Tutorial 9

1) i. Answer:

The reason is because customers, speculators or bankers need the valuation to hedge
their immediate Forex exposure risk.

ii. Answer:

Quoting FX rate for value ‘tom’ and value ‘tod’ from the spot rate (spot date) is a
‘backward’ valuation.

iii. Answer:

As bid swap point > offer swap point, then it is selling at discount. As offer swap
point is impossible selling at lower rate than bid swap point, then discount should add
to the spot rate. As bid swap point < offer swap point, then it is selling at premium,
then the premium rate should deduct to the spot rate.

As forward premium is a positive increase to the forward price, if the currency is to

valued backward to the current rate, the forward premium will have to be subtracted
from the spot rate.

on the other hand, a forward discount is a decrease of forward price, so to bring the
value of the currency backward, we need to add the forward discount swap point to
the spot rate.

2) i) Answer: Cross subtract the swap points from the spot rate.

ii) Answer: USD

3. a) Answer:

First type of forex contract is a two month outright Forward Foreign Exchange
contract for GBP/MYR 20 mil. Second type of forex contract is value tom foreign
exchange contract.

b) Answer:

Value date: June 12th, Settlement amount: GBP/MYR 7 X 20 million = MYR140

million
Value date: April 13th, Settlement amount: GBP/MYR 6.90 X 30 million = MYR207
million

c) Answer:

Advantages:
- Customer can lock in cost of forex transaction and can mitigate forex risk.

- Contracts are customizing and simple to use.

- Minimum cost because customer usually pays a minimal cost on top of the interbank
rates and gets full protection from forex risk.

Disadvantages:

- Does not favour the customer against positive future currency movements
- No flexibility on delivery date
- Contractual agreement that must be completed on the due date
- No opportunity to benefit from favorable movement in exchange rate
- Cash flow and receivables may not correspond to the contracted date of the
forex contract.

4) Answer:

5) Answer:
a)
Value “tod”
GBP is at forward premium, need to cross deduct.
The FX value “tod’ for bid rate = 7.0780 – (0.00011 + 0.00012)
= 7.07777
The FX value “tod” for offer rate = 7.0785 – (0.0001 + 0.00011)
= 7.07829
The Bank takes a margin of 5 points on all transactions.
Bid rate = 7.07777 – 0.0005
= 7.07727
Offer rate = 7.07829 + 0.0005
 = 7.07879
Receipt of GBP 10 million expected on 4th January
Value “tom”
GBP is at forward premium, need to cross deduct.
The FX value “tom” for bid rate = 7.0780 – 0.00012
= 7.07788
The FX value “tom” for offer rate = 7.0785 – 0.00011
= 7.07839
The Bank takes a margin of 5 points on all transaction
Bid rate = 7.07788 – 0.0005
= 7.07738
Offer rate = 7.07839 + 0.0005
= 7.07889
Payment of GBP 20 million due on 5th April
Spot GBP/MYR = 7.0780 / 7.0785
3-month GBP interest rate = 2.3500 – 2.3000 (91 days)
3-month MYR interest rate = 2.9600 – 2.9200 (91 days)
To sell GBP to MNC in the future, to compute offer rate.
GBP Nostro account will be in long: lend GBP at 2.3000
MYR Nostro account will be in short: borrow MYR at 2.9600.
[(1+ MYR interest rate)]
3-month GBP/MYR TTS = Spot GBP/MYR ×
(1+GBP interest rate)
[1+(0.029600)(91/365)]
= 7.0785 ×
[1+(0.023000)(91/365)]
= 7.0785 ׿)
` =7.0905
Swap point = 7.0905 – 7.0785 = 0.012 (120 swap points)
Spot rate 7.0785 < forward rate 7.0905
*swap point is at forward premium
The Bank takes a margin of 5 points on all transactions.
Forward FX offer rate + margin point = 7.0905 + 0.0005
= 7.0910
b. Answer:
The spot rates and forward exchange rates are related to each other through the
interest rate parity. So the main factor that causes the forward rates between two
currencies to be different from their spot rates is actually the interest rate difference of
those two currencies.
The relationship between forward premium / discount is countries with higher
interest rate has a currency forward discount while countries with lower interest rate
has a currency forward premium. In the relationship between the forward premium /
discount and interest rates, if the base currency interest rate is lower than the quoted
currency interest rate means that the forward outright exchange rate is always greater
than the spot rate. This means the base currency is worth more units of the quoted
currency for delivery forward than it is for delivery spot.
If an investor were to deposit money in the quoted currency, instead of the
base currency, he will receive more interest. If the investor were to sell forward the
maturing deposit amount to lock in the advantage, the forward exchange rate is
correspondingly worse so investor loses the advantage. The base currency is paid to
be at a premium to the quoted currency while the quoted currency to be at a discount
to the base currency. (refer chapter8, slide 12,13)

6) a) Answer:

i. 6.5070 – 0.0003 – 0.0003 = 6.5064

6.5064 + 0.0004 = 6.5068

ii.

Bid Offer
Spot 6.5050 6.5070
T/N swap 3 3.1
Value ‘tom’ 6.50531 6.5067

6.5070 - 0.0003 = 6.5067

6.5067 + 0.0004 = 6.5071

iii. 6.5050 – 0.0004 = 6.5046

 b) Answer:
Advantage:
1. Can use the contract on any good business day with the specific option
period.
2. Simplicity and flexibility as he can draw the contracted amount in smaller
portion as and when needed
3. As he can also draw smaller amount and thus can be cheaper
4. If there is any remaining amount left “unutilised” the hedge can “close-
out” the contract or request for an extension
5. Solve timing and irregular cash flow problem
Disadvantage:
1. Cost more as bank have to provide for the transaction, bank do not know
exactly date of draw down
2. Bank may restrict the customer to use the option only once and also use
the whole contracted amount
7) a) Answer:

The Forex profit made from USDMYR trading position

= (100 million × 4.1800) - (100million × 4.1565)

=418,000,000 - 415,650,000

=MYR 2,350,000

The bank will earn a swap point profit of:

(0.08- 0.05) × 4.1800 × 30/360 = RM1,045,000

Therefore, total profit is MYR 2,350,000 + MYR1,045,000 = MYR 3,3950,00.

b) Answer:

 Square all position at day-end.

 Cover part of the position and leaves the balance overnight.

 Keep position intact and leaves it overnight but provide instruction “stop loss”
or “take profit” to counterparty.