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Hi Sir
Can you please explain the logic behind choosing the type of contracts i.e whether to sell or to buy?
it seems that there are only four scenarios( which i came across)
1) Domestic company (Uk=£)
Need to make a payment in Euros
Contract currency is Euro
2)domestic company (UK=£)
Need to make a payment in Euros
Contract currency is £
3) domestic company (UK=£)
Receipts in Euros
contract currency in Euro
4) domestic company (UK=£)
receipts in Euros
Contract currency in £
Also why sometimes the contract currency is in terms of the domestic currency and sometimes the contract is in terms of the foreign currency?Im stuck with the logic here!! please help
This is the only thing i understood i.e if you have to make a payment
in Euro and your domestic currency is £ and IF euro appreciates against £ you will end up using more £ to buy Euros. So you Buy Euro futures now which is cheaper and sell them later.Now if you have a receipt in Euro and if euro depreciates you will end up with less £ upon conversion, so you sell Euro contracts now and buy cheaper later.
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Firstly questions will not always just be in pounds and euros!
The best way to decide is this:
Check what currency the contract size is quoted in (you are always told in the question).
Look at the transaction and decide whether it involved buying or selling the currency that the contract is quoted in.
If it involves buying that currency, then buy futures.
If it involves selling that currency, then sell futures.For example, we are in the UK, and suppose the contract size is £250,000 (so the contract size is quoted in £’s)
Suppose the transaction is receiving Euros.
The transaction therefore is selling euros to buy pounds.So you buy futures.
It will help you to watch the free lecture on this, where I give the rule and explain the logic behind it with worked examples.
Why do the currency contract differs? is it an option available in real life? for example if im in the uk and im receiving Euros , i can choose to hedge with Euro or £ future contracts? ( obviously in exams they will give only one)
Uk company receiving euros, contract in £, we are selling Euros , so we are buying £ and thus we buy £ contracts.
Now if the contract was in Euro?, we sell Euro contracts?
In real life, futures are available in different currencies (although if you are in the UK where most futures are traded, then they are available in other currencies – not in £’s).
However, as you have said, in the exam they have to give you the contract size and the currency it is quoted in.
The reason the currency differs is obvious in that you are able to deal in a variety of different currencies (and obviously we want to deal in the same currency that we are at risk from in the transaction).
The reason for a fixed contract size is that it would not be workable if people were able to deal in odd amounts – futures are bought and sold in the same way that shares are bought and sold, and so they do need a standard sized ‘unit’.
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