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Hello,
in the above named question( part a on currency futures) when calculating the number of contracts why was 1.9035 used? Based on my understanding, the current futures price should be used, which is 1.8986. Pls can u explain why a different rate was used?Thanks
It is because they have used the lock-in rate. (Because we can predict the basis risk if we assume linearly, then we can predict the resulting effect of using futures).
However, you do not need to do this.
When deciding how many contracts to deal in, the effect of the above will always be minor and does not matter. If you had used the normal current futures price of 1.8986 you would still have got full marks (and the same number of contracts).
Thanks Sir! Is it okay to simply use the lock-in rate to know the effect of using futures when we are not given adequate information? In the question above we were not given the closing futures rate which could be used to determine the profit or loss as a result of hedging.
Yes.
In general, much more important is that you prove you know how futures work – proving this is worth more than the numbers themselves
In this question we can find out closing future rate as,
Spot future
1st jun 1.9156 1.898631st Oct 1.9029 1.8980
Basis risk 0.017 x 2/7 = 0.00486
1.9029-0.00486= 1.8980
But in the exam kit solutions, they added 0.00486 + 1.8986=1.9035
In all other questions I’ve been following that if there is increasing trends so add the monthly apportioned basis risk or vice versa , it’s very confusing
Plz guide me
ThanksAnd 2nd question is
While calculating currency option @ ex price 1.92, closing spot 1.9029
Claim back profits of option is 0.0171x19x31250= $10153/ 1.9081 1.9081 is selling rate as should be, while in book solutions they have used 1.9029 which is buying rate
Why?First question:
As I wrote in my first response on this page, they are not calculating the closing futures price. Instead they are calculating the effective lock-in rate. You could do either. You can find out about the lock-in rate by watching the free lecture.
Second question:
I only have the examiners own answer to this question, which shows the results in a different way. Without seeing the full answer that you are looking at it is not possible for me to explain what they have done.
Ok thank you so much, gonna watch that lecture,
I calculated profits on option to claim back, gain on exercising option is $10153
I need to convert it into local pounds
From the rate ($/£) 1.9029-1.9081
I’m using selling rate 1.9081 as I’ll sell the dollar gain to get my local currency, as dollar is first currency so I’m using sell rate,
Plz correct if above mentioned is wrong
Thanx loads tutor for being helpfulHello,
My question is regarding part c of this question. I have property calculated the exchange rates for 5years. And I thought EMV can be calculated by taking sum of present value of 4.2m/exchange rate and then discounted by 11%. But examiner has taken “difference to spot” calculation for 5years and then he has been discounted those cashflow to get the EVM. Could you kindly explain me the logic behind taking “difference to spot” calculation here?
Thanks Sir,
JMThe question asks for the effect on the market value. So it wants to know how much the market value will be changed by.
You can get the same result in 2 ways. Either calculate the PV if the exchange rate stays at the current spot, then calculate the PV with the estimated exchange rates, and look at the difference in the PV’s; or, (and slightly faster) look at the differences in the cash flows (as in the examiners answer) and calculate the PV of the differences.
Either approach is valid and gives the same end result 🙂
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