Institute of Chartered Financial Analysts of India (ICFAI) University 2006 Certification Finance International and Trade - II - Question Paper

In the changed scenario, it is very unlikely that the Chinese will go back to the fixed peg since the principle of total market exclusion would be detrimental to its interests. There are 3 possible options, which China can select from. 1st is a totally market determined reform where all controls are relaxed. This is highly unlikely since such a situation would outcome in exchange rate overshooting. This is something the Chinese can ill afford as a 40% revaluation of the yuan will badly affect its exports; and lead to large scale unemployment as no manufacturing unit will set up its base in China. The 2nd possible choice can be widening the 'band' or the range within which the yuan can float. This is a sensible choice on account of 2 reasons. One, there is certainty as to the maximum and minimum range of possible deviation. Two, this will be akin to managed floating where the control of the monetary authority is also exercised while the market is also provided due importance. The 3rd possibility is the choice of pegging to a 'basket of currencies'. This will have the advantage that too much dependence on the dollar as a single reserve currency is decreased and any exchange rate risk is diversified by pegging to other major currencies



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International Finance and Trade - II (222) : April 2006

part D : Case Study

1. The expected exchange rate for 5 years using PPP can be determined as follows:

Current Rs./Can$ =

After one year Rs./Can$ =

After two year Rs./Can$ =

After three year Rs./Can$ =

After four year Rs./Can$ =

After five year Rs./Can$ =

After six year Rs./Can$ =

The adjusted current value is provided by,

APV = –S0 (C0 –A0) + ++ +

Where,

S0 = Current exchange rate = Rs./Can$ 38.23

A0 = Blocked funds – if those funds Rs./Can$ 110 million are repatriated the company have to pay 35% tax. Thus the opportunity cost of using these funds for the project is only Rs./Can$ 38.50 crore.

St = Expected exchanger rate at time ‘t’

Ct = Expected cash flow at time ‘t’, in foreign currency terms

Et = Effect of loss of export sales, in domestic currency terms

Earning:   Approval pending.