4. You are the CFO of Yep Bank, a private Indian bank, and you are evaluating following two options to raise capital worth Rs.50 million Rupees:-

Option1: Issue 1-year Commercial Paper at par (CP) in rupees worth Rs.50 million with a FV of Rs.100000 having yield of 7.5%.

Option 2: Issue 1-year CPs at par in UK with a yield of 5% worth Rs.50 million.

Current spot rate is 92INR/Pound and you expect exchange rate at the end of the year will be between 90INR/ Pound - 95INR/ Pound.

4.1 Compare the cost of raising capital in India and the cost of raising capital in UK in worst and best case scenario when the currency risk is unhedged. What is the relation between net exposure in foreign currency and exchange rate fluctuation?

4.2 Suppose now as the CFO you decide to enter the foreign exchange market to hedge currency risk and the 1 year forward rate is 93.5INR/Pound. What is the cost of raising money in UK now? Which of the above two options (raining money purely in India or raising money in UK and hedging the currency risk) seems more beneficial for the bank? If spot rate after 1-year turns out to be 90INR/Pound what is the notional loss/ profit in percentage point terms between hedged and unhedged position.

4.3 Suppose the 1-year interest rate in India is 5.1% and that in UK is 1.75%. What should be the exchange rate after 1 year if no arbitrage condition holds. The spot rate is 92INR/Pound.

4.4 Suppose the domestic interest rate suddenly falls by 100 basis point what will be effect if this on short run exchange rate? Show graphically.