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  1. Dear John

    With regards to whether to buy or sell futures, following example 9, if the spot rate in November and future rate for December both went down, wouldn’t it make more sense to short sell futures in September?

    Kind regards

    • Maybe it would, but the whole point is that you don’t know in advance what will happen to the spot rate and the futures price. They could end up moving the other way!! Doing that would be gambling and although some people do gamble on futures (because they think the price will move up or down), financial managers should not using futures to gamble the companies money.

      Financial managers are using futures to hedge against the risk of spot rates changing – whether it be up or down. By using futures they are effectively fixing the future result, whatever happens to the actual spot rate.

      • Thank you for your prompt reply. I was imagining a few different scenarios and that even add to more confusion. I thought dealing with futures were similar to dealing with options where we sell if we speculate or worry that the price/spot rate will go down and buy back later.

        I will clear all that in my mind and follow the rules :).

        Have a good evening

  2. This lecture was great. Your lectures are helping me to grasp difficult concepts of P4. But John, I didn’t understand the reason for using 1/3 in future price estimation and the statement that ” in reality, they would be zero, but will not be linear” is still unclear to me. John, could you help me in this area?

    • We assume that the basis (the difference between spot and future prices) will fall linearly to zero over the life of the future. So we need to count the months – if there are currently three months to the end of the future, and at the date of the transaction there is only one month to the end of the future, then the basis will then be 1/3 of what it is now.

      In practice it does not have to fall linearly and so the basis might not be exactly 1/3 of what it is now. That is the basis risk.

  4. US$/£1 CAD/£1 JPY/£1
    Spot 1·5938–1·5962 1.5690–1·5710 131·91–133·59
    3-month forward 1·5996–1·6037 1·5652–1·5678 129·15–131·05

    Kindly show me how to calculate the mid rates for each set?

  6. Hello sir ,
    with reference to P4 june 2014 exam, Question # 1,part (a) answer
    the examiner predict 4 month future price by..

    (spot rate now + ((6 month future – spot rate now )x4/6)

    there is confusion here whether basis is (spot – future price) or ( future – spot price )
    please make comment

    • Futures give the right to buy the currency at a fixed price on a future date (even though that is not the way we generally use them).

      If you were to buy a future on its last day then automatically you would therefore expect it to be the same as the spot rate because you would be buying the right to buy the currency on the same day.

  9. hi John i have some issues with the arithmetic here. in calculating tha future price from basis you subtracted spot rate from future price (1.4900-1.5100) to -0.0200, suppose i subracted future price from spot rate i will get 0.0200 instead. on the the date of the transaction the basis will have fallen to .0067 , to get the future price should i add this .0067 to the mid market rate (1.5250 +1.5370) = 1.531 or should i subtract it. in your lecture its subtracted. my question may sound stupid but but i have been having little problems like this and subtract or adding will give a different future price which will definitely determine if i exercise an option or allow it to lapse
    thank you

    • Mike does not teach P4!! 🙂

      The currency of the profit or loss on the future is always the opposite currency to that in which the contract size is quoted in.

      So……if we are looking at £/$ futures, then if the contract size is quoted in £’s then the profit/loss will be in $’s. If the contract size was quoted in $’s then the profit/loss would be in £’s.

      (And I guess you are happy with the fact that if the profit/loss is not in our own currency then we need to convert it at spot on that date)

      • thank you John and excuse me i meant to write John and not Mike. Just that i have been used to asking questions to mike to. That is quite easy to remember in the exam hall

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