Accounting & Finance for Bankers

MODULE A
PRESENTATION
BY
Cma Sunil Kumar Mohan

cmaskmohan@gmail.com
9839736168
 JAIIB-Accounting & Finance for Bankers
MODULE-A
BUSINESS MATHEMATICS and finance

1. Calculation of Simple and compound Interest

2. Calculation YTM
3. Capital Budgeting Techniques
4. Depreciation Methods
5. FX Exchange Arithmetic

5/6/2018 S K MOHAN 2
 Calculation of Interest
• Simple
• Compound
• Rule of 72
• Sinking fund method
• Annuities ordinary annuity and annuity due
• Amortization of debts (EMI)
• Perpetuities (infinite series of payment made at fixed
intervals )

5/6/2018 S K MOHAN 3
 Calculation of Simple and compound Interest-1
• Total repayment = Principle + interest
• Rate of Interest
– Simple Interest = Principle X time period X rate
– When interest earns interest , it is called Compounded interest
– Fixed Interest rate and floating interest rate
– Front end and back end interest
– Teaser rate of interest
• In how many years will take to double your money with
specific rate of interest is called RULE 72.
• An annuity is a series of payments made at fixed intervals
. types of annuities are :-
– Ordinary annuity and ( payment at the end of period)
– Annuity Due ( Payment at beginning of each period)
– Present value and Future value of both annuities are different

5/6/2018 S K MOHAN 4
 Simple Interest
• 'Simple' interest or 'flat rate' interest is the amount of interest
paid each year in a fixed percentage of the amount borrowed
or lent at the start.
• Formula for calculating simple interest :
Interest = Principal x Rate x Time (PRT), where:
• 'Interest' is the total amount of interest paid
'Principal' is the amount lent or borrowed
'Rate' is the percentage of the principal charged as interest
each year.
'Time' is the time in years of the loan.
• Example :
• Principal: 'P' = Rs. 50,000, Interest rate: 'R' = 10% = 0.10,
Repayment time: T = 3 years. Find the amount of interest paid.
• Interest = PRT
= 50,000x0.10x3
= Rs. 15,000

5/6/2018 S K MOHAN 5
• Simple Intt :-- P x R x T
• A sum of money amount to Rs.2,240 @ 4% simple interest in 3
years. Find the interest on the same sum for 6 months @ 3.5%
p.a.
• a. Rs. 35
• b. Rs. 40
• c. Rs. 45
• d. Rs. 50
• Ans – a
• A=P(1+rt)= 2240=P(1+4/100 X3)=28/25
• 2240/28*25=2000
• 3.5% of 2000= 70 and six month is rs.35/-
5/6/2018 S K MOHAN 6
• At 5% per annum simple interest, Rahul borrowed
Rs. 500. What amount will he pay to clear the debt
after 4 years ?
– A. 750
– B. 700
– C. 650
– D. 600
• Ans - D
• Explanation:
• We need to calculate the total amount to be paid by
him after 4 years, So it will be
• Principal + simple interest.
• So,=>500+500*5*4/100
• =>Rs.600
5/6/2018 S K MOHAN 7
 Compound Interest
• Compound interest is paid on the original principal and accumulated part
of interest.
• A=P(1+r)n
• P = the principal
A = the amount of money accumulated after n years
r = Annual the rate
n = number of years that interest is compounded
• Formula for calculating compound interest :
• A = P(1 +r/n)^nt, where
• P = the principal
A = the amount deposited
r = the rate (expressed as fraction, e.g. 6 per cent = 0.06)
n = number of times per year that interest is compounded
t = number of years invested
• Frequently compounding of Interest. If the interest is compounded :
Annually = P (1 + r)
Quarterly = P (1 + r/4)^4
Monthly = P (1 + r/12)^12

5/6/2018 S K MOHAN 8
• What is the principal amount which earns Rs. 264 as compound
interest for the second year @ 10% p.a.?
– a. Rs. 2,000
– b. Rs. 2,200
– c. Rs. 2,400
– d. Rs. 2,600
• Ans - c
• Solution :

• A = P(1+r/100) n
– In the formula, A represents the final amount in the account after n years at interest rate 'r'
with starting amount 'p'.
– P 2nd year = 2640
– A 1st Year = 2640
• P 1st = (2640/110*100) = 2400
• Rs. 400 at 5% p.a. compound interest will amount to Rs. 441 in......
– a. 1 year
– b. 2 years
– c. 3 years
– d. 4 years
• 5/6/2018
Ans – b S K MOHAN 9
• Find the compound interest on Rs 160000 for one year at
the rate of 20% per annum, if the interest is
compounded quarterly.
• Solution:
• Given:
• P = Rs 160,000
• R = 20 % p. a.
• n = 1 year
• We know that:
• A = P(1+R/400)4n
• A = 160000(1+20/400)4
• A = 160000(1.05)4
• A = Rs 19,4481
• Now, CI = A – P = Rs 19,448.1 – Rs 16,000 = Rs 3,4481
• Mewa Lal borrowed Rs 20000 from his friend Rooplal
at 18% per annum simple interest. He lent it to Rampal
at the same rate but compounded annually. Find his
gain after 2 years.
• Solution:
• SI for Mewa Lal = P*R*T = 20000×18/100×2 = Rs 7,200
• Thus, he has to pay Rs 7,200 as interest after borrowing
CI for Mewa Lal = A – P
• = 20000(1+18/100)2 – 20,000
• = 20000(1.18)2 – 20,000
• = 27,848- 20,000
• = Rs 7,848
• He gained Rs 7,848 as interest after lending. His gain in
the whole transaction
• = Rs 7,848 – Rs 7,200 = Rs 648
• Rohit deposited Rs 8000 with a finance company for 3
years at an interest of 15% per annum. What is the
compound interest that Rohit gets after 3 years?
• Solution:
• We know that amount A at the end of n years at the rate
of R% per annum is given by = A = P(1+R/100)n
• Given:
• P = Rs 8,000
• R = 15% p.a.
• n = 3 years.
• Now,
• A = 8000(1+15/100)3
• A = 8000(115/100)3
• A = Rs. 12,167
• And, CI = A – P = Rs 12,167 – Rs 8,000 = Rs 4,167
• In a laboratory, the count of bacteria in a certain experiment was increasing
at the rate of 2.5% per hour. Find the bacteria at the end of 2 hours if the
count was initially 5,06,000.
• Ans. Here, Principal (P) = 5,06,000, Rate of Interest (R) = 2.5%, Time = 2 hours
• After 2 hours, number of bacteria,
• Amount (A) =
•
• =

• =

• 5,31,616.25
• Hence, number of bacteria after two hours are 531616 (approx.).
• Qus. If the simple interest on a sum of money at 5% per annum for 3 years is Rs.
1200, find the compound interest on the same sum for the same period at the
same rate.
Sol. Clearly, Rate = 5% p.a., Time = 3 years, S.I.= Rs. 1200. ..
So principal=RS [100*1200]/3*5=RS 8000
Amount = Rs. 8000 x [1 +5/100]^3 - = Rs. 9261.
.. C.I. = Rs. (9261 - 8000) = Rs. 1261.
• The difference between the S.I. and C.I. on a certain sum of money for 2 years
at 4% per annum is Rs 20. Find the sum.
• Solution:
• Given:
• CI – SI = Rs 20
• [P(1+4/100)2−P]−P×4/100×2=20 P[(1.04)2−P]−0.08P=20
• 0.0816P – 0.08P = 20
• 0.0016P = 20
• P = 200.0016
• P = 12500
• Thus, the required sum is Rs 12500.
• ) The present population of a town is 25000. It grows at 4%, 5% and 8% during first
year, second year and third year respectively. Find its population after 3 years.
• Solution:
• Here,
• P = Initial population = 25000
• R1 = 4%
• R2 = 5%
• R3 = 8%
• n = Number of years = 3
• Therefore, Population after three years
= P(1+R1/100)(1+R2/100)(1+R/3100)
• = 25000(1+4100)(1+5100)(1+8100)
• = 25000 (1.04) (1.05) (1.08)
• = 29484
• Hence, the population after three years will be 29484.
•
• Aman started a factory with an initial
investment of its 100000. In the first year, he
incurred a loss of 5%. However, during the
second year, he earned a profit of 10% which is
the third year rose to 12%. Calculate his net
profit for the entire period of three years.
• Solution:
• Aman’s profit for three years = P(1−R1/100)(1+R2/100)(1+R3/100)
• = 100000(1−5/100)(1+10/100)(1+12/100)
• = 100000 (0.95) (1.10) (1.12)
• = 117040
• Therefore, Net profit = Rs 117,040 – Rs 100,000
• = Rs 17,040
• The cost of a T.V. set was quoted Rs 17000 at the
beginning of 2015. In the beginning of 2016 the
price was hiked by 5%. Because of decrease in
demand the cost was reduced by 4% in the
beginning of 2017. What was the cost of the T.V.
set in 2017?
• Solution:
• Cost of the TV = P(1+R/100)(1−R/100)
• => 17000(1+5/100)(1−4/100)
• = 17,000 (1.05) (0.96)
• = 17,136
• Thus, the cost of the TV in 2017 was Rs 17,136.
• Ashish started the business with an initial
investment of Rs 500000. In the first year he
incurred a loss of 4%. However during the
second year he earned a profit of 5% which in
third year rose to 10%. Calculate the net profit
for the entire period of 3 years.
• Solution:
• Profit for three years
= P(1−R1/100)(1+R2/100)(1+R3/100)
• => 500000(1−4/100)(1+5/100)(1+10/100)
• = 500,000 (0.96) (1.05) (1.10) = 554,400
• Thus, the net profit is Rs 554,400
• Illustration
• The population of an industrial town is increasing by 5 per cent
every year. If the present population is 1 million, estimate the
population five years hence. Also, estimate the population
three years ago.
• Solution
• Present population, P = 1 million, rate of increase = 5% per
annum
• A = P(1+R/100)n
• Hence, the population after 5 years
• = 10,00,000 (1.05)5
• = 12,76,280
• P= A /(1+R/100)n
• Population three years ago = 10,00,000/ (1.05)3= 8,63,838
• Since the population three years ago, compounded at 5 per
cent, is equal to 1 million, today.
 Calculation of Simple and compound Interest-1
• Mr. x borrowed a sum of Rs. 20000/- from Y at 12%
p.a. What is the amount of total interest payable
in two years?
• 1200
• 2400
• 4800
• 7200
• Non of above
• X borrowed Rs.10000/- from Y at 10% p.a. what is
total amount repayable by X to y in three years
» Rs.10000/-
» Rs.3000/-
» Rs.13000/-
– Rs.11000-
» NOA

5/6/2018 S K MOHAN 20
• A sum of money doubles itself at compound
interest in 15 years it will become 8 time in
• A) 60 B)80 C)45 D ) 40

• According to rule of 72, to calculate the time

when the amount becomes double what formula
is used:
• a. Principal / time
• b. Interest rate / 72
• c. 72 / time
• d. 72/ interest rate
• e. Principal /72

5/6/2018 S K MOHAN 21
 Calculation of Simple and compound Interest-2
• Interest that is paid on the original principal amount and also
on the accumulated part of the interest , is called
» Yield on Maturity
» Annuities
» Compound interest
– interest
– NOA
• On an amount of Rs.50000/- lent on 8% interest. On which of the
following compounding periods, the interest amount will be
highest
– Half yearly compounding
– Yearly
– Quarterly
– Monthly
– Weekly
5/6/2018 S K MOHAN 22
• What will be the compound interest on Rs. 25000
after 3 years at the rate of 12 % per annum?
– a. Rs 10123.20
b. Rs 10123.30
c. Rs 10123.40
d. Rs 10123.50
• Ans - a
• Explanation:
• A=P(1+r)n
• = (25000×(1+12/100)^3)
= 25000×(28/25)^3
= 35123.20
• So Compound interest will be 35123.20 - 25000
• = Rs 10123.20

5/6/2018 S K MOHAN 23
 Sinking Fund

• A sinking fund is an account earning compound

interest into which you make periodic deposits.
• Suppose that the account has an annual
interest rate of compounded times per year, so
that is the interest rate per compounding
period.
• If you make a payment of at the end of each
period, then the future value after years, or
periods, will be
• FV=PMT { (1+i)n -1 }
• i
• Payment Formula for a Sinking Fund
• Suppose that an account has an annual rate of
compounded M times per year,
• so that i = R/M is the interest rate per
compounding period.
• If you want to accumulate a total of FV in the
account after T years, or N=MT periods, by
making payments PMT of at the end of each
period, then each payment must be .
• PMT= FV
• Sinking fund is created to accumulate the principle at
the end of term of loan period or end of life of assets
• schedule showing how a sinking fund accumulates to
the desired amount is called sinking fund schedule
• Sinking fund deposit is determined by the SIZE of the
payment to be made at the end of a particular period
• Sinking fund are used to pay –off debts, to redeem
bonds issues , to replace worn-out equipment , to buy
new equipment ,
• It is also one of the Depreciation method
• Formula for Sinking Fund ===
• F (future value) = A{ (1+i)n- 1}
• i
5/6/2018 S K MOHAN 26
• Illustration
• 1. If you wish an annuity to grow to Rs. 17,000 over 5 years so
that you can replace your car, what monthly deposit would be
required if you could invest at 12 per cent compounded monthly?
• Formula for future value of annuity
• F (future value) = A{ (1+i)n- 1}
• i
• =0.12/12 =0.01% per month
• = 5 x 12 =60 Months
• 17,000= A [(1+0.01)60-1]
• 0.01
• A = 208.16
• The monthly payment should be Rs. 208.16
• How much must Mohan save each month in
order to buy a new car for Rs12,000 in three
years if the interest rate is 6% compounded
monthly?
• PMT= FV{( i )
• ( 1+i) n -1
• 12000 ( 0.06/ 12 )
• (1+.06/12) 36 -1
• =305.06
• Illustration
• Prakash Publishers buy a machine for Rs. 20,000. The rate of
depreciation is 10 per cent. Find the depreciated value of the
machine after 3 years. Also, find the amount of depreciation.
What is the average rate of depreciation?
• Solution
• Original value of machine = Rs. 20,000,
• Rate of depreciation, i = 10%
• Hence, the book value after 3 years = 20,000(1-0.1)3
• = 20,000(0.9)3
• = 20,000 (0.729) = Rs. 14,580.
• Amount of depreciation in 3 years = Rs. 20,000 - Rs. 14,580 =
Rs. 5,420
• Average rate of depreciation in 3 years
• (5,420/20,000) x (100/3) = 9.033%
• Qus :-An annuity consists of monthly repayments of Rs. 600 made over
20 years.
– (a) What is the present value of the annuity?
– (b) How much money is repaid?
– (c) What is the future value of the payments?
– (assume 14 per cent compounded monthly)
• Solution a
• r = 0.14/12 = 0.0117
• n= 20 x 12 = 240
• F= 600 [(1 +0.14/12)240-1/0.14/12]
• F = 48,250.10 (The present value of annuity)
• Solution b
• The amount repaid = 600 x 12 x 20 = 1,44,000
• Solution c
• F= 600 [(1 +0.14/12)240-1/0.14/12]
• = 7, 80,699.45
• The future value of the annuity is Rs. 7,80.699.45
 Repayment of Debts
• Most popular method of paying Loans is EMI. It is called
Amortization Method .
• ENTIRE PERIOD OF PAYMENT IS CALLED TERM OF
ANNUITY AND
• EACH PERIOD OF PAYMENT (Month, quarter, year etc )is
called payment period
• equal monthly /quarterly installment of principle PLUS
interest applied during the period
• Equated monthly /quarterly installment covering both the
principle and interest
• Bullet repayment under the entire loan amount is repaid at
the end of the period
• Balloon repayment is that amount of repayment increased
slowly every month
5/6/2018 S K MOHAN 31
 Understanding Formula for EMI, Annuities
• Let us take case of a Car loan of Rs 1lac at 12%p.a. ,repayable in 180
installments (here p=1,00,000and r=12/100*12=.01)
– In the 1st month, bank will charge interest equal to p*r=Rs 1000 and so, the
outstanding amount will become Rs 1,01,000.
• What happens if the EMI is fixed at p*r, which is Rs 1000?
• This EMI will meet only the interest applied and so the principal will remain
unchanged at Rs 1,00,000.
• This process will continue and the loan will remain outstanding for ever.
Therefore, EMI has to be slightly more than p*r so that some amount can go
towards reducing the principal amount
• If EMI has to be more than p*r, we should multiply p*r by a fig which is more
than 1.
• This fig is (1+r)n
• (1+r)n -1.
• You will observe that denominator in less than numerator by 1 only. E.g., if
numerator is 5.2310, the denominator will be 4.2310 . So, this fig is
always more than 1.
• Therefore, in a question, if periodic payment ,n and r are given, you can
calculate PV. FV is calculated byS Kmultiplying
5/6/2018 MOHAN PV by (1+r)n.• 32
 Formula FOR EMI

• E = P×r×(1 + r)n/((1 + r)n - 1)

• E = is EMI
• P = is Principle Loan Amount
• r = is rate of interest
• If calculated in monthly basis it should be = Rate of
Annual interest/12/100
• if its 10% annual ,then its 10/12/100=0.00833
• n = is tenure in number of months
• Example :
• For 100000 at 10% annual interest for a period of 12
months, it comes to :
• 100000*0.00833*(1 + 0.00833)12/((1 + 0.00833)12 - 1) =
8792

5/6/2018 S K MOHAN 33
 Annuities
• An annuity is any series of equal payments that are
made at regular intervals.
• Types of annuities are :-
– Ordinary annuity and ( payment at the end of period)
– Annuity Due ( Payment at beginning of each period)
• The periods between payments in an annuity can be
just about anything -- years, months, weeks;
• It doesn't matter as long as the interval is consistent
• Present value and Future value of both
annuities are different
• The difference lies in the timing of each payment
relative to the period the payment covers.
5/6/2018 S K MOHAN 34
• if you're the one making the payments, you're
better off with an ordinary annuity.
• If you're the one receiving the payments,
you're better off with an annuity due.
• The reason lies in a basic principle of finance
known as the "time value of money":
• Each payment of an ordinary annuity belongs
to the payment period preceding its date,
• while the payment of an annuity-due refers to
a payment period following its date.

5/6/2018 S K MOHAN 35
• A more simplistic way of expressing the
distinction is to say that payments made under
an ordinary annuity occur at the end of the
period
• while payments made under an annuity due
occur at the beginning of the period.

5/6/2018 S K MOHAN 36
 Calculating the Value of an Annuity Due

An annuity due is calculated in reference to an

ordinary annuity.
1st calculate either the present value (PV) or
future value (FV) of an ordinary annuity,
 multiply the result by a factor of (1 + i) as
shown below…
Annuity Due = Annuity Ordinary x (1 + i)

5/6/2018 S K MOHAN 37
• Present Value of an Annuity
calculate the PV of an ordinary annuity of 50 per year over 3
years at 7% as...
...

• and the present value of an annuity due under the same terms
is calculated as...
..

• the PV of the annuity due is greater than the PV of the ordinary

annuity; by 9.18.

5/6/2018 S K MOHAN 38
• Future Value of an Annuity
calculate the FV of an ordinary annuity of 25 per year
over 3 years at 9% as...

• future value of an annuity due under the same terms is

calculated as...

•
...and again the FV of the annuity due is greater than
the FV of the ordinary annuity; by 7.38.

5/6/2018 S K MOHAN 39
• Example :
• 1. Calculate the present value on Jan 1, 2015 of an
annuity of 5,000 paid at the end of each month of the
calendar year 2015. The annual interest rate is 12%.
• Solution
We have,
Periodic Payment R = 5,000
Number of Periods n = 12
Interest Rate i = 12%/12 = 1%
Present Value
PV = 5000 × (1-(1+1%)^(-12))/1%
= 5000 × (1-1.01^-12)/1%
= 5000 × (1-0.88745)/1%
= 5000 × 0.11255/1%
= 5000 × 11.255
= 56,275.40
5/6/2018 S K MOHAN 40
• A certain amount was invested on Jan 1, 2015 such that it
generated a periodic payment of 10,000 at the beginning of
each month of the calendar year 2015. The interest rate on
the investment was 13.2%. Calculate the original investment
and the interest earned.
• Solution
Periodic Payment R = 10,000
Number of Periods n = 12
Interest Rate i = 13.2%/12 = 1.1%
Original Investment = PV of annuity due on Jan 1, 2015
= 10,000 × (1-(1+1.1%)^(-12))/1.1% × (1+1.1%)
= 10,000 × (1-1.011^-12)/0.011 × 1.011
= 10,000 × (1-0.876973)/0.011 × 1.011
= 10,000 × 0.123027/0.011 × 1.011
= 10,000 × 11.184289 × 1.011
= 1,13,073.20
Interest Earned = 10,000 × 12 − 1,13,073.20
•
= 1,20,000 – 1,13,073.20 = 6926.80
5/6/2018 S K MOHAN 41
 SUMMARY OF ANNUITIES FORMULAS
• FUTURE VALUE OF INVESTMENT AT THE END OF PERIOD,
FVOA (Future Value of Ordinary Annuity) is applied.
• FVOA = (C ÷ R) x { (1 + R)^T - 1 }
• FUTURE VALUE OF INVESTMENT AT THE BEGINNING OF
PERIOD, FVAD (Future Value of Annuity Due) is applied.
– FVAD = (C ÷ R) x { (1 + R)^T - 1 } x (1 + R)
• PRESENT VALUE OF INVESTMENT AT THE END OF PERIOD,
PVOA (Present Value of Ordinary Annuity) is applied.
• PVOA = (C ÷ R) x { (1 + R)^T - 1 } ÷ (1 + R)^T
• PRESENT VALUE OF INVESTMENT AT THE BEGINNING OF
PERIOD, PVAD (Present Value of Annuity Due) is applied.
• PVAD = (C ÷ R) x { (1 + R)^T - 1 } x (1 + R) ÷ (1 + R)^T

5/6/2018 S K MOHAN 42
 Present Value

Present value describes how much a future sum of money is

worth today.
Three most influential components of present value are :
time,
expected rate of return,
the size of the future cash flow
The formula for present value is:
PV = CF/(1+r)n
Where:
CF = cash flow in future period
r = the periodic rate of return or interest (also called the
discount rate or the required rate of return)
n = number of periods
5/6/2018 S K MOHAN 43
 Example :
Assume that you would like to put money in an account today
to make sure your child has enough money in 10 years to
buy a car. If you would like to give your child 10,00,000 in
10 years, and you know you can get 5% interest
per year from a savings account during that time, how
much should you put in the account now?

PV = 10,00,000 / (1+.05)10 = 6,13,913/-

Thus, 6,13,913 will be worth 10,00,000 in 10 years if you

can earn 5% each year. In other words, the present value of
10,00,000 in this scenario is 6,13,913.

5/6/2018 S K MOHAN 44
• Future Value
The value of an asset or cash at a specified date in the future that is equivalent in value
to a specified sum today. It refers to a method of calculating how much the present
value (PV) of an asset or cash will be worth at a specific time in the future. There are
two ways to calculate FV:
1) For an asset with simple annual interest: = Original Investment x (1+(interest
rate*number of years))
• .2) For an asset with interest compounded annually: = Original Investment x
((1+interest rate)^number of years)
Example:
1) 10,000 invested for 5 years with simple annual interest of 10% would have a future
value of
FV = 10000(1+(0.10*5))
= 10000(1+0.50)
= 10000*1.5
= 15000
2) 10,000 invested for 5 years at 10%, compounded annually has a future value of :
FV = 10000(1+0.10)^5)
= 10000(1.10)^5
= 10000*1.61051
= 16105.10

5/6/2018 S K MOHAN 45
 Calculation of Simple and compound Interest-3
• An annuity under which payments are made in the beginning of each
period are known as
– Annual annuity
– Special annuity
– Ordinary annuity
– Annuity due
– NOA
• An annuity under which payment are made at the end of each period
are known as ;-
– Annual annuity
– Special annuity
– Ordinary annuity
– NOA

5/6/2018 S K MOHAN 46
• When a debt is amortised by equal payment at equal payment
intervals, the debt becomes
» Annuity
» Future value of annuity
– Present value of annuity
– Discounted value of annuity
– NOA

• Total time during which the debt is amortised , is called

– Term of annuity
– Payment period of annuity
– Annuity duration
– Annuity period

5/6/2018 S K MOHAN 47
• When amount is accumulated by means of equal periodic
contribution with the objective of using it for a specific
purpose , this is called
» Specific Reserve
» Special reserve
» Time deposit
» Sinking fund
» Annuity

• Which of the following can not be an objective

of creation of sinking fund :-
» Buy new equipment
– Pay off debts
– Redeem bond issues
– Replace worn out equipment
– NOA
5/6/2018 S K MOHAN 48
• A=P (1 – r)n is used to calculate the following:
– a. simple interest on annual basis
– b. compounded interest with annual rest
– c. compounded interest with half-yearly rest
– d. compounded interest with quarterly rest
• The annuity is annuity due. It represents which of the
following:
I. cash flow is at the end of the given period
II. cash outflow only is at the given period
III. cash flow in the beginning of the given period
IV. cash inflow only in the beginning of the given period

5/6/2018 S K MOHAN 49
 Bonds
• What are bonds and what is relation between purchaser and issuer
• Who issues bonds
• Types of bonds
• Straight Bonds or Fixed rate bonds
• Zero Coupon Bonds
• Deep Discount Bonds
• Floating rate Bonds – linked with reference rate of interest e.g. LIBOR , MIBOR ,
• Convertible bonds
• Inflation –indexed Bonds
• Other index bonds - equity link etc
• High yield bond ( JUNK BON DS ) rated below investment grade
• Assets Backed Securities Bonds
• Subordinate bonds – lower priority at the time of liquidation
• Perpetual Bonds -- no maturity date
• Bearer bonds – indira vikas patra
• government bonds also called Treasury Bonds
• Bond Valuation
• Present value method of Bond valuation
• Bond value with Semi –annual Coupons (Interest)

5/6/2018 S K MOHAN 50
 Terms related to Bonds
• Face value -----
– Straight bonds
– face value of Zero Coupon bonds
• Coupon rate
• Maturity
• Term to Maturity
• Market Value
• Discount rate
• Yield
• Current Yield
• Yield To Maturity
5/6/2018 S K MOHAN 51
 YTM
• YTM is a annual return which an investors
gets ,if he holds the bonds till maturity .
• In other world it is an internal rate of interest
(IRR) which an investors received on bonds,
which he has purchased in current market
value holds it till maturity

5/6/2018 S K MOHAN 52
 Assumption at the time of calculation of YTM
• Bond once purchased will be held till maturity
• Cash flow will be received and there will be no default
• All cash flow are immediately reinvested (else where) at the
rate which is equal to the promised Y T M
• Important terms :-
• PVIF:-Present value interest factor;- it represent the discount
value of Rs. One for a period concerned of interest rate
• PVIFA:-Present value interest factor of annuity :-it represent the
present value of an ordinary annuity for the period concern and
interest rate
• Current Yield = coupon interest/ current market price
• Call option= Right to repay the bond before maturity date
• Put option=holder has right to force the issuer to repay the bond

5/6/2018 S K MOHAN 53
 Theorems for bonds value
Required rate of return is denote with symbol =Kd

1. When Kd= coupon rate result price is = par value

2.When Kd > Coupon rate result value of bond is < par value

3.When Kd<coupon rate value of bond is > par value

4.When Kd >coupon rate discount on bond declines as
maturity comes near
5.When Kd < coupon rate Premium on bonds reduces as
maturity comes near
6.Bond prices is inversely proportional to its yields maturity

7.If there is a deference between YTM and coupon rate of bond ,

the longer the term to maturity ,the greater will be the change in
the price with the change in YTM
5/6/2018 S K MOHAN 54
• The face value of the bond is Rs. 1,000, coupon rate
is 11 per cent, years to maturity is seven years. The
required rate of return is 13 per cent, and then the
present value of the bond is
– 110 x PVIFA (13 per cent, 7) + 1,000 (PVIF 13 per cent, 7)
110(4.423)+1,000 (0.425) = 911.53
• One year from now, when the maturity period will
be six years, the present value of the bond will be
– 110 x PVIFA (13 per cent, 6) + 1,000 (PVIF 13 per cent, 6)
110 (3.998) + 1,000 (0.480) = 919.78
• Similarly, when maturity period is 5, 4, 3, 2, 1 the
Bond value will become 929.87, 940.14, 952.71,
966.48, 982.35, respectively.

5/6/2018 S K MOHAN 55
 Bond Value

• A bond, whose par value is Rs. 1,000, bears a coupon

rate of 12 per cent and has a maturity period of 3
years. The required rate of return on the bond is 10 per
cent. What is the value of this bond?
• Solution
• Annual interest payable = 1,000 * 12% = 120
Principal repayment at the end of 3 years = Rs. 1,000
The value of the bond
= 120 (PVIFA 10%, 3 yrs) + Rs. 1,000 (PVIF 10%, 3 yrs)
= 120 (2.487)+1,000 (0.751)
= 298.44 + 751
= Rs. 1,049.44

5/6/2018 S K MOHAN 56
• A bond, whose par value is Rs. 1000, bears a coupon rate
of 12 per cent payable semi-annually and has a maturity
period of 3 years. The required rate of return on bond is
10 per cent. What is the value of this bond?
• Solution
• Semi-annual interest payable = 1,000 x 12 per cent/2= 60
Principal repayment at the end of 3 years = Rs. 1,000
• The value of the bond
= 60 (PVIFA 10%/2, 6 Period) + Rs. 1,000 (PVIF 10%/2, 6
Period) =
60 (5.0746) + 1,000 (0.746) = 304.48 + 746 = 1,050.48

5/6/2018 S K MOHAN 57
• 12% , 4 years bonds of Rs.100 each were
purchased by Mr. Y for Rs.100 . If the market
interest rate decreases by 1% what will be
the market price
• Solution
• 12xPVIFA (11% for 4 years) + 100(PVIF 11%,4 )=
12X3.10245)+100x(0.65873) = 37.22 + 65.87 =
103.09

5/6/2018 S K MOHAN 58
 Problem on YTM

• Consider a Rs. 1,000 par value bond, whose

current market price is Rs. 850/-. The bond
carries a coupon rate of 8 per cent and has the
maturity period of nine years. What would be
the rate of return that an investor earns if he
purchases the bond and holds until maturity?

5/6/2018 S K MOHAN 59
• Solution
• If kd is the yield to maturity then,
• 850 = 80 (PVIFA kd per cent, 9 yrs) + 1,000 (PVIF kd, 9 yrs)
• To calculate the value of kd, we have to try several values:
• = 80 (PVIFA 12 per cent, 9) + 1,000 (PVIF 12 per cent, 9)
• = 80x 5.328+ 1,000 x (0.361)
• = 426.24 + 361 =787.24
• Since, the above value is less than 850, we have to try with value less
than 12 per cent. Let us try with kd =10 per cent
• = 80 (PVIFA 10 per cent, 9) + 1,000 (PVIF 10 per cent, 9) = 80
• x 5.759 + 1.000 * 0.424 = 884.72
• From the above it is clear that kd lies between 10% and 12%. Now we
have to use linear interpolation in the range of 10% and 12%. Using it,
we find that kd is equal to the following:
• (884.72-850) / (884.72-787.24)
• 34.72 / 97.48 = 10%.+
• .71=10.71%
• Therefore, the yield to maturity is 10.71%

5/6/2018 S K MOHAN 60
• For two bonds X and Y having face value of Rs. 1.000,
coupon rate of 10 per cent each, years to maturity is three
and six years respectively.
• Market value of bond X at YTM of 10 per cent is
– 100 PVIFA (10 per cent, 3) + 1.000 PVIF (10 per cent, 3) = 1,000
• Market Value of Bond Y at YTM of 10 per cent is
– 100 PVIFA (10 per cent, 6) + 1,000 PVIF (10 per cent, 6) = 1,000
• Now market value of bond X at YTM of 11 per cent is
– 100 PVIFA (11 per cent, 3) + 1,000 PVIF (11 per cent, 3) = 975
• And Market Value of Bond Y at YTM of 11 per cent is
– 100 PVIFA (11 per cent, 6) + 1,000 PVIF (11 per cent, 6) = 958
• Change in price for X on increasing YTM by 1 per cent is
(1,000 - 975)/l,000 = 2.5 per cent
• Change in price for Y on increasing YTM by 1 per cent is
(1,000 - 958)/1,000 = 4.2 per cent
5/6/2018 S K MOHAN 61
• A bond of face value of Rs. 1,000 par value X bond with a
coupon rate of 12 per cent maturity period of six years and
YTM of 10 per cent. The market value of the bond will be Rs.
1,087.
– Consider another identical bond Y but with differing YTM of 20 per
cent. The market value of this bond will be Rs. 734.
• If the YTM increase by 20 per cent, i.e. YTM of bond X rises to
12 per cent (10 x 1.2) and bond Y rises to 24 per cent (i.e., 20 x
1.2) then the market value of both bonds will change to:
– Bond X: 120 PVIFA (12 per cent, 6) + 1,000 PVIF (12 per cent.
6) = Rs. 1,000
– Bond Y: 120 PVIFA (24 per cent, 6) + 1,000 PVIF (24 per cent, 6)
= 638
– Market value of X bond with a lower YTM decreased by 8 per
cent
– whereas in case of Y bond with an higher YTM the decrease is
13 per cent.

5/6/2018 S K MOHAN 62
 Yield to Maturity , Bonds Pricing
• Debt capital mainly consist of which of the
following
» Bank borrowing
» Term loans and bank borrowing
» Bank term loan and debenture
– Bonds and debentures
– Bonds and bank term loan s
• The bonds or debenture holders , return for
providing debts capital to a company gets.
» Fixed dividends
» Variable dividend
» Commission
– Discount
– Coupon rate

5/6/2018 S K MOHAN 63
• A bond carries a specific rate of interest which is known as
» Fixed dividend
» Variable dividend
» Commission
» Discount
» Coupon rate
• The amount represented by the bonds , that a company has to
pay back to the bonds holder at the end of term of bond , is
called
– Premium on bonds
– Value of the bond
– Maturity value of the bonds
– Face value
– NOA
• The value at which a bond is traded on a stock exchange is
called:
• face value
• net asset value
• net present value
• market value
• cost price
5/6/2018 S K MOHAN 64
 BONDS Valuation
• A bond with face value Rs’5000/-carrries a coupon rate of 12%
Market price of this bond is quoted at Rs.4500/- what is the
current yield of the bond
• 0.12*5000 =13.3%
• 4500
• Bond is a type of long term, interest bearing note payable on
maturity F
• When the require rate of return (kd) is greater than the coupon
rate bond price will trading at discount to face value T
• An secure bond is a debenture bond T
• A convertible bond is a bond that can be converted to cash at any
given time T
• The value which bond holder gets on maturity is called
Redemption value T
• When the expected rate of return(market discount rate)is lesser
than coupon rate bond price will rise T

5/6/2018 S K MOHAN 65
• If a 7% coupon bond ( Rs.1000) is trading for Rs.
975.00, it has a current yield of ___ percent.
» 7.01
» 6.83
» 7.23
» 8.13
» 7.18

• A zero coupon bond has been issued for 10 years.

What is its duration.
– 10 years
– less than 10 years
– more than 10 years
– NOA.

5/6/2018 S K MOHAN 66
 DURATION OF BOND

• The holding period for which the interest rate risk

disappears, is known as the duration of the bond.
• There is a simple way of computing the desired
holding period (duration), which is as follows:
– 1. Determine the cash flows from holding the bond.
– 2. Determine the present value of these cash flows by
discounting the flows with discount rate (YTM).
– 3. Multiply each of the present values by respective
numbers of years left before the present value is
received.
– 4. Sum these products up and divide by the present
value to get the duration of the bond.
5/6/2018 S K MOHAN 67
 Problem

• 1. Calculate the Macaulay Duration, Modified

Duration of a bond for company A, if the
coupon rate is given to be 8 per cent, the YTM
is 6 per cent and the time to maturity is five
years. The face value of the bond is Rs.
1,00,000. The interest payments are made
annually. Also, calculate the percentage
change in price of the bond if the YTM falls by
100 basis points or 1 per cent from 6 per cent
to 5 per cent

5/6/2018 S K MOHAN 68
5/6/2018 S K MOHAN 69
 470804.38/108424.72=4.3422234

5/6/2018 S K MOHAN 70
 Capital Budgeting
• Capital Budgeting is a process of planning
capital investment :- Expansion,
diversification, replacement, modernization
• NEED OF CAPITAL BUDGETING
– Volume of money invested is quite high
– Return are spread over uncertain long period
– Investment decision can not be reversed
– Project profitability is the basis of decision
– Probability of assets becoming obsolete is very high

5/6/2018 S K MOHAN 71
 Steps to capital budgeting
• Estimate Cash flows Outlays Inflows
• Estimate/Determine the appropriate cost of
capital.
• Define the Acceptance or Rejection Criterion
• Apply the Project Appraisal Techniques
• Rank Projects
• Accept/Reject Projects

5/6/2018 S K MOHAN 72
• What is the difference between independent
and mutually exclusive projects?
• Projects are:
• independent, if the cash flows of one are
unaffected by the acceptance of the other. --
In other words A project whose acceptance (or
rejection) does not prevent the acceptance of
other projects under consideration
• mutually exclusive, if the cash flows of one
can be adversely impacted by the acceptance
of the other.
5/6/2018 S K MOHAN 73
 Capital Budgeting Techniques

– Payback Period (PBP)

– Internal Rate of Return (IRR)
– Net Present Value (NPV)
–

5/6/2018 S K MOHAN 74
 Proposed Project Data
MR.JRD is evaluating a new project for his firm,
he has determined that the after-tax cash flows for the project
will be
1. Rs.10,000;
2. Rs12,000;
3. Rs15,000;
4. Rs10,000; and
5. Rs7,000,
respectively, for each of the Years 1 through 5. maximum pay
back accepted by company is 3.5 years
The initial cash outlay will be Rs40,000.

5/6/2018 S K MOHAN 75
 Independent Project
 For this project, assume that it is independent of any other
potential projects that JRD may undertake.

• Independent -- A project whose acceptance (or

rejection) does not prevent the acceptance of
other projects under consideration.

5/6/2018 S K MOHAN 76
 Payback Period (PBP)

0 1 2 3 4 5

-40 K 10 K 12 K 15 K 10 K 7K

PBP is the period of time required for the

cumulative expected cash flows from an investment
project to equal the initial cash outflow.

5/6/2018 S K MOHAN 77
 Payback Solution (

Year Cash out Flow Cash inflow Cumulative cash inflow

0 40000 (B)
1 10000 10000
2 12000 22000
3 (A) 15000 37000 ©
4 10000 (D) 47000
5 70000 54000

PBP =a+(b-c)/d
= 3 + (40 - 37) / 10= 3 + (3) / 10
= 3.3 Years
5/6/2018 S K MOHAN 78
 Payback Solution Alternative

year Cash Cumulative Cash Flows

flow
0 --40000 -40000
1 10000 -30000
2 12000 -18000
3 15000 -3000
4 10000 +7000
5 7000 +14000
PBP = 3 + ( 3K ) / 10K
= 3.3 Years
Note: Take absolute value of last negative
cumulative cash flow value.
5/6/2018 S K MOHAN 79
 PBP Acceptance Criterion

The management of JRD has set a maximum

PBP of 3.5 years for projects of this type.
Should this project be accepted?

Yes! The firm will receive back the initial cash

outlay in less than 3.5 years. [3.3 Years < 3.5 Year
Max.]

5/6/2018 S K MOHAN 80
 Internal Rate of Return (IRR)

IRR is the discount rate that equates the present

value of the future net cash flows from an
investment project with the project’s initial cash
outflow. It is calculated on the basis of trial and
error method

CF1 CF2 CFn

ICO = + +...+
(1+IRR)1 (1+IRR)2 (1+IRR)n

5/6/2018 S K MOHAN 81
 IRR Solution
RS.40,000 =
Rs.10,000 + Rs.12,000 +
(1+IRR)1 (1+IRR)2
Rs.15,000 + Rs.10,000 + Rs.7,000
(1+IRR)3 (1+IRR)4 (1+IRR)5

Find the interest rate (IRR) that causes the

discounted cash flows to equal Rs.40,000.
5/6/2018 S K MOHAN 82
 IRR Solution (Try 10%)
Rs40,000 = Rs10,000(PVIF10%,1) + Rs12,000(PVIF10%,,2) +
Rs15,000(PVIF10%,,3) + Rs10,000(PVIF10%,4) + Rs
7,000(PVIF10%,5)
Rs40,000 = Rs10,000(.909) + Rs12,000(.826) +
Rs15,000(.751) + Rs10,000(.683) + Rs 7,000(.621)
Rs40,000 = Rs9,090 + Rs9,912 + Rs11,265 +
Rs6,830 + Rs4,347
= Rs41,444 [Rate is too low!!]

5/6/2018 S K MOHAN 83
 IRR Solution (Try 15%)

Rs40,000 = 10,000(PVIF15%,1) + 12,000(PVIF15%,2) +

15,000(PVIF15%,,3) + 10,000(PVIF15%,,4) +
7,000(PVIF15%,,5)
Rs40,000 = 10,000(.870) + 12,000(.756) + 15000(.658) +
10,000(.572) + 7,000(.497)
Rs40,000 = 8,700 + 9,072 + 9,870 + 5,720 + 3,479
= Rs36,841 [Rate is too high!!]

5/6/2018 S K MOHAN 84
 IRR Solution (Interpolate)

15%-10% X {41444-40000}
41444-36841

== 0.05X1444 = 0.0157
4603
IRR Will be =0.10+0.0157=0.1157 i.e. 11.57%

5/6/2018 S K MOHAN 85
 IRR Acceptance Criterion

The management of JRD has determined

that the hurdle rate is 13% for projects of
this type.
Should this project be accepted?

No! The firm will receive 11.57% for each

Rs. invested in this project at a cost of 13%.
[ IRR < Hurdle Rate/Cost of project ]
5/6/2018 S K MOHAN 86
• 1. Company A is considering a new piece of
equipment. It will cost Rs. 6,000 and will
produce a cash flow of Rs. 1,000 every year for
the next 12 years (the first cash flow will be
exactly one year from today). Cash Flows look
like the following:

5/6/2018 S K MOHAN 87
• (a) What is the NPV if the appropriate discount rate is 10%?
• You can either discount each individual cash flow or recognize
that the
• Rs. 1,000 cash flows are just a twelve year annuity. So,
• PV = a/i[l -1/(1 +i)n]
• PV= 1,000/0.1 [1 - 1/(1.1)12] = PV = Rs. 6,814
• Adding this to the original investment gives an NPV of
• NPV = Rs. 6,814 - Rs. 6,000 = NPV =Rs. 814
• (b) What is the NPV if the appropriate discount rate is 12%?
• PV= 1,000/0.12 [1 -1/(1.12)12] = PV = Rs. 6,194
• Adding this to the original investment gives an NPV of
• NPV = Rs. 6,194-Rs. 6,000 = NPV=Rs. 194
• (c) What is the NPV if the appropriate discount rate is 15%?
• PV= 1,000/0.15 [1-1/(1.15)12] = PV = Rs. 5,421
• Adding this to the original investment gives an NPV of
• NPV = Rs. 5,421-Rs. 6,000
5/6/2018 S K MOHAN 88
 Net Present Value (NPV)

NPV is the present value of an

investment project’s net cash flows
minus the project’s initial cash
outflow.

CF1 CF2 CFn

NPV = + +...+ - ICO
(1+k) (1+k)2
1 (1+k)n
5/6/2018 S K MOHAN 89
 NPV Solution

JRD has determined that the appropriate discount rate (k) for this
project is 13%.

Rs.10,000 Rs12,000 Rs15,000

NPV = + + +
(1.13)1 (1.13)2 (1.13)3

Rs10,000 Rs7,000 -Rs40,000

+
(1.13)4 (1.13)5

5/6/2018 S K MOHAN 90
 NPV Solution
NPV = Rs.10,000(PVIF13%,1) + Rs12,000(PVIF13%,2) +
Rs15,000(PVIF13%,3) + Rs10,000(PVIF13%,4) +
Rs 7,000(PVIF13%,5) - Rs40,000
NPV = Rs10,000(.885) + Rs12,000(.783) +
Rs15,000(.693) + Rs10,000(.613) + Rs
7,000(.543) - Rs40,000
NPV = Rs8,850 + Rs9,396 + Rs10,395 +
Rs6,130 + Rs3,801 - Rs40,000
= - Rs1,428

5/6/2018 S K MOHAN 91
 NPV Acceptance Criterion
The management of JRD has determined
that the required rate is 13% for projects
of this type.
Should this project be accepted?

No! The NPV is negative. This means that the

project is reducing shareholder wealth. [Reject
as NPV < 0 ]
5/6/2018 S K MOHAN 92
• The discount factor at 12% rate of interest p.a. is 0.893,
0.797, 0.712, 0.636 for 1st year, 2nd year, 3rd year and 4th year
respectively. If the cash inflow from the project is Rs. 10000 in
each of these years, calculate the present value of cash inflows.
I. Rs. 40000
II. Rs. 36260
III. Rs. 32980
IV. Rs. 30380
•
• The discount factor at 12% rate of interest p.a. is 0.893, 0.797,
0.712, 0.636 for 1st year, 2nd year, 3rd year and 4th year. If the
initial investment is Rs. 30000 and cash inflow from the project is
Rs. 10000 in each year. Whether the project can be taken up for
investment or not.
i. investment can be made as the cash inflow is Rs. 40000 in 4 years
and cash outflow is Rs. 30000.
ii. The investment can be made as the present value of cash inflow is
positive.
iii. The investment cannot be made because NPV is negative
iv. NOA

5/6/2018 S K MOHAN 93
 DEPRECIATION
• Meaning Depreciation is a reduction in the
book value of all fixed assets excepting land
used in business
• all fixed assets
• all fluctuating assets
• both fixed and current assets
• all assets used in business.

• Need for depreciation

» To know correct profit
» Show correct financial position
» Make provision for replacement of assets
» To ascertain the real cost of production
» To comply with legal requirements
5/6/2018 S K MOHAN 94
 Causes of Depreciation
• I. Internal Causes
• Wear and tear
• Disuse : When a machine is kept continuously idle, it becomes potentially less useful

• Maintenance: The value of machine deteriorates rapidly because of lack of proper

maintenance.
• Depletion: It refers to the physical deterioration by the exhaustion of natural resources
eg., mines, quarries, oil wells etc.

• II. External Causes

• Obsolescence: The old asset will become obsolete (useless) due to new inventions,
improved techniques and technological advancement
• .
• Effluxion of time: When assets are exposed to forces of nature, like weather, wind, rain,
etc., the value of such assets may decrease even if they are not put into any use.

• Time Factor: Lease, copy-right, patents are acquired for a fixed period of time. On the expiry
of the fixed period of time, the assets cease to exist.

5/6/2018 S K MOHAN 95
 Factors of depreciation

• Original Cost of asset

• Residual value
• Life of an asset

5/6/2018 S K MOHAN 96
 METHODS OF Calculating DEPRECIATION
• 1. Straight line method or fixed installment method.
• 2. Written down value method or diminishing balance
method
• 3. Annuity method.
• 4. Depreciation Fund method.
• 5. Insurance Policy method.
• 6. Revaluation method.
• 7. Sum of year’s Digit Method

• 5/6/2018
all assets used in business.
S K MOHAN 97
 Straight line method or fixed installment method
• Under this method, the same amount of depreciation is charged
every year throughout the life of the asset. The amount and rate
of depreciation is calculated as under
• Amount of depreciation = Total cost –– Scrap value
————————————
• Estimated Life

• Rate of depreciation = Amount of Depreciation

• = ———————————— x 100
• Original Cost

5/6/2018 S K MOHAN 98
 Illustration
• A company purchased Machinery for Rs.1,00,000. Its installation
costs amounted to Rs.10,000. It’s estimated life is 5 years and the
scrap value is Rs.5,000. Calculate the amount and rate of
depreciation
• Solution:
• Total cost = Purchase Price + Installation Charges
• Rs.1,00,000 + Rs.10,000 = Rs. 1,10,000
• Amount of depreciation = Total cost –– Scrap value
Estimated Life
1,10,000 –– Rs.5,000 = 105000 = 21000
5 5
• Rate of depreciation = Amount of depreciation x 100
• Original cost
• 21000 X 100 = 19.09%
• 110000

5/6/2018 S K MOHAN 99
 Written Down Value Method or Diminishing Balance
Method or Reducing Balance Method
• Under this method, depreciation is charged at a fixed
percentage each year on the reducing balance (i.e., cost
less depreciation) of asset.
• The amount of depreciation goes on decreasing every
year.
• For example,
• if the asset is purchased for Rs.1,00,000 and
depreciation is to be charged at 10% p.a. on reducing
balance method, then Depreciation for the
• 1st year = 10% on Rs.1,00,000, ie., Rs.10,000
• 2nd year = 10% on Rs.90,000 (Rs.1,00,000 –– Rs.10,000) = Rs. 9,000
• 3rd year = 10% on Rs.81,000 (Rs.90,000 - Rs.9,000) = Rs.8,100 and so on.

5/6/2018 S K MOHAN 100

 Annuity Method
• The annuity method considers that the business
besides loosing the original cost of the asset in
terms of depreciation and also looses interest on
the amount used for buying the asset.
• This is based on the assumption that the amount
invested in the asset would have earned in case
the same amount would have been invested in
some other form of investment.
• The annual amount of depreciation is determined
with the help of annuity table. This method is
used to calculate depreciation amount on lease
5/6/2018 S K MOHAN 101
 Depreciation Fund Method or Sinking Fund Method
• Under this method, funds are made available for the
replacement of asset at the end of its useful life.
• The depreciation remains the same year after year
and is charged to Profit and Loss account every year
through the creation of depreciation fund.
• The amount of annual depreciation is invested in
good securities bearing interest at a specified rate.
• The aggregate amount of interest and annual
provision is invested every year.
• When the asset is completely written off or is to be
replaced, the securities are sold and the amount so
realised by selling securities is used to replace the old
asset
5/6/2018 S K MOHAN 102
• Q.In sinking fund method of depreciation
accounting
– A fund is created at the beginning to which
depreciation is charged annually.
– Since acquiring an asset results in sunk costs
depreciation of the asset is called so.
• Depreciation charged annually is transferred to a fund
which is invested in growth and income generating
securities to take care of the replacement of the asset.
• None of the above.

5/6/2018 S K MOHAN 103

 Choose the correct answer :
1. Depreciation arises due to
» a) wear and tear of the asset
» b) fall in the market value of asset
» c) fall in the value of money
2. Under straight line method, rate of depreciation is
calculated on
– a) Original cost b) Written down value c) Cost less scrap value

3. Under diminishing balance method, depreciation

– a) decreases every year b) increases every year c) constant
every year
4. The term depletion is used for
– a) Intangible assets b) Fixed assets c) Natural resources
5. If selling price is more than the book value of the asset on
the date of sale, it is
• a) a loss b) an income c) a profit

5/6/2018 S K MOHAN 104

 Insurance Policy Method
• According to this method, an Insurance policy is
taken for the amount of the asset to be replaced.
• The amount of the policy is such that it is sufficient
to replace the asset when it is worn out.
• A sum equal to the amount of depreciation is paid
as premium every year.
• The amount goes on accumulating at a certain rate
of interest and is received on maturity.
• The amount so received is used for the purchase
of new asset, replacing the old one.
5/6/2018 S K MOHAN 105
 Revaluation Method:

• Under this method, the assets like loose tools

are revalued at the end of the accounting
period
• same is compared with the value of the asset
at the beginning of the year.
• The difference is considered as depreciation.

5/6/2018 S K MOHAN 106

• Machinery worth Rs.82000 is purchased and
the firm spent Rs.8000 on its installation. Its
effective commercial life is estimated as 10 years
and scrap value Rs.10000.What will be written
down value at the end of 3rd year, under straight
line method?.
• Solution
• The amount of annual depreciation would be
Rs.8000 p.a.
• == (82000+8000-10000, divided by 10).
• For 3 years it will be Rs.24000 (8000 x 3).
• The WDV would be Rs.66000 (90000-24000).
5/6/2018 S K MOHAN 107
• In the previous question, if the method would have
been written down value method, what would be the
amount of depreciation for 3 years and WDV of the
machinery?
• Answer—
• For 1st year the amount of depreciation would be
Rs.8000,
• for 2nd yearRs.7200 (80000-8000 x 10%)
• and for 3rd yearRs.6480 (72000-7200 x 10%).
• The total depreciation for three years would be
• Rs.21680.
• There would be saving of Rs.2320 (24000-21680) on
account of change in the method of depreciation. To that
extent profit would increase along with the WDV of the
fixed asset.

5/6/2018 S K MOHAN 108

• A firm purchased machinery worth Rs_76000 on
January 01, 2003 and its life is expected to
• be 8 years, with scrap value at the end
Rs.12000. What is amount of depreciation.
• Solution—
• Depreciation = (Cost-Scrap value) / no. of years
of expected economic life
• = 76000-12000 / 8 = Rs.8000 per annum

5/6/2018 S K MOHAN 109

• A firm purchased certain machinery on January 01, 2013 for Rs.1 lac. It
added more machinery on July 01, 2013 for Rs.50000. 1/2 of the
machinery purchased on January 01, 2013 was sold for Rs.25000 on
Dec 31, 2014. The rate of depreciation is to be assumed 20%and the
annual closing of accounts as on Dec 31. Find the value of machinery as
on Dec 31, 201 4.
• Solution :
• WDV of 1st machine as on Dec 31, 2014 would be Rs.30000 as under:
• Original value = 1,00,000
• 2 years' depreciation @ 20% = 40000
• Hence, WDV = 60,000
• Sale of I /2 of machinery : Rs.25000
• Loss on sale of machinery= 30000-25000 = 5000
• Hence WDV = 60000-30000= 30000
• WDV of 2nd machinery :
• Original value = 50,000—depreciation of 1-1/2 year i.e.
• Rs.5000 + 10000 = 15000.
• WDV = 50000 —15000 = 35000
• Total WDV : 30000 + 35000 = 65000
5/6/2018 S K MOHAN 110
 SUM OF THE YEARS' DIGITS
• To calculate depreciation charges using the sum of the years' digits method, take the expected life of an
asset (in years) count back to one and add the figures together.
• This is a method of calculating depreciation of an asset that assumes a higher
depreciation charge and a greater tax benefit in the early years of an asset's life.
• Illustration
• 10 years useful life = 1 0+ 9 + 8 + 7 + 6 + 5 + 4 + 3 + 2 + 1 Sum of the years = 55
• In the first year, the asset would be depreciated 10/55 in value [the fraction 10/55 is equal
to 18.18%]
• the first year,
• Second year 9/55 [ 16.36%]
• 8/55 [ 14.54%] the third year, and so on. Going back to our
• Illustration from the straight-line discussion: a Rs. 5,000 computer with a Rs. 200 salvage
value and 3 years useful life would be calculated as follows:
• 3 years useful life = 3 + 2 + 1 Sum of the years = 6
• Taking Rs. 5,000 - Rs. 200, we have a depreciable base of Rs. 4,800.
• In the first year, the computer would be depreciated by 3/6, i.e [50%], the second year, by
2/6 [33.33%] and the third and final year by the remaining 1/6 [16.67%].
• This would have translated into depreciation charges of Rs. 2,400 the first year, Rs.
1,599.84 the second year, and Rs. 800.16 the third year.
• The straight -line Illustration would have simply charged Rs. 1,600 each year, distributed
evenly over the three years useful life.

5/6/2018 S K MOHAN 111

 Recording Depreciation
• Depreciation is directly charged against the asset by debiting
Depreciation account and crediting the Asset account.
Depreciation account is closed by transferring to Profit and Loss
account at the end of the year. The entries will be as under:
• 1) For the amount of depreciation to be provided at the end of the
• year:
• Depreciation A/c….. Dr. with the amount
• To Asset A/c. of depreciation

• For transferring the amount of depreciation at the end of the year.

•
• Profit and Loss A/c….. Dr. with the amount
• To Depreciation A/c. of depreciation
• transferred

• Asset Account will be shown at cost less depreciation i.e., written

down value at the end of the year in the Balance sheet.
5/6/2018 S K MOHAN 112
 Illustration : 2

• Raheem & Co. purchased a fixed asset on

1.4.2000 for Rs.2,50,000. Depreciation is to be
provided @10% annually according to the
Straight line method. The books are closed on
31st March every year.
• Pass the necessary journal entries, prepare Fixed
asset Account and Depreciation Account for the
first three years.

5/6/2018 S K MOHAN 113

5/6/2018 S K MOHAN 114
5/6/2018 S K MOHAN 115
• Accounting Entries under the Sinking Fund
Method The following accounting entries are
recorded in the books: (A) At the end of the
first year
• (i) Depreciation a/c Dr. (For Providing
Depreciation)
• To Sinking Fund a/c
• (ii) Sinking Fund Investment a/c Dr. (For
Investment of Fund in Securities)
• To Bank a/c

5/6/2018 S K MOHAN 116

• FX Exchange Arithmetic

5/6/2018 S K MOHAN 117

 What is Foreign Exchange

• Foreign Exchange is a mechanism by which the

currency of one country gets converted into the
currency of an other country

5/6/2018 SKMOHAN 118

 What is Foreign Exchange?

Sec 2 (n) of FEMA provides the definition of Foreign Exchange:-

Foreign Exchange simply means “foreign currency “.
It also means deposit , credits and balance payable in Foreign currency
 It means draft / travelers cheques / LC /Bill of exchange drawn in FC
by Banks out side India
 It also means draft / travelers cheques / LC /Bill of exchange expressed
in Indian rupees but payable in FC
FX includes all claims payable abroad . It consists of chaques
, bills , deposits payable outside India. It also consists of funds
held in FC with Banks abroad
Thus foreign money and near money instruments denominated in
foreign currency are called Foreign Exchange.
Foreign Currencies balances kept abroad;
TT / DD / MT / International postal order, FTC and (Bill of Exchange,
Credit Cards and foreign currency, currency payable abroad). etc
Deposit ,Credits and balance payable in FC.

5/6/2018 SKMOHAN 119

 EXAMPLES OF FX

A postal order issued by New York Post office in US $

A Credit Card ,International Debit card issued by the Bank outside
India to draw F Ex or Rupee in India
Balance in FCNR (B) or RFC or EEFC account
Deposit Balance in NRE account in F Currency
Vostro account Maintained By Foreign Bank in India.
Nostro account maintained by Indian Bank outside India
Draft Drawn by the IOB Hong Kong payable in Delhi In Indian
Rupee
TC drawn in Foreign Currency

5/6/2018 SKMOHAN 120

 CHARACTERISTIC FEATURES OF
Foreign Exchange
• Scarcity Character
• Commodity Character

5/6/2018 SKMOHAN 121

 Who Control Foreign Exchange

Ministry of Ministry of
Government of India
Finance Commerce

Only deals with Import and

Finance matter Export

Trade control
RBI
Department

Exchange
control deptt
5/6/2018 SKMOHAN 122
 How These Deptt. Function

Exchange control deptt and trade control

deptt

Authorized dealer

AD-3 Certain
AD-1 Scheduled Ad -2 strong RRB, Co financial and other AD- 4 Full pledged
commercial operative FFM can institutions for own moneychangers
Bank,all type of do current account use NABARD,IFCI
transactions transactions They can
release Fx for Non
Trading activity

5/6/2018 SKMOHAN 123

 Powers of RBI over Authorised persons

• Chapter IV Sn 13 provides that in case an

authorized person contravenes the directions
or fails to submit any report, RBI is
empowered by FEMA to impose penalty up to
Rs 10,000.
• In case the contravention continues it can
• imposes an additional penalty of Rs 2000/-
per day for the period of such continuation

5/6/2018 SKMOHAN 124

 Different categories of branches of an authorized dealer
 Category A : These branches are not only permitted
to handle all types of business but also maintain
and operate bank’s NOSTRO Account at Foreign
Centre.
 Category B : These branches are permitted to
handle all types of foreign exchange transactions
But not maintain Nostro account and However they
are permitted to operate bank’s NOSTRO Accounts.
At foreign centre
 Category C : Not permitted to independently
handle foreign exchange transactions. These
branches can route their FX transactions through
their designated AD branches

5/6/2018 SKMOHAN 125

 FEMA 1999Effective from 01.06.2000
 This act extends to whole of India and also to all offices outside
India which are controlled by persons resident in India.
 The act contains 49 sections divided into 7 chapters
 Chapter 2 (sec3 To -9)deals with the restrictions imposed on
various type of fx transaction
 Sec 10 to 12 of the Act authorizes RBI to appoint different banks,
companies etc., as “Authorized Persons” to deal in foreign
exchange
 Chapter 3 (13 to 15) deals with offences and penalties
 Sec.46 of the Act empowers Govt. of India to make Rules on
any matter to carry out the provisions of this Act.
 Sec.47 of the Act authorizes the RBI to make regulations to
carry out the provisions and rules made there under.

5/6/2018 SKMOHAN 126

 Account to be open by AD
• NOSTRO ACCOUNT ( our account with you)
• VOSTRO ACCOUNT ( Your account with us )
• Vostro account is also called NON –RESIDENT Bank ACCOUNT as it is
maintained by a bank not resident in India)

• LORO ACCOUNT ( their Nostro account with you Or Third party

account )

• MIRROR ACCOUNT: or shadow account

• Escrow Account It is also called trust and
retention account ( Financing infrastructure projects , or payment
from third country e.g Nigeria payment is made from UK )

5/6/2018 SKMOHAN 127

1. As per FEDAI rule 2 an usance export bill purchased remaining unpaid is required to be
crystallized
 (a) within 30 days from date of purchase,
 (b) on the 30th day after due date,
 (c) As per the policy decision taken by the bank
 (d) a or b whichever is earlier.
2. Authorized Dealers are appointed by
 (a) GOI (b) RBI (c) FEDAI (d) SEBI (e) NOA
3. Authorized Person" does not include the following
 (a) Authorized Dealer
 (b) Authorized Money Changer
 (c) Off-shore Banking unit
 (d) a+b+c (e) NOA

4. Directives to Authorized Persons are given by RBI through the following series of
circulars,
◦ (a) A.D. (MA) (b) A.D. (Dim) (c) A.P. (DIR) (d) A.P. (MA) (e) NOA
5. Non-Exchange Dealing branches are classified as category branches.
 (a) A (b) B (c) C (d) B or C (e) NOA

6. ADs are not permitted to do any commercial transaction in foreign exchange on

◦ (a) Sundays (b) Saturdays (c) evening hours (d) afternoon hours (e) NOA

5/6/2018 SKMOHAN 128

 Fill in the Blank
1. The term Foreign exchange is used , to denote FC
as well as the exchange of one currency into
another
2. The exchange rates of major currencies fluctuate
every ----- second
3. The Forex markets are dynamic and round the
clock markets. True/False
4. Forex markets are not affected by government
policies. True/False
5. A large part of the total global forex turnover
results from global commodities trade. True/False

5/6/2018 SKMOHAN 129

 What is Need Of Control

• Conserve Foreign exchange Recourse for

purchase of essential material and services from
Cross the Board.

• For That government require .

• to Know the Balance of trade and balance of
Payment

5/6/2018 SKMOHAN 130

 What is Balance of Trade
Difference between Total value of Export
good and total value of Import in Goods
(Visible) in a particular period
Value of Goods Exported
Less Value of Goods Imported
For purpose of Balance of Trade
 Value of export are valued on FOB basis
 And Import are valued on CIF bases

5/6/2018 SKMOHAN 131

 Balance of Payment
• Capital account Transaction
• Current account Transaction

5/6/2018 SKMOHAN 132

 CAPITAL ACCOUNT
The transactions which alter the assets and
liability (including contingent Liabilities) outside
India of a person resident in India or assets and
liabilities in India of a person resident outside
India ( u/s2(e) FEMA)
 CAPITAL ACCOUNT == Receipt on capital transaction
 Less Payment on capital Transaction
 Example :-
◦ resident borrows foreign exchange from outside India
◦ A resident issued guarantee in favour of a non-resident
◦ Resident buy /sells immovable property situated outside India
◦ Resident invest in securities /shares issued in Foreign currency
(outside India)
◦ Non resident keeps his deposit with a bank in India
◦ Non resident invest in immovable assets in India
5/6/2018 SKMOHAN 133
 Current account Transaction

• Which is not a capital account transaction is called

current account transaction
• It effects the Revenue a/c only
Which do not result in change in assets and liability position
of the person receiving and making payment
Current account transaction =
Balance of Trade +Net of Invisible import and
export transaction
Remittance for living expenses of parents/spouse/children
living abroad, remittance in connection with travel,
education, medical expenses etc

5/6/2018 SKMOHAN 134

1. A transaction which alters the asset or liability position
outside India of a person resident in India is called a
_____ transaction.
2. A person resident in India acquires an immovable
property in London. It is a --- transaction.
3. A person resident in U.K. invests in immovable property
in India. It is a----- transaction.
4. A bank accepts a FCNR deposit of US$ 1000 from a non-
resident. It is a === transaction.
5. Payment of interest on non-resident deposits by a bank is
---------transaction.
6. Release of foreign exchange for travel, medical expenses,
study or for gift is classified as _____ transaction.
 ( ans 1 to 4 Capital account and 5& 6 are current account )
5/6/2018 SKMOHAN 135
 Some Information related to Foreign Currency

Hard Currency

Green back US dollar as color of all denomination is green

Convertible currency

Permitted Currencies

Designated Currencies For FCNR(B)

Basket of Currencies

EURO

5/6/2018 SKMOHAN 136

 Characteristic of Fx Market
 No Exact Location
 OTC market :- over the counter market means direct deal without
intervention of any one .
 Twenty four hours market
 Very Volatile Fx rate fluctuate almost every 4 second
 ADs are market makers
 Five days operation except some middle east /Islamic countries
 Major players Multinational companies , International
banks ( largest market is LONDON followed by New York,
Tokyo, Zurich ,Frankfurt)

5/6/2018 SKMOHAN 137

 FOREIGN EXCHANGE MARKETS
Merchant Market:
• It is the retail market, which involves the
transaction of customer with AD.

Inter bank Market:

• It is the market where transaction between
AD takes place in India

International Market:
• It is the market, where transaction takes
place between banks in different countries.
5/6/2018 SKMOHAN 138
 VALUE DATE IN FOREX TRANSACTIONS

MERCHANT MARKET

FORWARD
SPOT
Rate decided today
Rate decided today And
Transaction at a Future
transaction today
date
5/6/2018 SKMOHAN 139
 INTER BANK MARKET &
INTERNATIONAL MARKET

• Rate Today Settlement The same Day/

CASH Working Day

TOM • Rate Today Settlement on First

Succeeding Working Day
• Rate Today Settlement on Second
SPOT Succeeding Working Day

• Rate Today Settlement from Third

FORWARD Succeeding Working Day

5/6/2018 SKMOHAN 140

 What is EXCHANGE RATES
• The rate at which an AD buys and sells the currency
is called Exchange rate.
• It means the rate at which one currency is converted
into another currency is called exchange rate .
• In other words it denotes the price or the ratio or
the value at which one currency is exchanged for
another
• Exchange rate is very dynamic
• The foreign exchange market is round-the-clock
market due to different time zones
• Major participants- central banks, commercial
banks, forex brokers, corporations, individuals
5/6/2018 SKMOHAN 141
 The exchange rates are quoted in two
ways.
• Direct Method
• Indirect Method

5/6/2018 SKMOHAN 142

 Direct Method
• the home currency is quoted per unit of foreign
currency or it can also be defined as a quote
where the home currency is the variable unit..

• e.g 1 USD = Rs. 65.23

How to show Purchase rate and sale rate
AD would buy 1USD = Rs. 65.30 and sell at 1 USD =
Rs. 65.45 in order to make profit.

5/6/2018 SKMOHAN 143

 Indirect Method
• the Home Currency unit remains constant and
the foreign currency is the variable unit.
e.g.Rs. 100 = USD 1.153

India was following indirect method of

quotation till 01.08.1993.

5/6/2018 SKMOHAN 144

 Types of Rates
RATE

Selling
• TT Selling
• Bills Selling

Buying
• TT buying ( it is the best rate for
customer)
• Bills Buying
5/6/2018 SKMOHAN 145
 Price or Rate of Fx exchange
 Buying Rate / Bid rate
 Selling Rate/ offer rate
 WE TREAT BUYING AND SELLING TRANSACTION ONLY
WHEN THE AD IS REQUIRED TO CONVERT FX. EXCHANGE
TO RUPEE OR vice versa
 Difference between two transaction is called
MARGIN
 The mean of Bid rate and offer rate is called middle rate
 Selling Rate – buying rate = spread /margin/profit / BASIS
POINT SPREAD
 E.g. 1usd = Rs.48.3050/3060 ( the basis point spread is 10basis points)
 All inward remittance / receipt of Fx exchange when
converted to rupee involve Buying Transaction
 While all outward remittance /payments of Fx
exchange involve sales transaction

5/6/2018 SKMOHAN 146

 Purchase and sales
• We say purchase , we imply that
• The bank has purchased and
• It has purchased Fx currency
• Similarly when we say SALE , it imply that
• The bank has sold
• It has sold Fx currency

• in Purchase transaction bank acquires Fx

Currency and part with home currency
• In sale transaction the Bank part with the
Fx currency and acquires home currency
5/6/2018 SKMOHAN 147
1. Mr. Ravi presents a foreign draft for $20000 for credit of
his SB account . Is it a buying or selling transaction
2. Mr. X wants a Fx draft for $ 1000 to subscribe a foreign
magazine . What type of transaction is for AD.
3. DUNLOP India has lodged an export bill for USD 100000
. Which is realized and credited into our nostro account .
AD wants to vouch the same and credit the amount in the
account of DUNLOP India. Is it buying or selling
transaction
4. AD wants to issue travelers cheque of pound sterling
5000 to Mr. Jain who is going on foreign tour . Is it a
buying or selling transaction

5/6/2018 SKMOHAN 148

 Purchase and Sale
• The purchase or sale of foreign currency is to be
viewed from the point of view of the AD.
• For an Authorised Dealer foreign exchange is like
a commodity and like in any other trade the
objective is to make profit while buying or selling a
foreign currency.

• The buying and selling are not effected at the same

rate.
• e.g AD would buy 1USD = Rs. 65.35 and sell at 1
USD = Rs. 65.45 in order to make profit.
• The maxim is ‘Buy Low & Sell High’.
• Where indirect method of quotation is followed, the
maxim would be ‘Buy High and Sell Low’.
5/6/2018 SKMOHAN 149
 PURCHASE/ BID RATE
1. Clean Inward remittances (MT, TT, DD) where cover has TTB
already been provided in NOSTRO
1. Realization of instruments sent on collection. TTB
1. Cancellation of DD/MT/TT etc., Payment of FCNR deposit TTB

1. Cancellation of Forward Sale contract. TTB

1. Purchase/discounting of bills and other instruments BB
i. Where bank has to claim cover after payment.
ii. Where drawing bank at one centre remits cover for credit
to a different centre.
1. Foreign currency notes and Travellers cheques It is a
specific
version
*** AT THE DISCRETION OF THE AUTHORISED DEALER of B B
rate ***
• Other than Bill, T C , Currency purchase of other transaction as per FADAI we have
to deduct 0.15% or 0.125% from TTB

5/6/2018 SKMOHAN 150

 SALE/ OFFER RATE/ Ask rate
1. Issuance of TT/DD/MT etc. and no document are TTS
handled by AD
1. Cancellation of purchase like: TTS
i. Bill purchased/discounted returned unpaid.
ii. Bill purchased/discounted transferred to collection
account.
iii. Refund of earlier inward remittance converted to
rupees.

1. Cancellation of forward purchase contract TTS

1. Import Bills payment. , Advance payment of Import BS

transaction ,Where documents are handled by AD
1. Sale of foreign currency notes and Travelers cheques. ***
2. TC rate = TTS + maximum margin of 0.50%
3. Currency Note selling rate = TC rate +maximum margin
of .50% in TC rate
5/6/2018 SKMOHAN 151
 Different Rates
 Card rates these are buying and selling rates computed by the ADs during the
start of business hours it is used for small transaction for handling of small value
transaction It is a indicative rates .
 Notional rate: Weekly average of daily rates for different currencies advised by
FEDAI on every Friday. This is used on liability transaction ( deposit ) {in other
words it is a assumed rate which is used to express the rupee value of Foreign
currency deposit }
 . Inter-Bank Rates: / based rate called a two-way quote
 one is for purchase and second is for sale
• The first rate is called the BID rate and the second is the Ask
rate
 Merchant rate :- actual quoted to public /customer based on bases of market
rate
 Cross rate if the rate of Foreign currency is given in term of another foreign
currency it is called a cross rate
 Fine rate:- rate quoted to good customers with thinner spread
 REER:-Real effective exchange rate used for Basket of currencies
5/6/2018 SKMOHAN 152
• a) Cross rate
• If a person wants to remit Euros from India, and as a banker, and for
argument sake, rupees/Euros are not normally quoted and therefore,
we have to first buy dollars against the rupees and the same dollars will
be disposed off overseas to acquire the Euros.
• (b) Chain rule
Calculation of the cross rate is based on a commonsense approach.
However, it can be reduced to a rule known as the chain rule with
similar steps.
• (c) Value date
The value date is a date on which the exchange of currencies actually
takes place.
• (v) Premium: When a currency is costlier in forward or say, for a future
value date, it is said to be at a premium. In the case of the direct
method of quotations, the premium is added to both the selling and
buying rate.
• (vi) Discount: If currency is cheaper in the forward or for a future value
date, it is said to be at a discount. In the case of a direct quotation, the
discount is (deducted) subtracted from both the rates, i.e. buying and
selling rates.
TT buying rate In Rs.
Dollar /Rupee market spot buying rate ----
Less Exchange margin -----
TT buying Rate -----
Rounding of to nearest multiple of 0.0025( after loading Exchange margin only )
On the 15th Sept. IOB received a mail transfer from New York correspondent for
USD 10000payable to his customer Bank’s account with the correspondent has
been credited with the amount
Assuming Rupee /Usd are quoted in local interbank market as under
Spot USD 1 = 39.2500/2700
Spot/ Oct = 2200/2300
Bank require exchange margin 0.080% rupee nearest to whole value
Rate applicable TT buying rate 39.2500
Less exchange margin 0.080% of 39.2500 0.03140
39.21860
Rounding off 39.2175

customer will get 10000 X 39.2175 3,92,175

5/6/2018 SKMOHAN 154
For calculation of BB rate

Forward margin is normally available for a period of

calendar month not for number of days

forward margin may be on premium or on discount

Premium is to be added to the spot rate

and discount should be deducted from spot rate

Rule of loading forward margin in BB rate
calculate BB rate
If Forward margin is at premium round off the transit period
add usance period to lower month
if the forward margin is at discount round off the forward
margin to the higher month
5/6/2018 SKMOHAN 155
• Premium When currency is costlier in
forward /future value date . It is added in
buying and selling rates
• Discount When currency is cheaper in
forward /future value date . It is deducted
from both buying and selling rate

5/6/2018 SKMOHAN 156

calculation of BB rate Rs.

Dollar /Rupee market spot buying rate -----

If Premium -----
Add premium
( Transit and usance period rounded of to lower
month
If Discount ------
Less Forward Discount
( Transit and usance rounded to higher month

Less exchange margin -----

Bills buying rate -----

Rounded off to nearest multiple of 0.0025

5/6/2018 SKMOHAN 157
• on 25th July a customer presented to the
bank at sight documents for USD 100000
under LC . The LC provides for
reimbursement by negotiating bank’s own
demand draft on opening bank at NEW YORK
• Rupee / usd rate
• Spot 1usd = 39.6525/6650
• Spot /august = 6000/5700
• Spot /September = 1.000/0.9700
• transit period is 25 days bank require
exchange margin of 0.15% calculate the rate
and amount to be payable in Rupee

5/6/2018 SKMOHAN 158

 Dollar is at discount and transit period is 25 days

Dollar /Rupee market spot buying rate 39.65250

Less discount for one month 00.60000

forward rate 39.05250

Less exchange margin 0.15% 0.05859

Bills buying rate 38.99391

Rounding off 38.9950

Amount paybale to customer 38,99,500

100000X 38.9950

5/6/2018 SKMOHAN 159

• on 8th sept , an exporter tenders a demand bill for Usd 100000
drawn on New York .The ruling rates for Usd in the inter bank
market are as under
Spot Usd 1=Rs.39.3000/3500
Spot /sept. .6000/7000
Oct. .8000/9000
Nov 1.000/1000
Transit period is 25 days The bank requires an exchange margin of 0.10% .
Interest on export finance is 10% p.a.
Customer opts for retain of 15% proceeds in US dollars
You are required to compute
The rate at which the bill will be purchased by the Bank
The rupee amount payable to the customer
Interest to be recovered from him
5/6/2018 SKMOHAN 160
Since the currency is at premium .the transit period will be
rounded off to lower month ( i.e. nil) and rate to the customer will
be based on spot rates
Dollar /rupee spot buying rate 39.3000
less exchange margin 0.10% on 39.3000 0.0393

39.2607
Round off to the nearest multiple of 0.0025 , the rate quoted to
the customer would be Rs.39.2600
Customer account will be credited with USD 85000 x39.2600 =
33,37,100
Interest charges on 33,37,100 @10% for 25 days is Rs.22,857

5/6/2018 SKMOHAN 161

Selling rate

Dollar /Rupee market spot selling rate ------

Add Exchange margin for TT selling rate -----

TT selling Rate ------

Add exchange margin for bills selling rate ----

Bills selling rate ----

Rounded off to nearest multiple of0.0025 and quoted

to customer

5/6/2018 SKMOHAN 162

 on 12 th feb an importer receive a bill for usd 10000 . He
asks his bank to retire the bill to the debit of his account .
Interbank rate for dollar is
 Spot 1 USD = 38.7050/7200
 Spot/ march = 5000/4500
 Bank retain margin 0.15% for TT selling rate and 0.20%
on BS rate what amount will be debited the importer ‘s
account
 Solution
 Figures in Rs.
 Dollar / rupee market spot selling rate 38.7200
 Add exchange margin for TTS0.15% of 38.7200 0.05808
 tt selling rate 38.77808
 Add exchange margin at 00.20% on 38.77808 0.07756
 bills selling rate 38.85564
 Rounding off 38.8550
 Customer have to pay 10000 X 38.8550 = Rs.388550
5/6/2018 SKMOHAN 163
 A customer requests IOB to issue DD on New York for USD 25000.
Assuming the on going spot rates in the local market in the local
market for USD are as under
 Spot usd = rs.39.3575/3825
 1 month forward rs.39.7825/8250
 Bank requires an exchange margin of 0.15%
 What rate will be quoted to the customer and what is the rupee
amount payable by him
 Solution
 Bank has to quote its TT selling rate based on the
market selling rate
 Dollar/rupee market spot selling = 39.3825
 Add exchange margin at 0.15 % on Rs. 39.3825 = 0.05907
 39.4415
 Rounding of 39.4425
 The amount payable by the customer for usd 25000
at Rs.39.4425 per dollar is Rs. 9,86,063
5/6/2018 SKMOHAN 164
 Examples of buying and selling rate

• A traveler tender traveller cheque of USD 5000

for encashment exchange rate is 1usd =
Rs.49.30/50. how much AD will pay to customer.
• Mr. Man Mohan Singh , a NRI sends DD for
GBP2000 to be credited in his account . Rate 1GBP
=68.20/.50 . Find the amount to be credited in his
account .
• Miss Katrina wants DD of DEM100 for
subscribing the journal Rate 1DEM= 35.40/60
How much she have to pay

5/6/2018 SKMOHAN 165

 EXERCISE ON SELECTION OF RATES
1. An authorised dealer receives a TT from its correspondent
bank for credit to the account of its customer. The exchange
rate to be applied is
◦ (a) TT Selling Rate, (b) Bills Buying Rate, (c) Rate prescribed by the
correspondent, (d) TT Buying Rate.
2. A customer brings a DD for US$ 1000 drawn by Banker Trust, New
York drawn on your branch & requests you to give credit to his
account. You will apply
 (a) DD Buying Rate (b) Notional Rate (c) TT Selling Rate (d) TT
Buying Rate.
3. Mr. Ashok deposits his personal cheque for GBP 1000 to be
credited to his NRE account. The rate to be applied is
(a) TT Buying Rate, (b) Separate rate to be worked out from TT
Selling Rate (c) Personal cheque cannot be purchased,
(d) Separate rate worked out from TT Buying Rate.

5/6/2018 SKMOHAN 166

1. The exchange rate of a foreign currency is
determined by
◦ (a) RBI (b) AD (c) FEDAI (d) IBA (e) market forces of
demand and supply
2. The inter-bank foreign exchange rates for US$
are Rs. 45.10/20. A customer requests for
encashment of FC demand draft for US $ 5000. if
there are other no charges or commission, what
amount will the customer be receiving?
 a. Rs. 226000
 b. Rs. 225500
 c. Rs. 225000
 d. Rs. 220000

5/6/2018 SKMOHAN 167

• Inter bank rate is USD 1 = Rs.48.05/10. Your bank
has to take up following USD transactions.
Choose appropriate rate (
a) Purchase of an export bill from exporter
b) Payment of an import bill by importer
c) Payment of inward TT remittance favoring customer.
Cover received.
d) Remittance of examination fees to USA on behalf of
a remitter customer
e) Crediting proceeds of Export Collection Bill realized
• Ans:-.a-(48.05) Bills Buying Rate, b-(48.10) Bills
Selling Rate, c-(48.05) TT Buying Rate, .d-(48.10)
TT Selling Rate, e- (48.05) TT Buying Rate,
5/6/2018 SKMOHAN 168
 QUS .
 Calculate rates of exchange for the undernoted transactions when your
bank is quoting following card rates for USD (Jan, 2015). Please note
that you are required to make the above card rates favorable for your
customers by 5 ps. per $ for every transaction
 Buying Rates Selling
Rates
 TT BB TT BS
 45.10 45.00 45.80 45.90
 (i) Converting rupees from NRESB A/c for preparing FCNR (B)
deposit for USD 10,000.
 (ii) Purchasing of an export bill for USD-10,000.
 (iii) Crediting rupee proceeds of inward remittance after getting funds in
NOSTRO a/c USD-5000.
 (. iv) Remittance of USD-5000 outside India for a permissible current a/c
transaction
 (v) Retirement of an import bill on collection USD-5000


 ANS (i) Rs.45.75 (TT Selling), (ii) Rs.45.05 (Bills Buying), (iii) Rs.45.15 (TT Buying),
(iv) Rs.45.75 (TT Selling), (v) Rs.45.85 (Bills Selling

5/6/2018 SKMOHAN 169

1. Forward differential is known as:
 a. swap rate
 b. arbitrage rate
 c. forward rate
 d. spot rate
2. An exporter presented sight bills valuing US $ 50000 for purchase
on 31.3.2015. What rate will you quote and what amount will be paid
to the customer taking into account the following assumptions:
 Exchange margin is 0.15%
 Inter-bank spot rate 1 USD = 43.5525 / 5650
 April forward discount 0.6000 / 0.5700

 Solution : The bank will quote bills buying rate i.e. = 43.55250
 Less : discount for one month = 0.60000
 One month forward rate = 42.95250
 Less : 0.15% exchange margin on 42.9525 = 0.06443
 Bills buying rate = 42.88807
 Amount payable to exporter in Rupees = 2144404.

5/6/2018 SKMOHAN 170

 Cross rates:
 A cross rate is the currency exchange rate between
two currencies when neither are official currencies of the
country in which the exchange rate quote is given.
 Foreign exchange traders use the term to refer
to currency quotes that do not involve the U.S. dollar,
regardless of what country the quote is provided in

 In India, the inter-bank transaction always has USD as

one leg. If we have to arrive at the INR equivalent of any
other currency, we have to apply cross rates. The
calculation involves two stages.
 1. USD / INR
 2. USD / other Foreign Currency

5/6/2018 SKMOHAN 171

 How to calculate Cross Rate?:
 The math is simple algebra: [a/b] x [b/c] = a/c
 Substitute currency pairs for the fractions shown above,
and you get, for instance,
 GBP/AUD x AUD/JPY = GBP/JPY.
 This is the implied (or theoretical) value of the GBP/JPY,
based on the value of the other two pairs.
 The actual value of the GBP/JPY will vary around this
implied value, as the following calculation shows.
 Here are Friday's actual closing BID prices for the 3 currency pairs in this example

 GBP/AUD = 1.73449,
 AUD/JPY = 0.85535

 GBP/JPY = 1.48417. Now, let's do the math:

 GBP/AUD x AUD/JPY = GBP/JPY
 1.73449 x 0.85535 = 1.4836,
 which is not exactly the same as the actual market price. Here's why. During market hours
(Sunday afternoon to Friday afternoon, EST), all prices are LIVE, and small departures from the
mathematical relationships can exist momentarily

5/6/2018 SKMOHAN 172

• EXAMPLE: Derive the rate for EUR/AUD
• EUR/USD =1.3798/1.3858
• USD/AUD =1.0432/1.0502
• Bid Ask
• The EUR/AUD Bid rate= Multiply the term currency bid by the
base currency
• ask = 1.3798 x 1.0432 = 1.4394
• this is the rate at which the market buys EUR and sells AUD
• The EU/AUD Ask rate=
• Multiply the term currency ask by the base currency
bid
• = 1.3858 x 1.0502 = 1.4553
• this is the rate at which the market sells EUR
and buys AUD
• Derive the rate for GBP/EUR
• GBP/USD = 1.9850/1.9950 GBP is base, /USD is terms
• EUR/USD= 1.3460/1.3520 EUR is base, /USD is terms The GBP/EUR
• Bid rate
• = divide the base currency bid by the terms currency
ask =
• 1.9850 / 1.3520 = 1.4682
• this is the rate at which the market buys GBP and sells EUR at 1.4682
EUR per GBP.
• The GBP/EUR Ask rate=
• divide the base currency ask by the terms currency bid =
• 1.9950 / 1.3460 = 1.4821
• this is the rate at which the market sells GBP
and buys EUR at 1.4821 EUR per GBP
 Cross Rate
calculation of TT buying rate on the basis of cross rate

Dollar / Rupee market spot buying rate ----

Less Exchange margin ------

TT buying rate ------ (1)

Dollar Fx currency market spot rate selling rate ----- (2)

TT buying rate for Fx currency = 1 divided by 2 ------

Rounding of to nearest multiple of 0.0025

5/6/2018 SKMOHAN 175

 Bills buying rate
calculation of Bills buying rate on the basis of cross rate
Dollar / Rupee market spot buying rate ----
If Premium
Add premium( Transit and usance period rounded of to lower month
If Discount
Less Forward Discount ( Transit and usance rounded to higher month
Less exchange margin
BB rate for Dollar --- (1)
Fx currency / Dollar market spot selling rate --
If Premium
Add premium( Transit and usance period rounded of to higher month
If Discount
Less Forward Discount ( Transit and usance rounded to lower month
--- (2)
BB rate for Fx currency = 1 divided by 2 -----
Rounded off to nearest multiple of 0.0025
5/6/2018 SKMOHAN 176
 Example

• IOB has issued a demand draft on Montreal for Canadian dollar

50000 at CAD = Rs.32.4850 however , after a few days the
purchaser of draft requested the bank to cancel the draft and
repay the rupee equivalent to him
• Assuming the Canadian dollar were quoted in Singapore Fx
exchange market as under :-
• USD 1=CAD 1.2541/2561
• And in the interbank market
• 1 USD = Rs.39.5275/5350 ,
• how much the customer will gain or loss on cancellation of the
draft ? Exchange margin on TT buying is 0.08%

5/6/2018 SKMOHAN 177

 Solution
The bank cancel the DD at TT Buying rate
USD /rupee market buying rate =39.5275
Less exchange margin at 0.08% on Rs.39.5275 = 0.0316
TT buying Rate 39.4959
USD /CAD market selling rate 1.2561
CAD TT buying rate (39.4959 /1.2561 31.4433

Rounding up to 0.0025 == 31.4425

Amount paid by the customer on purchase of DD for CAD 50000 at 16,24,250

32.4850
Amount received by the customer 50000X31.4425 = 15,72,125

Loss to the customer 52125

5/6/2018 SKMOHAN 178

 Example
 An exporter received an advance remittance of
Danish kroner 100000 by way of TT .He likes to
remain 15% of the remittance in Fx currency in
the interbank market dollar was quoted at
 Spot 1 usd = Rs.39.3500/3600
 1 month forward 1100/1200
 Singapore market Danish kroner was quoted as
under spot USD 1= DKR6.9220/6.9280
 Bank require an exchange margin of 0.08% what
rate will be quoted to the customer / what is the
rupee amount payable to him
5/6/2018 SKMOHAN 179
 solution

Bank has to quote TT buying rate to the customer

Dollar / Rupee market spot buying rate 39.3500

Less Exchange margin0.08% of 39.3500 0.03148

TT buying rate for dollar 39.31852

Dollar /Danish kroner spot selling rate DKR 6.92800

TT buying rate for Kroner 39.31852/ 6.9280 5.6753

Rounded to 0.0025 5.6750

Amount paid to customer DRK 85000X 5.6750 482375

5/6/2018 SKMOHAN 180
 Selling rate

Dollar /Rupee market spot rate ---

Add exchange margin Rs.---
TT selling rate for dollar Rs.---- (1)
add exchange margin for bills selling rate Rs.---
Bill selling rate of dollar Rs.--- ( 2)

Dollar / Fx currency buying rate Fx C----(3)

For TT S rate for Fx currency 1 is divided by 3 ---
Bills selling fx currency 2 is divided by 3 ---
Rounding of to nearest multiple of 0.0025

5/6/2018 SKMOHAN 181

 Example
• on 17th July usd is quoted in the interbank market as follow
– spot 1usd = Rs.38.6025/6100
– Spot /July 500/600
– August 1500/1600
• At Singapore market Malaysian Ringit are quoted as follow
• spot Usd 1 = MYR 3.8012/59
• 1month 24/26
– 2 month 48/50
• bank require the margin of 0.10% on TT selling rate and 0.15% on Bills
selling rate
• 1. Mr. Sk Kapoor requested for a bank draft for MYR 5000
• 2. M/s SMCO ltd desire an import bill for MYR 15000
• calculate the exchange rate to be quoted by the bank in each case

5/6/2018 SKMOHAN 182

1st we have to calculate the selling rate for USD

Dollar / rupee market spot selling rate 38.6100

Add exchange margin 0.0386
TT selling rate for dollar 38.6486
Add exchange margin at 0.15% on 38.6486 0.0580
Bills selling rate for dollar 38.7066
1. Tt selling rate for MYR
dollar /rupee selling rate 38.6486
dollar / MYR spot buying rate Usd 1 = MYR 3.8012
MYR / rupee TT selling rate 38.6486/3.8012 Rs.10.1675
bank will quote a rate of 10.1675 for issue of DD
Bills selling rate for MYR
dollar /rupee bills selling rate 38.7066
dollar / MYR spot buying rate 38.8012
MYR / rupee bills selling rate 38.7066/3.8012 10.1827
rounded of to nearest 0.025
5/6/2018
Rs. 10.1825for
SKMOHAN
Import bill 183
 Example of a Chain Rule (1 )
• All foreign exchange calculations have to be worked with
care and accuracy and several rules have to be kept in mind
• Chain rule- is used to attain comparison or ratio between
two quantities which are linked together through another
or other quantities.
• Equation in the form of a chain is derived.
• Per cent and per mille- Per 100 units/per 1000 units

• Query: If we have to remit French Francs to France from

India how do we go about it? (We have to arrive at cross
rates between FRF and INR.)
• Mumbai interbank market:
– US $ 1 = Rs. 41.2550/2650
• London Market
– US $ 1 = FRF 6.0500/6.0550

5/6/2018 SKMOHAN 184

 Chain rule (2)
• At what rate can one buy FRF against rupees?
• How many Rs----- = FRF 1?
• FRF 6.0500 = US $ 1
• US $ 1 = 41.2650, therefore,
• FRF 6.0500 = US $ 1 = Rs. 41.2650
• Hence, FRF 1 = 41.2650/6.0500
• Or FRF 1 = Rs. 6.8206

5/6/2018 SKMOHAN 185

 Forward Contracts
 Definition:
 Contract between two parties, one of them a Banker.
 To buy or sell a fixed amount of Foreign Currency.
 On a specified future date or within a specified period
 Pre-determined rate of exchange.

 Forward contracts can be booked on the basis of the
ongoing spot rate. It can be used to hedge any exposure in
forex. Customer should have a limit sanctioned.
 Forward contract can be booked on declaration basis also
by exporters with good track record.
 Types of Forward Contracts:
 Fixed Forward
 Option Forward.
 In Option forward contracts, the option period cannot
exceed one calendar month.
5/6/2018 SKMOHAN 186
1. An AD enters into an agreement to take delivery of foreign exchange at a
specified rate on a specified time. This agreement is called a .
– (a) Forward Sale Contract (b) Forward Purchase Contract (c) Future Contract (d) Swap
Contract (e) NOA
2. In option contract, the option period shall not exceed .
– (a) six months (b) twelve months (c) nine months (d) one month (e) NOA
3. If the date of delivery in case of forward contract falls on a holiday, the
delivery has to be effected on the .
– (a) succeeding day (b) preceding day (c) succeeding working day (d) preceding working
day (e) a day to be mutually agreed.
4. When a foreign exchange for forward transaction is at premium, it means the
currency will be_____ in future.
• (a) dearer (b) cheaper (c) same rate (d) more in supply (e) NOA
5. For computing a forward quotation for a currency which is in premium, the
premium margin is to be_________ in case of direct quote.
– (a) added for both selling and buying rate (b) deducted for both selling and buying rate
(c) added to selling rate and deducted from buying rate (d) deducted from buying rate and
added to selling rate (e) NOA
6. If US Dollar is in premium, it is beneficial to .
– (a) exporters (b) importers (c) Authorised Dealers (d) Indian Tourists going abroad (e) b+c
7. For import bills received on collection basis the AD may be required to book
contract.
– (a) Forward purchase contract (b) Forward sale contract (c) Future contract (d) No contract
can be booked for a collection bill (e) NOA

5/6/2018 SKMOHAN 187

calculation of forward buying rate Rs.

Dollar /Rupee market spot buying rate -----

If Premium -----
Add premium
( for forward period ,Transit and usance period
rounded of to lower month
If Discount ------
Less Forward Discount
(for forward period ,Transit and usance rounded to
higher month
Less exchange margin -----

Forward Buying Rate -----

Rounded off to nearest multiple of 0.0025

5/6/2018 SKMOHAN 188
calculation of forward selling rate Rs.

Dollar /Rupee market spot selling rate -----

If Premium -----
Add premium( for forward period ,

If Discount ------
Less Forward Discount (for forward period ,

Add s exchange margin for TT selling rate -----

Forward TT selling rate ----1

Add exchange margin bills selling rate

Forward bills selling rate ----2

5/6/2018 SKMOHAN 189

Forward premium (or discount) in percent per annum

(Forward Rate -Spot Rate)/ X 12 X 100

Spot Rate n

Where ‗n‘ is the number of months till maturity of the forward contract

suppose that the forward rate (60 days) for the Rupee is 49.05/$ whereas the spot rate for
it is 48.20/$ . The forward premium on Indian Rupee will be

49.05-48.20 X 6 X 100 10.58 % Premium

48.20 1

on the other hand, the forward rate for the Rupee is 47.80/$, the forward discount on it
will be

47.80-48.20 X 6 X 100 4.97 % discount

48.20 1

5/6/2018 SKMOHAN 190

 Interpretation of interbank quotation
• Base currency is the currency which is being
bought and sold and the other currency is
incidental.
• Forwards are quoted as follows on 15th January
– Spot/1 month 16/18
– Spot/ 2 months 34/36
– Spot/ 3 months 53/56
• If forward differentials are in the ascending order
(1st figure is lower than the 2nd) the base
currency is at premium
• If rates are quoted in this manner one month
forward margin is valid for one month from 15th
jan to 14th Feb i.e last date of delivery two
months forward margin is valid from 15th feb to
14th March so on

5/6/2018 SKMOHAN 191

• Forwards are quoted as follows on 10th January rates
are given as
– Spot usd 1 = 49.5000/5200
– Spot Feb 3000/3200
– Spot march 3500/3700
– in 1st statement is spot rate for USD buying
49.5000 and selling 49.5200
– 2nd and 3rd gives forward margin during the month
of Feb and March respectively. Feb rate is valid
from 1st feb to last date of Feb while March rate
is valid from 1st march to 31st march

– REMEMBER
– Forward margin is given in ascending order ---
premium add to spot rate ( AA =Ascending order
ADD)
– Descending order deduct from spot rate ( DD =
Descending = deduct )
5/6/2018 SKMOHAN 192
• You have received on 15th jan a TT from
your New York correspondent for USD
10000 for credit to your customer account .
The interbank rate is as follow
• Spot usd 1 = Rs.49.3500/.3700
• spot feb .2500/.2600
• You are require exchange margin @
0.080% calculate the rate to be applied
and the rupee amount to be credited to the
customer’s account

5/6/2018 SKMOHAN 193

As nostro account already credited rate to be applied is
TT buying rate

Calculate TT B rate
inter bank buying rate 48.3500
deduct exchange margin of 0.080 of 48.3500 0.0386
48.31132

Amount to be rounded off to nearest rupee 0.0025 48.3125

which comes to

a/c to be credited with 10000X 48.3125 = 483125

5/6/2018 SKMOHAN 194

 Forward Contracts
• Types of Forward Contracts:
• Fixed Forward and
• Option Forward.
• In Option forward contracts, the option period cannot exceed one
calendar month.
• Definition:
• Contract between two parties, one of them a Banker.
• To buy or sell a fixed amount of Foreign Currency.
• On a specified future date or within a specified period
• Pre-determined rate of exchange.
•
• Forward contracts can be booked on the basis of the ongoing spot rate.
It can be used to hedge any exposure in forex. Customer should have a
limit sanctioned.
• Forward contract can be booked on declaration basis also by exporters
with good track record.
•

5/6/2018 S K MOHAN 195

5/6/2018 S K MOHAN 196
 Forward Points

• Forward Points: The forward premium or

discount, expressed in percentage points, is
called Forward Points, e.g. a forward premium
of 0.0150 is referred to as premium of 150
points.

5/6/2018 S K MOHAN 197

 Forward point
• Let us suppose that the spot rate of US$/Euro is
• Spot Euro 1 =US$ 1.3180
• the exchange rate three months forward is 3 months Euro 1 = US$
1.3330
• The difference of 150 points referred to is the forward point.
• Calculating forward points
• We can calculate the approximate forward points for a given forward period with
the help of the following information
• Spot rate 1.5000
• Interest rate different 3%
• Forward period 90 day
• number of days of the year for calculation 360 days
• Formula for
• spot rate X intt. Rate different X Forward period
• 100 X number of days in the year
• 1.500X3X90 = 0.01125
• 100X360
5/6/2018 S K MOHAN 198
1. In "Tom Contracts" the delivery of foreign exchange should
take place
– (a) within two days (b) next day (c) within 3 days (d) next working
day (e) NOA
2. Currency position does not include one of the following.
– (a) Encashment of foreign currency notes (b) Booking forward
contract (c) Delivery under forward purchase contract (d) Sale of
foreign currency notes (e) NOA
3. Arbitrage is a process of simultaneous buying and selling of
foreign exchange for the sake of making profit from the
difference of .
– (a) An exchange rate at two centers (b) Forward margin at two
centers (c) Interest rates at two centers (d) a+b+c (e) NOA

4. Buying Spot & Selling Forward simultaneously is called

deal.
– (a) Swap (b) Arbitrage (c) Speculative (d) Cover (e) NOA

5/6/2018 S K MOHAN 199

1. An AD enters into an agreement to take delivery of
foreign exchange at a specified rate on a specified
time. This agreement is called a
1. (a) Forward Sale Contract (b) Forward Purchase Contract (c) Future
Contract (d) Swap Contract (e) NOA
2. If US Dollar is in premium, it is beneficial to .
– (a) exporters (b) importers (c) Authorised Dealers (d)
Indian Tourists going abroad (e) b+c
3. For import bills received on collection basis the AD
may be required to book contract.
– (a) Forward purchase contract (b) Forward sale contract
(c) Future contract (d) No contract can be booked for a
collection bill (e) NOA

5/6/2018 S K MOHAN 200

• The spot Euro 1=US$ 1.4250/70. The forward premium is
30-25 for one month, 70-65 for 2 months, 110-105 for 3
months. What rate will be charged for 2 months forward
sale by Bank.
• a. 1.4335
• b. 1.4300
• c. 1.4200
• d. 1.4205
• The home currency price of one unit of foreign currency
is called:
• a. selling rate
• b. buying rate
• c. direct rate
• d. indirect rate

5/6/2018 S K MOHAN 201

• . Forward Rate = Spot Rate + Premium or –
Discount
• If the value of the currency is more than being
quoted for Spot, then it is said to be at a
premium.
• If the currency is cheaper at a later date than
Spot, then it is called at a Discount.
• The forward premium and discount are generally
based on the interest rate differentials of the
two currencies involved.

5/6/2018 S K MOHAN 202

 ARBITRAGE
• It consist of purchase of one currency in one
centre and almost simultaneously sale of same
currency in another centre with an objective to
make profit due to exchange difference prevalent
in these two centers .
• Exchange Arbitrage are of three type :-
• Arbitrage in space – price very in different place buying
and selling of currency it is also called Simple /direct / two point
arbitrage
• Arbitrage in time :-WHEN THE FORWARD MARGIN
FOR ONE PARTICULAR CURRENCY IS FOR PARTICULAR
PERIOD HAVING DEFFFERENCE THAN BUYING AND SELLING
IS CALLED ARBITRAGE IN TIME
• Arbitrage in interest rate WHEN SHORT TERM
INTEREST RATES ON DEPOSIT VARY IN TWO PLACES
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 Arbitrage
• Arbitrage opportunities available to forex traders are known as the
inter market arbitrage. Forex traders regular make arbitrage profit
though interest rate differential in two countries. This is known as
“interest rate arbitrage”.
• Interest rate arbitrage works like this:
• Spot rate £1 = €1.6140. Interest rate for coming 12 months is 5.5%
for Pound Sterling and 3.75% for Euro.
• Suppose a bank quotes a 3 month forward rate as £1 = €1.5970.
• Now let us see whether there exist an arbitrage opportunity or not.

• For example, a trader borrows £100,000 for 3 months. He has to

pay £101,375 after 3- months. He converts £100,000 to € at the
spot rate. He receives €161400.
• Invests €161400 at 3.75% interest rate for 3 months. He earns €
162913. He converts euro proceeding to Pound sterling at the 3
month forward rate of £1 = €1.5970.
• He earns £102,012. He returns £101,375and makes a arbitrage
profit of £636.

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