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Currency Options (Question CMC co from Kaplan Exam Kit, Specimen exam 2018)

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  • This topic has 3 replies, 3 voices, and was last updated 1 week ago by John Moffat.
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  • November 21, 2020 at 8:32 pm #596001
    srklodhi96

    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?

    November 22, 2020 at 9:44 am #596031
    John Moffat
    Keymaster

    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 馃檪

    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/ )

    November 23, 2020 at 12:57 pm #596148
    adamliew

    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= 1.0651

    since we sell future first and buy later
    1.0659-1.0651=0.008
    (US$ 0.0008/CHF)x38 contract x CHF 125,000= US$ 3800

    since 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/CHF

    US$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
    =4,707,383

    ok, it is my payment if hedge by future
    but the question answer is CHF4,750,728

    John, could you correct my mistake, also check whether my explanation got wrong or confuse.

    November 23, 2020 at 3:54 pm #596169
    John Moffat
    Keymaster

    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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