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Hi Sir,
may you please explain, why we are adding 0.0016 to 5 month future. we need 4 month, as not available using 5 month. but why we are not deducting 1 months 0.0016 from 5 month future 1.3698.
What does it mean- Assuming that the spot rate in four months is the same as the futures rate, the outcome will be
The outcome will depend on the spot and future prices, the futures price can be estimated as
follows:
Now 4 months
5-month future 1.3698 1.3714 balance
Spot rate 1.3618 1.3698 assumed
Basis 0.0080 × 1/5 = 0.0016
5 months 1 month remainingAssuming that the spot rate in four months is the same as the futures rate, the outcome will be:
Thank you
I do not know whether you are looking at an answer in a book, or at the examiners own answer.
However for futures we calculate the lock-in rate and it can be calculated in two ways.
You can either apportion between the 2 month and 5 month futures to get a 4 month rate.Alternatively (and strictly more correct and as I explain in my free lectures) you can subtract 0.0016 from the 5 month futures price as you have written, which gives a lock-in rate of 1.3682.
The examiner shows both ways in his answer, and either is acceptable.
I cannot find anywhere in the answer a statement saying ‘assuming the spot tase in four months is the same as the futures rate’. There is no reason at all why this should be the case.
Thank you Mr. John
i just copied the answer from the kit. were it says -Assuming that the spot rate in four months is the same as the futures rate, the outcome will be: page 219
in the solution part the one month basis 0.0016 is added to 5 month future not deducted that is why i raised this question. 0.0016+1.3698 = 1.3714
thank you for your support
I have found it in one of the mock exams in the BPP Revision Kit 🙂
Their answer is dreadful (and they have not copied the examiners answer as they usually do).
However at the top of the second page of the answer they do show what they call ‘an alternative shortcut approach’. Apart from the fact that it is not a ‘shortcut approach’ but is the correct approach, they do what you want to do and arrived at a lock-in rate of 1.3682 🙂
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