Thanks for you lecture Mr. John. Why will the basis become zero at the end of the futures contract
J
John MoffatTutor·
Because (just as will foreign exchange futures where it is perhaps more obvious) it would be ridiculous it it were possible to buy and sell on the same day and make a profit - the markets could not allow that to happen.
A
Adithya·
Thanks for your reply John. another doubt, we arrive at the basis by subtractiing the spot rate the underlying asset and Futures price right?
The underlying asset in this case is a commodity like bonds of T-bill (Which we call in india)
J
John MoffatTutor·
Correct
A
Anna·
Thank you for the great lecture!
S
SvetlanaSupporter·
Thank you sir for another wonderful lecture!
J
John MoffatTutor·
And thank you for your comment :-)
J
Jie Xiong·
Hi Sir, for example 4, can u explain when we calculate the future price why the interest rate used is LIBOR instead of the interest rate the company use to borrow the loan (7% in Nov and 10% in Jan)? Like example 3 the future price is 100-8 which 8% is the interest on loan instead of LIBOR.
Thanks in advance
J
John MoffatTutor·
Individual companies will pay different interest rates because of different levels of risk. Futures prices don't move with the interest rate each company pays - they move with LIBOR.
In example 3 (which is a simple illustration to explain the idea) the wording means general interest rates are 8% (i.e. LIBOR).
A
Asenam·
Hi John
Example 4
May you please explain the reason why the effective interest of 7.33% was more than the 7%
J
John MoffatTutor·
Because the futures price changes by 2.67 whereas the interest rate changes by 3. The difference is 0.33.
H
hhashmi·
Sir, when we are calculating the gain/loss on futures why are we dividing the difference of the futures prices by 400? and how did the figure 400 come to be?
J
John MoffatTutor·
I do explain this in my lectures!!
We divide by 100 because the futures prices are equivalent fo %'s, and we divide by 4 because they are always 3 month futures and there are four 3 months periods in a year (so we are effectively applying one quarters interest).
P
patrick·
Hello John,
Thanks for the great lecture. I have a question regarding the relationship between the interest rate and the price. For example, an interest rate of 6% is equivalent to a price of 94. What is the logic behind this relationship?
J
John MoffatTutor·
It is simply that in order to make the trading of futures simple (and for it to be the same sort of way people deal in shares i.e. buying at one price and selling at another price), they price the futures at 100 less the equivalent interest rate. So as you write, a futures price of 94 is equivalent to an interest rate of 6% (100 - 94).
P
patrick·
Thanks for the reply. I have one follow-up question. Seems the future price tries to simulate the way stock prices work but they are not the same. For example, if a stock price rises from 90 to 92, then the gain should be calculated as (92 - 90)/90 = 2.22%. However, in case of future prices, the gain will be 2%.
It sounds like the futures price is just a scale from 0 - 100 so that people can easily tell whether the futures contract is rising or falling. Am I correct?
J
John MoffatTutor·
It is correct, but is not really of any relevance. In a perfect world (i.e. ignoring basis risk) the gain or loss will match the loss or gain on the underlying transaction, and that is the purpose of using futures as far as the financial manager is concerned.
C
Collette·
Hi John, can I just say I love your lectures they explain everything so well! One thing that strikes me is that when dealing with the futures we will be receiving these monies when we close the contract which is at the start of the loan and therefore have the receipt sat in our bank account before loan interest is due in 6 months time, theoretically wouldn't this be invested/used to pay off overdraft for example up until the date that the monies would be due and therefore an additional saving on interest/receipt from deposit can be achieved? why would we not factor this in? or have I missed something?
J
John MoffatTutor·
You are right in that there is a timing element here, but we ignore it for the exam :-)
J
John MoffatTutor·
Equity futures are not in the syllabus.
As far as interest rate futures (and exchange rate futures) are concerned, nobody is withdrawing anything. As I do explain in the lectures, using them is effectively gambling and you are not really buying or selling anything. You must have a 'buy' and a 'sell' (in either order depending on the nature of the underlying transaction) and at the end of the deal you receive any gain or suffer any loss (together with a refund of the deposit/margin that had been paid.
B
Belinda·
Hi Sir, when we calculating the futures price for 1 Jan, the futures price on 1 JAN will be lower than the Interest rate (94.00) on 1 JAN because of the futures price on 1 NOV is lower than the interest rate (91.00) on 1 NOV.
Is it this theory applicable to the currency futures as well? i am not sure when to deduct or when to add the unexpired basis risk.
Thank you.
J
John MoffatTutor·
Yes, it is applicable to currency futures. The spot rate and the futures price always move closer together over time, but whichever is higher 'now' will always be higher.
B
Belinda·
thank you,sir.
J
John MoffatTutor·
You are welcome :-)
C
Cathal·
Hi John,
For my understanding please, are the rates under a futures the actual rate we would be locking in to borrow at, or are they just locking in a future base rate (on top of which the bank would add our risk spread, here 1%)? I realise we are only using futures here to hedge the risk and not to actually borrow at the futures specified rate, but I'm curious if I understand.So if we wished to use the January futures and take out a loan at the end of January, would the 6.5% (Price 93.5) be the total interest rate or would it only replace LIBOR as the base rate, with a further risk-spread added by the bank (here, 1%). Many thanks.
J
John MoffatTutor·
If the loan were to be taken on the closing date for the futures (in your example, January) then the 6.5% would replace LIBOR and the actual interest payable would be higher due to the credit risk applicable to the company.
C
Cathal·
Brilliant John. Helps me understand the basis calculation here better i.e. LIBOR/spot rate vs future's rate. Thanks a mil.
J
John MoffatTutor·
Interest is calculated for the period of the loan. There is no interest between now and the date the loan starts because you are not owing anything during that period!!
C
claudia1·
Hello John,
Is there a premium charged on futures?
J
John MoffatTutor·
No - no premium :-)
H
hadehola·
Hello John.
Can you advice: You have used the price of the futures as at January (93.5) to find the basis point on Nov 1st. If the Futures date was March, would you have used 93.35 against 94 to calculate the basis?
J
John MoffatTutor·
93.50 is the price of January futures as at 1 November (not as at January!)
If March futures had been used then we would have taken 93.35 against 94.
The underlying asset in this case is a commodity like bonds of T-bill (Which we call in india)
Thanks in advance
In example 3 (which is a simple illustration to explain the idea) the wording means general interest rates are 8% (i.e. LIBOR).
Example 4
May you please explain the reason why the effective interest of 7.33% was more than the 7%
We divide by 100 because the futures prices are equivalent fo %'s, and we divide by 4 because they are always 3 month futures and there are four 3 months periods in a year (so we are effectively applying one quarters interest).
Thanks for the great lecture. I have a question regarding the relationship between the interest rate and the price. For example, an interest rate of 6% is equivalent to a price of 94. What is the logic behind this relationship?
It sounds like the futures price is just a scale from 0 - 100 so that people can easily tell whether the futures contract is rising or falling. Am I correct?
As far as interest rate futures (and exchange rate futures) are concerned, nobody is withdrawing anything. As I do explain in the lectures, using them is effectively gambling and you are not really buying or selling anything. You must have a 'buy' and a 'sell' (in either order depending on the nature of the underlying transaction) and at the end of the deal you receive any gain or suffer any loss (together with a refund of the deposit/margin that had been paid.
Is it this theory applicable to the currency futures as well? i am not sure when to deduct or when to add the unexpired basis risk.
Thank you.
For my understanding please, are the rates under a futures the actual rate we would be locking in to borrow at, or are they just locking in a future base rate (on top of which the bank would add our risk spread, here 1%)? I realise we are only using futures here to hedge the risk and not to actually borrow at the futures specified rate, but I'm curious if I understand.So if we wished to use the January futures and take out a loan at the end of January, would the 6.5% (Price 93.5) be the total interest rate or would it only replace LIBOR as the base rate, with a further risk-spread added by the bank (here, 1%). Many thanks.
Is there a premium charged on futures?
Can you advice: You have used the price of the futures as at January (93.5) to find the basis point on Nov 1st. If the Futures date was March, would you have used 93.35 against 94 to calculate the basis?
If March futures had been used then we would have taken 93.35 against 94.