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Hello,
I am struggling with the futures hedge in this question from the past paper.
I have tried to follow the steps as outlined in the lectures as below:
– Buy (18,600,000/1.1422)/200,000 = 81.4 (say 81 contracts)
– Convert transaction @ spot: 18.6m x 0.8729 = 16,235,940 (receipt)
– Close futures: 81 x 200,000 x (1.1431-1.1422) = 14,580
– Convert @ spot: 14,580 x 0.8729 = 12,727 (receipt)Net receipt = 16,235,940 + 12,727 = 16,248,667
The answer given in the solution is 16,271,386
Please can you assist with my calculations and advise where I have gone wrong.
Many Thanks.
Although you would have got most of the marks for what you have done, the problem is that you have assumed that the spot rate in 6 months time is 0.8729. However that is not the spot rate, it is the 6 month forward rate (which is not the same thing).
Given that we don’t know the spot rate in 6 months time, we have to use the ‘lock-in’ rate (which is what the examiners answer has done). As I do explain in my lectures, the lock-in rate is the rate that gives the net effect of converting the transaction at spot together with any gain or loss on the futures.
Sorry sir I am still a bit confused.
After calculating the lock in rate of 1.1431, I have calculated the expected receipt $18.6m/1.1431 = 16,271,542
The amount unhedged is $81,780 which converts to 71,386.
Net receipt = 16,271,542 + 71,386 = 16,342,928
(Or do we not have to calculate the amount underhedged when using the lock in rate, therefore an answer of 16,271,542 would receive full marks?)
Thanks
No, although you would still get most of the marks you would not get all of them.
The lock-in rate is the rate to apply but as always only to the contracted amount. So you can’t apply it to the full $18.6M but only to the 81 contracts.
So the end result is only fixed on 81 x 200,000 x 1.1431 = $18,518,220 (not the full receipt of $18.6M).The remaining $81,780 (the under hedge) would either be left at risk and converted at whatever spot turns out to be, or – more sensibly – we wolds a forward contract on that amount. (As far as the marks go, there is 1/2 marks for mentioning that there is an under hedge and the possibility of using the forward rate, and another 1/2 mark for actually calculating the 71,386.
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