Great Lecture !! Super clear. Thank you so much MR. John
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John MoffatTutor·
Thank you for your comment :-)
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Sohaibb·
Hi Sir, I had the concept of futures but I do not understand the logic behind it. As you said we do it to cancel out the risk but as of my real life experience not of LIFE tho but as far as I know The percentage of risk compare to percentage of cost of transaction are quite different. What I mean is if we get loss the loss amount would be quite high compare to the transaction cost. If I am wrong somewhere please help me out. Thanks
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Holly·
Thank you! Your videos explain much better than the paid content I've been using!!
J
John MoffatTutor·
Thank you for your comment :-)
J
JojoBeat·
Sir, I don't understand the futures changing from week to week. Isn't it an obligation to buy at a FIXED rate and a FIXED date therefore it won't change?
J
JojoBeat·
Sir, I don't understand the futures changing from week to week. Isn't it an obligation to buy at a FIXED rate therefore it won't change?
J
John MoffatTutor·
The price of futures changes each day just like the price of shares does.
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Ania·
hello sir , fantastic lecture , whats the difference between currency swaps and money market hedging?
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John MoffatTutor·
Money market hedging is converting foreign currency now into order to avoid the risk of exchange rates changing on the date of the transaction.
Currency swaps are a way of reducing the interest payable on borrowings but are not examinable until Paper AFM. (They are the same sort of idea as interest rate swaps which are examinable in Paper FM (and are explained in my free lectures) although calculations cannot be asked for in Paper FM.)
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Tauqeer·
it might be stupid of me to ask but i still did not get that how is Financial manager hedging the risk by buying futures?
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John MoffatTutor·
Because there is risk on the underlying transaction due to exchange rate movements and the risk on the futures deal cancels out the risk on the underlying transaction. As the exchange rate moves against us and the underlying transaction costs us more, the futures make a gain which cancels out the extra cost (and vice versa).
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Tauqeer·
Thank you so much sir. You are the best :)
J
John MoffatTutor·
Thank you :-)
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Parth·
Hello John,
Great lecture, really improved my understanding of futures. One thing I'm still confused about though is at what points did we actually spend money to buy the future since initially we just made a phone call and a deposit?
Thanks in advance
J
John MoffatTutor·
You never pay for them in the normal way.
What happens is that you pay a deposit at the start of the deal. At the end of the deal it is effectively as though you then pay for the futures (at the price they are at the start ) and immediately sell them at the price on the date you finish the deal.In practice there is just the one net payment if the price has fallen, or one net receipt if the price has increased.
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Parth·
Hello John,
Great lecture, really improved my understanding of futures. One thing I'm still confused about though is at what point
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a7mdsuliman·
Hi John, thanks for this amazing lecture as always but I have a question regarding example 8 and I hope it's not stupid one,
if we have decided to get futures now on 12 June, why didn't we use the rate today as of 12 june 1.5631 and get more benefit and futures at rate of 1.5580 instead of waiting spot rate at 10 of august 1.5831
I might think of holding cash can lose interest or the value of keeping it working but it may worth.
appreciate your advice
J
John MoffatTutor·
Certainly they could do that (provided they have the cash available or can borrow it, and the interest rate is OK). It would be effectively using a forward rate.
Using futures is simply one method available for them to consider, and although here they will be paying money, what about if they were receiving money? The problem then is that might not be certain as to when the customer would pay, and futures give the flexibility.
For the exam it is just a matter of being aware of the various alternatives that are available for them to choose from (and appreciate that as far as futures are concerned, the examiner in Paper FM will not expect calculations but just an understanding of the idea).
A
a7mdsuliman·
Thanks John, you are awesome
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John MoffatTutor·
You are welcome :-)
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Pan·
Where is the 1.5831 come from ? ?
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John MoffatTutor·
I assume that you have downloaded the free lecture notes that go with the lectures. In which case, you will see that the current spot rate is 1.5631 and the question says to assume that it increases by 0.02 (which will increase the spot rate to 1.5831).
A
Ali·
Thank u for your valuable lectures,
just small question regarding e.g. 8,
at the first step, since we are buying the $ , why we did not used the first rate according to the rule you explained on exchange rate risk lecture which stated that " used the first rate if we are buying the first currency and used the second rate if we are selling the first currency"
J
John MoffatTutor·
In this example, because we are paying GB pounds and we are in the US, we need to buy pounds (which means we need to sell $'s in order to buy the pounds).
So we are selling the first currency in the quote (which is $'s) and therefore we use the second of the two rates.
J
John MoffatTutor·
The exchange rates and future prices given are quoting the dollar against the pound, and therefore the futures profit is in dollars.
(However, do remember that you cannot be asked calculations on this in Paper FM. All that matters is that you understand the idea behind using futures.)
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Suaad·
Hello Sir,
First of all, your lectures are absolutely amazing and helpful.
"If the ER is against us, we lose on the transaction but gain on the futures, and vice versa".
So why would i invest at all? If it cancels out or gives an extremely small gain for a large risk.
I also did not understand what the difference between 1266480 - 16000 = 1250480 gave us? why it it such a large pay out amount if we\re making a gain ??
Please guide me with this.
J
John MoffatTutor·
Thank you for your comment.
However you seem to have missed the whole point of using futures - have you watched the previous lectures on foreign exchange risk management?
The whole point is to use the risk of the futures to 'cancel' out the risk of the transaction. The company is having to make a payment of 800,000 and if the exchange rate was not going to change then it would end of costing them $1,250,480. However, the exchange rate is likely to change and they will end up having to pay more or less as a result - so there is risk. By using futures, the net payment is fixed at $1,250,480, whatever happens to the exchange rate - so no risk.
(In practice, as pointed out in the lecture, things will not work quite so perfectly, but this is not dealt with until Paper AFM)
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Ali Ansari·
What a brilliant lecture,thanks for amazing explanation :)
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Poonam·
Why would a Financial manager choose futures to hedge his risk over Forward contracts? As i understand the futures rates affects the forward contract rates and hence they would be moving in a similar fashion so what would be the difference between the two in terms of choice for hedging the risk? TIA
J
John MoffatTutor·
I explain why in my lectures :-)
If you use forward contracts, then the conversion has to take place on a fixed date. This can be a big problem, especially with receipts - how can you be certain as to on what date a customer will pay?
However, futures deals can be closed at any time (up to the end of the future) and therefore you are more flexible with regard to the date of the transaction.
K
kkipouros·
Hi,
I am sorry but we do not actually add money, are we? I mean The 0.02 is added as a percentage on the exchange rate to convert our amounts and not as dollars or cents, no?
J
John MoffatTutor·
The 0.02 is not a %. The exchange rate in $'s per GBP changes from day to day - in this example it changed by 2 cents.
P
Poonam·
Just for my understanding I want to know in example 8 we are adding 0.02 to the spot and future prices. Is this in $ or cents?
Currency swaps are a way of reducing the interest payable on borrowings but are not examinable until Paper AFM. (They are the same sort of idea as interest rate swaps which are examinable in Paper FM (and are explained in my free lectures) although calculations cannot be asked for in Paper FM.)
Great lecture, really improved my understanding of futures. One thing I'm still confused about though is at what points did we actually spend money to buy the future since initially we just made a phone call and a deposit?
Thanks in advance
What happens is that you pay a deposit at the start of the deal. At the end of the deal it is effectively as though you then pay for the futures (at the price they are at the start ) and immediately sell them at the price on the date you finish the deal.In practice there is just the one net payment if the price has fallen, or one net receipt if the price has increased.
Great lecture, really improved my understanding of futures. One thing I'm still confused about though is at what point
if we have decided to get futures now on 12 June, why didn't we use the rate today as of 12 june 1.5631 and get more benefit and futures at rate of 1.5580 instead of waiting spot rate at 10 of august 1.5831
I might think of holding cash can lose interest or the value of keeping it working but it may worth.
appreciate your advice
Using futures is simply one method available for them to consider, and although here they will be paying money, what about if they were receiving money? The problem then is that might not be certain as to when the customer would pay, and futures give the flexibility.
For the exam it is just a matter of being aware of the various alternatives that are available for them to choose from (and appreciate that as far as futures are concerned, the examiner in Paper FM will not expect calculations but just an understanding of the idea).
just small question regarding e.g. 8,
at the first step, since we are buying the $ , why we did not used the first rate according to the rule you explained on exchange rate risk lecture which stated that " used the first rate if we are buying the first currency and used the second rate if we are selling the first currency"
So we are selling the first currency in the quote (which is $'s) and therefore we use the second of the two rates.
(However, do remember that you cannot be asked calculations on this in Paper FM. All that matters is that you understand the idea behind using futures.)
First of all, your lectures are absolutely amazing and helpful.
"If the ER is against us, we lose on the transaction but gain on the futures, and vice versa".
So why would i invest at all? If it cancels out or gives an extremely small gain for a large risk.
I also did not understand what the difference between 1266480 - 16000 = 1250480 gave us? why it it such a large pay out amount if we\re making a gain ??
Please guide me with this.
However you seem to have missed the whole point of using futures - have you watched the previous lectures on foreign exchange risk management?
The whole point is to use the risk of the futures to 'cancel' out the risk of the transaction. The company is having to make a payment of 800,000 and if the exchange rate was not going to change then it would end of costing them $1,250,480. However, the exchange rate is likely to change and they will end up having to pay more or less as a result - so there is risk. By using futures, the net payment is fixed at $1,250,480, whatever happens to the exchange rate - so no risk.
(In practice, as pointed out in the lecture, things will not work quite so perfectly, but this is not dealt with until Paper AFM)
If you use forward contracts, then the conversion has to take place on a fixed date. This can be a big problem, especially with receipts - how can you be certain as to on what date a customer will pay?
However, futures deals can be closed at any time (up to the end of the future) and therefore you are more flexible with regard to the date of the transaction.
I am sorry but we do not actually add money, are we? I mean The 0.02 is added as a percentage on the exchange rate to convert our amounts and not as dollars or cents, no?