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

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  2. Hi John,

    I used example 11 to practise converting at the lock-in rate (1.4843) and realized that the net result differed from the question answer. One reason would be the contract number which is not exact. After accounting for this, it still does not match and I realized that due to the differences in the spread between the spot rate (buy and sell) on the futures purchase (75 ticks) and sell (21 ticks) dates, the net result will not match exactly.

  3. Hello Sir,
    Since we鈥檙e taking the days from 20th June to 31st September, shouldn鈥檛 the days be 10 for June, 31 for July, 31 for August, and 30 for September? Which would be 10+31+31+30=102 days? Kindly clarify.

  4. Thanks Sir for your clear and inspiring lecture
    I have a question, please help to clarify, why in example 11 we round down the contracts from 5.39 to 5 but not round up to 6, will it make us more risk when we do not cover all the amount of the original transaction in the future deal?

  5. Hi John,

    Could you please explain the bank ‘buys low sells high rule’? I have watched your previous lectures but I am still getting confused.

    Like in example 11,

    We OWE $500,000 and so we will sell pounds in order to buy $ (and the base currency is $). So according to this when we buy $, the bank will sell $ at a higher price (so that the bank is benefited from the transaction).

    But in this example when you converted the $500,000 on 12th September you used the lower rate i.e 1.4791 rather than 1.4812.

    • I do not use that ‘rule’!! It is safer to use logic in Paper AFM rather than just learn ‘rules’.

      You use whatever rate is the worst one for the company. In example 11, we are buying $’s. The exchange rate is for the $ quoted against the Pound (so it is the number of $’s that 1 Pound will buy). 1.4791 means that the company pays more Pounds (500,000/1.4791) than if we used 1.4812 (which would mean paying 500,000/1.4812 Pounds).

  6. Hi John. thank you for your lectures.
    i have question regarding the calculation of basis on transaction day.
    It is from the question #2 from AFM December 2018.
    the approach of the examiner in my opinion conflicts with your approach

    shortly the period is 7 months:
    transaction happens on the end of 6th month:
    and the examiner does the following: Futures price = Lock in rate + 6/7 * basis. but by your logic we should use 1/7 since there is only 1 month left. Could you please clarify that part for me?

    • No. The exam answer has calculated the lock-in rate as being the current spot + 6/7 of the basis.
      Alternative you can calculate it as the current futures price less 1/7 of the basis.

      Both ways always give the same result. (As to whether to add or subtract in both cases, just remember that the lock-in rate must always be somewhere between the current spot and the current futures price 馃檪 )

  7. Quick question about the spot rates. In this case we owe a supplier $500k so we are going to sell 拢 to buy $.

    On the 20.06 I considered the relevant rate to be 1.4821 and on the 12,09 the relevant rate would be 1.4791.

    When calculating the future value I used the above mentioned rates and I did not calculate the average.

    20-Jun 12-Sep 30-Sep

    spot 1.4821 1.4791 x

    future 1.4840 1.4794 x

    basis 0.0019 0.0003 0

    Can it be considered correct in an exam scenario or I am going to lose marks?

    Thanks, all the lecture was really helpful.

  8. Hello John, the point you mentioned at 27:19 ”that if the futures rate is lower than the spot today, then it will be lower than spot in future as well” is it just an assumption or it’s practically this way?
    You’re always a great help, Many thanks 馃檪

      • Thank you, one more question that if the spot rate at the transaction date is not given, how will we calculate closing futures price. Can we use forward rate quoted at the transaction date as expected spot?
        Also many times examiner calculates the basis as the difference between two futures prices quoted, rather than difference between current spot and futures rate (Dec 2018 Q2), why is that so and in what case this approach will be required in exam?
        Thank you for your support 馃檪

      • When we do not know the spot rate at the date of the transaction we use the lock-in rate instead. There is more than one way of arriving at the lock-in rate, but the method I explain in the lecture is strictly the correct way.

  9. Hello sir, in the final step on 12th Sept, while converting 500,000$ to pounds we used the rate at 1.4791. And in the next step we are using 1.4812 to convert the profits earned from dollars to pounds.

    My question is, should we not use the same rate (which is 1.4791) to convert the profits into pounds. Please clarify me.

    • For the $500,000 we are buying $’s and therefore use 1.4791.

      For the profit on the futures, we will be selling $’s and therefore use 1.4812.

      (However, you could in fact use the $ profit to make part of the $ payment, and that would be effectively the same as converting the profit at 1.4791)

  11. Just like in example 9 we were selling the first currency which is the us dollar so we used the higher rate both at the time of converting at spot rate which was 1.5190 and also on converting the gain on futures we used this higher rate.

  12. Sir,t thanks for the lectures . I wanted to ask that in example 11 you have used the higher spot rate on Sept 12 to convert the gain on futures whereas in this example we we’re actually buying usd to pay the supplier and as the dollar is the first currency and we’re buying it so shouldn’t we take the lower rate 1.4791 to convert the gain on futures???. since this is also the rate at which converted the transaction at spot rate $500000梅 1.4791

  13. Hi John ,
    In the last bit of example 11, while converting the gain to pounds why have we used the selling rate of 1.4812 . We did use 1.4791 as the rate for converting $500000 on 12th sep so shouldn’t the same rate be used for the gain calculation ?

    • When converting the $500,000 we are buying dollars. When converting the gain we are selling dollars (because the gain is calculated in dollars).

      (Out of interest, you could use some of the dollar gain to make part of the dollar payment, which then would effectively convert it at 1.4812)

  14. Hello, Sir.
    Since we’re taking the days from 20th June to 31st September, shouldn’t the days be 10 for June, 31 for July, 31 for August and 30 for September? Which would be 10+31+31+30 that is 102 days? Do correct me if i’m missing something.
    Thanks a tonne.

  15. Hi John,

    For example 11 (say in the real exam scenario), will I score any extra marks if I do the following format?

    – Sell Pound Futures
    – Price 1.4840 – End September 2004
    – Tick value $6.25
    – No of contract: 5 [workings below ($500,000 / 1.4840) / GBP 62500]

    In case of indicating “Sell Pound Future” is to remind myself for Sell high 1.4840, and buy back low 1.4799 for profit, make sure my tireness doesn’t cause me to do the opposite (Loss) for a Buy Pound scenario

    Thanks

  16. Hi Sir ,

    Can basis risk be negative ?
    Here in the above example , spot price is greater than future price and hence basis is positive .
    In few exam questions future price is higher than spot price , so that means basis will be negative . Is this logic applicable to all questions regardless or receipt or payment ?

    • Yes – although I don’t really like to think of it as being negative even though arithmetically I suppose it is. But more importantly the futures price can be higher or lower than the spot rate and therefore it will always be higher or lower as the difference approaches towards zero.

  17. Good day. Thanks for the lecture. On the e.g. 11. I do not understand why you are deducting the 1.4799 from 1.4840 to calculate the gain on the futures. In the last 2 previous examples we deducted the sell was the closing future price and the buy the future price now.

    • In example 9, the underlying transaction is selling $’s because they are receiving $’s. In example 11 the underlying transaction is buying $’s because they are paying $’s.

      We buy or sell futures at the current price depending on whether the underlying transaction involves buying or selling the currency. I do explain this, and also read again note 1 below example 9 in the lecture notes.

      • Hello. Please clearify the note 1 to the example 9: why have we to buy futures when we buy currency? I guess we act on the “contraversial” and in the following examples there are written “buy” futures when we sell the currency and “sell” wnen we buy currency.

        And one more question: there is no question 13 in the answers.

        (Thank you, the lectures and notes are very helpfull)

      • We buy futures when the transaction involves buying the currency in which the futures are quoted (the currency in which the contract size is quoted). We sell futures when the transaction involves selling the currency in which the futures are quoted.
        This is what happens in all of the examples.

        There is no printed answer to example 13, but I explain the free lectures.

      • It will be clear to give the last words in the note to the ex.9:
        “The contract currency is the currency in which the FUTURS contract is quoted”.

        I really spend several days to get what was meant there.

      • I am not changing the notes, because I make this clear in the lecture (and the notes should not be used on their own – it is in the lectures that I explain and expand on the notes).

  20. Hi Mr Moffat, I may be wrong but from 1 July to 31 August should actually be 2 months? Therefore 0.0200 x 2/3 (rather than 1/3). Then from 31 Aug to 30 Sep will be 1/3. You made the point very clearly, I just want to make sure that this logic is correct. Thanks for the lectures!

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