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When the libor raise by 2% and the future price also move by 2%,this mean basis has reduced in linear manner ,am I right ?
As the march future price is 86.25
My calculation on future price is as follows ,I read this from Kaplan Text book
31 December 30march
If Libor increased by 2%Libor 14% 16
Future price 86.25 84
Future interest 13.75 16
Basis 0.25 0
It is from Practice Question from Open tuition,I want to know where I am wrong in calculating future price after the increase of 2% in interest rate and 2 % increase in the future market,I have calculated 84 .but it should be 84.25 in order to get profit of 50000 in future marketBasis= Libor-future interest rate
14% – 13.75%
0.25As the basis reduces in linear manner the basis at the end of March is Zero (0),as basis is zero future interest rate equals to Libor and the Future price becomes 84, 2% increase in the interest rate give raise to $50000 as calculated in the open tuition ,but inorder to get profit of $50,000 ,the future price after 3months must be 84.25,but I have calculated 84,
Please tell me where I am wrong
it is from practice question of opentuition from question no 9 b,if interest rate raise by2% and future price also move by 2%
Usually we have to calculate the futures price at the date of the transaction ourselves. To do this we make the assumption that the basis falls linearly.
However, in this example we are told what the futures price is at the date of the transaction – if it moves by 2% then it changes from the current value of 86.25 to 84.25.
So we do not need to estimate it ourselves – if you are told the value then you use what you are told.It does not happen like this very often in the exam, although this was an actual old exam question.
i did not understand please tell me once again
if future price move by 2%,then how to calculate 84.2586.25 is equivalent to 13.75%
If it moves by 2% then it goes to 15.75%, which is equivalent to a futures price of 84.25
thank you very much John Moffat,
I knew about this, but what about the basis risk?,as the basis at 31 dec is 0.25, and if future moved by 2% when interest rate move by 2% on 1march,in this case basis at the end of march is 0 ,and by this end of march we are going to close our future contract by buying future as earlier we sold future,and now i am modifying the original question by assuming that it was 1dec instead of 31dec and toytown need $5m in 3months time on 1march and the remaining basis at 1March is 0.0625 and other information remain as it is,what should we do to calculate future price?what will be the future price be will it be still 94.25?In practice it would be a miracle if the basis fell exactly linearly – futures and spot rates are two different things that are traded on different markets.
It is simply an assumption we make if we are required to estimate a futures price on a future date. There is no other reason for estimating the basis risk.
If we are told the futures price on the futures date (as we are in this example) then there is no relevant in estimating the basis.
(You asked before “how to calculate 84.25”. I explained, but now you say that you knew about this!)
that means ,if future price movement in future contract is given then we must not adjust remaining basis,am I right?
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