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Hello John,
Hope you are doing well. Many thanks for your constant and valuable support you provide to us.
May I please ask you to clarify for me the assumption that the basis (i.e. the difference between the spot rate and future price) will fall to 0 at the end date of future? I mean why do we assume that the futures price at for instance 31 Dec will be the same as spot rate at the same period?
What is not clear for me is that we used to say that actually spot rate and future price are different things but in the end of futures period (for instance on 31 Dec 2024) we equal these two figures…
And would you please advise if my understanding is right: is it true that for instance if I buy the USD/GBP December Futures for a price let’s say 1.6$ it means that I have a right to convert USD to GBP on 31 Dec at the rate of 1.6$ per pound?
Thank you in advance,
YegyanaYour last paragraph is correct.
And that is the reason that the futures price on the last day of the future must be the same as the spot rate on that day. If you bought December futures on 31 December then you would have the right to buy or sell the currency at whatever the price of the futures is on 31 December. That price must be the same as the spot rate on 31 December because otherwise you could but futures and convert currency then convert it back at spot and make a profit, which would have to be impossible 🙂
Thanks a million for the answer, would you please support on the following as well (hopefully the last question):
– If I bought December futures on 31 December, I would also have to sell them the same day i.e. for instance $1.6 per pound as a purchase and selling price – so doesn’t it mean that I anyway wouldn’t be able to make a profit even if the spot is different from the purchase price?
– I slightly don’t understand the mechanism of how futures work, I mean if I buy the futures, I have to sell them back, so basically the futures are used for trading only. So how can I convert the currency using the futures if I have to sell the futures I bought and, in the end, I will not have any futures.
Thank you,
YegyanaAlthough futures can be used to actually purchase currencies, that it not the way that the financial manager is using them in the exam.
The currency will always be converted at whatever the spot rate turns out to be on the date of the transaction. The futures are used so that the gain or loss on the futures cancels out the gain or loss on the conversion resulting for converting on the date of the transaction as opposed to converting ‘now’.
Have you watched my free lectures on futures?
Hello John,
I have a question regarding the calculation of basis.
I have done many questions and cannot work it out.
Which spot rate do we use to calculate the basis = Opening futures rate minus spot rate. Which spot rate to use? Various questions use various rates, either buy rate or sell rate. Is there a rule here? If we are buying futures we should use buy spot rate? (eg. spot rate quoted: 1CHF = 1.1196-1.1222 USD$), so rate 1.1196 should be used?
I always use the wrong rate as every question seem to have its own rule :(.
If i use the wrong spot rate, would I lose many marks in the exam?Many thanks
MonikaThere are arguments for using different rates. I always use the mid-market spot rate as I explain in my free lectures, but you will not lose marks for using the different rate.
Hello John,
Thanks very much for replying to my question, it is much appreciated as I am self studying. Good to hear about the marking scheme too.
Your lectures are great and helped me a lot.
Many thanks
Monika
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