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Hi Sir John Moffat,
I had been practicing risk management and when I saw the solution of this question, I had two queries as follows:
– The payment to be made in CHF(Swiss Currency) is 4,750,000. Where did this amount come from?
– While converting the premium in contract currency i.e. CHF why was the current date currency rate chosen whereas the payment is to be made 4 months later
For your assistance, how do I share the question with you?
There is no need to share questions with me because although I do not have the Kaplan Kit (I only have the BPP Revision Kit), I do have copies of all past exam questions 🙂
They are having 38 contracts of CHF 125,000 (because we can only deal in fixed sized contracts), which is 38 x CHF 125,000 = CHF 4,750,000.
Option premiums are always paid immediately the option is purchased whether or not the option is exercised.
(You can find lectures working through the whole of this question linked from the following page:
https://opentuition.com/acca/afm/afm-revision-lectures/ )Hi sir John, for the same question, to future currency hedge,
ask what i know, future hedging is we buy/ sell the future, and later, if the spot rate go to unfavourable rate, we will gain from the future price.but when i see the answer for calculate the future hedge, why they just show expected payment US$5,060,000/1.0651=CHF 4,773,728
i thought we just need to calculate the payment at spot, then knock off the profit earn from future price.
my answer :
i can calculate the future price at 4 month UA$ 1.0651 by
1.0659-1.0635=0.0024
0.0024x (2/6)= 0.0008
future price 1.0659 + 0.0008= 1.0651since we sell future first and buy later
1.0659-1.0651=0.008
(US$ 0.0008/CHF)x38 contract x CHF 125,000= US$ 3800since it is profit in future, so convert it spot in future
spot in 4 month time
US$1.0635/CHF x (1.01)=US$1.0741/CHFUS$3800 divide US$1.0741/CHF = CHF 3538
US$5,060,000 divide US$1.0741/CHF =4,710,921
payment CHF 4,710,921 minus profit from future price CHF 3538
=4,707,383ok, it is my payment if hedge by future
but the question answer is CHF4,750,728John, could you correct my mistake, also check whether my explanation got wrong or confuse.
We are dealing in 6 month futures and 1.0651 will not be the price of these 6 month futures in 4 months time.
The price depends on whatever the spot rate is in 4 months time (it will be the spot rate in 4 months as adjusted by the basis in 4 months time).
However we do not know what the spot rate is going to be in 4 months time and therefore we cannot calculate what the futures price will be.Therefore was have to use the lock-in rate (which is 1.0651). What this is (as I explain in my lectures) is a rate that we apply to the contract amount and gives the net result of converting the transaction at what ever spot turns out to be together with any gain or loss on the futures deal.
You can find lectures working through the whole of this question linked from the following page:
https://opentuition.com/acca/afm/afm-revision-lectures/
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