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  1. Profile photo of christopheryaheya says

    Hi Sir,
    What is the future price in the question below

    Now is 30th June, The company is located in USA that has contract to purchase goods from Japan in two months time, on 1 September. The payment is to be made in Yen and will total 140 Million.
    The company is considering using currency future. the following data are available.

    Spot foreign exchange rate
    Yen/$ 128.15
    Yen Currency future contract on SIMEX (Singapore Monetary Exchange)
    Contract size 12,500,000 Yen. Contract prices are in US$ per Yen.

    Contract prices.
    September 0.007985
    December 0.008250

    • Profile photo of John Moffat says

      The current futures prices are given in the question (0.007985 and 0.008250 depending on whether you are interested in a September or December future. In this question you will be after a September future).

      However, I guess that what you are interested in is the basis (difference between the current spot and the current futures price) in order to be able to estimate the basis on the day the contract is closed out (1 September).
      The problem obviously is that the spot is quoted Yen/$ whereas the futures are quoted $/Yen. (which is very unusual – it has only ever happened this one time in the exam, and this question was a long time ago, almost 15 years!).

      However, in order to calculate the basis we need them both quoted the same way. To do this you restate the current spot as Yen/$ which is 1/128.15 = 0.007803.
      Now that we have the spot and futures both quoted the same way, you can carry on as normal – the basis now is 0.007985 – 0.007803 = 0.000182. We assume that this falls linearly over the life of the future.

  2. avatar says

    hey, thanks for making future hedge a lot clearer. i appreciate. However, while solving example 11, you converted $1281.25 into £ using the currency spot selling rate of 1.4812. why did you not use the buying rate of 1.4791 since on the 12 of sept, we will be buying back the £ futures or instead use the currency spot rate of 20th june to convert if we are to stick with selling futures, after all, we were supposed to sell the future on 20th june and buy it back on 12 of sept. please i need for explanation

    • Profile photo of John Moffat says

      When we ‘buy’ futures we do not actually pay out any cash, and similarly when we ‘sell’ futures we do not receive any cash.
      A futures deal needs a ‘buy’ and a ‘sell’ and (apart from having to pay a deposit (margin) at the start of the deal) the only cash involved is the receipt of the profit (or payment of the loss) at the end of the deal. It is nothing but a gamble or bet on the movement of the exchange rate.

      In this question, at the end of the deal we made a profit on the future of $1281.25 and so we would receive that many $’s. Since we are in the UK we need to sell the $’s to convert to £’s.

      Hope that helps :-)

      • avatar says

        wow never thought of that, the profit is a foreign exchange receipt not a payment. make a great deal of sense. thanks

      • Profile photo of christopheryaheya says

        Hi Sir,
        What is the future price in the question below

        Now is 30th June, The company is located in USA that has contract to purchase goods from Japan in two months time, on 1 September. The payment is to be made in Yen and will total 140 Million.
        The company is considering using currency future. the following data are available.

        Spot foreign exchange rate
        Yen/$ 128.15
        Yen Currency future contract on SIMEX (Singapore Monetary Exchange)
        Contract size 12,500,000 Yen. Contract prices are in US$ per Yen.

        Contract prices.
        September 0.007985
        December 0.008250

    • Profile photo of Arwa says

      wow cant believe it ,,, had the same doubt , jumped to the comments and found the answer ! I am impressed ,,,

      thank you John and a big thank you to Open tuition :D

  3. Profile photo of nickneouk says

    Great lecture thanks. In your example, in order to work out how many contracts are needed you divide by the futures exchange rate but the textbook example (I won’t mention the text) divides by the current exchange rate. Has anyone else spotted suuch an anomally as I know the textbooks can make mistakes sometimes?

  4. Profile photo of freshmint says

    Brilliant lecture! One problem that I had was how to decide on whether to buy a future or to sell a future to mitigate the transaction risk. I’ve now learned that buying/selling a futures deal depends on the contract currency. If the contract currency is Pounds, and we are buying Dollars, it means we are SELLING the contract currency, i.e. Pounds, therefore, we SELL futures contracts now.

    Thank you sir, for your wonderful teaching. I am forever grateful!

  5. Profile photo of anneliese464 says

    i think i get it….if we make a profit on futures we have to use the “right” rate. if we make a loss we have to used the “left” rate. but i am confused a little bit now, u wrote the “buy” rate of 1.4812 or “buy” rate of 1.5910.
    i thougt if the quote from the bank is 1.4791 – 1.4812, then the first is buy and the second sell…so on profits we should use sell rate and on losses the buy rate.
    hm…i hope that there will be INterest rate futures, not currrency :-) are u also taking the exam P4?? greetings and good luck with ur study!

    • Profile photo of estherpang87 says

      Hi there, the 1.5190 is for the Example 9 in the lecture notes. Your interpretation about the buy and sell rate is wrong. 1.4791 is called bank sell rate whereas the 1.4812 is called bank buy rate. lets say we want to sell dollar and buy pound, therefore we will use the bank buy rate for conversion. because we are asking the bank to buy dollar from us as we want to sell it. So the bank will pay us lesser if the bank buy rate of 1.4812 is used. I’m taking P4 this time. Good luck to u

  6. Profile photo of estherpang87 says

    for the previous example 9, it is correct too in the sense that we made profits on futures denominated in dollars, so we would sell $ and buy £, therefore, buy rate of $1.5190 is being used.

    But lets say if we made losses on the futures denominated in dollars, we would then have to make payment in dollars by selling £ and buying $. and thus, sell rate is to be used. Hope you’ll get my point.

  7. Profile photo of estherpang87 says

    Hi there, after seeing your comment, I replay the video lecture. and now, I totally understand the reason why tutor used the buy rate of $1.4812. It’s because we would receive profits on futures denominated in dollars. Then, we would sell $ to buy £.Thus, buy rate of $1.4812 is used. Thanks anyway.

  8. Profile photo of estherpang87 says

    Hi sir, for this example 11, why did u use the buy rate of 1.4812 for converting the profits on futures at the end of transaction date, 12/9? Since the underlying transaction in the cash market on 12/9 is converted at a sell rate of 1.4791, (where we sell pound to buy $), so I personally think that the profits on futures should also be converted at a sell rate of 1.4791, rather than at a buy rate of 1.4812. Please correct me If i am wrong. Thank you sir.

    • Profile photo of anneliese464 says

      I thought about it again…we have to pay 500.000 $ therfore on 12. Sept we use the rate 1,4791 -> 338.043 GBP. if we used the other rate of 1,4812 this would be 337.564. As I remember it that it is always the “worst” outcome for us as the bank is gaining, it is logical that we have to use the rate 1,4791 as thus we have to pay more GBP.
      concerning the profit we make a profit of 1.281,25 $. now i am not sure at what rate to convert cause if we use 1,4791 than this is a profit of 866,24 GBP. If we use the rate 1,4812, we would have a profit of 865 GBP. this would be the “worse” outcome for us as we would gain less from converting the $ profit to GBP profit. so perhaps 1,4812 is the right rate? then it was not correct in the previous example

      • avatar says

        @anneliese464,
        For the reason we use the rate 1,4812 to convert because we gain the profit of $1.282,25 at 12 Sep, mean that the money we have at that moment. To convert to GBP, we have to use to selling rate of USD at that time @ 1,4812.

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