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  1. Hy john sir,

    In the question Polytot from Bpp to calculate the number of contracts a lock in rate is used because the transaction took place in november and the futures rate of december was given.
    Why do we use the december futures rate in this question and not calculate a lock in rate?

  3. Thank you for the nice lecture!
    in the example9,
    in the future deal, I understood that the company receives in $ so that it is afraid $ to be appreciated as final receiving value in pounds to company are depreciated.

    So using hedge that makes profit if $ is appreciating, which offsets the risk of company($ appreciates) they want to buy the $ and sell it later at higher value.

    this lead to buy the futures at 1.5045(which is lower value than 1.5110-current spot rate)
    and sell it later at the transaction date when using the futures at 1.5120
    then they could make profit 1.5120-1.5045

    Btw, 1) transaction leaves the risk
    and at the date of transaction,
    i just wonder if it leaves the risk, then why does not translate $1200,000 using the spot rate of the date?

    • Sorry – the numbers are correct, but the dates are typed wrongly.

      The first line should say “converting at current (10 September) spot”

      Further down it should say “On 12 November” (not “on 10 September”)

      Again, the numbers themselves are correct.

      Thank you for noticing – I will have it corrected.

  6. I noticed you divided $1200000 by 1.5045

    If the rate is quoted $1.5020 to 1pound. shouldnt you be multiplying and then dividing by the number of contracts (62500 pounds)

    • No.

      If $1.5045 = 1 GBP, then $3.090 = 2 GBP and so on.
      To get from $’s to GBP we need to divide by 1.5045.

      You really should watch the first lecture on foreign exchange risk management where I explain how to decide which rate to use and whether to divide or multiply.

      • I did hence my confusion .

        you said the rates are quoted as such $/pounds 1.5050 – 1.5150

        This means it is quoted at the first currency i.e dollars. so 1.5 dollars is to a pound .

        Therefore to get dollars we divide

        to get pounds we mulitply

        the first spred being the dollar buy rate, the second being the dollar sell rate.

        where am i going wrong here ?

        Thanks for your time

        Kind regards

      • You need to watch again. Think about it – if $1.5 = 1 GBP, then to go from $’s to GBP you have to divide.

        If you were to multiply you would end up saying $1 was equal to 1 x 1.5 = 1.5 GBP which is exactly the opposite of what it should be 馃檪

  7. i am slightly confused on the outcome on the future, since they are POUND contracts, our closing position should be to buy pounds, then we have to sell the pound first, so then when we sell our it’s pounds 1.5045 & when we buy the Pound back it is @ Dollars 1.5120, arent we Making a loss of $ 0.0075 , since we are paying more dollars to buy the POUND back ON the FUTURES contract. I am confused on this. thankyou.

    • Why should our closing position be to buy pounds?

      We are not using the futures in order to buy pounds (when we receive the dollars, we exchange them for pounds at whatever the spot rate happens to be).
      We are using the futures to hedge against the risk of exchange rate movements.

      The underlying transaction (selling dollars and buying pounds) will lose if the exchange rate goes up. So we buy futures now and sell them later, so that if the exchange rate does go up then we make a compensating profit.

      If you have not watched the previous lecture then do so, because I go through a more basic example just to explain the principle behind the use of futures.

  8. Thank you so much OT for this very helpful lecture. It’s cleared a lot of the misunderstandings I initially had.
    I would also want to thank DeepMaharaj for putting up that formulae chart…. its helped ALOT!
    God Bless!

  11. nice lecture indeed. but i didnt quite understand the area on whether to buy or sell futures in september. to me it’s but quite normal that the future price in december is higher than in september thus we buy futures in september. Does it mean that in the exam the future price at a future date is not given

    • Sometimes the futures price on the future date is given, but usually it is not given (and of course in real life you will have no idea what will happen to the futures price in the future).

      Remember that the financial manager is not dealing in futures simply to try and make a profit – this would just be gambling.
      They are using futures to make the profit or loss on the futures equal to the gain or loss on the actual transaction, i.e. to ‘cancel’ the risk in the transaction, and in this way to remove the risk.

    • Whether to buy or sell Futures – BPP has got very good formula Table

      Receive –> Currency other than US $———-> Sell ( Always)
      Pay —> Currency Other than US $—————> Buy ( Always)
      Receive—-> US $————————————–> Buy ( Always)
      Pay—->US $——————————————–> Sell ( Always)
      So Mnemonic is RPRP =SBBS
      ( First TWO RP for Currencies other than US $)
      ( Later TWO RP for US $)

  12. it then means using the reference point that i would have expected my US$1,200,000 to be equal to pound of 794176, however using 12th Nov spot rate its Pounds of 789993. indicating an assumed loss in pounds of 4183.

    However my futures hedge gives me a profit of US$6093 which since i cant net dollars to pounds i then have to convert to pounds so iam able to see if this hedge helped or iam worse off. now the first thought that comes to me is i have to sell this dollars at todays spot rate and using the rate in which the bank buys dollars by today of 1.5100, this dollars equal pounds of 4035. hence overall i have lost 148 pounds. But hei if i had not hedged i would have lost pounds of 4183!

    I can accepts that. Nice . Iam still following and catching on, still waiting for more challenges to come. going to next lecture.

  13. In June 2011 paper Q2 we are asked to hedge US dollar receipt . We are given currency futures but examiner does not provide neither the spot rate nor the price of the future at the transaction date . In the answers provided, the examiner does not uses mid- market prices when he arrives at the futures price. I am a bit confused with the way examiner presents his answer. Would appreciate some explanations, please.

    • The examiner has done it two ways. One way he has done it is simply to apportion between the 2 month and 5 month futures prices.

      The more accurate way is the way that he has put in brackets. What he has done is calculate the basis now (the difference between todays spot and todays futures price), assumed (as we always do) that it falls to zero over the 5 month life of the future, and therefore estimated the basis risk at the date of the transaction (it will be 1/5th of the current basis because at the date of the transaction the future only has one month left to run).

      If the basis risk was to stay unchanged, then using future would lock the transaction at todays spot rate (any gain/loss on the transaction is ‘cancelled’ by the profit or loss on the futures. However, because the basis risk will change (and we have estimated what it will be), using futures will not exactly ‘cancel’ the gain or loss, but will effectively lock the rate on the transaction at the current futures price minus the basis at the date of the transaction (or, alternatively it locks it at the current spot rate plus 4/5 of the current basis (the amount by which the basis will change) – I find this more logical and it gives exactly the same result.)

      He has not used the mid-market spot because he is finding a lock-in rate, but using mid-market spot would still have got full marks (even though the answer would be a little different)

      • The current basis is 1.3698 (the 5 months futures price) – 1.3618 (the current spot rate) = 0.0080

        This basis will fall linearly to zero over 5 months, so in 4 months it will have fallen by 4/5 x 0.0080 = 0.0064

        Therefore using the 5 month futures will effectively lock the rate applicable to the contract amount to 1.3618 (the current spot) + 0.0064 (the change in the basis) = 1.3682.
        (which is the same figure that the examiner shows in his alternative answer in brackets).

        The basis has been calculated using the rate for selling dollars. However you could have calculated the basis using the mid-market spot instead, in which case you would get the current basis as 0.0096, and the change (4/5) to be 0.0077
        This would have resulted in a lock-in rate of 1.3618 + 0.0077 = 1.3695

      • @Johnmoffat, so when you want to calculate the profit or loss on futures do you use the 5month futures price as the buying rate and the ‘apportioned'(method 1 of examiner’s answer) futures price as the selling price? And is it ok to use the 4month forward rate as the spot rate at month 4 (stating the assumption ofcourse) to calculate the basis risk? Please help me understand before I fail AGAIN.

      • With regard to your first sentence, the profit or loss on the futures is the difference between the current price of the futures and the price of the future on the date of the transaction. (Which is buy and which is sell depends on whether you are hedging against a receipt or a payment of the foreign currency)

        The basis is the difference between the spot rate and the future price. We can estimate it by looking at the current basis (difference between the current spot and the current futures price) and assuming that it falls linearly over the life of the future.
        We do not need the future spot rate to be able to estimate the basis.

  16. Of course there is basis risk!
    However it is not necessary to calculate it in this example because the question actually tells you the spot rate and the futures price on the date of the transaction. That is all we need.
    If we are not given the futures price on the date of the transaction then we need to calculate the basis risk. See the next lecture!

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