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Dear tutor,
in part a) it is necessary to calculate expected revenues in different hedging techniques. In answer when calculating results from futures hedging we need to calculate “lock-in rate” (1.5353) and closing future price (1.5296).
Could you explain the meaning of these rates?Firstly, you do not need to calculate a ‘lock-in rate’ although I will explain what it is later.
As far as the closing futures price is concerned, we know what the current basis is (the difference between the current spot and the current futures price) so we can calculate what it will be on the date of the transaction (we assume it falls linearly to zero over the life of the future). So if we have the spot rate at the date of the transaction we can calculate what the futures price will be at the date of the transaction.
(I assume that you have watched the free lecture on this, and so you understand what I am writing).Since we are not given the spot rate at the date of the transaction (and of course in real life, we have no idea what it will be), then to illustrate how the futures will work simply assume any spot rate (and state what spot you are assuming) and then show the result.
As regards the lock-in rate, although it is not actually needed in this question, we can predict the net effect of converting at whatever sport turns out to be, together with the profit or loss on the futures. The reason we can predict is is because the only reason it will not be a perfect hedge is because of the change in the basis. Since we can calculate the change in the basis we are able to predict what the net effect will be.
If you have not watched the free lecture then not all of the above may make sense. However in that case I do suggest you watch the lecture – I cannot type it all out here 🙂
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