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I am just getting to grips with some question practice… a bit weak on this subject at the mo and home studying although I do have a revision course that I am going to need!
I have the Kaplan question book and trying question 54… this is the first I heard of Hedge Efficiency. I’m confused looking at some of the answer. It doesn’t work out total cost but I guess the question didn’t ask for that. What is the Loss on spot market is this just something to compare the futures transaction with? It would be appreciated if anybody has this question they can give me the picture what is going on…
Thanks in advance.
@pattrick hey sorry i dont have the question.. but i can try and help u out 😉
look, u enter into a futures transaction.. e.g in case of currency, lets suppose u have a payment in 3 months time so u will now buy futures now so that u can sell futures after 3 months close ur position.. now when u will have to make the payment after 3 months u will buy the currency from the spot market.. so if the exchange rates would have moved adversely during this 3 month period, u will be making a loss on the spot market.. and to offset this loss, u entered into a futures transaction, so u will be making some profit from the futures market… now the extent to which the profit from the futures market can offset the loss from the spot market is the hedge efficiency i.e how efficient u were in hedging ur loss 🙂Thanks for your reply. I have a further query. Do we actually buy and sell at the spot as well as the future? When we have to sell the future we buy the currency at spot… I understand this BUT when we buy the future do we actually have to sell the currency at spot? If this sounds a bit of a stupid question apologies but getting a bit mixed with all these terms re Foreign Exchange and Interest Rates! Thanks.
@pattrick said:
Thanks for your reply. I have a further query. Do we actually buy and sell at the spot as well as the future? When we have to sell the future we buy the currency at spot… I understand this BUT when we buy the future do we actually have to sell the currency at spot? If this sounds a bit of a stupid question apologies but getting a bit mixed with all these terms re Foreign Exchange and Interest Rates! Thanks.hey, sorry for the late reply .. well u sure are confused :p
whenever u will buy/sell the currency.. u will do so at the spot market.. it dosent has anything to with whether u buy the futures or sell the futures.. remember that u enter into the futures market SEPERATELY (i.e buy/sell futures).. its just like shares trading.. where suppose u first buy shares then sell them at a later date so u can make profit.. like in forward contracts.. suppose when u buy a forward contract then the rate is fixed according to the terms of the forward contract.. u have to execute ur contract.. but in futures., u dont enter into the futures contract to execute it,, u always close ur position.. e.g sell futures at a later date if u have bought them before.. this ensures that u dont have to execute ur original contract.. so since u dont have any obligation left now to execute the future contract.. so u buy/sell the currency at the spot marketand u will always consider first whether u have to sell the currency or buy it.. then accordingly also taking into account the currency of contract in the question..u will then decide whether to buy futures first or sell them.. if u buy them first then obviously u will sell them later on, whereas if u sell them first then obviously u will have to buy them later on
hope that helps 😉
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