Session 2, 21/12/2017, Thursday

We require foreign currency either today or tomorrow:

 Wholesale segments: 4 decimals
 Retail: 2 decimals
Quotes, trading and settlement:
Forex rate:
 Cash/spot
 Forward rate
Bills (acknowledgement of goods that you have received)
 Sight bill or demand bill (payable on demand)
 Time/usance bill: (there is a time gap between the transaction and settlement)
Both of these bills can either be an export bill or an import bill.
 I need to debit $1000 for higher studies to transfer. If TT: telegraphic transfer or
online transfer. (import bill)
 If a bill is raised the bank will charge a bit more. The rate is called merchant rate.
This will be up to two decimals.
 SBI: 66.60 (Bid rate) 66.73 (Sell rate) the difference between these two is spread
(refer to PPT “exchange rates”). With this it will charge its margin (let’s say 0.1)
and sell at 66.83.
 Therefore, TT selling = 66.73+margin = 66.83
 Export Bill:
o TT Buying = 66.60 – margin = 66.50(example)
 Let us consider
o Import Bill again, and supplier has given me 3 months’ time. If I want to
stop the US $ rate. I would arrive at a forward rate like this:
Forward rate = Spot rate +/- Premium or Discount + margin
o Suppose it is an export bill then,
Forward rate = Spot rate +/- Premium or Discount – margin

Forward contracts / Forward Rates:

 You agree on the term and conditions today that the payment happens on a forward
or future date.
 21/12/2017: Import Bill: 10000 US $, $ = 67₹
 20/3/18: due date
o You can either wait until maturity
o Or enter into Forward contract
 You are expecting that the dollar might increase to ₹68.10
 I will ask my banker for a rate, and he says 67.76₹
 Here, you will purchase 3 months forward @ ₹67.76.
  If on the due date the $ rate is ₹68.10 the you have a profit (68.10-67.76)
 If it drops to 67.5₹ then you will have a loss of (67.5-67.76)
 Important aspects of a forward contract:
o Buyer will take delivery and seller of the contract will deliver.
o No win-win situation.
o No liquidity (liquidity comes with a charge)
o No standardisation
o Difficult to exit
o Credit risk
 The profit and loss on account of exchange rate differences are to be shown in
SoPL.
 If the dollar value depreciates against ₹ you can still cancel the contract and bank
charges on this cancellation. Therefore, there is a certain amount of counter party
risk. As you go closer to the contract date then the cancellation charges will be
higher.
 These points are all about Merchant rates. Now we will discuss about the deals
happening in Inter-bank market or authorised dealers.

“Non-deliverable forward contract” Preliminary reading

SESSION 4, 27/12/2017, Wednesday.

Recap: of session 3
Arbitrage activity:
 Let us assume Interest rate in India is 5% and interest in US is 2% Spot = ₹64
 Here we can borrow in
 Interest Rate Parity: 2% in US and Invest in 5% in India. This is Arbitrage.
 I borrow 100$ from US at 2% for an year
 I will invest in India = 100*64 = 6400 INR at 5% interest
 I need to repay $100 on the day of Maturity I get 6400 + 323 interest = 6720 ₹
Interest rate parity here says,
 =6720/(100+2) = 65.88 should be expected Spot rate
 Forward rate = Spot rate +/ - Premium/discount
 = (65.88-64)/64 * (12/12)*100
 Therefore, Forward rate differential = Interest rate differentials according to
IRP/PPP
 If there is mismatch here then “arbitrage” happens.
Covered interest arbitration (CIA)
 Here we take into consideration the forward rate as explained above “arbitrage
activity”.
Uncovered Interest rate Arbitration
 In uncovered rate we take spot rate

Session 5, 28-12-2017, Thursday. Only practical

Session 7, 02-01-2018, Tuesday.
Article: Covered against volatility. The Hindu newspaper: 29th October 2017
Talks about how transaction exposure can be hedged. Exposure management is
about 34% and 66% is still unhedged. This is because of
1. High transaction cost. Margin is now shrinking so the factor of High transaction
cost might not prevail.
2. Interference of the central bank
3. Natural hedging: A natural hedge is a method of reducing financial risk by
investing in two different financial instruments whose performance tends to
cancel each other out. A natural hedge is unlike other types of hedges in that it
does not require the use of sophisticated financial products such as forwards
or derivatives. Wiki
4. Netting: settling on the net balance. The issue in this “aging schedule” similar
to asset management and receivables management.
5. OTC Forward contract: lack of transparency. Whatever banks quote you will
have to accept
 The article suggest to go to exchange traded currency derivative contract instead
of OTC.
 Even is the exposure is managed it is restricted to the forward contracts.

Session 8, 05/01/2018, Friday

Session 9, 06/01/2018, Saturday

Features of Futures Contract:

1. Exchange traded derivative
2. Win – win situation
3. Screen based trading
4. Cash settlement
5. No counterparty risk
6. There is an intermediary/Clearing house
7. No physical delivery
8. Liquidity (entry and exit)
9. Margin:
a. Initial martin
b. Maintenance margin
10. Standardised products no customisation like Forward contract
 a. Aussie: 100000
b. Pounds: 62500
c. Yen 12500000
11. Marked to market (M2M)

Session 10, 09-01-2018, Tuesday

Going to buy a home in JC nagar worth ₹2500000
Paid 100000 ₹ advance
A similar asset is available at much cheaper price in the heart of the town at ₹2200000
If you go to the other property then your advance will be forfeited.
If you will go to call option,
100000 will be you premium
Call option: right to buy but no obligation (seller is the writer and buyer is the holder)
Put option: right to sell but no obligation.
In the money: profit
No profit no loss: at the money
Out the money: loss
Two types of option:
American option and European option
The article: the Hindu “the options for covering risk”
 Period of maturity
 FP/Discount
 TRD
 Volatility of exchange rate
Session 13, 16-01-2018, Tuesday
Managing risk through swaps
Issues faced by corporates:
1. How do I access my global markets?
2. How do I get / borrow the currency at the rate at which I want?
Borrowings include short term as well as long term but in this course we look into short
term currency.
What is swap?
Private agreement between parties to exchange the cash flows in the future according
to a formula. OTC product. Customised product.
Two types of swaps:
1. IRS (interest rate swaps)
2. CS (Currency swaps)
Who mediates a swap deal?
Banks. They can play parts of both intermediates and counterparty.
Comparative advantage (CA) principle:
 Some companies may have CA when borrowing in fixed rate markets and some
other company might have CA in floating rate markets. It makes sense to
borrow in a market where a company has a CA.
 Fixed is given to highly credit rated companies.
 Floating rate is given to less credit rated companies.
 This might led the company borrowing fixed when it requires floating and vice
versa.
Quality Spread Differential (QSD)
 Spread is the difference between interest rate of two parties in the market.
 QSD: potential gains from the swaps that can be shared between the
counterparties and the swap bank.
Uses of currency swaps.
 Lower your cost of funds
 To gain access to restricted capital market
 To obtain funds in the form which otherwise is not available.
 Credit arbitrage
Types of currency swaps (couldn’t note down)
An example of interest rate swaps:
FIXED FLOATING
COMPANIES RATE RATE
X 10% MIBOR+0.5%
Y 12.50% MIBOR+1%
Quality
spread 2.5 0.5
QSD 2*(2.5-0.5)

2 represents the potential gain from the swaps that can be shared by the counter
parties and the swap banks.
“2” will be divided between two parties:
X = 10% - 1 = 9% floating= (MIBOR+0.5-1)
Y = (MIBOR + 1%) – 1 for fixed = 12.5-1 = 11.5%
MIBOR, LIBOR

Net Interest for X Net Interest for Y

pay fixed 10% pay floating MIBOR + 1%
received under received under
swap 11.50% swap MIBOR + 1%
pay under swap MIBOR + 1% pay under swap 11.50%
Net cost MIBOR - 0.5% Net cost 11.50%

X wants to borrow in USD and company Y wants to Borrow in JPY. Company X

requires 1000000 USD and at the currency exchange rate of USD = JPY. Company Y
requires 1150000 JPY.
Rates quoted by them
Companies USD JPY
X 9.5% 5%
Y 10% 6.5%
Quality spread 0.5 1.5%
QSD 1*(1.5-0.5)

Com X will borrow at 5% and Y in 10%

Session 14, 18-01-2018, Thursday
Case Goodrich – rabo bank
Questions for discussion
How comfortable are you with some of the terminologies of the case?
 Thrift institutions: rely heavily on public deposits
 Super now accounts: accounts which get slightly higher rates than that of NOW
accounts
 Euro Bond Market: it is different from Euro or Euro currency market.
o When I prefix the word “Euro” it means it is a bond or currency that can be
easily traded across the globe. All the major currencies that are traded
across the globe are used to raise debts in this market.


1. What is the state of affairs for B.F. Good rich?

 Financials are not so encouraging as a result of which there is lower
credit rating. From BBB to BBB-.
  Low credit rating companies will usually have floating rate of interest.
That has happened here as well

2. Why rabo bank Netherland wants to tap Euro Bond Market?

 Predominantly they are in to Agriculture lending.
 They want to diversify their product portfolio.
 They are not recognised in US market. Therefore they are entering into
swap to get recognition.
 They entered with 50 Million Dollars.

3. Who are the parties involved with the swap deal (direct/indirect)?
1. Morgan Guaranty Bank “MGB” – AAA, guarantee, Bilateral
agreement, one time guarantee fee of $125000
2. Salomon Brothers.

4. Why is the advisor suggesting B.F. Good rich to tap U.S debt Market?
5. What has been the role of intermediary in the deal? How different is it from what
we have understood of the term intermediary?
Session 15, 20-01-2018, Saturday
Case study: Hedging Currency risk at AIFS.
Risk management policy of the company reflects if the management of the company
is aggressive or conservative when it comes to handling the risk.
If the company is conservative: go to the basic well understood hedging product, i.e.
forward contract. If the company is very very conservative then no need to hedge at
all.

Session 17, 25-01-2018, Thursday

A company’s capital structure is basically the mixture of the debt and equity.
1. Debt
2. Equity
3. Preference
We will first calculate individual costs, put weights to it and then calculate WACC.
WACC: weight can be through:
1. Book value
2. Market value
Scenarios:
a. The company can raise funds in foreign currency. (most of the Indian
companies come under this category)
 b. ‘MNC’ can raise through FDIs, or can use M & A, or 100% subsidiaries, JVs to
enter foreign market

a. Why will a company go overseas?

 The cost of capital of Indian companies is more than cost of capital raised
overseas. Therefore WACC is reduced. For this,
o You should first see if the economy the company is operating is
segmented (controlled) or integrated (liberated)
o If it is integrated then it can use ADR, GDR, and IDR for equity. This
type of listing is called cross-listing. Advantages: (1) lesser cost of
capital, (2) better Image in global market. For debt, Eurobonds can
be raised.
b. MNCs:
 Should the company stick to the parent company’s capital structure?
 Should the company have its own capital structure?
 Or should it have a combination of both?

Session 18, 27-01-2018, Saturday
Multinational capital budgeting
Important factors of Domestic capital budgeting:
1. Estimation of cash flows
2. Discount rate
The principles of budgeting remains same.
The point we have to note form previous class is that, ‘MNC’ can raise through FDIs,
or can use M & A, or 100% subsidiaries, JVs to enter foreign market. Broadly this can
be classified as FDI.
1. Preparation of project cash flows. Subsidies: incentives given by the host
country should also be factored in the estimation of cash flows.
2. Discount rate.
3. Variables which affects your investments: Exchange rate
4. Government policies:
a. What is the policy of the host country as for as repatriation of profits?
Generally, a developing country will be looking for conservation policies.
(Blocked funds)
b. If you still want to share some money with your parent company, you will
be charged withholding tax.
c. “Transfer pricing” (dummy subsidiaries): there are three methods of
transfer pricing the IT ministry has declared.
d. Financial pattern.
Methods:
 1. IRR (modified IRR method)
2. NPV (MNPV Method)
3. PI
4. APV (Adjusted PV method)
We will be calculating two aspects of cash flows:
1. Conventional cash flows.
CF = PAT + Depreciation + PV of Incentives given by Govt.
WACC may not capture the effect of subsidies given by the Govt. Therefore it
is calculated separately by other Discount rate (Opportunity cost)