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Need a bit of clarification, please.
The scenario is like this on Future:
Today: 30th November 2001
Transaction date: 31 May 2002
June Futures was taken
Other information on future prices were given for:
Dec
March
JuneI felt in determining the basis the period to be considered should be between Nov 31st and 30th June and the Spot rate to consider for the future should be the Spot rate given in November alongside other information on forward contract. (This Spot rate wasn’t referenced to the future, though)
But in determining the lock-in-rate, the March future price was taken as the Future’s Spot rate & was compared to June futures price to determine the basis; again basis period was taken to be 3 months from March.
The treatment looks confusing because I don’t understand the relevance of March in the scenario & the use of its future rate as the Spot rate.
Kindly assist with a clarification. Thanks.
Strictly the correct way of determining the lock-in rate is to do it as I do in my free lectures, which is to take the current spot and adjust by the basis at the date of the transaction, or tae the current futures price and adjust by the change in the basis between now and the date of the transaction. Both of which always give exactly the same result. In your example the basis will be calculated on the June futures.
What the examiner often does in his answers is apportion between (in your example) the March futures price and the June futures price to get a price for 31 May. It always (in his questions) results in the same answer, but he always accept either method and almost always shows the calculations using either method.
Dear Sir,
Can we use lock-in rate method in calculating interest rate futures price?
ThanksYes – and I explain this in my free lectures on interest rate risk management. (The lock-in rate does not calculate the futures price – whether with foreign exchange or interest rates – it gives the net effect of using the spot rate at the date of the transaction together with the gain or loss on the futures deal).
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