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For the June 2014 Question 1 , Four month spot rate is not given. I agree we can do the predicted futures approach for the future calculation. Is it okay to assume Forward rate as four month spot.. ? I got a very close answer with that assumption. Is it wrong.. ?
The Answer sheet talks about unhedged and overhedged amounts; we did not follow that approach in the Tutorial lessons? Could we ignore the unhedged and overhedged amounts and still come close?
Can you please take us through this problem using the same method we followed in the tutorials ?
Thank you.Roma
You need to calculate expected lockin rate through unexpired or expired basis.
Tutor how can forward rates be acceptable for taking as spot rates ? Banks incorporates their risk n premium into forward quotes.
Romanus: the under or over hedge is due to the fact that because of fixed fixed contracts it is not possible to hedge against the exact amount. As a result the futures deal will be off a bit less or a bit more than the actual amount of the transaction.
Most of the marks are for proving you know how futures work. However it is good to mention that the amount left over is left at risk – this could make be dealt with by using forward rates.
muneebnawaz90:
You can illustrate how futures work by using any example for the future spot rate (obviously in practice we have no idea what the future spot rate will be).
Banks do not incorporate a risk premium into their forward rates. Forward rates are determined purely by the relative interest rates for the two currencies (in real life, money market hedging and forward rates give the same end result – the banks use money market hedging, but quote to the customer as a forward rate). The interest rate parity formula is used to determine the forward rate.
Thank you, I will recalculate using the forward rate given in as the spot rate on transaction date and see how close I get.
I recalculate the futures using the forward of 1.0677 as the spot rate and got an answer very close to the one given in the answer sheet. I did the following:
Transaction date: ( 4 months)
Transaction: “5060000/1.0677″ 4,739,159 PAYComplete Futures deal: profit/loss
no of contractx x 125000(1.0659-1.0685)
” 12350/1.0677″ loss 11567 PAYTOTAL PAYMENT 4,750,726
Working:
No of contracts: “5060000/1.0659/125000) 37.9 =38Estimation of Futures rate:
Now 4 Months 6month
Future:1.0659 1.0685 xSpot : 1.0635 1.0677 x
Basis: 0.0024 0.0008 0“2/6*.0024= 0.0008
I ignored the over-hedged amount which was also ignored in the answer sheet.Transaction date: ( 4 months)
Transaction: “5060000/1.0677″ 4,739,159 PAYComplete Futures deal: profit/loss
no of contractx x 125000(1.0659-1.0685)
” 12350/1.0677″ loss 11,567 PAYTOTAL PAYMENT 4,750,726
Working:
No of contracts: “5060000/1.0659/125000) 37.9 =38Estimation of Futures rate:
Now 4 Months 6month
Future:1.0659 1.0685 xSpot: 1.0635 1.0677 x
Basis: 0.0024 0.0008 0“2/6*.0024= 0.0008
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