor the banking sector.

Recently EURO and thereby ECB has faced financial crisis situation because of Solvency
problem of member countries PIGS. (Poland, Ireland, Greece & Spain)

(b) Ans.
    (Page No. 153)