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Hi John,
in this question when calculating the basis You do:
Future: 0.8656
Spot: 0.8632(1/1.1585)
Equals 0.0024However what if you did it the other way round so instead of changing the spot you changed the future as this:
Future: 1.1553(1/0.8656)
Spot: 1.1585
Equals -0.00321)Why do we get different basis?
2)is it always the case that we should never change the futures currency and always the spot if it has to be done in a question as shown on the first version above?
1. The basis will be different because you are looking at the difference between reciprocals (the difference between 2 and 4 is obviously different than the difference between 1/2 and 1/4 🙂 ). However, when you actually apply the basis the final answer will not be so much different (although it will be different).
2. You should calculate the basis using the spot rate to be in the same terms as the futures price.
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Hi John
Thanks very much that was bugging me.
Say a student does answer the question using the second method would they still get close to full marks?
Thanks
Yes, certainly – most of the marks in P4 are for proving that you understand how things work. The final answer itself it not worth many (if any!) marks.
Dear Sir.
According to this question, We are gonna Receive Euro 20m so the option choice in the answer for premium is call option on examiner answer sheet while BPP pocket note indicating it is put option in case of different currency whereas for $ Receipt it is call.Can you plz explain, why?
It all depends on what currency the options are in (which you know from the contract size currency). Here the contract sizes are in $’s.
They are receiving €’s so they want to sell €’s and buy $’s.
If they want to buy $’s then they need call options on $’s.The answer is correct 🙂
(My free lectures on options will help you)
Dear Sir,
Thanks for clearing this up; as I was so confused on this for such a long time. I will go through your lecture again.Dear sir,
Please forgive me if i ask not reasonable question.
I wonder why there is no tax allowable depreciation in FCFBut there is tax allowable depreciation!
The tax has been calculated on the profit of 300M (with inflation) which the question says is already after depreciation. We only need show the tax saving on tax allowable depreciation separately when we have calculated the tax on the profit before depreciation.
The depreciation is not added back because there is an equal outflow each year as per note (2) in the question.
Hi Respected Teacher, my question is about the months of the basis calculation as today is 1 march 2016
so Today at transaction date end of future
1 march 2016 31 may 2016 31 june 2016future 0.856
spot 0.8638
=2/4 *0.0018
but teacher they have done 2/3 *0.0018
can you please explain this?
What the examiner has done is apportion between the March and June futures prices.
The March futures end in 1 months time, so to approximate to a futures price in 3 months time he has taken the March futures price and ‘adjusted’ for 2 more months by taking 2/3 of the difference between the March and June futures prices (2/3 so as to add on 2 months when the time between the finishing of the March and June futures is 3 months).
More sensibly (and the examiner said it would get full marks) would have been to calculate a lock-in rate the way I do in the lectures.
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