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April 14, 2020 at 12:25 pm
Thank you for the lecture on currency futures. I’m not there yet but working on it.
Just clarify that the spot and future price increase by 0.02 is added to the September futures £1.5580, making £1.5780. However, the previous examples on Forward contracts example 4, the 3 months forward rates were given as 0.62-0.51 which were subtracted to the 4th and 5th digits of the spot rate $/£ 1.5326-1.5385. This confuses me because 0.02 I was referring to the last digit of £1.5580, making £1.5582.
To round up my undestnading, the currency futures do not completely hedge the amount at risk it’s only fluctuates the market volatility which the exposure of loss have to be absorbed by an investor. How does a broker make money on this highly volatile transaction?
Thank you very much, Daiva
John Moffat says
April 14, 2020 at 12:57 pm
The adding of 0.02 in the example was just to give a simple illustration of the basic way in which futures work.
However forward rates are quoted in a special way and differences from spot are quoted in cents (so 0.62c = $0.0062).
The two reasons that futures do not completely hedge the risk is because of the contract size (which means it is unlikely that the exact amount can be hedged) and because of the basis (the spot and futures price do not in real life move linearly). Depending on the underlying transaction, some people buy futures and others sell futures. So depending on which way the futures price moves, some make a gain and some make a loss (the dealer makes the opposite gain or loss). If you have more questions then please ask in the Ask the Tutor Forum.
April 14, 2020 at 2:51 pm
Thank you so very much. Superb response with great explanation. Daiva
April 10, 2020 at 8:59 pm
$/€ Which is the foreign currency here and which is the home currency
November 16, 2019 at 3:40 pm
can you please explain why are we multiplying? wont the dollar currency be taken as the base currency?
November 16, 2019 at 3:51 pm
oh never mind i viewed your previous lecture about it. thankyou
August 11, 2019 at 8:17 am
I don’t quite get why do we need to buy these futures at all in this example. Why can’t we just spend $1,250,480 to buy GBP on 12th of June? Why do we need to go through all these transactions with futures just to arrive to the same result as if we just bought the currency on spot?
August 11, 2019 at 10:04 am
Where are you going to get the moment from to be able to convert now? Presumably you would need to borrow it and then have to pay interest on it? (And what if you were going to receive money on a future date – again you would have to borrow money in order to convert now). Of course you could do that – that is what money market hedging is, as I explain in the earlier lectures. However I also explain what the problems are and why you might prefer using futures, forward rates, or options. Which is the ‘best’ approach depends on the circumstances and the amount involved, as again I explain.
January 23, 2019 at 9:37 am
Thanks for the lecture.
Example 8 on Currency Futures. Please clarify because I’m still in doubt about what the requirement trying to say (if the spot and future price increase by 0.02)
The spot rate on Example was 1.5631 (buying GBP) on 12 June Today, but the Answer says 1.5631 was on 10 August. Can you explain what have I missed out?
If R buy GBP 800,000 furtures now at 1.5580 on 12 June, R will pay $1,246,400 Compares to the spot rate 1.5831 (1.5631 + 0.02) on 10 August later which R $1,266,480 would have paid. Therefore R will pay less $20,080 (net savings) if buy the futures now.
If R buy GBP 800,000 Spot now at 1.5631, R will pay $1,250,480. The Future, value at 1.5780 (1.5580 + 0.02) on 10 August which is $1,262,400 R would have paid. Therefore still a net savings of $11,920.
So the most viable option will be buying futures now on 12 June at 1.5580. Does this make sense?
Thank you. Bob
January 23, 2019 at 10:44 am
There is a typing error in the printed answer. If they were to convert the money ‘today’ (i.e. 12 June, then they would pay $1250480.
However, they are not converted today. Instead they are converting on 10 August when the rate is 1.5831. To hedge against the risk they are buying futures today at 1.5580 and selling them on the 10 August at 1.5780. The net result on 10 August is that the risk has been hedged exactly and they end up paying a net 1250480. (But as you will see in the later examples this is only to illustrate the idea – in practice it will not be a perfect hedge because of basis risk and contract sizes).
I will have the wording in the printed answer corrected, but I do show it correctly in the lecture.
August 30, 2018 at 12:27 pm
John, suppose I speculate on the prices of March future. For the future we can have multiple deals until the last day of March, right? and the profit / loss is calculated on each individual deal, right? So by the last day, i could have profit on some and losses on the other, right? And land with a net loss / profit collectively, but i have to pay the dealer individually at the end of each deal i close, right?
August 31, 2018 at 5:15 am
Yes – each deal would be separate (although this is not relevant at all for the exam 🙂 )
June 22, 2018 at 12:49 am
22:30….we need £, therefore we buy, and the bank sells. Are we not supposed to use the low rate since the bank sells low?
June 22, 2018 at 2:08 am
I get it now. I can assume I am the bank in this case since I am the one buying, ie. no bank involved.
June 22, 2018 at 7:13 am
No we don’t assume that we are the bank at all!!!
The company needs to buy Pounds. The Dollar is quoted against the Pound. Using the lower rate would mean it would cost the company fewer dollars, which could not possibly be the case – it is always the bank that gains and ‘us’ who lose.
Have you not watched the earlier lectures, especially the first in this series, because I use several examples to explain which rate we use depending on which way the exchange rate is quoted, and which currently the company is buying or selling. How you learn the ‘rules’ is your choice – I explain what I regard as the easiest way to remember it. But you cannot simply say ‘the bank sells low’ without deciding which currency they are selling and which way round the exchange rate is quoted!!!!
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