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Sir, watched your lectures for the second time on exchange rate risks as i have exam after a week almost. then watched the video for interest rate risk. what i understood from exchange futures example can be briefly worded as:
we buy futures (virtually) of the amount of foreign currency we need to pay in future. wait till the date when we actually need to make the payment. if exchange spot rate rises on that day the future rate will too rise. we simply convert using the spot rate and ask the futures dealer to sell the futures we bought earlier. the profit we make by selling futures at high price cancels the loss we make by paying at high rate. FIRSTLY AM I RIGHT AT THIS?after watching all the videos for foreign exchange risks, watched interest risk video too.. understood everything until you talked about interest futures. listened to it twice and could only learn what’s stated below (briefly):
if we are to take a loan in future off (suppose 800$- 2 months later) , interest rates maybe anything at that time, we simply keep it at risk and buy interest rate futures today. after two months, the day when we need loan, if there’s a rise in interest rate (hence, loan will cost us higher) there will be reduction in futures prices and a fall in interest rates increases futures prices.
how does it benefit us sir? i listened to it so carefully again and again but couldn’t understand your words. Can you please help me. what did you mean, when you said we start a deal today end it on the day when we need loan? i have read the technical article relating to the topic also, still couldn’t understand.Your first paragraph is correct.
With regard to interest rate futures, if we are borrowing money we are worried that the interest rate will rise (and it will therefore cost us more). If the interest rate rises, the futures price will fall.
If you listen to the lecture again, I do not say that we buy interest rate futures. What we do is sell futures now and then buy them at the start of the loan.
So if interest rates have risen it is costing us more, but the futures price will have fallen and so by selling them now and then buying them at a lower price, we will have made a gain to ‘cancel’ the extra interest payable.(Appreciate that you cannot be asked for calculations on futures in Paper F9 – you are just expected to be aware as to how they work)
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