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Hello,
If the question does not state whether or not a company wanys to under hedge and then hedge the remaining amount using a forward contract, would we get full marks for simply calculating the net receipt/payment based on an over hedge. Or should we always assume that they are going to underhedge and then hedge the remaining through a forward contract.
Similarly for options – does the same rule apply?
Thanks,
Raheel
Go to the nearest whole number of contracts and that automatically determine whether there is an over-hedge or an under-hedge.
Dear sir,
what in case when we are able only to calculate the effective rate on futures hedge? If I’m not wrong you explained in the lectures that in this case we can only calculate the final approximation of the outcome, without separating the unhedged amount. But in the exam from March 20, Q2b – the answer seems to calculate the effective rate and use this rate to later calculate the numbers of contracts and the unhedged amount… Is this solution ok?
I think you are confusing futures with options.
We don’t calculate an effective rate for futures. Unless we are given the spot rate or the futures price on the date of the transaction, we calculate the lock-in rate and apply this to the contracts. Any difference because of having to have whole numbers of contracts is the over or under hedge and we will use forward rates on this.
Thank you sir!
I was referring to lock-in rate (I followed the term used by BPP in their workbook).
I watched again the lecture (FX risk mgmt 1 p8) and in fact, it was my misunderstanding. So in fact we have to use the lock-in rate to calculate the number of contracts (not the futures price) and any difference is then over/underhedged.OK (although they shouldn’t really call it an effective rate 🙂 ).
Correct 🙂
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