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hello john
hope you are well
i have a slight confusion in future currency hedging
lets say we are due to receive a payment from abroad in US$ in 4 months time and local currency is £
then in this case spot rate is usually known in question but i am confused as to which future price to use in order to buy or sell contracts.
is it 5 month future expiry price or 4 month future expiry price
please explain which and why
thanks
It is neither!! You will deal in the futures that first mature after the 4 months. You will then calculate the lock-in rate to apply.
This is all explained in my free lectures on foreign exchange risk management.
hi john
please look at this question
P4 June 11 2ai
over here why did we take out 4 month future price when we are due to receive payment in 4 month?
what you said is that we always take 1 month after the 4 month matures. in this case we should have taken 1.3698, the fifth month expiry price.
why did we work out the 4 month which was not given in the question?
thanks
hi john
i guess i know where my confusion is
when the question says “futures at 4 month expiry” or for example “2 month expiry” then this is referring to the end of the that particular month. this is why in the above question that i mentioned we had to calculate the future price at the start of the 5th month since the question had 5th month expiry price which is basically at the end of the 5th month
is that right?
I think after 4 months’ time, the company will receive $20m in $US but at present it wants to invest in treasury bills, so using future contracts. If you use the 2-month contracts, it will take much more contracts and you dont know after the first 2 months, what rate it will be.
Nhan: Please don’t answer in this forum – it is the Ask the Tutor Forum and you are not the tutor (but please do help people in the other AFM forum).
Abbas7796: The payment will be received in 4 months and therefore ideally we would use futures expiring in 4 months (and the examiners answer estimates a 4 month futures price by apportioning between the 2 month and 5 month prices).
Strictly, however, it is better to calculate the lock-in rate for 4 months (as the examiner states in the answer). I explain in my lectures everything about calculating the lock-in rate.thanks john much appreciated
one more confusion.
formula for basis is spot rate – futures price.
lets say spot rate is 100 and futures are 90 so the total basis is positive 10
however if the spot rate is 90 and futures are 100 then total basis is negative 10
lets assume its just one monthso am i right in saying that when the basis is negative then we add the basis to the spot rate of the future in order to get the future basis and when the basis is positive then we deduct?
is that right?
hi john
please ignore what i have written above. apologies for that.
i just want you to correct me if i am wrong below.
1) formula for basis is futures price minus the spot rate. if this number is negative then we subtract the unexpired negative basis from the spot price on the day. if the number is positive then we add the positive unexpired basis to the spot price
2) formula for lock in rate is futures price +- unexpired basis. we add the unexpired basis to the futures price if the basis is negative. we subtract it if positive.
please correct me if i am wrong
thanks
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