SCOrEBMS.

com 31
st
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
income.
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
customers.
(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. SDRs are entitlements granted to member countries enabling them to draw from the
IMF in addition to drawings against their quotas.
2. SDRs 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 SDRs are credited to it. When a member needs to borrow against SDRs 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.
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March I.F. Solution 9833088336
(c) Vostro Account
Demand deposit accounts, denominated in domestic currencies maintained by overseas
banks withdomestic 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.
(d) FEDAI
The FEDAI was set up in 1958as 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.
Q,2)
a] Ans.
Step 1: Existenceof Arbitrage
4210 . 42
4210 . 42 2300 . 43
=

S
S F
=0.0191
12
6
100
8 12
12 100
x
n
x
Rb Rv
=

= 0.0200
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March I.F. Solution 9833088336
Hence, Arbitrage exist
12 100
n
x
Rb Rv
S
S F
<

So borrowing in base currency USD & Invest in variable currency INR.

Step 2:
Borrowing
Let capital borrowed be 1 million USD
|
.
|

\
|
+ =
100
1 x P payable Amount
RT
|
|
.
|

\
|
+ =
12
6
100
8
1 x 000 , 00 , 0 1 x
200
208
x 000 , 00 , 0 1 =
=USD 10,40,000
Step 3:
Investment
(i) Convert USD into INR (spot)
=10,00,000 x 42.4210
(ii) Invest INR
|
.
|

\
|
+
12
6
100
12
1 42.4210 x 10,00,000 = x x
200
212
42.4210 x 10,00,000 = x
(iii) Convert INR into USD(forward)
2300 . 43
1
200
212
42.4210 x 10,00,000 = x x
=USD 10,40,163.31
Step 4:
Arbitrage Gain =Amount Receivable Amount Payable
=10,40,163.31 10,40,000
=USD163.31 or 163per 1 million USD
Q.2 [b]
(iii) Ans.
The role of RBI in the exchange market is as follows:
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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.
- INTERNAL HEDGING METHOD:
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
position.
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.
- EXTERNAL HEDGING METHODS:
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.
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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
Q.3)
a] Ans.
USD/CAD 1.1630 1.1650
Direct quote =Canada
2
bid Ask
Rate Mid
+
=
2
1630 . 1 1650 . 1 +
=
=1.1640
Spread =Ask Bid
=1.1650 1.1630
=0.0020 or 20 pips
100 % x
Rate Mid
Spread
Spread =
100
1640 . 1
0020 . 0
x =
=0.1718%
Inverse quote
ask
bid
CAD USD
USD CAD
/
1
/ =
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March I.F. Solution 9833088336
1650 . 1
1
=
=0.8584
bid
ask
CAD USD
USD CAD
/
1
/ =
1630 . 1
1
=
=0.8598
Hence,
CAD/USD 0.8584 0.8598
Q.3)
b] Ans.
USD/GBP 0.6542 0.6547
USD/CHF 1.5530 1.5535
GBP/CHF
Bid
=GBP/USD
Bid
x USD/CHF
Bid
5530 . 1
6547 . 0
1
x =
=2.3721
GBP/CHF
Ask
5535 . 1
6542 . 0
1
x =
=2.3747
Hence
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.
Q.4)
a] Ans.
USD/INR 47.7000 47.7200
(+) Premium (2m) 0.0240 0.0300
2m fwd USD/INR 47.7240 47.7500
100
12
x
n
x
S
S F
AFM
(

=
SCOrEBMS.com 31
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March I.F. Solution 9833088336
100
2
12
7000 . 47
7000 . 47 7240 . 47
x x rate Bid

=
=0.3019 %
AFM bid rate is premium 0.3019%.
100
12
x
n
x
S
S F
AFM
(

=
100
2
12
7200 . 47
7200 . 47 7500 . 47
x x Askrate

=
=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
40
0 60
0 300
40
0 60
0 240
x x

=
=160 =200
Q.4)
b] Ans.
Calculation of Interest Receivable
(a) Invest in INR 4 million
000 , 00 , 40
12
6
100
75 . 5
1 000 , 00 , 40
|
.
|

\
|
+ = x x
=INR 1,15,000
(b) Invest in USD
000 , 00 , 40 20 . 45
12
6
100
25 . 4
1
87 . 44
000 , 00 , 40

|
.
|

\
|
+ = x x x
=INR 1,15,043.46
(c) Invest in GBP
000 , 00 , 40 23 . 93
12
6
100
25 . 5
1
93
000 , 00 , 40

|
.
|

\
|
+ = x x x
=INR 1,15,152.15
Recommendation:-
Invest in currency GBP Since it results into highest interest i.e. INR 1,15,152.15
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March I.F. Solution 9833088336
Q.5)
(a) Ans.
- EUROPEAN CENTRAL BANK: (ECB)
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
EUROZONE.
Objectives of ECB:
1. To ensure price stability within the Euro-zone through low inflation rates. (Ideally less than
2%)
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.
- DISTINCTION BETWEEN FOREIGN DIRECT INVESTMENT (FDI) AND
FOREIGN PORTFOLIO INVESTMENT (FPI):
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