When you say that the lock-in rate only applies to the contract amount and like you say that if there was a contract size of 100,000 pounds and there were 7 contracts then do you mean that the lock-in rate applies to 700,000 pounds?
And if it would then your second statement that ‘any remaining amount left at risk’ does not apply, right? Because the amount that we would be getting in pounds would in any case be less than 700,000 pounds?
Your first statement is correct, but your second paragraph is wrong.
Suppose the amount of money at risk was 720,000 pounds. With a contract size of 100,000 then you could still only deal in 7 contracts. This would fix the amount on 700,000, but what about the other 20,000? This would remain at risk unless we did something else on the 20,000.
Thank you John now I get the logic behind the Lock-In Rate. Just one more question. Will the Lock-in Rate always be in the middle of the “Futures and Spot rate”? no matter which one is higher?
So John, What should we do in the exam? If Spot and Future Rates are not provided for the Transaction Date and Forward Contracts rates are provided? Or even when Forward rates are also not provided (examiner is the boss and can do anything)?
Which approach will score good marks?
1- Assuming that Forward rates provided for the date of transaction will be the same as Future Rate and solving the rest of the question. 2- Assuming any Spot Rate Ourselves and solving the question. or 3- Just simply using the Lock-In Rate and showing the net effect. 4- Or any other approach that I may have missed?
Hi Sir, In your previous examples when calculating futures price you were always starting when setting up the table with the future price and under you listed spot price.
In this example you started with Spot rate 1.5 under listed future 1.47 and calculated the difference. In your example the difference is 0.03.
If you set it up like in the previous examples (example 11 or 10) future rate first and spot rate under the calculation looks like 1.47-1.5=-0.03
This will change the value of estimated future rate as at 1 August because of the negative -0.03
Which order is correct? You can get two different results estimating future rate depending on the order of spot rate and future rate today.
Whether you write it as plus or minus makes no difference. what does matter is that the futures price and the spot rate will get closer together over time, so you adjust in the way that makes them close together.
sush97 says
Hello sir
You’ve mentioned in the example of future prices spot rate
John Moffat says
I don’t understand what it is that you are asking me.
Arun says
Hi John,
When you say that the lock-in rate only applies to the contract amount and like you say that if there was a contract size of 100,000 pounds and there were 7 contracts then do you mean that the lock-in rate applies to 700,000 pounds?
And if it would then your second statement that ‘any remaining amount left at risk’ does not apply, right? Because the amount that we would be getting in pounds would in any case be less than 700,000 pounds?
Is my understanding correct?
Thanks.
John Moffat says
Your first statement is correct, but your second paragraph is wrong.
Suppose the amount of money at risk was 720,000 pounds. With a contract size of 100,000 then you could still only deal in 7 contracts. This would fix the amount on 700,000, but what about the other 20,000? This would remain at risk unless we did something else on the 20,000.
Rana Nabeel says
Thank you John now I get the logic behind the Lock-In Rate. Just one more question. Will the Lock-in Rate always be in the middle of the “Futures and Spot rate”? no matter which one is higher?
John Moffat says
Yes it always will be (because the spot and futures prices always get closer together).
Rana Nabeel says
So John, What should we do in the exam? If Spot and Future Rates are not provided for the Transaction Date and Forward Contracts rates are provided? Or even when Forward rates are also not provided (examiner is the boss and can do anything)?
Which approach will score good marks?
1- Assuming that Forward rates provided for the date of transaction will be the same as Future Rate and solving the rest of the question.
2- Assuming any Spot Rate Ourselves and solving the question.
or
3- Just simply using the Lock-In Rate and showing the net effect.
4- Or any other approach that I may have missed?
John Moffat says
If you are not given the spot rate at the date of the transaction then you should use the lock-in rate.
karyinyip says
hi, if the spot rate at the date of the transaction is given, is it still alright to use lock-in rate?
John Moffat says
No. If you know the spot rate you should use it.
Damian says
Hi Sir,
In your previous examples when calculating futures price you were always starting when setting up the table with the future price and under you listed spot price.
In this example you started with Spot rate 1.5 under listed future 1.47 and calculated the difference. In your example the difference is 0.03.
If you set it up like in the previous examples (example 11 or 10) future rate first and spot rate under the calculation looks like 1.47-1.5=-0.03
This will change the value of estimated future rate as at 1 August because of the negative -0.03
Which order is correct? You can get two different results estimating future rate depending on the order of spot rate and future rate today.
Thank you
John Moffat says
Whether you write it as plus or minus makes no difference. what does matter is that the futures price and the spot rate will get closer together over time, so you adjust in the way that makes them close together.