NMIMS Global Access School for Continuing Education

Course: International Finance

Answer 1.
Ever since the New Economic Policy was brought into force in 1991, entrepreneurs have been
eyeing the international finance markets to raise capital for their respective businesses. Adding to
that, the recent relaxations granted by the Indian government under the Make In India initiative,
allowing upto 100% Foreign Direct Investments in many sectors, access to the international
financial markets are at a high never seen before. The resilience of the Indian economy during the
2008 bond market collapse as well as the growth witnessed in the finance sector has prompted many
international institutions to invest in Indian ventures.
Borrowing funds from international markets which are non-rupee denominated exposes a business
to foreign currency rate fluctuation risks. Though the rate of interests charged by foreign institutions
located in developed nations might be lower than rates charged by Indian banks owing to the
developing economy of India, a dip in the Rupee value and the consequent foreign currency
translation of the foreign currency denominated interest payable may ultimately prove to not be in
favour of the enterprise. Careful analysis, determination of a mix that works for the enterprise and
hedging plans are required before one ventures out into the international financial markets to seek
funds. Often times the help of a professional is sought for such analysis and planning.
In the present scenario, as a banker, the following considerations must be taken on record and the
information must be provider to the Company before any borrowings are made:
Since the Company requires a medium to long-term period for repayment of the borrowing, seeking
funds from the international money market is not a viable plan. Instead, the Company must
approach the international credit markets. The possible avenues for the Indian Company, keeping in
mind the RBI regulations are:
 External Commercial Borrowings (ECB)
ECBs are borrowings from international credit or bond markets in the form of floating/ fixed
interest rate bank loans. ECBs are the most frequently used international borrowing
instruments in India. ECBS of upto $ 750 million are eligible to be processed through the
automatic approval route which also provides relief from a lot of red tape involved in
international transactions. ECBs are also subject to a all-in-cost ceiling of 500 bps i.e., 5%
of the amount borrowed.
 Foreign Currency Convertible Bonds (FCCB)
Bonds issued by an Indian Company but denominated in a foreign currency, which can be
subscribed non-resident individuals/ companies are known as FCCBs. The principal and
interest payments in such FCCBs are made in foreign currency. Upon maturity the FCCBs
may be wholly or partially converted into ordinary shares of the Company.
 Preference Shares
Preference share may or may not carry voting rights. This gives a Company to tweak
whether funds raised through issue of such shares should be given a say in the workings of
the Company. These are rupee denominated and the interest rates are adjusted to suit the
ongoing LIBOR (now Secured Overnight Financing Rate (SOFR)) rates.

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Course: International Finance
December 2022 Examination (Semester – IV)
 Foreign Currency Exchangeable Bonds (FCEB)
FCEBs are similar to FCCBs, with the difference being the convertibility of the bonds into
shares of another company instead of the company issuing the bonds. Such bonds are
usually issued by companies which may be new in the market and whose shares may not be
lucarative enough to garner interest of investor but another well-established company within
the same group may.
If the Company is unsure regarding its cashflows, considering the fact that the land is being bought
for setting up a manufacturing plant. Such set-up requires a long gestation period. The construction
of the plant itself, the training of new staff, testing phase for initial batches, may delay the
realisation of any actual considerable positive cashflows to the Company. Such a situation can lead
to problems for the Company, since any debt finance acquired by the Company will require timely
interest payments, which means a steady cash outflow without any mapped out corresponding
inflows from the funds invested. To avoid such cashflow crunch, the Company may also explore
equity-based funding sources.
 Foreign Institutional Investors (FII) or Foreign Portfolio Investors (FPI)
FIIs and FPIs are foreign investors which subscribe to the shares of the Company listed on
the domestic markets. After the relaxation of the Foreign Direct Investment Regulations,
such type of investment has become a significant part of the domestic equity markets in
India.
 Cross-listing/ Depository receipts
Another way of getting foreign investors attention towards equity shares of a Company is to
get the shares listed on a foreign stock exchange. If a Company incorporated in India and
listed on the Bombay Stock Exchange also gets themselves listed on the New York Stock
Exchange, such arrangement is called as Cross Listing.
A mix between the debt and equity options must be developed that best suits the needs of the
Company, minimises the cost of capital borrowed and allows the Company enough room to set-up
the production facility and generate cashflows and not get burdened by interest payments on debt.
Conclusion
Since the capital required to be raised is USD 50 million, the Company needs to evaluate the
effective costs of raising debt funds as well as equity. While calculating the cost of debt, the
effective rate of interest must be considered after adjusting for the upfront fees, processing fees, etc.
The mix of instruments to be utilised for raising capital must be based on weights such that the
overall weight average cost of capital gets minimised while at the same time ensuring that the
Company will be able to generate enough cash flows to meet the burden of compulsory timely
interest payments on debt-based finance.
Effective hedging arrangement must also be placed in order to safeguard against foreign exchange
fluctuation risks, else the Company may end up incurring a higher cost of capital than it would have
if the capital were to be raised domestically.

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Course: International Finance
December 2022 Examination (Semester – IV)

Answer 2.
In this era of globalisation, more and more market participants are entering into international
transactions, which requires settlement in foreign currencies. This increased traffic in terms of
settlement transactions involving various foreign currencies have led to the development of highly
sophisticated foreign exchange markets. These primarily deal with purchase and sale of domestic
currency against various foreign currencies as also exchange of one foreign currency for another.
The banks which act as intermediaries to facilitate such exchange of currencies mark their own
spread between the rates at which they purchase a certain currency and the rates at which they are
selling the same currency. This has led to the development of the Bid/Ask Rate system. The Bid
rate is the price that the bank is bidding or offering to purchase the currency whereas the Ask rate is
the price at which the bank is willing to sell the currency. The gap between these prices is the
spread for the bank.
Foreign exchange rates are always denoted in terms of how many units of currency 1 are required to
be exchanged for one unit of currency 2. E.g., how many INR for one USD. For a trader it is always
convenient to receive quotes for foreign currencies in terms of how much domestic currency is
required to be exchanged for a single unit of the foreign currency. Such type of a quote is known as
a direct quote or a direct exchange rate. Whereas when the number of foreign currency required to
be exchanged to obtain one unit of the domestic currency is specified it is known as an indirect
exchange rate.
In the present scenario, the information gathered by the forex trader location in Mumbai, having his
domestic currency in INR, the direct exchange rate would the one where the number of units of INR
required for a single unit of EURO is specified.
a. Direct Exchange Rate
Bid Price : EURO 1 = INR 80.8300
Ask Price: EURO 1 = INR 80.8400
b. Indirect Exchange Rate
The indirect exchange rate can be ascertained as follows:
1
Indirect Exchange Rate=
Direct Exchange Rate
1 1
Bid Price = = =0.0123701 i.e., INR 1 = EURO 0.0124
Direct Ask Price 80.8400

1 1
Ask Price = = =0.0123716 i.e., INR 1 = EURO 0.0124
Direct Bid Price 80.8300

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Course: International Finance
December 2022 Examination (Semester – IV)
Note: The spread between Bid and Ask price is getting eliminated on account of rounding off

into 4 decimals.

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Course: International Finance
December 2022 Examination (Semester – IV)
c. Cross Rate
When exchange quotes between any two currencies are not available, such exchange rates
are computed based on the exchange rates quoted for both such currencies in terms of a
common third currency. E.g., if the quote between Swiss Francs (CHF) and Russian Ruble
(RUB) is not available, but the USD-CHF rates and RUB-USD rates are available, the
RUB-CHF rates can be determined by multiplying the USD-CHF rates to the RUB-USD
rates.
In common usage, the USD is used as the common currency when determining the cross-
currency quotes, since the USD is quoted against most currencies. It is, however, necessary
that if one quote is denoted in terms of USD per foreign currency 1 the second quote must
be denoted in foreign currency 2 per USD for the cross-rate method to be applicable.
In the present scenario, the INR per EURO rates are available and EURO per USD rates
have been made available. The INR per USD rates can be determined in the following
manner:
Bid Rate : 80.8300 X 1.0200 = 82.4466 i.e., INR 82.4466 /USD i.e., INR 82.4466 per
USD
Ask Rate: 80.8400 X 1.0300 = 83.2652 i.e., INR 83.2652 /USD i.e., INR 83.2652 per
USD

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Course: International Finance
December 2022 Examination (Semester – IV)

Answer 3a.
Forward contracts are a type of derivative instruments, wherein one person gets a right to receive a
certain commodity/ currency at a future date at the rates determined on the day of entering the
contract and the other person has an obligation to delivery such commodity/ currency on the agreed
date. Forward contracts are obligatory in nature, which means that on the agreed upon future date,
the second party must deliver the commodity and the one party must accept the delivery and make
payment for the same. Forward contracts are also settled without delivery by one party making
payment to the other on the basis of the forward rate booked and spot rates as on the agreed date.
Forward rates are determined on the basis of premium or discount charged by the banks on the spot
rates based on the bank’s outlook of whether a currency will appreciate or depreciate in the future.
The units of how much discount/ premium is being charged are called as pips. Pips are denoted as
the smallest unit of the prices being quoted i.e., when prices are being quoted in 4 decimals, 1 pip is
equivalent to 0.0001.
In the present case, the EUR/USD spot rates are 1.0973/1.0974. This means the bid rate is EURO
1.0973/ USD and the ask rate is EURO 1.0974 /USD. The pips being charged by the banks are
75.50 and 76.00. Which means the forward rates being offered by the bank are:
Bid Rate Ask Rate
EUR/USD Spot Rate 1.0973 1.0974
+ pips 75.50 76.00
= 1.0973 + (75.50/10000) = 1.0974 + (76/10000)
EUR/USD 3M Forward Rates 1.10485 1.1050

Since in the present case, the 3-month forward rates for EUR/USD are higher than their spot rates.
The base currency, being the USD, is being traded at a forward premium. Which means the EURO
is being quoted at a discount to the USD.
Also, the US Company being an exporter, has a receivable asset, to be settled in 3 months’ time.
Hence the US Company will be receiving EUR 100 million and will have to converted it into USD.
The applicable rate for the US Company to book the forward contract shall be the 3-months
forward bid rate i.e., EUR 1.10485/ USD or USD 0.9050/ EUR.

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Course: International Finance
December 2022 Examination (Semester – IV)

Answer 3b.
Currency Depreciation is a fall in the value of a currency in terms of its exchange rate versus other
currencies. It can also be used to refer to the loss in purchasing power of a currency, when more and
more currency needs to be exchanged for procuring the same goods/ services. Currency
Depreciation can occur due to many factors such as economic instability, interest rate differentials,
political instability, etc.
In the present scenario, the US Company being an exporter, has a net receivable asset, to be realised
in 3-months’ time. The Company has invoiced in EUR; hence it has a EURO exposure. The USD
depreciating means that as compared to the situation today, more USD will be needed to convert the
EUR 100 million in the future. This can also be evidenced by the USD-EUR forward rates being
quoted at a premium as computed in the Answer 3a above.
Taking the facts into consideration, that the USD is expected to depreciate, the net position being
receivable asset denoted in EUROs, it would be beneficial for the US Company to avoid getting
locked into the forward rate by entering into a forward contract. If the USD depreciates further
than the forward rates booked, the Company stands to gain by leaving its position unhedged.
However, if the US Company nonetheless hedges its receivable position by booking a forward
contract at the forward rates of USD 0.9050 /EUR (as computed above), the total USD amount
realised by the US Company shall be EUR 100,00,00,000 X 0.9050 = USD 90,49,77,376.
Whereas, if the US Company would have left its position unhedged and the spot rate would have
remained unchanged at the end of 3 months i.e.,
1 1
USD/EUR Spot Bid Rate = = =0.9112
Spot Ask Rate EUR /USD 1.0974
Hence, in an unhedged position, the Company would have realised EUR 100,00,00,000 X 0.9112 =
USD 91,12,44,760.
Due to the forward contract hedged the Company suffered a notional loss of USD 62,67,384
(91,12,44,760 – 90,49,77,376)
In the current scenario, the Company suffered a notional loss due to its hedging policy, however, on
prudent grounds, it is always advisable to minimize one’s foreign currency exposure risks by
implementing effective hedging instruments.

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