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Dear John,
I am struggling to understand Lock-In Rate.
With reference to Example 11, S plc’s net payment amount is GBP 337,178 (on transaction date Sep 12), which is not exactly the same as S plc’s payment on 20 June (if converted at spot rate) of $500,000 / 1.4821 = GBP 337,359. And I understand that the difference is due to the difference in changes in the Spot Rate and Futures Prices, as well as the impact from the contract sizes of Future Prices.However, if I use the Lock-In Rate method, where I get 1.4843 as the rate, and applying this to the total contract amount of GBP 312,500, I get US$463,843.75 as the net payment amount.
I am not sure how does this US$ 463,843.75 relate to the GBP 337,178 as they are both the derived net payment amount on the transaction date (Sep 12)?
Many Thanks in advance.
Regards,
TImThe lock-in rate is in fact 1.4856 (calculated as 1.4859 – 0.0003 (using the unexpired basis) or alternatively as 1.4840 + 0.0016 (using the expired basis))
Applying the lock-in rate to the contact amount would mean they would be paying GBP 5 x 62500 = GBP 312,500 and they would get 312,500 x 1.4856 = $464,250,
They actually need $500,000 and so because of the contract size limitation the would need an additional 500,000 – 464,250 = $35,750. They would have to either buy the extra $’s at whatever the spot rate was on the date of the transaction, or (more sensibly to avoid risk) they would use the current forward rate on the $35,750.
Either way the final cost would end up being more than the GBP 312,500. If there had not been the problem of the contract size then the total cost would come to exactly GBP 337,178 (subject to a bit of rounding given that rates are to 4 decimal places only).
(If contract size wasn’t a problem then they would have bought 500,000 / 1.4840 / 62500 = 5.391 contracts. This would have cost them 5.391 x GBP 62500 = GBP 336938 (and would give them 336938 x 1.4856 = $500,555). Again the difference from GBP 337178 and from $500,000, are irrelevant and are due to roundings).)
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