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In the answer, how do the examiner get 2/3 when calculating predicted futures rate.
The March futures price of 1.0345 is 4 months away from 30 November.
We want the price on 31 May which is 6 months away, i.e. an extra 2 months.So take the March price and add on 2/3 of the difference between the June and March prices (because they are 3 months apart).
Strictly the better way of calculating the lock-in rate is the way I show in my free lectures and which the examiner’s answer also shows (and gets 1.0358). However either way is acceptable.
Hi John,
For question 1, in the examiner answer, the examiner has used 1.0361 to obtain the expected futures receipt as per below.
Predicted futures rate at the end of May = 1·0345 + ([1·0369 – 1·0345] x 2/3) = 1·0361
Expected futures receipt = CHF12,250,000 x 1·0361 = $12,692,225
However, I had calculated as per your AFM lectures, the lock-in rate I calculated is 1.0358 using basis risk method.
I am confused of why is these 2 rates different? and which method to use in my calculation?
1.0358 is fine, and the examiners answer does show that as an alternative and it would still get full marks 🙂
Strictly 1.0358 is the more accurate answer, but again the examiners answer makes it clear that either was acceptable (and he always does accept either).
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