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Hi John,
I have been working through the currency exchange hedging questions from the past exam papers and have noticed some inconsistencies when it comes to calculating futures. My main questions are;
1.In calculating basis is it ok to use mid market spot in our calculations as this is what was done in the lecture notes?This approach has not been used in the exam paper solutions.
2. In calculating the number of contracts the examiner has in some instances used the lock in rate to determine the number of contracts – there are also some examples whereby the number of contracts has been determined using the given future price prior to working out the lock in rate. Can you advise on what the correct method should be?
3. Where we have determined the lock in rate and there is a slight underhedge or overhedge am I correct in saying that we should not simple divide the receivable/payable amount by the lock in rate and that we should always work out the over or under hedge element?In this scenario how do we deal with an overhedge?
Thanks,
Padraig1. Yes, it is OK to use the mid-market spot in the calculation.
2. If we are using the lock-in rate (because we do not know the spot or the futures price on the date of the transaction) then the lock-in rate should be used to determine the number of contracts.
3. You should always apply the lock-in rate to the contract amount and calculate the amount of the over or under hedge. If forward rates are available then convert that amount at the relevant forward rates (otherwise they are converted at the spot rate on the date of the transaction).
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