IFM Related Problems

Calculation of Annualized Premium

MM Forward Hedge 1
MM Forward Hedge 2
MM Fx Arbitrage
Cross Hedge
Capital Budgeting
Covered Interest Arbitrage
Currency Swaps 1
Currency Swaps 2
Exposure Coefficient 1
Exposure Coefficient 2
Masala Bonds
Operating Exposure
Exch Rate Advantage
Country risk premium
 Edited Version details
IFM Numbers
Useful Links 15062020 Edited Covered Int A
Bonds categories 16062020 Edited Covered Int A
29062020 Added a work sheet
20072020 Names of companie
02082020 Changes in Exposu
07092020 Bonds categories'
on details

dited Covered Int Arbitrage worksheet

dited Covered Int Arbitrage worksheet - added Carrry trades
dded a work sheet "Exch Rate Advantage"
ames of companies changed in Currency Swap 1 worksheet
hanges in Exposure coefficient worksheets (marginal changes)
onds categories' added + Country risk premium computation added
tion added
Index

4
Computation of Equity Risk Premium and Country Risk Premium (for investi

Implied equity risk premium for mature

markets
US Equity market return
US Treasury bonds

Local currency sovereign rating for India Baa3

(Moody's)
Default spread for the
above rating
(Or) Sovereign CDS spread for
India

SD of S&P Emerging market Equities

return
SD of S&P Emerging market Govt bond
index yield
Ratio of the above
parameters
Country risk premium for
India

Equity risk premium for India

Mature market equity risk
premium
Country risk premium
Expected return for investing in India
Cost of Capital (CAPM)
Equity risk premium for
India

Currency Volatility not considered

Order of risk (lowest to highest)

US Treasury securities
US Corporate Bonds
US Equities
India Sovereign Bonds
India Corporate Bonds
Indian Equities
um (for investing in Equity markets)

6.00%
6.50%
0.50%

2.44% Corporate Bond yield - Soverign Bond yield (for similar maturities)

2.11%

17.36%

12.91%

1.34

3.28%

9.28%

6.00%
3.28%
24.28%
15%

9.28%
ilar maturities)
Index
What are Eurobonds?
Example
Company that issued Euro bonds XYZ Ltd
Head quarters USA
Which country the bonds are issued Australia
In which currency the bonds were issued Canadian dollars

What is a Eurodollar bond?

Example
Company that issued Eurodollar bonds XYZ Ltd
Head quarters India
Which country the bonds are issued Australia
In which currency the bonds were issued USD

What is a EuroYen bond?

Example
Company that issued EuroYen bonds XYZ Ltd
Head quarters India
Which country the bonds are issued Australia
In which currency the bonds were issued JPY

What is a foreign bond?

Example
Company that issued foreign bonds XYZ Ltd
Head quarters USA
Which country the bonds are issued Australia
In which currency the bonds were issued Australian dollars

What are Rupee Denominated Bonds (RDB) also called Masala Bonds?
Example
Company that issued Masala bonds XYZ Ltd
Head quarters India
Which country the bonds are issued Anywhere outside India
In which currency the bonds were issued USD
Interest and Principal to be repaid in INR
A Eurobond is a debt instrument that's denominated in a currency other than
currency of the country or market in which it is issued. 

A Eurodollar bond is a U.S.-dollar denominated bond issued by an overseas co

held in a foreign institution outside both the U.S. and the issuer's home coun

A EuroYen bond is a JPY denominated bond issued by an overseas company a

foreign institution outside both the Japan and the issuer's home country. 
asala Bonds?

utside India
Index Sheet

Indian and Chinese exporters selling at

Scenario 1

Selling price in USD USD

Exch rate INR

Sales in INR INR

Cost 85%

Profit margin 15%

INR and CNY depreciates

Scenario 2

Selling price in USD USD

Exch rate 5%

Sales in INR

Cost 81%
Profit margin 19%
porters selling at the same price to US importers
Scenario 1
India China
100 100 USD

75 7 CNY

7500 700 CNY

6375 595 85%

1125 105 15%

Indian and Chinese willing to p

Scenario 2 Scenari
India China
100 100 USD Selling price in USD

78.75 7.7 10% Exch rate

7875 770 CNY Sales in INR

6375 595 Cost

1500 175 23% Profit margin
nese willing to pass on the exchange rate benefit to US importers
Scenario 3
India China
USD 95.24 90.91 USD Chinese becoming more competi

5% 78.75 7.7 10%

INR 7500 700 CNY

6375 595
15% 1125 105 15%
to US importers

becoming more competitive due to higher CNY depreciation against USD

on against USD
Index Sheet

Useful
Links

1 Reserve Bank of India

2 Federal Reserve, USA
3 Bank of England
4 Reserve Bank of Australia
5 European Central Bank (ECB)
6 International Monetary Fund (IMF)
7 Investing.com
8 Fxstreet.com
9 Forward Rates - Discounts and Premiums
10 SBI daily card rates for Forex
Australia
Bank (ECB)
netary Fund (IMF)

counts and Premiums (for study)

es for Forex
Index sheet

Important numbers related to IFM

Forex reserves (bn $)

Exports (bn $)
Imports (bn $)
Trade Deficit (bn $)
Current Account Deficit (% of GDP)
Portfolio Flows (bn $)
FDI Flows (bn $)
Total ECB borrowings (bn $)
NRI remittances (bn $)
NRI deposits outstanding (bn $)
Global Fx Turnover per day (bn $)
Dometic Fx Turnover per day (bn $)

USD/ INR
EUR/ USD
GBP/ USD
481.892 Mar 13, 2020
337.24 2018-19
517.52 2018-19
-180.28 2018-19

-0.618 2018-19
30.712 2018-19
10.416 2018-19
70.601 2018-19
130.423 31-Mar-19
6600 Avg in 2019
110 April 2019

75.79
1.0846
1.2453
Index Sheet

US Int rate for 1 year 1.70%

Spot 64.25 India Int rate for 1 year 6.70%
Int rate differential 5.00%

Int rate differential between US and India

Months Fwd Prms Annu Prm Forward rates
1 0.2425 4.53% 64.4925 0.4%
0.26 2 0.5 4.67% 64.75 0.8%
0.26 3 0.755 4.70% 65.005 1.2%
0.26 4 1.0125 4.73% 65.2625 1.6%
0.23 5 1.2375 4.62% 65.4875 1.9%
0.23 6 1.4674 4.57% 65.7174 2.3%
0.26 7 1.725 4.60% 65.975 2.7%
0.23 8 1.955 4.56% 66.205 3.0%
0.22 9 2.175 4.51% 66.425 3.4%
0.27 10 2.445 4.57% 66.695 3.8%
0.23 11 2.67 4.53% 66.92 4.2%
0.24 12 2.91 4.53% 67.16 4.5%
Index Sheet

Steps in Covered Interest Arbitrage

Using MM to borrow and Invest in Forward market

Spot rate USD/ INR 75.5
1 year Forward rate USD/ INR 80
Forward Premium (%) 5.96% Invest
1 year US interest rate 1%
1 year INR interest rate 6%
US INR Int rate differential 5% Borrow

Using Forward Market to borrow and Invest in MM

Spot rate USD/ INR 75.5
1 year Forward rate USD/ INR 78
Forward Premium (%) 3.31% Borrow
1 year US interest rate 1%
1 year INR interest rate 6%
US INR Int rate differential 5% Invest

Carry Trades (Uncovered Interest Trades)

USD JPY spot rate 107.5
1 year US interest rate 1%
1 year JPY interest rate 0%
1 year spot rate based on
interest rate parity 106.43
Likely 1 year spot rate 107.5
 STEPS
Borrow INR today
Buy USD at spot rate today using INR
Deposit today USD for 1 year
Sell USD at 1 year USD/ INR forward rate today @
Take USD deposit on maturity - 1 year later (maturity value)
Deliver USD - 1 year later honoring the forward contract and take INR
Use INR to repay the INR borrowed 1 year back with interest
Take arbitrage profit

STEPS
Borrow USD today
Buy INR at spot rate today using USD
Deposit today INR for 1 year
Buy USD at 1 year USD/ INR forward rate today @
Take INR deposit on maturity - 1 year later (maturity value)
Take delivery of USD - 1year later honoring the forward contract by giving INR
Use USD to repay the USD borrowed 1 year back with interest
Take arbitrage profit

Borrow JPY today

Buy USD at spot rate today using JPY
Deposit today USD for 1 year

Take USD deposit on maturity - 1 year later (maturity value)

Buy JPY using the USD at the USD/ JPY spot rate prevailing then
Repay JPY borrowed with interest
Take profit
Worked out Example

10000 INR
132.45 USD
132.45 USD
80 INR
133.7748 USD
10702 INR
10600 INR
102 INR

1000 USD
75500 INR
75500 INR
78 USD
80030 INR
1026 USD
1010 USD
16 USD

10000 JPY
93.02326 USD
93.02326 USD

93.95349 USD
10100 JPY
10000 JPY
100 JPY
Index Sheet

US Tax Rate 50%

Indian Tax Rate 48%
Merck's WACC 20%
Developing countries political risk premiu 6%
Discount rate for this project for Merck 26%
Merck's interest rate for borrowing in US 15%

Statement showing Operational fund flow 9/26/2020

Particulars 0
Inflows
Sales price per unit
Sales in units
Sales (in Rs.Mn)
Outflows
Variable costs / unit
Total variable costs (Rs.Mn)
Fixed costs (Rs.Mn)
Depreciation
Total expenses
PBIT
Interest outgo
PBT
Tax (at 48%)
PAT
Dividend repatriated (A)
Exchange rates
Dividend repatriated ($)
Depreciation repatriated at the end of the project
This is invested at 15% (tax free) compounded annually
Dividend repatriated

Evaluation of the project from the perspective of the pare

Particulars
Inflows ($) :
Dividend

Depreciation
Outflows :
Tax differential
Initial capital invested - 1,303,318
- 1,303,318
Discounting factor 1
Present value - 1,303,318
NPV (USD '000s) 4,458,335
IRR (%) Err:523

Sensitivity of the project cash flows when

all dividends are blocked and reinvested
at 15% tax free:
Evaluation of the project from the perspective of the parent in $:

Particulars 0
Inflows:
Interest income
Dividend income
Depreciation

Outflows:
Tax differential
Initial capital invested - 1,303,318

Net cash flows - 1,303,318

Discounting factor 1.0000
Present value - 1,303,318
NPV ($) 3,636,371
IRR (%) Err:523
Project NPV 4,458,335
Project IRR Err:523

8/9/2017 8/9/2018 8/9/2019 8/9/2020

1 2 3 4

1000 1500 1800 2000

200000 225000 250000 275000
200,000,000 337,500,000 450,000,000 550,000,000

600 690 793.5 912.53

120,000,000 155,250,000 198,375,000 250,945,750
20,000,000 22,000,000 24,200,000 26,620,000
10,000,000 10,000,000 10,000,000 10,000,000
150,000,000 187,250,000 232,575,000 287,565,750
50,000,000 150,250,000 217,425,000 262,434,250
400,000 320,000 240,000 160,000
49,600,000 149,930,000 217,185,000 262,274,250
23,808,000 71,966,400 104,248,800 125,891,640
25,792,000 77,963,600 112,936,200 136,382,610
25,792,000 77,963,600 112,936,200 136,382,610
42.2 42.5 42.6 42.8
 611,184.83 1,834,438 2,651,085 3,186,510
611,184.83 1,834,437.65 2,651,084.51 3,186,509.58

611,185 1,834,438 2,651,085 3,186,510

- 12,224 - 36,689 - 53,022 - 63,730

598,961 1,797,749 2,598,063 3,122,779

0.79 0.63 0.50 0.40
475,366 1,132,369 1,298,787 1,238,965

Amount in Rs

Year Dividend Multiplying factor Total Income

1 25,792,000 1.7490 45,110,369
2 77,963,600 1.5209 118,572,890
3 112,936,200 1.3225 149,358,125
4 136,382,610 1.1500 156,840,002
 5 159,025,360 1.0000 159,025,360

512,099,770 628,906,745
the parent in $:

1 2 3 4

- - - -
0.7937 0.6299 0.4999 0.3968
- - - -
 8/9/2021
5 1000000
8%
2200 5,000,000.00 400000
300000 4,000,000.00 320000
660,000,000 3,000,000.00 240000
2,000,000.00 160000
1,049.40 1,000,000.00 80000
314,820,000 0
29,282,000
10,000,000
354,102,000
305,898,000
80,000
305,818,000
146,792,640
159,025,360
159,025,360
43.5
 3,655,755
3,655,755.40

Depreciation repatriated at the end of the project:

Tax free compounding rate annually:
15%
Year Multiplying factor
1 1.74901
3,655,755 2 1.52088
3 1.32250
1,549,973 4 1.15000
5 1.00000
- 73,115
6.74238
5,132,613
0.31 Depreciation repat
1,616,165

Interest Income
19,318,369
40,609,290
36,421,925
20,457,392
 -

116,806,975

2,685,218 43.5
11,772,409
1,549,973

-320,152

15,687,447
0.3149
4,939,688
the end of the project:
annually:

67,423,813 43.50 1,549,973

Index Sheet
Example for Fixed for Fixed currency swap

U Ltd can borrow in the US for 9%, while A Ltd, an Australia

while U Ltd has to pay 8% to borrow in Australia. U Ltd will
while A Ltd will be doing business in US and needs USD. The
A Ltd needs USD 1.0 million and U Ltd needs AUD 2.0 Millio
The swap period is for 5 years. Calculate the cash flows for

Borrowi Borrowin
ng cost g cost

pa pa
U Ltd USA 9% Australia 8%
A Ltd USA 10% Australia 7%
Exchange rate of USD / AUD 2

A Ltd needs 1 mio USD

U Ltd needs 2 mio AUD
Swap period 5 years
U Ltd will borrow in USA at 9% pa 1 mio USD
A Ltd will borrow in AUD at 7% pa 2 mio
A Ltd CFs

2 AUD
-2 AUD
1 USD
Int paid on AUD borr AUD -0.14 0.14 AUD
-0.09 USD
Int paid on AUD borr AUD -0.14 0.14 AUD
-0.09 USD
Int paid on AUD borr AUD -0.14 0.14 AUD
-0.09 USD
Int paid on AUD borr AUD -0.14 0.14 AUD
-0.09 USD
Int paid on AUD borr AUD -0.14 0.14 AUD
-0.09 USD
2 AUD
-1 USD
-2 AUD
Ltd, an Australian Company, has to pay 10% to borrow in the US. A Ltd can borrow in
ralia. U Ltd will be doing business in Australia and needs AUD,
needs USD. The exchange rate is 2 AUD/USD.
s AUD 2.0 Million. They decide to borrow the funds locally and swap the borrowed fu
e cash flows for this swap.

U Ltd is an American Company with Business interests in Australia and needs

A Ltd is an Australian Company with Business interests in USA and needs USD

U Ltd CFs

1 USD Borrowed money

2 AUD Exchange of AUD
-1 USD Exchange of USD
-0.14 AUD Int payment from U Ltd to A Ltd
0.09 USD Int payment from A Ltd to U Ltd -0.09 Int paid of USD bo
-0.14 AUD
0.09 USD -0.09 Int paid of USD bo
-0.14 AUD
0.09 USD -0.09 Int paid of USD bo
-0.14 AUD
0.09 USD -0.09 Int paid of USD bo
-0.14 AUD
0.09 USD -0.09 Int paid of USD bo
-2 AUD Exchange of AUD
1 USD Exchange of USD
-1 USD Repayment of borrowed money
d can borrow in Australia for 7%,

the borrowed funds.

tralia and needs AUD

A and needs USD
t paid of USD borr

t paid of USD borr

t paid of USD borr

t paid of USD borr

t paid of USD borr

Index Sheet

US company has a project coming up in UK.

The company issues a $ denominated bond of 50 mln but has exposure to GB
How would the US company hedge its risk?
Take the Int rate conventions t30 days per month and 365 days per year.
Semi annual payments

USD/GBP 0.9000 Date of CFs US company

USD GBP 1/1/2019 50
Millions 50 45 1/1/2019 -50
5.60% 6.25% 1/1/2019 45
HY Int 1.380822 1.386986 6/30/2019 -1.386986
6/30/2019 1.380822
Convert $ liability into GBP liability 12/31/2019 -1.386986
as, cash flows are in GBP 12/31/2019 1.380822
12/31/2019 -45
12/31/2019 50
t has exposure to GBP through the project.

5 days per year.

ompany Swap Counter party US company project CFs

USD
USD 50 USD 50 USD Bonds issued proceed
GBP -45 GBP -45 GBP Investment in UK
GBP 1.386986 GBP 1 GBP Operating CFs
USD -1.380822 USD 1 GBP Operating CFs
GBP 1.386986 GBP 1 GBP Operating CFs
USD -1.380822 USD 1 GBP Operating CFs
GBP 45 GBP 45 GBP Investment wound up
USD -50 USD -50 USD Repayment of bonds
onds issued proceeds
vestment in UK
perating CFs
perating CFs
perating CFs
perating CFs
vestment wound up
epayment of bonds
 Index Sheet

CAD/ USD Spot 0.98

CAD/ USD Forward 0.94
USD int rate 4% p.a
CAD int rate 3% p.a

Time period 3 months

Import amount 400000 CAD

CAD/ USD Spot 0.98

CAD/ USD Forward 0.94
USD int rate 4% p.a
CAD int rate 3% p.a
Time period 3 months

Export amount 400000 CAD

Decision to use forward market to hedge the imports or money market

You as a US importer importing from Canada

You need 400000 CAD 3 months from now for imports.
Its PV today discounted at 3% p a CAD MM rate is 372093 CAD
Its equivalent in USD today applying spot CAD/USD is 364651 USD
Its value 3 months from now compounded at 4% pa USD int rate is 368297 US
Hence 400000 CAD is equivalent to 368297 USD or CAD/USD as per MM rate
cheaper than 0.94 quoted by forward market

The important thing to note from the above is that, for arriving at the implied
MM rates of CAD and USD, you are only using the spot CAD/USD rate and the
rates and no where the forward rates for CAD / USD

So for doing the above, you need to borrow in USD toay in USD MM and inve
CAD MM to meet the import requirements 3 months from now

You as a US exporter exporting to Canada

You will get 400000 CAD 3 months from now for your exports
Its PV today discounted at 3% pa CAD MM rate is 372093 CAD
Its equivalent in USD today applying spot CAD/ USD is 364651 USD
Its value 3 months from now compounded at 4% pa USD int rate is 368297 US
Hence 400000 CAD is equivalent to 368297 USD or CAD/USD as per MM rate
lesser than 0.94 quoted by forward market rate
So far doing the above, you need to borrow in CAD today in CAD MM and inv
USD MM and repay the CAD MM borrowing using the export proceeds to be
from now
Since MM is not attractive when compared to forward market rates you will j
CAD in the forward market at 0.94 CAD/ USD and not do anything in the MM
376000
Index Sheet

Money Market route to hedge Versus Forward Market t

USD / INR spot rate

Rupee depreciation expected in

the forward market for one
year

Today
Borrow DC now Importer
Convert to FC How many USD do you require?
Invest FC When do you need?
Use FC on maturity for Import
Repay DC with int Rate of interest for USD for abo
Check the DC outflow with
forward rate outflow Rate of interest for INR for the

PV of USD required for the

above period from now
(discounted at USD interest
rate)
Equivalent INR of PV of USD at
current USD/INR spot rate
 Principal + Interest at INR
interest rate of the above
amount

Principal + Interest at USD

interest rate of the INR
converted into USD

Forward Market
USD / INR 1 year forward rate

INR outflow one year from now

USD / INR spot rate

Today
Exporter
How many USD are you going to
When are you likely to receive?

Rate of interest for USD for 1 ye

Borrow FC now Rate of interest for INR for 1 yea
Convert to DC
 PV of USD to be received 1 year
from now (discounted at USD
Invest DC interest rate)
Equivalent INR of PV of USD at
Receive DC with int current USD/INR spot rate

Principal + Interest at INR

interest rate of the above
Repay FC using export proce amount

Check whether the DC Principal + Interest at USD

inflow is greater than the interest rate of the INR
forwards converted into USD

Forward Market
USD / INR 1 year forward rate

INR inflow one year from now

ersus Forward Market to hedge

64.69

4%

26-Sep-20

1,000,000 USD
1 year from now

3.00% p.a

6.50% p.a

970,874 Buy USD of this amount using the borrowed amount

62,805,825 Borrow this amount

 66,888,204 INR outflow for the importer one year from now using mon

1,000,000

67.2776

67,277,600 INR outflow for the importer one year from now using forw
r

64.25

26-Sep-20

10,000,000 USD
1 year from now

3.00% p.a
6.50% p.a
 9,708,738 Buy USD of this amount using the borrowed amount

623,786,408 Invest this amount for one year at INR interest rate

664,332,524 Realise this INR at the end of one year using money market

10,000,000 Repay this using the export proceeds

67.2776

672,776,000 INR inflow for the exporter one year from now using forwar
rowed amount
from now using money market

from now using forward market

rowed amount

interest rate

using money market

rom now using forward market

Index Sheet

Arbitrage Problem

Spot 1.03
Forward 1.07
Act like
an
fwd prm 3.88% importer
Ann fwd 7.77%
INR 7%
$ 5%

Annual 1
Half yearl 2 Act like
an
Quarterly 4 exporter
Monthly 12
Think like who ever would be losing in the
forward market, if they cover, compared to
money market difference

Borrow Rs.1 million now 1000000

convert to usd at usd / inr spot rate 970874
use the above usd to make usd deposit
take matured amount of usd after 6 months 1019417
convert usd into inr at forward rate 1090777
repay borrowed inr with interest 1065000

Borrow usd 1 million now 1000000

convert to inr at usd / inr spot rate 1030000
use the above inr to make inr deposit
take matured amount of inr after 6 months 1063475
convert inr into usd at forward rate 993902
repay borrowed inr with interest 1025000
25776.7

-31098
Index Sheet

A U.S. firm holds an asset in France and faces the following scenari
State 1 State 2 State 3
Probability 25% 25% 25%
Spot rate $1.20/€ $1.10/€ $1.00/€
P* € 1,500 € 1,400 € 1,300
P $1,800 $1,540 $1,300
In the above table, P* is the euro price of the asset held by the U.S
(a) Compute the exchange exposure faced by the U.S. firm.
(b) What is the variance of the dollar price of this asset if the U.S. fi
(c) If the U.S. firm hedges against this exposure using the forward c

Solution
Probability 25% 25% 25%
Spot rate (EUR/USD) 1.2 1.1 1
Asset price in Euro 1500 1400 1300
Asset price in USD 1800 1540 1300

Verification of hedge Sell € 2,400 to hedge

P/L of the hedge 360 120 -120

Net value in USD 1440 1420 1420

e following scenario:
State 4
25%
$0.90/€
€ 1,200
$1,080
set held by the U.S. firm and P is the dollar price of the asset
e U.S. firm.
s asset if the U.S. firm remains unhedged against this exposure?
using the forward contract, what is the variance of the dollar value of the hedged pos

Exp Values
25%
0.9 1.05 0.0125 Variance of spot rate
1200 1350
1080 1430 72100 Variance of land price in USD

30.00 Covariance between asset price and sp

at 1.05 2400 Exposure coefficient (Exchange exposu

-360 72000 Variance of dollar value of the property

Average
1440 1430 100 Variance of the dollar value of the hedg

SD 10
Variance 100
lar value of the hedged position?

spot rate

land price in USD

between asset price and spot rate

efficient (Exchange exposure faced by the US firm)

dollar value of the property attributable to exchange rate uncertainty

the dollar value of the hedged position (error term in the regression equation)
uncertainty

regression equation)
Index Sheet

Exposure Coefficient

Suppose that you hold a piece of land in the City of London that you
U.S. resident, you are concerned with the dollar value of the land. A
booms in the future, the land will be worth £2,000 and one British p
British economy slows down, on the other hand, the land will be wo
will be stronger, i.e., $1.50/£. You feel that the British economy will
probability and a slow-down with a 40% probability.
(a) Estimate your exposure b to the exchange risk.
(b) Compute the variance of the dollar value of your property that is
uncertainty.
(c) Discuss how you can hedge your exchange risk exposure and also
hedging.

ProbabiliGBP/$ Land PricLand Price

in GBP in USD
Booms 60% 1.4 2000 2800
Slows down 40% 1.5 1500 2250

Expected Values 1.44 1800 2580

Variance 0.002 60000 72600
CoVariance -13.2

Exposure
(a) coefficient -5500 GBP
 Variance of the
dollar value of the
property that is
attributable to
exchange rate
(b) uncertainty : 72600 USD

Variance of the
dollar value of
unhedged position : 72600 USD

Variance of the
dollar value of the
hedged position 0

C) Hedge the negative exposure coefficient by buying GBP 5500 in the

 of London that you may want to sell in one year. As a
value of the land. Assume that, if the British economy
00 and one British pound will be worth $1.40. If the
the land will be worth less, i.e., £1,500, but the pound
ritish economy will experience a boom with a 60%

our property that is attributable to the exchange rate

k exposure and also examine the consequences of

and Price
ng GBP 5500 in the forward market.
Index Sheet

MASALA BOND - Cash Flows

INR int rate 10%

USD/INR spot 60

10000000 USD

Proj INR Cash flows for

Dates Deprn Proj INR Issuer
6/15/2017 60 600,000,000
6/15/2018 5.00% 63.00 - 60,000,000
6/15/2019 5.00% 66.15 - 60,000,000
6/15/2020 5.00% 69.46 - 60,000,000
6/15/2021 5.00% 72.93 - 60,000,000
6/15/2022 5.00% 76.58 - 60,000,000
6/15/2022 5.00% 80.41 - 600,000,000

5.00% 10.0%
h Flows

INR CFs for the USD CFs for the Actual Spot
investor investor rates
- 600,000,000 - 10,000,000 60
60,000,000 952,381 62.7
60,000,000 907,029 64.8
60,000,000 863,838 68.2
60,000,000 822,702 69
60,000,000 783,526 67
600,000,000 7,462,154 65

USD return
4.01% for the
investor
USD CFs for the
investor
- 10,000,000
956,938
925,926
879,765
869,565
895,522
9,230,769

7.76%
Index Sheet

Cross Hedging Example

Euro / CZK are strongly positively correlated and liquid

CZK / INR is illiquid in the forward market and moderately

Indian exporter to Czech will receive in C

### Spot Euro / CZ 25 liquid

Euro / IN 75 liquid
CZK / INR 3 Moderately liquid
### 6 mnths Euro / CZ 30 liquid
Euro / IN 90 liquid
CZK / INRno rates illiquid

Case 1 Exporter unhedged

### Spot CZK / INR 1.8 Moderately liqu

Amount of INR realized by the Indian expor

Case 2 Exporter cross hedged through Euro

1 Buy Euro in the forward market a
2 Sell Euro in the forward market a

Amount of Euros bought selling C

Amout of INR realised selling the
orrelated and liquid
market and moderately liquid in the spot market

1,000,000

tely liquid

unexpected depreciation of CZK40%

1,800,000 INR

Euro / CZK 30
Euro / INR 90

33333
3,000,000
Index Sheet

US computer company has a wholly owned subsidiary Albion Compu

Albion Computers imports microprocessors from Intel.

Benchmark case
GBP/ USD 1.6
No. of Units sold 50000
Price per unit 1000 GBP
Sales 50,000,000
Variable costs per unit 650 32,500,000
Fixed overhead costs 4,000,000
Depreciation allowances 1,000,000
Net profit before tax 12,500,000
Income tax 50% 6,250,000
Profit after tax 6,250,000
Operating cash flow in GBP 7,250,000
Operating cash flow in USD 11,600,000

Variable costs 330 GBP

512 USD

CASE 1
GBP depreciates
No other changes
GBP/ USD 1.4
No. of Units sold 50000
Price per unit 1000 GBP
Sales 50,000,000
Variable costs per unit 696 34,785,714
Fixed overhead costs 4,000,000
Depreciation allowances 1,000,000
Net profit before tax 10,214,286
Income tax 50% 5,107,143
Profit after tax 5,107,143
Operating cash flow in GBP 6,107,143
Operating cash flow in USD 8,550,000

Variable costs 330 GBP

512 USD

CASE 2
GBP depreciates; Dollar value of unit price is maintained assuming t
GBP/ USD 1.4
No. of Units sold 50000
Price per unit 1,143
Sales 57,142,857
Variable costs per unit 696 34,785,714
Fixed overhead costs 4,000,000
Depreciation allowances 1,000,000
Net profit before tax 17,357,143
Income tax 50% 8,678,571
Profit after tax 8,678,571
Operating cash flow in GBP 9,678,571
Operating cash flow in USD 13,550,000
Variable costs 330 GBP
512 USD

CASE 3
GBP depreciates
Sales volume, selling price and the prices of both locally sourced and
Assumption : Selling price and price of locally sourced inputs increas
Units sold due to elastic demand for its products
Inflation 8%
GBP/ USD 1.4
No. of Units sold 40000
Price per unit 1080 GBP
Sales 43,200,000
Variable costs per unit 722 28,884,571
Fixed overhead costs 4,000,000
Depreciation allowances 1,000,000
Net profit before tax 9,315,429
Income tax 50% 4,657,714
Profit after tax 4,657,714
Operating cash flow in GBP 5,657,714
Operating cash flow in USD 7,920,800

Variable costs 356 GBP

512 USD
 GBP depreciates,
cost of inputs go
Summary up

Variables Benchmark casCase 1

Exchange rate (GBP/USD) 1.6 1.4

Unit variable cost (GBP) 650 696
Unit sale price (GBP) 1000 1000
Sales volume (units) 50000 50000
Annual CF in GBP 7,250,000 6,107,143
Annual CF in USD 11,600,000 8,550,000
15% Four year PV in USD 33,117,749 24,410,065
Operating profit/losses in USD - 8,707,684
-26.3%
PV factor
1 0.8695652174
2 0.7561436673
3 0.6575162324
4 0.5717532456
2.8549783627
ary Albion Computers PLC that manufactures and sells PCs in UK market.

1,600 USD

locally sourced inputs

imported inputs
 1,400 USD

locally sourced inputs

imported inputs

ained assuming the number of units sold is inelastic in UK

1,600 USD
 locally sourced inputs
imported inputs

cally sourced and imported inputs change following GBP depreciation.

ed inputs increase, reflecting the underlying inflation rate in UK

1,512 USD

locally sourced inputs

imported inputs
Dollar value Sales volume,
of price price and cost
maintained impacted

Case 2 Case 3

1.4 1.4
696 722
1,143 1080
50000 40000
9,678,571 5,657,714
13,550,000 7,920,800
38,684,957 22,613,713
5,567,208 - 10,504,036
16.8% -31.7%