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Hi John
For this question, my answer differs from the ACCA answer provided. Can you please advise whether if my workings below is still correct?
Future contracts
To hedge against USD from strengthening against Eur therefore Buy 5 mths Future contracts @ 1.3689 as we are receiving payment.
No. of contracts = (USD20m/1.3698)/125,000 = 116.8 ~ 117 contractsIn 4 mths time,
USD20m/1.3623 = Eur 14,681,054 (using 1.3623 as 4 mths forward rate = future spot rate)Futures transaction
(Sell @ 1.3639 – Buy @ 1.3698) x 117 contracts x 125,000 = -Eur8,629Therefore the net cash received would be Eur 14,672,425
Please advise if the above is correct as it differs from ACCA and am confuse
What you are doing is correct, except that when you calculate the loss on the futures transaction, I cannot understand where you get 1.3639 from.
You bought at 1.3698 – that is fine – but you sell at whatever the futures price is at the date of the transaction, and it is not 1.3639 (unless I am missing something 🙂 )
It should be 1.3676 (as per the examiners answer).Thanks John for the quick reply. Really appreciate it.
I got 1.3639 from the below:
Spot is 1.3618 (right side “sell USD” as i am a Eur company and receiving payment)
My 5 mths future is price is 1.3698 thus my basis is 1.3698 – 1.3618=0.0080.As we are receiving payment in 4 mths, we close out the future contract in 4 mths too. As the future contract is a 5mths future contract, I took 0.0080*1/5=0.0016. Having the forward rate of 1.3623 as the future spot rate, I used it to add 0.0016 to get 1.3639.
Please advise where did I go wrong in not getting 1.3676. Thanks 🙂
I am really sorry for not replying sooner – I missed your post for some reason and have only just seen it.
I will reply later this evening or tomorrow.Hi again!
Now I have time to look again at your workings and the question (and now I understand your problem!).
What you have done is fine.
Any answer here makes assumptions and although you have made different assumptions than the examiners answer, what you have done would get full marks (even though obviously the final answer is different).(This question was set by the old examiner who is no longer there – he used to set very confusing questions and give even more confusing answers 🙂 )
Thank John! It is comforting to hear that! Haha was confused and demoralised thinking what did i miss out or did not understand. Thanks!
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Can someday kindly guide me how the 2/6 is derived, it was used to calculate the basis of 0.18, am so confused to what the 2 and 6 stands. What I thought contradicts with what Kaplan text got theirs on page 506. Some one pleas explain to me am stuck. It Dec 2011 Q2. Thanks
The loan will start on 1 May, which is 4 months away from now (per the question).
We are using June futures, which finish at the end of June. So…..if 1 May is 4 months away, then end of June is 6 months away from now.
We assume that the basis falls linearly to zero over the life of the future. So….since the future will end in 6 months time, the basis will fall by 1/6 each month.
At the start of the loan, (1 May) there will then only be 2 months left until the end of the future (30 June) and so the basis will have fallen by 4 months at 1/6 each month. Or…..since there are only 2 months left, the basis remaining will be 2/6 of the current basis.
Hope that makes sense 🙂
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Wow understood well!!! Thanks John you just saved me I was stuck. I appreciate your help you, explanations and makes life much easier for students. Thank you, God bless your heart and may He double your wisdom.
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