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Dear Sir,
I have a question regarding currency futures. The examples you have solved from the notes have spot rate available for the date of transaction but in the real exam question there is no mention of spot rate for the date of transaction.
For example, let’s have a look at March/June 2016 question paper, the question is as follows:Sale of equity investment in the European country
It can be assumed that the date today is 1 March 2016.
It is expected that Lirio Co will receive Euro (€) 20 million in three months’ time from the sale of its investment. The € has continued to remain weak, while the $ has continued to remain strong through 2015 and the start of 2016. The financial press has also reported that there may be a permanent shift in the €/$ exchange rate, with firms facing economic exposure. Lirio Co has decided to hedge the € receipt using one of currency forward contracts, currency futures contracts or currency options contracts.
The following exchange contracts and rates are available to Lirio Co.
$ Per €1
Spot rates $1·1585 – $1·1618
Three-month forward rates $1·1559 – $1·1601Currency futures (contract size $125,000, quotation: € per $1)
March futures €0·8638
June futures €0·8656In the above scenario, what rate we would use in order to find out the amount that will be received on the date of transaction, i.e. in three months’ time?
Any help will be hugely appreciated.
Regards,
SamSome exam questions give the spot rate at the date of the transaction (in which case you use it as in the lectures), others do not.
If you are not given the spot rate at the date of the transaction then you calculate the ‘lock-in’ rate (which is the net effect of converting the transaction at spot together with the gain or loss on the futures – we can calculate this because we can calculate how the basis will change).
If you watch my free lecture on lock-in rates (it is listed on the list of lectures) then I explain this in detail.
Hello Sir,
Just a quick update. The lock-in rate I calculated is 0.8647 with the basis on 1st of March being 0.0049 and on the date of transaction 0.0012 (change in basis = 0.0037)
The examiner calculated lock-in rate being 0.8650 using both march and june futures.
Am I doing it wrong? I need your help.
Thanks!
Regards,
MaisamThe current spot is 0.8632 (1/1.1585) and the June futures are 0.8656.
So the current basis is 0.0024.There is 3 months to go to the date of the transaction, and 4 months to the expiry of the futures – so 1 month unexpired.
So the change in the basis is 3/4 x 0.0024 = 0.0018So the lock in rate = 0.8632 + 0.0018 = 0.8650
(or, if you prefer, 0.8656 – (1/4 x 0.0024) = 0.8650
Thanks for your help sir. I was using the mid-market spot to calculate lock-in rate as in your lectures you told us to use mid-market spot rate when two rates are given.
Thanks once again!
Regards,
MaisamOh that’s good to hear. At least my understanding is correct. Thanks for clarifying.
Regards,
MaisamHello Mr John
I have a question in regards to the basis. In all the questions we calculate the basis as Futures rate – Spot rate. This is what we did here as well. 0.8656-0.8632= 0.0024. As you also said above we have 1 month unexpired, so 1/4*0.0024=0.0006
The rule that the bpp book has is that if this is positive as it is above we add it to the futures rate. If it is negative we deduct it. Here it is positive 0.0006. Why do we need to deduct it from the futures rate?
Could you please help me?
Thank you very much! ! !
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