how to find future price at settlement date for currency future contract hedging?

You will choose a June future (the first one after the date of the transaction)

To estimate the futures price at the date of the transaction, you take the basis risk now (the difference between the future price now and the spot rate now) and assume it falls linearly to zero between now and the end of the future (end of June for a June future)

To get the futures price on 31 May, you need to know what the spot rate is on 31 May (which you did not type in the question).

The basis risk on 1 February is 1.4260 (June futures) – 1.4120 (spot) = 0.0140

The basis risk will fall linearly over the 5 months to the end of June – i.e. by 1/5 each month.

So, at the end May(start June) – the date of the transaction – the basis risk will have fallen by 4/5 and there will be 1/5 left. This means the basis risk will be 1/5 x 0.0140 = 0.0028

So….the futures price at the end of May will be 0.0028 higher than the spot rate at the end of May (which you have not given).

However the effect of using futures will be to effectively fix the net result on the date of the transaction at an exchange rate of 1.4260 (the current futures price) + 0.0028 (the basis risk at the time of the transaction) = 1.4288.

i agree with you,1.4232 is right. it is ok no exchange rate of june.1 not given in the question.

@sotjot said:
thank you sirs=)

thank you for your patient reply. but i still have questions,as in bpp kit 78,page77,Polytot(06/04),in the answer of the question a,we found that net outcome by using future hedge is 2686272,which means the effective exchange rate is 4124236/2686272=1.5353,which can also be calculated as future price 1.5272+0.0078(closing basis point).Didn’t it is a quicker method to calculate the effective exchange rate/.and in this cases,we could get the net outcome without knowing the future spot rate at conversion or transaction?

@johnmoffat said:

@nonoacca. Sorry, but that is simply not correct.
If you are not given the spot rate on 1 June then it is not possible to estimate the futures price on 1 June, and you cannot be expected to do so.

My answer before was correct – the futures price will be 0.0028 higher than whatever the spot rate happens so be. (So…..if the spot rate is 1.4000, then the futures prices will be 1.4028. If the spot rate is 1.5000 then the future price will be 1.5028. We obviously have no idea what the spot rate will be on 1 June – it could be anything.)

However, when the examiner does not give a spot rate at the date of the transaction, but asks you “how a UK company might hedge the risk exposure” then what he is expecting is that you explain how we would use futures (i.e. leave the transaction at risk, but start a futures deal so that the profit or loss not he futures will ‘cancel’ the gain or loss on the transaction); state the futures deal that you would enter into (i.e. buy 18 June futures contracts at 1.4269); and to state that this would effectively fix the net result (the transaction converted at whatever spot happens to be, plus or minus the profit or loss on the futures) as though it was being converted at 1.4288 (as calculated in my previous answer).

However, the question is very strange in that the UK does not use Euros, and so assuming that they worked in GB Pounds then using $/Euro contracts would not hedge the risk at all – they would use $/GBP futures!!!!

as said above,spot future price=1.4260,closing basis=(0.014)/5=(0.0028),so we put together of them 1.4260-0.0028=1.4232.
blockquote> @evalstngj said:
If i may ask, where did both of you get 1.4232 from. If you are not given spot at June or May you cannot get futures price – in May it shd be same as spot.

Quote: “”If i may ask, where did both of you get 1.4232 from. If you are not given spot at June or May you cannot get futures price – in May it shd be same as spot.””

The futures price will only be the same as the spot rate on the last day of the future (for a June future this will be on the last day of June).

At the end of May, the futures price will differ from the spot rate by 0.0028 (the basis risk). The calculation of this is in my previous answer.

Since we do not know the spot at the end of May, we cannot calculate the futures price on that day.

However, what we can say is that the net result of converting at spot together with the profit or loss on the futures, will be equivalent to converting at a rate of 1.4288 (see above)