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Foreign exchange risk management (1) Part 7 – ACCA (AFM) lectures

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  1. Dear sir,
    By the definition given in the notes the definition of futures say that it is “a binding contract to buy/sell contract currency at a fixed rate and at a fixed date” but the assumption given for estimating futures prices states that the price of the futures will be same as the spot rate at the end of its life

    Sir I had initially thought that the Price on the date of purchase of the futures contract would be the exercise price at the end of its life because of the definition, now I have understood that the price we purchase futures at is the market price and not the exercise price and the Market value of the future is assumed to be equal to the spot rate on the last day (on maturity)

    So does that mean the Market value of the futures on the last day is also the exercise price?

    Also, I still do not understand why in the definition of futures it is stated that Currency futures contract is a contract to buy/sell at a “Fixed price” because isn’t the price variable as its based on the spot rate on maturity, so can you pls clarify on what this fixed price is?

    • If you want to convert currency on a specific date then you convert it at whatever the sport rate is on that date (and that is the exercise price). However if the conversion is going to take place on a future date then obviously by that date in the future the spot rate may have changed and therefore the amount you will pay or receive on conversion will change – so there is risk.

      To avoid that risk you can use futures which effectively fix the exchange rate today that will apply on the future date.

      So, for example, the futures rate today that will apply to converting on (say) 30 September might be 1.20. If you enter the futures contract then the transaction on 30 September will be converted at 1.20 whatever the spot rate happens to be on 30 September.

      However, if you wait a week then the futures rate offered for conversion on 30 September will likely be different. The futures rate will change from day to day.

      If you waited until 30 September to enter into the futures contract then you will be getting a fixed rate for converting on 30 September. That fixed rate on 30 September must be the same as the spot rate on 30 September otherwise it would be ridiculous – nobody is ever going to give you a rate on 30 September for conversion on the 30 September that is different from the spot rate on 30 September 馃檪

  4. Hi John, Thanks for this amazing lecture. Just a quick question, at time stamp 23:36, for calculating the number of days, it should be 10 days in June + 31 in July + 31 in Aug and 30 days in Sep, should it not?

  6. Hi, I’m not sure why the basis risk is only 0.0067 at August 31 st in example 10. Don’t you have 3 periods for the futures (July 30, August 31, September 30)? If the spread starts at 0.02 at July 1, the spread will reduce by 0.0067, 0.0067 *2, and 0.0067 * 3 at July 30, August 31, and September 30 respectively. Which means that at August 31, the spread (basis risk) would be “reducing” the spot rate by 0.02/3*2 or 0.0134 to close the gap with the futures rate?

    • Remember the as we are assuming the difference between the spot and the futures falls linearly to zero the keeps reducing by .0067. Therefore by 31st Jul the Remaining Basis will be 0.0133 and by the 31 Aug it would be 0.0067. Hence why now you can use the remaining basis of 0.0067 to calculate the futures price.

    • To pay the supplier we are buying $’s and so convert at 1.4791.

      We are receiving a $ gain on the futures therefore we need to sell $’s and so convert at 1.4812.

      (What they could do is use the $ gain on the futures to part pay the $500,000 and so only the net $ amount would need to be converted at 1.4791). Either is acceptable in the exam.

      • Hi John, as I was watching example 11 , this was my thought too.

        Presumably in real life this is the better option as you save (by avoidance) twice on the spread ie the $1281.25 to GBP for the hedge, and the reduction of GBP required as now we need (500000-1281.25) $498,718.75?

        thanks

  8. that was amazing, just one doubt , at the end while we convert the profit to pounds should we use the buy rate ie the smaller rate or sell ie the higher rate ? , as in this case we need to pay dollars hence buy dollars and sell pounds so shouldn’t we be using the buy rate for that conversion?

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