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hi
i am confused how the spot and future price
Spot rate – $/£ 1.65770
September futures price – $/£1.65750were calculated in below question.
any assistance explaining this would be much appreciated. thanks
Question:
Imagine it is 10 July. A UK company has a US$6.65m invoice to pay on 26 August. They are concerned that exchange rate fluctuations could increase the £ cost and, hence, seek to effectively fix the £ cost using exchange traded futures. The current spot rate is $/£1.71110.Research shows that £/$ futures, where the contract size is denominated in £, are available on the CME Europe exchange at the following prices:
September expiry – 1.71035
December expiry – 1.70865The contract size is £100,000 and the futures are quoted in US$ per £1. Assume Outcome on 26 August:
On 26 August the following was true:
Spot rate – $/£ 1.65770
September futures price – $/£1.65750I dont understand why its gain on futures market(dollar/pound)
sell – on 10 July
1.71035Buy back – on 26 August
(1.65750)Because the transactions occurs on 29 August, they will trade in September futures.
Because the transaction involves selling Pounds (to buy $’s), they will sell Pound futures today (10 July) at the quoted price of 1.71035, and close the deal by buying Pound futures on 26 August at the then price of 1.65750. The gain on the futures (in dollars) is the difference between the buy and sell prices, as applied to the number of futures contracts in which they are trading.
This is all explained in detail, with examples, in my free lectures on foreign exchange risk management.
thank you for your swift response.
I did understood the gains what i can not figure out is how prices On 26 August were derived:
Spot rate – $/£ 1.65770 and
September futures price – $/£1.65750 were not given in the question.I tried lock-in rate of (1.71110-1.71035)=0.00075*35days/82days=0.00032 but i still can’t figured it out and am not sure if i am just missing out on something.
i would appreciate if you can explain the logic sir.
thanks.
From the way that you had typed it, I assumed that the prices had been given in the question.
One of the two would need to be given in order for the other to be calculated using the basis risk (unless this was just an illustrative question in your study text).
If it is a past exam question, or a question from the BPP Revision Kit, then tell me which one so that will then be able to answer you properly.
thank you so much for your time Sir.
The question was in fact an illustration from ACCA AFM Technical articles: topic – Exchange traded foreign exchange derivatives
the price for 26th August was not given which why I have been disturbing my brain going through the article having watch your lecture videos.
now i know that “One of the two prices would need to be given in order for the other to be calculated using the basis risk”
Thanks a lot Sir.
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