In example 3, assuming we are in the UK(as instructed) would we not have to sell £ to buy the $200,000? I was thinking the rate should have been 1.4970. Could you please clarify.
Yes, we would need to sell Pounds to buy $’s, but the correct rate to use is 1.4910.
It is up to you how you choose to remember which rates to use, but the way I choose to remember (and explain in the previous lecture) is that the lower rate is the rate to use when the company is buying the first currency (which for a $/Pound quote – the first currency is $ ))
But just think about it – if you converted at 1.4970 you would end up paying less Pounds, which cannot possibly be correct. It is whichever is worse for the company (it is the bank who makes the profit!!).
If you have not watched the previous lecture then please do so, because I go through several examples deciding which of the two rates to use.
You should ask this in the Ask the Tutor forum rather than as a comment on a lecture. You interpolate in exactly the same way as we do when calculating an IRR.
I have a question for clarity purpose. I am still a bit confused on which of the buy and sell rates to use. The General rule is if he is paying, using example 5, he is in possession of the pound sterling hence he is going to sell pound sterling to buy dollars right?
In this particular adjustment, why are we taking the gain of 1100 to the Other Comp of Equity? Why not adding it to the Retained Earnings?
Note 7 – Forward currency contract (Dec 2013) During July and August 2013 Alpha conducted a large marketing effort in Country X. The currency in Country X is the Euro. Alpha made no sales to customers in Country X in the year ended 30 September 2013 but is very confident of making substantial sales to such customers in the year ended 30 September 2014. On 5 September 2013, Alpha entered into a contract to sell €20 million for $28 million on 31 October 2013. Currency fluctuations in September 2013 were such that on 30 September 2013 the fair value of this currency contract was $1·1 million (a financial asset). The draft financial statements of Alpha do not include any amounts in respect of this currency contract since it has a zero cost. Alpha wishes to use hedge accounting whenever permitted by International Financial Reporting Standards. Alpha expects sales to customers in Country X to be at least €22 million in October 2013.
Sir,do we have a video lecture on chapter 15:Mergers and Acquisitions,16:The valuation of acquisitions and mergers and 17: Corporate reorganisation and capital reconstruction schemes?
If we are buying (say) $100,000, then if we convert at the higher rate it will only cost us £66800. If we convert at the lower rate it will cost us £67069.
The reason for the two rates is that the difference is the banks ‘profit’ and so it has to be whichever rate is worse for us. Since we are having to pay £’s, it is whichever ends up with us having to pay the most £’s
in your example 5, “chapter: foreign exchange risk management”, the amount Z will pay using the forward buying rate of 1.6665 cuz we have to buy $200,000 from bank before we pay it.(the question is , in order to buy $ from bank, we have to sell pounds to the bank then get the $, so why not using the selling rate of 1.6715 as the similar situation illustrated in example2 in the note?)
many thanks, your lecture is so clear! thank you again. hope to hear from you soon.
Cjm32228 In the example 5, Z needs to buy the 1st currency (which is $) from the bank. So we use the buying rate 1.6665.
In the example 2 Jimjam is in India and he has to sell Indian Rupees in order to buy Ruritanian Dollars and Indian rupee is the 1st currency again. So we used the Selling rate.
You have to decide are you buying or selling FIRST CURRENCY, keyword is the “first currency”. Thank you
In your example in the last paragraph, the SLR is quoted against the USD. (SLR/USD 109).
If the forward rate it quoted pm, it means that they are quoting the SLR at a premium (because the spot rate is quoted SLR to 1 USD). If the SLR is quoted at a premium it means that the SLR is to strengthen and therefore fewer SLR’s to the USD – you would subtract the premium.
The way spot rates are quoted in the exam is always how many of the first currency = 1 of the second. (e.g. SLR/USD 109 means 109 SLR = 1 USD). When the forward rate is quoted as pm or dis then it is always the first currency that is strengthening (pm) or weakening (dis) and so you always subtract a pm and add a dis.
Dear Tutor, Can you please confirm if the value of the domestic currency in relation to that of the foreign currency plays a crucial role in calculation of forward rate given a premium/discount rate?
As mentioned in the lecture, pm stands for premium meaning the forward rate is at a premium i.e the foreign currency is expected to appreciate in value in the future. Therefore, depending on whether the domestic currency appreciates (increases in value) or depreciates (decreases in value) in relation to the foreign currency, the premium is deducted or added, respectively. Is my understanding correct? In our examples 4 & 5, the GBP (local/domestic currency) is at a higher value than the USD (foreign currency). So if anticipating that the GBP were to appreciate further in 3 months, the US dollars forward rate would be set at a discount to the spot rate. If anticipating that the GBP were to depreciate in 3 months, the US dollar forward rate would be at a premium. If suppose we were transacting in Sri Lankan Rupee where, where 1 USD = SLR 109, the domestic currency (SLR) is at a lower rate than the USD (foreign currency). In this situation would we add the premium to the SLR assuming that the foreign currency appreciates in 3 months and deduct the discount assuming that the foreign currency depreciates?
Sir
In example 3, assuming we are in the UK(as instructed) would we not have to sell £ to buy the $200,000? I was thinking the rate should have been 1.4970. Could you please clarify.
Many thanks
Yes, we would need to sell Pounds to buy $’s, but the correct rate to use is 1.4910.
It is up to you how you choose to remember which rates to use, but the way I choose to remember (and explain in the previous lecture) is that the lower rate is the rate to use when the company is buying the first currency (which for a $/Pound quote – the first currency is $ ))
But just think about it – if you converted at 1.4970 you would end up paying less Pounds, which cannot possibly be correct. It is whichever is worse for the company (it is the bank who makes the profit!!).
If you have not watched the previous lecture then please do so, because I go through several examples deciding which of the two rates to use.
Thanks for the lecture.
You are welcome, and thank you for the comment.
I am having an issue with the interpolation between for example a three month forward and a one year forward to find a four month forward
You should ask this in the Ask the Tutor forum rather than as a comment on a lecture.
You interpolate in exactly the same way as we do when calculating an IRR.
Sir,
I have a question for clarity purpose. I am still a bit confused on which of the buy and sell rates to use. The General rule is if he is paying, using example 5, he is in possession of the pound sterling hence he is going to sell pound sterling to buy dollars right?
Hi Sir,
Just a small doubt:
In this particular adjustment, why are we taking the gain of 1100 to the Other Comp of Equity? Why not adding it to the Retained Earnings?
Note 7 – Forward currency contract (Dec 2013)
During July and August 2013 Alpha conducted a large marketing effort in Country X. The currency in Country X is the Euro. Alpha made no sales to customers in Country X in the year ended 30 September 2013 but is very confident of making substantial sales to such customers in the year ended 30 September 2014. On 5 September 2013, Alpha entered into a contract to sell €20 million for $28 million on 31 October 2013. Currency fluctuations in September 2013 were such that on 30 September 2013 the fair value of this currency contract was $1·1 million (a financial asset). The draft financial statements of Alpha do not include any amounts in respect of this currency contract since it has a zero cost. Alpha wishes to use hedge accounting whenever permitted by International Financial Reporting Standards. Alpha expects sales to customers in Country X to be at least €22 million in October 2013.
Thanks in advance,
Swati
Sir,do we have a video lecture on chapter 15:Mergers and Acquisitions,16:The valuation of acquisitions and mergers and 17: Corporate reorganisation and capital reconstruction schemes?
Given 3 months forward rate ($ per pound) 1.5398 and 1 year forward rate 1.5178, how to calculate 4 months forward rate?
Please help me into this.
I have the same issue
Nice Lecture . God bless
for example 3 u said we are buying $ won”t the bank sell to us at the highest of the rates i.e 1.4970 and not 1.4910?
No – think about it.
If we are buying (say) $100,000, then if we convert at the higher rate it will only cost us £66800. If we convert at the lower rate it will cost us £67069.
The reason for the two rates is that the difference is the banks ‘profit’ and so it has to be whichever rate is worse for us. Since we are having to pay £’s, it is whichever ends up with us having to pay the most £’s
I am gonna clear this exam this time for sure with the help of these lectures…thanks alot…
Dear professor:
i found one point confused.
in your example 5, “chapter: foreign exchange risk management”, the amount Z will pay using the forward buying rate of 1.6665 cuz we have to buy $200,000 from bank before we pay it.(the question is , in order to buy $ from bank, we have to sell pounds to the bank then get the $, so why not using the selling rate of 1.6715 as the similar situation illustrated in example2 in the note?)
many thanks, your lecture is so clear! thank you again. hope to hear from you soon.
Cjm32228 In the example 5, Z needs to buy the 1st currency (which is $) from the bank. So we use the buying rate 1.6665.
In the example 2 Jimjam is in India and he has to sell Indian Rupees in order to buy Ruritanian Dollars and Indian rupee is the 1st currency again. So we used the Selling rate.
You have to decide are you buying or selling FIRST CURRENCY, keyword is the “first currency”.
Thank you
Dear Mr. John Moffat,
Thank you for prompt reply. Your reply had made the concept very clear. Once again thank you very much.
You have got the idea, but be careful.
In your example in the last paragraph, the SLR is quoted against the USD. (SLR/USD 109).
If the forward rate it quoted pm, it means that they are quoting the SLR at a premium (because the spot rate is quoted SLR to 1 USD). If the SLR is quoted at a premium it means that the SLR is to strengthen and therefore fewer SLR’s to the USD – you would subtract the premium.
The way spot rates are quoted in the exam is always how many of the first currency = 1 of the second. (e.g. SLR/USD 109 means 109 SLR = 1 USD). When the forward rate is quoted as pm or dis then it is always the first currency that is strengthening (pm) or weakening (dis) and so you always subtract a pm and add a dis.
Dear Tutor,
Can you please confirm if the value of the domestic currency in relation to that of the foreign currency plays a crucial role in calculation of forward rate given a premium/discount rate?
As mentioned in the lecture, pm stands for premium meaning the forward rate is at a premium i.e the foreign currency is expected to appreciate in value in the future. Therefore, depending on whether the domestic currency appreciates (increases in value) or depreciates (decreases in value) in relation to the foreign currency, the premium is deducted or added, respectively. Is my understanding correct?
In our examples 4 & 5, the GBP (local/domestic currency) is at a higher value than the USD (foreign currency). So if anticipating that the GBP were to appreciate further in 3 months, the US dollars forward rate would be set at a discount to the spot rate. If anticipating that the GBP were to depreciate in 3 months, the US dollar forward rate would be at a premium.
If suppose we were transacting in Sri Lankan Rupee where, where 1 USD = SLR 109, the domestic currency (SLR) is at a lower rate than the USD (foreign currency). In this situation would we add the premium to the SLR assuming that the foreign currency appreciates in 3 months and deduct the discount assuming that the foreign currency depreciates?
Looking forward to your reply.
Thank you.
These lectures are SO helpful! Thanks a lot!! =)