Thank you John now I get the logic behind the Lock-In Rate. Just one more question. Will the Lock-in Rate always be in the middle of the “Futures and Spot rate”? no matter which one is higher?

So John, What should we do in the exam? If Spot and Future Rates are not provided for the Transaction Date and Forward Contracts rates are provided? Or even when Forward rates are also not provided (examiner is the boss and can do anything)?

Which approach will score good marks?

1- Assuming that Forward rates provided for the date of transaction will be the same as Future Rate and solving the rest of the question. 2- Assuming any Spot Rate Ourselves and solving the question. or 3- Just simply using the Lock-In Rate and showing the net effect. 4- Or any other approach that I may have missed?

Hi Sir, In your previous examples when calculating futures price you were always starting when setting up the table with the future price and under you listed spot price.

In this example you started with Spot rate 1.5 under listed future 1.47 and calculated the difference. In your example the difference is 0.03.

If you set it up like in the previous examples (example 11 or 10) future rate first and spot rate under the calculation looks like 1.47-1.5=-0.03

This will change the value of estimated future rate as at 1 August because of the negative -0.03

Which order is correct? You can get two different results estimating future rate depending on the order of spot rate and future rate today.

Whether you write it as plus or minus makes no difference. what does matter is that the futures price and the spot rate will get closer together over time, so you adjust in the way that makes them close together.

Am i right in thinking you only need to use lock in rate when calculating futures only when you havent been given the spot or futures excercise price? thanks

Sorry i am a bit confused lets suppose we are not given the spot rate or futures rate on the transaction date. I know we will need to use the lock in rate but how will this work if there are contract sizes given in the question? Thanks

You calculate the nearest number of contracts, then you apply the lock-in rate to the amount of the contracts. Any balance is an over or under hedge and forward rates can be used on this balance.

If the information is available, should I calculate the answer the long winded way? Only, for the CMC Co question, June 2014, I got the correct answer for the furtures question using a lock in rate. However, in the answer they did it the long way. Would I still get all the available marks it I used a short cut method?

Would I be correct in saying that, we only use forwards in conjunction with futures if we underhedge the furure transaction, in order to reduce the remaining bit of the transaction left at risk? But no need to use any forwards if we have overhedged the furure?

Ideally you should consider using forward rates whether you have under-hedged or over-hedged (because you will either have too much or too little of the other currency).

In the exam it is more important to simply mention the possibility that do the calculations, if you are running out of time.

When you were calculating futures, why did you divide the dollars by the spot rate on 1st April, rather than the future rate at the first of April? And the rule for lock in rate is that we will always deduct the difference of basis from the spot rate right?

There are arguments for using both – the spot rate or the futures rate. The difference will not make much difference and either will be allowed in the exam.

As to whether to deduct or add the difference in the basis to the spot – it is whichever makes the futures price and spot rate closer together.

Hi Sir, I have a small doubt about the concept of the Lock In Rate. Isn’t the Lock In Rate affected to a small extent by the future spot rate? Seeing that the gain loss on the futures transaction needs to be converted back to GBP, the spot rate in the future will thus affect the gain/loss in our home currency.

So to that extent, is the Lock In Rate not exactly fixed, but a very close approximation to our net rate at the end of the day?

Yes, that is true. (In addition appreciate that the lock-in rate assumes that the basis falls linearly, which is not necessarily going to be the case in practice.)

What is the actually the rule for adding/subtracting the basis to the spot if we’re doing it by the first method or the future price if we’re doing it by the second method?

Sir, i have a confusion.lets suppose that i have 7 contracts of 62500 pounds, how will i use lock in rate. ( 7*62500*…..?) what rate i will use here?the same 1.48 lock in rate ?

Hi John, thanks a lot for a lecture. Im trying to figure out what Lock in rate and original amount to apply for example 11. I calculated Lock in rate of 1,4843. But when I apply it to the contract amoun- 62500 * 5 * 1,484. I get a strange result of 312 437, which is definitely not the outcome of the hedge…could You please shed a bit more light here? Thank You!

You should apply it to the amount of the transaction.

Therefore $500,000/1.4843 = 336859

The difference between this and the net amount in the answer to the example is because the contract size means we are not able to hedge the exact amount.

I had three issues as below that need you help me more clearly:

1. in previous lectures on future, The basis risk is the difference between future price and spot rate. However, in this lecutre i saw you shown them in positive sign (0.03 & 0.01) while future price wa less than spot rate. what I meant that why didn’t they were -0.03 and -0.01

2. for the first way of calculation of Lock-in rate, you took spot (1.50) minus change in basis risk (0.02) to get lock-in rate $/GBP 1.48 because of spot rate greater than future price. If spot rate smaller than future price, we will take spot rate(1.50) plus change in basis risk (0.02) to get lock-in rate (1.52). Am i correct and is it a rule for calculation?

3. for the second way of calculation of Lock-in rate, you took future price (1.47) plus basis risk on date of transaction (0.01) to get lock-in rate $/GBP 1.48 because of future price smaller than spot rate. If spot rate smaller than future price, we will take future pric(1.47) minus basis risk on date of transaction (0.01) to get lock-in rate (1.46). Am i correct and is it a rule for calculation?

The answer to all three questions is that the spot and futures prices will get closer together over time. So if the current spot is higher than the current futures price, then the lock-in rate will be lower than the current spot. If the current spot is lower than the current futures price, then the lock-in rate will be higher than the current spot (which means that you are correct in point (2) 🙂 )

I was studying the exam question “Polytot”, with an answer given that calculated the unhedged amount using an exchange based on the lock-in rate, and I spent two hours of fruitless Google hunting trying to figure out what was going on.

It is simpler, and ‘predicts’ the end result of the future. However you should still understand how futures work in real life, because that can be asked.

Dear John, what is the correct anwer? Is it total receipt of 675796 GBP=657894+17902? “Lock-in-rate” would be also something like 1M/675796=1.4797 – something like effective rate we have experienced after combining all outcomes from transaction and futures deal? Also how do you think if there might be a situation where examiner will ask us to use LOck-in rate for our calculation or is it just a one of the methods to come to final answer? Thanks for advise. With kind regards, Olga

As to when to use it, it depends what information is given. If you are given a spot rate to use at the date of the transaction then you do it the way in the earlier lectures (calculating what futures price will be on the date of the transaction).

If you are not told a spot rate to use at the date of the transaction (which these days is a bit more likely) then you should use the lock-in rate.

Whatever you do, make sure you write down what you are doing. Most of the marks are for proving that you understand how futures work rather than for the precise figures.

Hi John, your lectures are greatly appreciated!! 🙂 So far everything has been very well explained, however, I was a bit confused as to why we divide $ 1 mn by 1.5 (spot rate on 1st April) instead of 1.47 (futures price on 1st April) in calculating the profit/loss on futures. Since we have always converted the $ amount to Sterling using the futures price in the previous examples. Hope you can explain a little more on that. Thank you again Sir 🙂

But Sir, what I meant is why profit = 1mn/1.5*(1.51-1.47) ? In previous futures examples we took the number of contracts by ($ amount/current futures price)/Contract size. And the profit/loss on futures we calculated by No. of contracts*contract size*difference in futures price. So why don’t we take the profit here by 1mn/1.47*(1.51-1.47)?

In future please ask this sort of question in the Ask the Tutor Forum rather than as a comment on a lecture.

If you really mean revise (i.e. you have already studied everything and just need to remind yourself) then you need to work through as many questions as you can – preferably using a Revision Kit from one of the approved publishers, but certainly the last 8 real exams (which were all set by the current examiner). Also, you might find it useful to watch the lectures where I go through Question 1 of the last two exams.

If you have not already studied, then you are going to have to move fast. Watch all of the lectures (with the lecture notes in front of you). Go back to relevant F9 lectures if there is anything that you have forgotten or were not happy about. When you have done this, then what I have written in the previous paragraph 🙂

First you do not have to use a forward contract on the remainder. However it is a sensible recommendation and it is the difference between the contracted amount (on the futures) and the actual amount.

Rana Nabeel says

Thank you John now I get the logic behind the Lock-In Rate. Just one more question. Will the Lock-in Rate always be in the middle of the “Futures and Spot rate”? no matter which one is higher?

John Moffat says

Yes it always will be (because the spot and futures prices always get closer together).

Rana Nabeel says

So John, What should we do in the exam? If Spot and Future Rates are not provided for the Transaction Date and Forward Contracts rates are provided? Or even when Forward rates are also not provided (examiner is the boss and can do anything)?

Which approach will score good marks?

1- Assuming that Forward rates provided for the date of transaction will be the same as Future Rate and solving the rest of the question.

2- Assuming any Spot Rate Ourselves and solving the question.

or

3- Just simply using the Lock-In Rate and showing the net effect.

4- Or any other approach that I may have missed?

John Moffat says

If you are not given the spot rate at the date of the transaction then you should use the lock-in rate.

Damian says

Hi Sir,

In your previous examples when calculating futures price you were always starting when setting up the table with the future price and under you listed spot price.

In this example you started with Spot rate 1.5 under listed future 1.47 and calculated the difference. In your example the difference is 0.03.

If you set it up like in the previous examples (example 11 or 10) future rate first and spot rate under the calculation looks like 1.47-1.5=-0.03

This will change the value of estimated future rate as at 1 August because of the negative -0.03

Which order is correct? You can get two different results estimating future rate depending on the order of spot rate and future rate today.

Thank you

John Moffat says

Whether you write it as plus or minus makes no difference. what does matter is that the futures price and the spot rate will get closer together over time, so you adjust in the way that makes them close together.

kkhatani says

Hi,

Am i right in thinking you only need to use lock in rate when calculating futures only when you havent been given the spot or futures excercise price? thanks

John Moffat says

Yes – that is correct 🙂

kkhatani says

Hi,

Would we ever be asked to calculate a lock in rate for a interest rate question or is it more likely to be asked for a currency question? thanks

John Moffat says

Yes – it could be asked for either.

kkhatani says

Sorry i am a bit confused lets suppose we are not given the spot rate or futures rate on the transaction date. I know we will need to use the lock in rate but how will this work if there are contract sizes given in the question? Thanks

John Moffat says

You calculate the nearest number of contracts, then you apply the lock-in rate to the amount of the contracts. Any balance is an over or under hedge and forward rates can be used on this balance.

neilsolaris says

If the information is available, should I calculate the answer the long winded way? Only, for the CMC Co question, June 2014, I got the correct answer for the furtures question using a lock in rate. However, in the answer they did it the long way. Would I still get all the available marks it I used a short cut method?

Thanks.

neilsolaris says

I think you’ve address this question in your lecture on the June 2014 question 1. I understand I won’t lose any marks using the lock in rate.

Thanks.

John Moffat says

Yes – you would still get the marks (and these days more and more the only way possible on the information given is to use the lock-in rate).

neilsolaris says

Hi,

Would I be correct in saying that, we only use forwards in conjunction with futures if we underhedge the furure transaction, in order to reduce the remaining bit of the transaction left at risk? But no need to use any forwards if we have overhedged the furure?

Many thanks.

John Moffat says

Ideally you should consider using forward rates whether you have under-hedged or over-hedged (because you will either have too much or too little of the other currency).

In the exam it is more important to simply mention the possibility that do the calculations, if you are running out of time.

neilsolaris says

Thanks very much. Coincidentally, I just watched you explaining just that in your June 2014 question 1 lecture.

John Moffat says

You are welcome 🙂

Amer says

When you were calculating futures, why did you divide the dollars by the spot rate on 1st April, rather than the future rate at the first of April? And the rule for lock in rate is that we will always deduct the difference of basis from the spot rate right?

John Moffat says

There are arguments for using both – the spot rate or the futures rate. The difference will not make much difference and either will be allowed in the exam.

As to whether to deduct or add the difference in the basis to the spot – it is whichever makes the futures price and spot rate closer together.

Isaac says

Hi Sir, I have a small doubt about the concept of the Lock In Rate. Isn’t the Lock In Rate affected to a small extent by the future spot rate? Seeing that the gain loss on the futures transaction needs to be converted back to GBP, the spot rate in the future will thus affect the gain/loss in our home currency.

So to that extent, is the Lock In Rate not exactly fixed, but a very close approximation to our net rate at the end of the day?

John Moffat says

Yes, that is true. (In addition appreciate that the lock-in rate assumes that the basis falls linearly, which is not necessarily going to be the case in practice.)

olanrewaju says

Can we use the lock-in rate in the exam?

John Moffat says

Yes – most times you need to use the lock-in rate.

Arun says

Hi John,

What is the actually the rule for adding/subtracting the basis to the spot if we’re doing it by the first method or the future price if we’re doing it by the second method?

Thanks.

John Moffat says

The futures price and the spot rate will move closer together, so the lock-in rate will be between the current spot and the current futures price.

You add or subtract in whichever way gives a lock-in rate between the two.

twilight1987 says

Sir, i have a confusion.lets suppose that i have 7 contracts of 62500 pounds, how will i use lock in rate.

( 7*62500*…..?) what rate i will use here?the same 1.48 lock in rate ?

John Moffat says

Yes – the same lock-in rate

beata says

Hi John, thanks a lot for a lecture. Im trying to figure out what Lock in rate and original amount to apply for example 11. I calculated Lock in rate of 1,4843. But when I apply it to the contract amoun- 62500 * 5 * 1,484. I get a strange result of 312 437, which is definitely not the outcome of the hedge…could You please shed a bit more light here? Thank You!

John Moffat says

You should apply it to the amount of the transaction.

Therefore $500,000/1.4843 = 336859

The difference between this and the net amount in the answer to the example is because the contract size means we are not able to hedge the exact amount.

aliimranacca007 says

In last example when we find the contract size we divide with curent future price but in lock in rates why we divid with curent which is 1.5

khanhhoangvu says

Dear Teacher,

I had three issues as below that need you help me more clearly:

1. in previous lectures on future, The basis risk is the difference between future price and spot rate. However, in this lecutre i saw you shown them in positive sign (0.03 & 0.01) while future price wa less than spot rate. what I meant that why didn’t they were -0.03 and -0.01

2. for the first way of calculation of Lock-in rate, you took spot (1.50) minus change in basis risk (0.02) to get lock-in rate $/GBP 1.48 because of spot rate greater than future price. If spot rate smaller than future price, we will take spot rate(1.50) plus change in basis risk (0.02) to get lock-in rate (1.52). Am i correct and is it a rule for calculation?

3. for the second way of calculation of Lock-in rate, you took future price (1.47) plus basis risk on date of transaction (0.01) to get lock-in rate $/GBP 1.48 because of future price smaller than spot rate. If spot rate smaller than future price, we will take future pric(1.47) minus basis risk on date of transaction (0.01) to get lock-in rate (1.46). Am i correct and is it a rule for calculation?

Could you please give me an explanation

Thank you Sir

John Moffat says

The answer to all three questions is that the spot and futures prices will get closer together over time.

So if the current spot is higher than the current futures price, then the lock-in rate will be lower than the current spot. If the current spot is lower than the current futures price, then the lock-in rate will be higher than the current spot (which means that you are correct in point (2) 🙂 )

rana2majid says

Can we use Lock in rate in the Interest rate Futures?

John Moffat says

Yes – in exactly the same way 🙂

Simon says

I was studying the exam question “Polytot”, with an answer given that calculated the unhedged amount using an exchange based on the lock-in rate, and I spent two hours of fruitless Google hunting trying to figure out what was going on.

But your video explains it perfectly. Thank you!

John Moffat says

You are welcome 🙂

jigsaw1992 says

im thinking lock in rates is the simplyfied version of futures. its like an update, cuz its simpler to remember and even simpler.

am i right?

John Moffat says

It is simpler, and ‘predicts’ the end result of the future. However you should still understand how futures work in real life, because that can be asked.

braske77 says

Dear John, what is the correct anwer? Is it total receipt of 675796 GBP=657894+17902?

“Lock-in-rate” would be also something like 1M/675796=1.4797 – something like effective rate we have experienced after combining all outcomes from transaction and futures deal?

Also how do you think if there might be a situation where examiner will ask us to use LOck-in rate for our calculation or is it just a one of the methods to come to final answer?

Thanks for advise.

With kind regards,

Olga

John Moffat says

What you say at first is correct.

As to when to use it, it depends what information is given. If you are given a spot rate to use at the date of the transaction then you do it the way in the earlier lectures (calculating what futures price will be on the date of the transaction).

If you are not told a spot rate to use at the date of the transaction (which these days is a bit more likely) then you should use the lock-in rate.

Whatever you do, make sure you write down what you are doing. Most of the marks are for proving that you understand how futures work rather than for the precise figures.

Yashodha says

Hi John, your lectures are greatly appreciated!! 🙂 So far everything has been very well explained, however, I was a bit confused as to why we divide $ 1 mn by 1.5 (spot rate on 1st April) instead of 1.47 (futures price on 1st April) in calculating the profit/loss on futures. Since we have always converted the $ amount to Sterling using the futures price in the previous examples.

Hope you can explain a little more on that. Thank you again Sir 🙂

John Moffat says

But I do not use the spot rate on 1 April to calculate the profit/loss on futures!

The profit/loss on futures is the difference between todays futures price and the futures price on the day that we complete the deal.

Yashodha says

But Sir, what I meant is why profit = 1mn/1.5*(1.51-1.47) ?

In previous futures examples we took the number of contracts by ($ amount/current futures price)/Contract size. And the profit/loss on futures we calculated by No. of contracts*contract size*difference in futures price. So why don’t we take the profit here by 1mn/1.47*(1.51-1.47)?

John Moffat says

Sorry – it was my mistake (I must re-record it). I should have divided by 1.50.

uuuu says

u mean divide by 1.47

John Moffat says

Oh dear – I was having a bad day it seems! Yes I do mean that 🙂

Sorry 🙁

Greenson says

how do i effectively revise for P4 exams?

John Moffat says

In future please ask this sort of question in the Ask the Tutor Forum rather than as a comment on a lecture.

If you really mean revise (i.e. you have already studied everything and just need to remind yourself) then you need to work through as many questions as you can – preferably using a Revision Kit from one of the approved publishers, but certainly the last 8 real exams (which were all set by the current examiner).

Also, you might find it useful to watch the lectures where I go through Question 1 of the last two exams.

If you have not already studied, then you are going to have to move fast. Watch all of the lectures (with the lecture notes in front of you). Go back to relevant F9 lectures if there is anything that you have forgotten or were not happy about. When you have done this, then what I have written in the previous paragraph 🙂

Daniyal says

so what is the remaining amount on this example? I mean the amount on which we apply foward contract

John Moffat says

First you do not have to use a forward contract on the remainder. However it is a sensible recommendation and it is the difference between the contracted amount (on the futures) and the actual amount.

Shayan says

Thank you!!! Really helpful…