Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA AFM Exams › Basis Risk application in closing Fut & lock-in-rate
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John Moffat.
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- May 20, 2013 at 2:22 am #126150
Dear Sir,
I am attempting P4 this June. I have a doubt in Futures. I am not able to understand why do we need to add basis risk in the opening Future rate (presuming given in the que that is Opening Futures rate) to get closing future rate, which helps us in finding out gain or loss in Futures market . And I have this same problem in Interest Rate future when the question says when interest rate will rise by 1% or fall by 0.5%.Can you also explain why do need lock-in-rate in futures? do we need to find out lock-in rate on all future questions? It could be better if you can explain with a BPP revision kit question no. 78 (Polytot) only Futures calculation
can mail me mail me at alexjacob_18@yahoo. co.in or alex.jcb30@gmail.com
Regards….
AlexMay 20, 2013 at 8:34 am #126177I cannot explain with the BPP question because I do not have the BPP questions.
However, as the spot exchange rate changes (or with interest rate futures, as the interest rate changes) then so too will the futures price. However the spot and the futures prices are not the same, but the difference (the basis) will fall to zero by the last day of the future.
If the question tells you what the spot exchange rate (or the actual interest rate) is on the date of the transaction then we can calculate was the futures price will be on that day (we assume that the basis falls linearly to zero), and then you can show the end result in full.
However, if you are not told what the figures are at the date of the transaction, we can still estimate the net effect (because whatever the figures turn out to be at the date of the transaction, then movement in the spot rate and the futures price will differ by the change in the basis which we can calculate). This figure that we can calculate is called the lock-in rate and means that this will be the net effect of using futures, whatever happens.
Without numbers, the above may or not make sense. However, if you look at the revision questions for P4 on this website then you will find a full worked example (for both currency futures and interest rate futures) which goes through both ways (showing exactly what happens at the date of the transaction, and also calculating the lock-in rate).
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