J. K.

SHAH CLASSES

FINAL C.A. - FINANCIAL MANAGEMENT

EXTRA PROBLEMS ON F. M.
Q. 1. From the following data, calculate the fixed date forward buying & selling rates for the month of November : (a) $1 = 44.5450 44.5475 Forward Sept. = 2600 2800 Oct. = 5400 5700 Nov. = 7900 8400 (b) $1 = 44.7475 44.9500 Forward Sept. = 2600 2400 Oct. = 5400 5100 Nov. = 7900 7400 Q. 2. You have following quotes from Bank A and Bank B : Bank A Bank B SPOT CHF/USD 1.4650/55 CHF/USD 1.4653/60 3 months 5/10 6 months 10/15 SPOT USD/GBP 1.7645/60 USD/GBP 1.7640/50 3 months 25/20 6 months 35/25 Calculate : (i) How much minimum CHF amount you have to pay for 1 million GBP spot? (ii) Considering the quotes from Bank A only, for CHF/GBP what are the Implied Swap points for Spot over 3 months? Q. 3. In March, the Multinational Industries makes the following assessment of st dollar rates per British pound to prevail as on 1 September. $ / Pound Probability 1.60 0.15 1.70 0.20 1.80 0.25 1.90 0.20 2.00 0.20 st (i) What is the expected spot rate for 1 September? (ii) If, as of March, the 6-month forward rate is $1.80, should the firm sell forward its pound receivables due in September?
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FINAL C.A. - FINANCIAL MANAGEMENT

Q. 4. In 2000 a Transistor costs $ 22.84 in New York. S $69 in Singapore, and 3240 rubbles in Moscow. (i) (ii) If the law of one price held, what was the exchange rate between US dollars and Singapore dollar? Between US dollar and rubles. The actual exchange rate in 2000 were S $1.63 = US $1 and 250 rubles = US $1. Where would you prefer to buy your Transistor?

Q. 5. You as a dealer have the following position in Swiss Francs on October 31 : Balance in Nostro Account Cr. Opening position (overbought) Purchased a bill on Zurich Sold TT forward Forward purchase contract cancelled Remitted by telegraphic transfer Draft on Zurich cancelled 1,00,000 50,000 80,000 60,000 30,000 75,000 30,000

What steps you would take if you are required to maintain a credit balance of Swiss Francs 30,000 in the Nostro Account and keep an overbought position of Swiss Francs 10,000.

Q. 6. On January 2, the dealer had the following position in Euros. Balance with Banque de Brussels, Antwerp in Euros Opening position (oversold) T Ts purchased on January 2 Draft issued but not presented for payment Remitted by telegraphic transfer Purchased cheques on Antwerp Forward Sales 1,00,000 25,000 2,00,000 50,000 2,50,000 3,00,000 2,25,000

What steps the dealer should take to keep the position square and maintain a balance of not more than Euros 50,000 with the Belgian correspondent?
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J. K. SHAH CLASSES

FINAL C.A. - FINANCIAL MANAGEMENT

Q. 7. Startrek Ltd. is an Indian Co. It has subsidiaries in U.S., U.K. and Singapore, named X, Y and Z respectively. The inter-company owings are as follows : Debtor X X Y Y Z Creditor Y Z X Z X Amount Due GBP 1,00,000 SG $ 30,000 US $ 70,000 SG $ 25,000 US $ 65,000

The relevant exchange rates are as follows: US $ 1 GBP 1 SG $ 1 = = = Rs 46.15 Rs 83.80 Rs 27.70

If Startrek Ltd. wants to do multilateral netting, ascertain the net payment for settlement to be made mutually by the subsidiaries.

Q. 8. In Delhi 1 = Rs.81.2/ Rs.81.9 In London 1 = 2.14$/2.156$ In New York 1$ = Rs.38.6/ Rs.39. Calculate arbitrage gain from Rs.1 crore.

Q. 9. Spot price of Infosys is Rs.2,000. Interest rate prevailing is 14% p.a. Expected dividend after 2 month is Rs.10 per share. Calculate what should be the expected price of infosys today in 3 months future market.

Q. 10.For X Ltd., spot rate = Rs.70, continuous compounded rate of interest is 8%. Calculate price of future with 3m expiry if the stock pays a dividend of Rs.1.5 (e 0.02 = 1.02020).

Q. 11.Stock index currently stands at Rs.3,500. The risk free rate is 8% p.a. & the dividend yield on the index is 4% p.a. (a) (b) Calculate 4m index future Calculate 4m index future if the rate of 8% is CCRI [e 0.0133 = 1.014]
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J. K. SHAH CLASSES

FINAL C.A. - FINANCIAL MANAGEMENT

Q. 12.The current price of cotton is Rs.400 per bale. The storage costs are Rs.100 per bale per year payable in arrears. Assuming that interest rates are 10% p.a. (CCRI). Calculate one year future price per bale of Cotton. [e 0.1 = 1.1051) Q. 13.Following information is available for standard gold. Spot rate = Rs.15,600 per10 gms Future price = Rs.17,100 for 1 year future contract Risk free rate = 8.5% PV of storage cost = Rs.900 per year Calculate PV of convenience yield of the standard gold.

Q.14.The following quotes were observed by Mr. Arvind on Mar. 11, 2005 in the Economic Times. Contracts SBI MAR 05 FUT 735 740 735 738 433 138000 92 Explain the details that are displayed against the futures. Q.15. A stock with a current market price of Rs 50 has the following exercise price and call option premium. Compute intrinsic value and time value. Exercise price Premium 45 5 48 6 50 4 52 5 55 7 Open High Low Close Open Int. Traded Number of Qty. Contracts

Q.16. A stock with a current market price of Rs 50 has the following exercise price and put option premium. Compute intrinsic value and time value. Exercise price Premium 45 5 48 6 50 4 52 5 55 7

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J. K. SHAH CLASSES

FINAL C.A. - FINANCIAL MANAGEMENT

SOLUTIONS TO EXTRA PROBLEMS ON F. M.

Forward Exchange Rates Exchange rates are normally quoted on spot basis i.e. settlement taking place on the 2nd working day after the day of transaction. The exchange rate for settlement on a day beyond spot date is called forward rate. The forward rate has two parts : 1. 2. Spot rate Forward points or swap points or forward differentials. Swap points can be presented in ascending or descending order.

For E.g. If spot rate is 1$ = 45.57 ` / 46.01 ` & one month swap points are 10/ 12, it means dollar is at premium as swap points are in increasing order. Therefore $ will become costly & hence swap points will be added to the spot rate and forward rate will be higher. Forward rate will be as under : Forward Bid Rate Spot rate 1$= 45.57 ` + 0.10 Forward 1 $ Rate 45.67 ` Forward Rate 1 $ Forward Ask Rate Spot rate 1$= 46.01 ` + 0.12 46.13 `

If swap points are given as 12/10 it indicates $ is at discount and $ will become cheaper. Therefore, swap points will be deducted and the forward rate will be lower than the spot.

Ans. 1.

(a)

Spot 1$ Forward Differentials OR Swap Points

44.5450 Sept. 2600 Oct. 5400 Nov. 7900

44.5475 2800 5700 8400

Swap points are in the ascending order i.e. swap points of offer / ask rate is higher than the bid rate. Therefore, $ is at premium. Hence swap points will be added to the spot rate to get forward rate.
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J. K. SHAH CLASSES

FINAL C.A. - FINANCIAL MANAGEMENT

Nov. Bid rate Spot (+) Nov. Swap point 44.5450

Nov. Ask rate Spot 44.5475 0.8400 45.3875

0.7900 (+) Nov. Swap point Nov. Forward rate

Nov. Forward rate 45.335

Nov. Forward rate will be 1$ = 45.335 / 45.3875.

(b)

In this case swap points are in the descending order i.e. swap points of bid rate is higher than the ask rate. Therefore, $ is at discount. Hence swap points will be deducted from the spot rate to get the forward rate. Nov. Bid rate Spot (-) Nov. Swap point 44.7475 Nov. Ask rate Spot 44.9500 0.7400 44.2100

0.7900 (-) Nov. Swap point Nov. Forward rate

Nov. Forward rate 43.9575

Nov. Forward rate will be 1$ = 43.9575 / 44.2100

Ans. 2.

(i)

Customer wants to buy GBP paying CHF. However, CHF / GBP rate is not available. Hence, cross rate will be calculated. He will first buy USD from bank A as it is cheaper than Bank B and buy GBP from Bank B as it is cheaper than Bank A.
CHF / GBP

= =

1.4655 x 1.7650 2.5866

CHF required to buy 1 million GBP

= =

10,00,000 25,86,600

e x 2.5866

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J. K. SHAH CLASSES

FINAL C.A. - FINANCIAL MANAGEMENT

(ii)

For calculating swap points for CHF / GBP we 1st have to find the spot & 3 months forward cross rates. Spot rates Bid rate = 1.4650 x 1.7645 [lower rates are used] = 2.5850 Offer rate = 1.4655 x 1.7660 [higher rates are used] = 2.5881 3m Forward rates Swap points for CHF / USD are in the ascending order so they will be added to spot rate & for USD / GBP they are in the descending order so they will be deducted from spot rate. Bid rate = (1.4650 + 0.0005) x (1.7645 - 0.0025) = 1.4655 x 1.7620 = 2.5822 Offer rate = (1.4655 + 0.0010) x (1.7660 - 0.0020) = 1.4665 x 1.764 = 2.5869 Spot CHF / GBP = 2.5850 / 2.5881 3m Forward rates CHF / GBP = 2.5822 / 2.5869 Swap points For Bid = 2.5850 - 2.5822 = 0.0028 For Offer = 2.5881 - 2.5869 = 0.0012 Swap points = 28 / 12 $/Pound Probability =axb (a) (b) 1.60 0.15 0.24 1.70 0.20 0.34 1.80 0.25 0.45 1.90 0.20 0.38 2.00 0.20 0.40 1 1.81 e Expected spot rate on 1st September is 1 = 1.81$ Company will receive pound after 6 months i.e. on 1st September which will be converted into $ e Rate offered by the dealer in forward contract is 1 = 1.8 $ Whereas the expected rate is e 1 = 1.81$ e Hence, it is not advisable to sell forward the receivable in September. i.e. the company should not enter into forward contract.
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Ans. 3.

(i)

(ii)

J. K. SHAH CLASSES

FINAL C.A. - FINANCIAL MANAGEMENT

Ans.4.

Law of 1 price held indicates that the cost of transistor would be same in all the countries. (i) Cost of transistor in US = Cost of transistor in Singapore 22.84 $
1$

= =

S $ 69 3.02 S $

Cost of transistor in US = Cost of transistor in Moscow 22.84 $

1$

= =

3240 Rubbles 14.86 R

(ii)

To find out where the transistor is cheaper we have to convert the cost of transistor in all the 3 countries in common currency. Cost of Transistor in US Cost of Transistor in Singapore = = 22.84 $ 42.33 $ .........(1) .........(2) .........(3)

Cost of Transistor in Moscow = 12.96 $ 1$ 42.33 $ 1$ 12.96 $ X X S $ 1.63 S $ 69 259 R 3240 R .........(3) .........(2)

From (1) (2) & (3) it is clear that one should purchase transistor from Moscow as it cost lowest at 12.96$ .

THEORY OF NOSTRO A/C

Nostro A/c (It means "our account with you") It is an account maintained by Indian bank with a bank outside India for foreign exchange transactions. All payments & receipts in foreign currency are affected through this account. For e.g. HDFC Bank India having an account with Citi bank USA. It is maintained in foreign currency. It is like a current account having no interest.
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J. K. SHAH CLASSES

FINAL C.A. - FINANCIAL MANAGEMENT

Following 2 terms are important to understand to solve problem based on Nostro A/c : 1. Fund position : It indicates balance in Nostro a/c. Credit balance indicates that dealer in India have + ve balance with bank outside India and vice - versa. The fund position is ascertained on daily basis. Only those transactions are recorded which actually increases or decreases the foreign currency balance today. Forward sale & purchase of foreign currency is not considered. 2. Exchange position : It indicates the difference between the purchase & sale transactions during the day. All transactions whether spot or forward are recorded. If purchase transactions are more than sale transactions it is called overbought position and if sale transactions are more than purchase transactions, then, it is called oversold position. Dealer always try to keep lower balance of foreign currency by trying square off buy & sale transactions. This is to avoid foreign exchange fluctuation risk. If the balance is overbought, bank will try sell forward or in spot market and vice - versa. Vostro A/c : (means "your a/c with us") When a bank outside India maintains an account with bank in India in Indian ` then, it is called Vostro a/c. For E.g. Citi bank USA have an account with SBI Bank India. Mirror A/c : This account shows a reverse image of Nostro a/c. It is maintained by an Indian bank in foreign currency and same transactions are recorded with equivalent amounts in rupees. It is used for reconciliation of Nostro a/c. Loro A/c : It means "their account with you". For e.g. SBI bank India have an account with Citi bank USA. If HDFC bank refers to this account in any correspondence with Citi bank USA it would refer it as Loro A/c. Ans.5. Exchange position on 31st October (CHF) Opening position (Overbought) Purchase a Bill on Zurich Sold TT (Telegraphic Transfer) Forward purchase contract cancelled Remittance by telegraphic Trans. (TT) Draft on Zurich cancelled (Draft issued by US which is not entertained) Closing position (without Adjt.) (Oversold)
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Buy 50,000 80,000 ---------30,000 1,60,000 5,000 1,65,000

Sell ------60,000 30,000 75,000 ---1,65,000 ---1,65,000

J. K. SHAH CLASSES

FINAL C.A. - FINANCIAL MANAGEMENT

Funds position (Nostro A/c) on 31st October Dr. Balance in Nostro A/c (Opening) Remittance by T.T. (Refer Note) Closing Balance (without Adjt.) Action Required 1. To have a credit balance of 30,000 CHF in NOSTRO A/c, CHF 5000 should be purchased (Cash purchase). Hence fund position will be 30000 CHF credit. In exchange position before Adjustment 5000 CHF is oversold so after the above purchase of exact 5000 CHF the exchange position will become square. However, it is desired to keep the position overbought. Hence a forward purchase of 10,000 CHF should be made so that from square position it will become overbought by 10,000. This will not affect fund position as it is forward transaction & not cash transaction. ---75,000 25,000 1,00,000 Cr. 1,00,000 ------1,00,000

2.

3.

Note : Out of all the transactions recorded in the Exchange position only one transaction (i.e. Remittance by T.T. 75,000) affects the currency balance on 31st October, which is recorded in fund position. All other transactions will affect the balance on some future date. Ans. 6. Exchange position on January 2. (Euros A/c) Buy Opening position (Oversold) TT purchased Draft issued (But not presented for Payment) Remitted by Telegrafic Trans. Purchased cheques on Antwerp. Forward sale Closing Oversold (without Adjt.)
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Sell 25,000 ---50,000 2,50,000 ---2,25,000 5,50,000 ---5,50,000

---2,00,000 ------3,00,000 ---5,00,000 50,000 5,50,000

J. K. SHAH CLASSES

FINAL C.A. - FINANCIAL MANAGEMENT

Fund position on January 2. (Nostro A/c) Dr. Opening Balance T.T. purchased (Immediate Payment) Remittance by T.T. = Closing Balance (without Adjt.) 2,50,000 50,000 3,00,000 Action Required 1. Since the maximum Balance in Nostro A/c required is 50,000 Euros and the actual balance is also 50,000 Euros. Hence nothing is required to be done in Nostro A/c. Square position is required whereas there is oversold position of 50,000 Euros. Hence there should be made a forward purchase of 50,000 Euros. ------3,00,000 ---Cr. 1,00,000 2,00,000

2.

Note : Only T.T. purchased 2,00,000 Euros & Remittance by T.T. 25,000 Euros affects currency balance today and hence recorded in fund position. All other transactions are forward & will not affect fund position.

Ans. 7.

Multi - lateral Netting refers to setting off mutual owings between different Divisions, Branches and Subsidiaries and making the Net payment. MLN is done with a view to avoid Exchange Loss, Operating difficulties due to many transactions and most importantly for reducing transaction cost. In the present case the amounts are due between different subsidiaries and in different currencies. They are first converted into single currency, i.e. currency of the parent Indian Co. as follows : Debtor X X Y Y Z Creditor Y Z X Z X Amt. Due GBP 1,00,000 SG $ 30,000 US $ 70,000 SG $ 25,000 US $ 65,000
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Existing Rate Amt. Due in INR e 1 = Rs.83.8 83,80,000 ` $ 1 = Rs.27.7 $ 1 = Rs.46.15 $ 1 = Rs.27.7 $ 1 = Rs.46.15 8,31,000 ` 32,30,500 ` 6,92,500 ` 29,99,750 `

J. K. SHAH CLASSES

FINAL C.A. - FINANCIAL MANAGEMENT

Statement showing company wise dues & set - off

X Co. Receivable ------32,30,500 ---29,99,750 62,30,250 Net Payable 83,80,000 8,31,000 ---------92,11,000 29,80,750 Y Co. Receivable 83,80,000 ------------83,80,000 44,57,000 Payable ------32,30,500 6,92,500 ---39,23,000 ------8,31,000 ---6,92,500 ---15,23,500 ---Z Co. Receivable Payable ------------29,99,750 29,99,750 14,76,250

After multilateral Netting X co. will pay Rs.29,80,750 Z Co. will pay Rs.14,76,250 and Y Co. will Receive Rs.44,57,000 Ans. 8. As per the given information it is not possible to have arbitrage gain by using currency of two countries. Hence the investor has to use 3 way arbitrage technique. He has Rs. 1Crores and therefore, he has to start with Rupees and end up with Rupees. There are two possibilities out of which he can gain from one of them. Ist Possibility e Buy in Delhi e Sell in London Sell $ in N.Y. e Step I Buy in Delhi e 1 ` 81.9 eX 122100.12 ` 1 Cr. e II Sell in London ec 2.14 $ 1 Xe 122100.12 261294.26 $ III Sell in N.Y. 1$ 261294.26 Net gain = ` 1,00,85,958 - `1 Cr. = 85958 `
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IInd Possibility Buy in $ in N.Y. e Buy in London e Sell in Delhi Buy $ in N.Y. 1$ 256410.26 $ `1 Cr. e Buy in London ec 1 2.156 $ X e 118928.69 256410.26 $ e Sell in Delhi ec 1 ` 81.2 X e 118928.69 ` 9657009 Net loss = ` 1 Cr. - 9657009 = 342991 ` X ` 39

` 38.6 ` 1,00,85,958

If the investor goes with the 1st possibility he will have gain of ` 85,958.

J. K. SHAH CLASSES

FINAL C.A. - FINANCIAL MANAGEMENT

THEORY OF COST OF CARRY MODEL Explanation & derivation of formula 1. Suppose we want to purchase a security having spot price of Rs.100. For this we borrow Rs.100 which will be repaid on the due date say after 1 year at interest of 10% (assumed). Therefore, payment of loan alongwith interest will be Rs.110 after 1 year. 2. 3. We buy the security at Rs.100 today and will sell at forward price after 1 year. Suppose the selling price is FP i.e. future price. Net flow on delivery date will be : = = = FP - Spot rate (1 + r) FP - 100 (1 + 0.1) FP - 110

FP should be equal to spot (1 + r). If it is other than this, then the investor can take advantage of arbitrage. 4. If there is no arbitrage opportunity the net flow should be zero.
FP - Spot (1 + r) = 0 FP = Spot (1 + r)

5.

If dividend is received on securities then FP - Spot (1 + r) + Div. = 0 FP = Spot (1 + r) - Div.

6.

If FP is for commodities & it involves storage cost then FP - Spot (1 + r) - Storage cost = 0 FP = Spot (1 + r) + Storage cost

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FINAL C.A. - FINANCIAL MANAGEMENT

Ans. 9.

FP = Spot (1 + r) - Dividend = = = 2000 (1 + 0.14 x 2070 - 10.12 ` 2059.88 3 12 ) - 10 (1 + 0.14 x 1 12 )

Dividend is expected to be paid after 2m & so interest is calculated for the balance 1m, as opportunity cost. Ans.10. FP = (Spot - Present value of Dividend) ern where FP = = = = = r n = = 8% CCRI 3m

(Spot - Present value of Dividend) ern (70 - 1.47) e0.08 x 3/12 68.53 x e0.02 68.53 x 1.02020 ` 69.91 = = = 1.5 x 1.5 x ` 1.47 1 ern 1 e0.08 x 3/12

P.V. of Dividend (Discounting)

Note : 1. 2. It is assumed that dividend is paid at the end of 3m. P.V. of dividend is calculated by discounting as spot is at present value and dividend is to be deducted from spot rate FP = = = = Spot (1 + r) - Dividend 3500 (1 + 0.08 x 4 12 ) - (3500 x 0.04 x ) 12 4

Ans.11.

(a)

3500 x 1.027 - 46.67 ` 3547.83

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J. K. SHAH CLASSES

FINAL C.A. - FINANCIAL MANAGEMENT

(b)

FP

= = = = =

Spot.e(r - d)n 3500 x e(0.08 - 0.04) x 4/12 3500 x e0.0133 3500 x 1.014 ` 3549

Ans.12.

FP

= = = =

(Spot + P.V. of storage cost) ern (400 + 90.50) e0.1 490.5 x 1.1051 ` 542 = = = 100 x 100 x ` 90.5 1 ern 1 e0.1

P.V. of storage cost

Ans.13.

Convenience yield is a premium received (extra earning / yield) by not entering into future contract & actually purchasing the gold. P.V. of Convenience yield = = = = P.V. of total cost of gold - P.V. of future price (Spot + P.V. of storage cost) (15600 + 900) ` 740 17100 1.085 17100 1+0.085

Ans.14.

SBI Futures These are SBI March, 2005 future details on 10th March. When the market started the value of SBI future opened at Rs.735 & closed at Rs.738 in the evening. During the day SBI future rose to highest level of Rs.740 & reached the lowest level of Rs.735. During the day 1,38,000 units were traded & 92 contracts were entered into. It means that the lot size or contract size is 1500 (1,38,000 92). As on 10th March 433 contracts are yet to be squared off.
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J. K. SHAH CLASSES

FINAL C.A. - FINANCIAL MANAGEMENT

Option Premium

Intrinsic Value (IV)

Extrinsic Value (EV) OR Time Value (TV)

Different between exercise price & TimeValue=Option Premium -IntrinsicValue. Market price (MP) only if the option is in the money.

Intrinsic value refers to that portion of the option premium which represent the extent to which the option is in the money. The balance premium amount is charged for time value. If the option is at the money or out of the money then intrinsic value will be nil.

Ans.15.

Exercise Price
(EP) 45 48 50 52 55

Nature In the money In the money At the money Out of the money Out of the money

Premium 5 6 4 5 7

Intrinsic Value MP - EP 5 2 ----------

Time Value Premium - T.V. ---4 4 5 7

Ans.16.

Exercise Price
(EP) 45 48 50 52 55

Nature Out of the money Out of the money At the money In the money In the money

Premium 5 6 4 5 7
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Intrinsic Value MP - EP ---------2 5

Time Value Premium - T.V. 5 6 4 3 2