Extra Questions Solutions JK Shah

FINAL C.A. - FINANCIAL MANAGEMENTJJJJJ..... K. K. K. K. K. SHAH CLASSES SHAH CLASSES SHAH CLASSES SHAH CLASSES SHAH CLASSES

: 1 :

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

dollar rates per British pound to prevail as on 1st

September.

$ / Pound Probability

1.60 0.15

1.70 0.20

1.80 0.25

1.90 0.20

2.00 0.20

(i) What is the expected spot rate for 1st

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?


: 2 :

Q. 4. In 2000 a Transistor costs $ 22.84 in New York. S $69 in Singapore, and 3240

rubbles in Moscow.

(i) If the law of one price held, what was the exchange rate between US

dollars and Singapore dollar? Between US dollar and rubles.

(ii) 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. 1,00,000

Opening position (overbought) 50,000

Purchased a bill on Zurich 80,000

Sold TT forward 60,000

Forward purchase contract cancelled 30,000

Remitted by telegraphic transfer 75,000

Draft on Zurich cancelled 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 1,00,000

Opening position (oversold) 25,000

T Ts purchased on January 2 2,00,000

Draft issued but not presented for payment 50,000

Remitted by telegraphic transfer 2,50,000

Purchased cheques on Antwerp 3,00,000

Forward Sales 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?


: 3 :

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 Creditor Amount Due

X Y GBP 1,00,000

X Z SG $ 30,000

Y X US $ 70,000

Y Z SG $ 25,000

Z X US $ 65,000

The relevant exchange rates are as follows:

US $ 1 = Rs 46.15

GBP 1 = Rs 83.80

SG $ 1 = 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 (e0.02 = 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) Calculate 4m index future

(b) Calculate 4m index future if the rate of 8% is CCRI [e0.0133 = 1.014]


: 4 :

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. [e0.1 = 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 Open High Low Close Open Traded Number of

Int. Qty. Contracts

SBI MAR

05 FUT 735 740 735 738 433 138000 9 2

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 4 5 4 8 5 0 5 2 5 5

Premium 5 6 4 5 7

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 4 5 4 8 5 0 5 2 5 5

Premium 5 6 4 5 7

FINAL C.A. - FINANCIAL MANAGEMENTJ. K. SHAH CLASSES

: 1 :

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. Spot rate

2. 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. There-

fore $ 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 Forward Ask Rate

Spot rate 1 $ = 45.57 `̀̀̀ Spot rate 1 $ = 46.01 `̀̀̀

+ 0.10 + 0.12

Forward 1 $ Rate 45.67 `̀̀̀ Forward Rate 1 $ 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$ = 44.5450 44.5475

Forward Sept. 2600 2800

Differentials Oct. 5400 5700

OR

Nov. 7900 8400Swap Points

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.


: 2 :

Nov. Bid rate Nov. Ask rate

Spot 44.5450 Spot 44.5475

(+) Nov. Swap point 0.7900 (+) Nov. Swap point 0.8400

Nov. Forward rate 45.335 Nov. Forward rate 45.3875

∴∴∴∴ 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 Nov. Ask rate

Spot 44.7475 Spot 44.9500

(-) Nov. Swap point 0.7900 (-) Nov. Swap point 0.7400

Nov. Forward rate 43.9575 Nov. Forward rate 44.2100

∴∴∴∴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 ££££ x 2.5866

= 25,86,600


: 3 :

(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

Ans. 3. (i) $/Pound Probability= a x b

(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

Expected spot rate on 1st September is ££££1 = 1.81$

(ii) Company will receive pound after 6 months i.e. on 1st September

which will be converted into $

Rate offered by the dealer in forward contract is ££££1 = 1.8 $

Whereas the expected rate is

1 ££££ = 1.81$

Hence, it is not advisable to sell forward the ££££ receivable in September.

i.e. the company should not enter into forward contract.


: 4 :

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 $ = S $ 69

∴ ∴ ∴ ∴ 1 $ = 3.02 S $

Cost of transistor in US = Cost of transistor in Moscow

22.84 $ = 3240 Rubbles

∴ ∴ ∴ ∴ 1 $ = 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 = 22.84 $ .........(1)

Cost of Transistor in Singapore = 42.33 $ .........(2)

Cost of Transistor in Moscow = 12.96 $ .........(3)

1 $ S $ 1.63.........(2)

42.33 $X

S $ 69

1 $X

259 R.........(3)

12.96 $ 3240 R

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.


: 5 :

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)

Buy Sell

Opening position (Overbought) 50,000 ----

Purchase a Bill on Zurich 80,000 ----

Sold TT (Telegraphic Transfer) ---- 60,000

Forward purchase contract cancelled ---- 30,000

Remittance by telegraphic Trans. (TT) ---- 75,000

Draft on Zurich cancelled 30,000 ----

(Draft issued by US which is not entertained)

1,60,000 1,65,000

Closing position (without Adjt.) (Oversold) 5,000 ----1,65,000 1,65,000


: 6 :

Funds position (Nostro A/c) on 31st October

Dr. Cr.

Balance in Nostro A/c (Opening) ---- 1,00,000

Remittance by T.T. (Refer Note) 75,000 ----

Closing Balance (without Adjt.) 25,000 ----

1,00,000 1,00,000

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.

2. In exchange position before Adjustment 5000 CHF is oversold so

after the above purchase of exact 5000 CHF the exchange position

will become square.

3. 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.

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 Sell

Opening position (Oversold) ---- 25,000

TT purchased 2,00,000 ----

Draft issued (But not presented for Payment) ---- 50,000

Remitted by Telegrafic Trans. ---- 2,50,000

Purchased cheques on Antwerp. 3,00,000 ----

Forward sale ---- 2,25,000

5,00,000 5,50,000

Closing Oversold (without Adjt.) 50,000 ----

5,50,000 5,50,000


: 7 :

Fund position on January 2. (Nostro A/c)

Dr. Cr.

Opening Balance 1,00,000

T.T. purchased (Immediate Payment)

---- 2,00,000

Remittance by T.T. 2,50,000 ----

= Closing Balance (without Adjt.) 50,000 ----

3,00,000 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.

2. 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.

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 Creditor Amt. Due Existing Rate Amt. Due in INR

X Y GBP 1,00,000 ££££1 = Rs.83.8 83,80,000 `̀̀̀

X Z SG $ 30,000 $ 1 = Rs.27.7 8,31,000 `̀̀̀

Y X US $ 70,000 $ 1 = Rs.46.15 32,30,500 `̀̀̀

Y Z SG $ 25,000 $ 1 = Rs.27.7 6,92,500 `̀̀̀

Z X US $ 65,000 $ 1 = Rs.46.15 29,99,750 `̀̀̀


: 8 :

Statement showing company wise dues & set - off

X Co. Y Co. Z Co.

Receivable Payable Receivable Payable Receivable Payable

---- 83,80,000 83,80,000 ---- ---- ----

---- 8,31,000 ---- ---- 8,31,000 ----

32,30,500 ---- ---- 32,30,500 ---- ----

---- ---- ---- 6,92,500 6,92,500 ----

29,99,750 ---- ---- ---- ---- 29,99,750

62,30,250 92,11,000 83,80,000 39,23,000 15,23,500 29,99,750

Net ⇒⇒⇒⇒ 29,80,750 44,57,000 ---- ---- 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 IInd Possibility

Buy ££££ in Delhi Buy in $ in N.Y.

Sell ££££ in London Buy ££££ in London

Sell $ in N.Y. Sell ££££ in Delhi

Step I Buy ££££ in Delhi Buy $ in N.Y.

1 ££££ X

`̀̀̀ 81.9 1 $ X

` ` ` ` 39

122100.12££££ ` ` ` ` 1 Cr. 256410.26 $ `̀̀̀1 Cr.

II Sell ££££ in London Buy ££££ in London

1 £ £ £ £ X

2.14 $ 1 £ £ £ £ X

2.156 $

122100.12 ££££ 261294.26 $ 118928.69 ££££ 256410.26 $

III Sell in N.Y. Sell ££££ in Delhi

1 $ X ` ` ` ` 38.6 1 £ £ £ £

X `̀̀̀ 81.2

261294.26 ` ` ` ` 1,00,85,958 118928.69 ££££ ` ` ` ` 9657009

Net gain Net loss

= ` ` ` ` 1,00,85,958 - `̀̀̀1 Cr. = `̀̀̀ 1 Cr. - 9657009

= 85958 `̀̀̀ = 342991 `̀̀̀

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


: 9 :

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. 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.

3. 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


: 10 :

Ans. 9. FP = Spot (1 + r) - Dividend

= 2000 (1 + 0.14 x 3

) - 10 (1 + 0.14 x 1

) 12 12

= 2070 - 10.12

= `̀̀̀ 2059.88

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 r = 8% CCRI

n = 3m

FP = (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

P.V. of Dividend (Discounting) = 1.5 x 1

ern

= 1.5 x 1

e0.08 x 3/12

= `̀̀̀ 1.47

Note :

1. It is assumed that dividend is paid at the end of 3m.

2. P.V. of dividend is calculated by discounting as spot is at present value

and dividend is to be deducted from spot rate

Ans.11. (a) FP = Spot (1 + r) - Dividend

= 3500 (1 + 0.08 x 4

) - (3500 x 0.04 x 4

) 12 12

= 3500 x 1.027 - 46.67

= `̀̀̀ 3547.83


: 11 :

(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

P.V. of storage cost = 100 x 1

ern

= 100 x 1

e0.1

= `̀̀̀ 90.5

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) - 17100

1+0.085

= (15600 + 900) - 17100

1.085

= `̀̀̀ 740

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.


: 12 :

Option Premium

Intrinsic Value (IV) Extrinsic Value (EV)

OR

Time Value (TV)

Different between exercise price & Time Value = Option Premium - Intrinsic Value.

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 PriceNature Premium

Intrinsic Value Time Value

(EP) MP - EP Premium - T.V.

45 In the money 5 5 ----

48 In the money 6 2 4

50 At the money 4 ---- 4

52 Out of the money 5 ---- 5


Ans.16. Exercise PriceNature Premium

Intrinsic Value Time Value

(EP) MP - EP Premium - T.V.



50 At the money 4 ---- 4



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Extra Questions Solutions JK Shah