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I have watched the chapter of Foreign exchange risk management, but I am still confused on lock-in rate.
Lock-in rate = Current future price +/- Unexpired basis
However, in past paper 2016 Mar/Jun Q1, why does the answer use March futures and June futures to find out the lock-in rate?
1 March 2016 (Today):
March Future: 0.8638
June Future: 0.8656
Lock-in rate: 0.8638 + (2/3 x (0.8656 – 0.8638))If I use the formula to calculate the lock-in rate, is below calculation collect ?
1 March 2016 (Today):
Spot rate: $1.1618/€1 = €0.8607/$1
Future price: €0.8656
Basis: €0.00491 June 2016 (Transaction date):
Lock-in rate = €0.8656 – (€0.0049 x 1/4) = 0.8644But why is the calculate different with the answer?
Thank you.
The problem is that the spot rate and the futures price are quoted the other way round from each other (the spot rates are per euro and the futures are per $). (It is easily missed but the way to notice this is because the futures price will never be that much different from the spot rate).
So….you need to convert the spot rate to the same way round as the futures. 1.1585 $’s per Euro is the same as 1/1.1585 = 0.8632
So the basis is 0.8656 – 0.8632 = 0.0024, and the unexpired basis is 0.0024/4 = 0.0006.
So the lock-in rate = 0.8656 – 0.0006 = 0.8650
I hope that makes sense ?
(What the examiner has done is apportion between the March and June futures prices)
Is the apportion between March and June futures prices always same as the lock-in rate?
If yes, should I use the apportion calculation to find out the lock-in rate in ACCA examination?
And I have a few confusion on choosing the spot rate…
Buy futures: convert the spot rate at 1.1585
Sell futures: convert the spot rate at 1.1618Is it correct?
Thank you!
The two will give the same answer and you can use either in the exam.
When buying or selling futures, you don’t convert anything – you buy or sell at whatever the futures price is.
But the spot rates on today is $1.1585 – $1.1618 per €1, if I use the spot rate of $1.1618:
$1.1618/€1 = 1/1.1618 = €0.8607/$1
Basis is 0.8656 – 0.8607 = 0.0049, and the unexpired basis is 0.0049/4 = 0.0012.
Lock-in rate = 0.8656 – 0.0012 = 0.8644
Why do I get the different answer if using the spot rate at $1.1618?
Because you are using the wrong spot rate. I explain what rate should be used in my earlier reply.
@johnmoffat said:
The two will give the same answer and you can use either in the exam.When buying or selling futures, you don’t convert anything – you buy or sell at whatever the futures price is.
Since I buy $ futures, I need to use the spot rate at $1.1585?
Strictly speaking, yes you should. (However it is a fairly minor point for the exam and unlikely to lose you marks)
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