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Hello, sir. Hope you well and safe. Firstly, thank you so much for your lectures and notes.
My question is regarding Notourne Co question. From what i have watched in your lectures, there werent any sums regarding under hedging and its calculation so this problem seemed a bit off to me.
So, i just went ahead and calculated the lock in rate according to how you taught in your lectures:Mid rate spot = 1.0292+1.0309/2 = 1.03005
futures = 1.0369
Therefore, 1.03005-1.0369= -0.00685 * 1/7 = -0.000978 (unexpired basis)
Lock in rate = Opening futures price + unexpired basis on the transaction
date
= 1.0369 + (-0.000978)= 1.0359Receipt = 12,300,000 * 1.0359= $12,741,834
Isnt this enough? We are getting the same answer right?
Why do we hedge the remainder amount specifically for this question? There are so many questions where there was an underhedged amount but we just round it up/down and solve the question accordingly.What you have typed is fine except for the fact that we apply the lock-in rate to the contract amount and in this question the contract amount is 98 contracts of CHF125,000.
I do mention the over or under hedge in my lectures, and the problem is that the contract amount is very unlikely to be exactly the same amount as the amount of the transaction. If we do nothing then the difference between the two remains at risk, and the only way we can remove that risk is to use a forward rate on the amount left over.
In the exam, always mention any over or under hedge. If it is tiny (so, for example, had it been 98.05 contracts that we rounded to 98 contracts) then do not bother doing more. If it is a larger amount (so here it was 98.4 contracts that we rounded to 98 contracts) then mention it and if you have time then calculate the amount left over and use the forward rate on it.
Okay i think i got it. So, for the Lammer PLC (june 06 adapted) question, they havent calculated the total outcome? They didnt even calculate underhedging separately. Why?
This is a question from 15 years ago and the examiner has change twice since then. These days you certainly would be expected to show the final outcome for futures and to at least mention the over/under hedge (which has been mentioned in the case of the options).
Hello Mr. John,
My query in this question is in calculating the receipt (under-hedged amount). In the answer they derived the Receipt = CHF50,000 x 1·0358= $51,790. But can I know the reason why CHF50,000 was multiplied with 1·0358?
I think that CHF50,000 needs to be multiplied with six months higher forward rate of $1.0380, right?
No, the answer is correct.
They are selling CHF and therefore buying US$ and so the relevant rate is 1.0358.
(Had they been able to exchange at 1.0380 they would have ended up receiving more, and that can never be the case – it is always what is worse for the company because the difference in the banks profit 🙂 )
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