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Hello,
In this question, the 5 months forward rate is needed however, only 3months and 1 year forward rate was given.
Can u please assist with explaining how a forward rate of 1.9029 was calculated in examiner answer.
Thank you.
Zainab
You interpolate between 3 months and 12 months.
Since the difference is 9 months, then for a 5 month rate we take the 3 months rate and add on 2 months, which is 2/9 of the difference between the 3 month and 12 month rate.
1.9066 + 2/9 (1.8901 – 1.9066) = 1.9029
(I think that is a more obvious way of doing it than the way done in the answer 🙂 )
Hello John,
Pls money market for payment is giving serious headache and it annoying cause I know it is easy. So plssss help.
Using question Lammer Pls
The process is to borrow moneny in home currency, convert to foreign currency USD, and then deposit n the foreign bank to get the original money 1150.My problem is, I don’t know how the £595,373 that was in the first stage was arrived at. I have tried to convert the $1,150,000 with spot rate 1.9210 but I get but I get £5,986,465 and with 1.9156, I get $600,334.
Pls help how was the £595,373 calculated.
Please pls help.
Thank you.
ZainabThe actual calculations have to be done in the opposite order from the way the examiner has listed them in his answer.
They need $1,150,000 in 5 months time.
The invest $’s now at 5/12 x 2% i.e. 0.83333%
So they need to invest 1,150,000 / 1.0083333 = $1,140,496 now
The buy these dollars at the current spot rate and so it costs GBP 595,373
To be able to buy the dollars they need to borrow GBP 595,373 at 5/12 x 5.5%I do suggest that you watch my free lectures on foreign exchange risk management, because this is all explained in detail (and for money market hedging, it is in the F9 lectures as well because it is revision of F9).
OK thanks.
Do u have lectures on swaps. This last aspect of the syllabus that I’m having challenges with.
Thank u.
Thnk U John, the way I did is crrt got confused with the way the examiner has set out his answers.. 🙂
Thank you so much John for all Ur support! I passed my P4 paper – 55%. Thanks loads, I’m now qualified! Yippee!
That is great news – many congratulations and all the best for the future 🙂 🙂
Hi John, I have the following questions on this question:
1. For part (a), why do we have to compute the net exposure for both forward contract & money market hedge? Furthermore, for the money market hedge, I initially calculated both import (ARS490)& export (ARS890+750) instead of using the net amount of 1150 to calculate the importer(Deposit,Convert,Borrow). The computation only require importer.
2. For the futures method, even though the contract is due in Dec, it needs to be sold in Oct. In the answer, the rate used to sell in Oct is the Dec rate. Does this mean that no matter the month it was sold in before the due date, the rate is locked and will not change?
3. For the put option,
the question states:
Currency options prices, ARS/$ options $31,250(centavos per dollar).
(Note: One Argentine peso is divided into 100 centavos).Therefore, the call & put option premium is to divide by 100. E.g Dec put option for 1.92 is 6.55/100. Is this because the premium charge for each $1 of options is in centavos as stated in the question. The question stated ARS/$ and centavos per dollar so I found that confusing.
4. When the Company exercise the right from the put option to sell S$593,750(31,250×19) at 1.92 to get ARS1,140,000, the company will also buy $593,750 at 1.90293. Therefore, there will be a gain of ARS10,135.
The company then sell to the bank at the forward rate of 1.9081.
I wanted to ask if my understanding above is correct. Also, how do we decide when to use futures or forward contract? Above, there is a mix of future spot rate and forward rate used in this put option method.5. For the option market, 1150,000/60,000=19.17 contracts.
For the remaining 0.17 contracts, it is assumed that it will be hedged in the forward market. Do we need to calculate the impact of the 0.17 contracts?1. The question asks how Lammer should hedge all the transactions. The most obvious way of reducing the risk is to use netting as I explain in my lectures.
2. The future price could be anything on the date the future is sold. We calculate the lock-in rate which gives the net effect of converting the transaction at whatever spot turns out to be, together with the gain or loss on the futures.
3. The premiums are always quoted in the smaller units of currency (in this case centavos) and is always stated in the question as is the case here.
4. I do not know where you are getting 1.90293 from. We do not know what the spot rate will be on the date of the transaction and therefore if (and obviously only if) the option is exercised then we will convert at the relevant exercise price. The forward rate is only relevant for hedging the amount not covered by the options because of the fixed size contracts.
5. Ideally yes you do need to calculate the impact of the under hedge.
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