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I am doing the final revision of P4, and what happened with me is really unfortunate !
I saw your lecture on Lock in rate in the start of month, but up till now i was not sure when we have to use what is the reason of using it.I had done all Future question is this way, bird eye view is given
Future
Step1: Find no of contracts
Amount /Future price today x contract sizeStep 2 At the date of transaction(Here i use the spot rate and future price on the transaction date)
-Normal transaction as if there was no future
Amount/Spot rate at the transaction date-Future deal
no. of contracts x contract size(Buy price- Sell price)(Please identify if i have choose incoorect rate or other mistake)
My understanding was that there are total 4 rate and price
1-Spot rate
2-Future price.
3-Spot rate on transaction date.
4-Future price on transaction date.1 and 2 is always given and for the 3rd one(spot rate on the transaction date) i used the forward rate given in question, and so find 4th one.
NOW My friend told me that we must have to use Lock in rate, forward rate is wrong ! After this i review the question and I notice I have made a mistaken in all questions by using forward rate, instead of Lock in! Now I am totally CONFUSE my confidence is shacking, I again see the lock-in rate lecture and pick the concept. I am astonish how have I have done 8-10 question without noticing this.Now these are the 3 main questions which are pulling my confidence
A-In which which hedging methods Lock-in could be used just in Currency OR in Interest too?B-What would be calculations in Step 2(How do we calculate profit loss), why lock-in is used for calculating the No. of contracts in different questions(like CMC J-14), we should have use the today future price.
C-Should i need to do all the question again or just do currency future contracts?
A: Using the lock-in rate applies when the question does not tell you the spot rate (or the interest rate) on the date of the transaction. It is the same approach for both exchange rates and for interest rates.
B: The lock-in rate gives the effective overall result that will occur from converting the transaction at whatever the spot is, together with the profit or loss on the futures.
(You will know from the lectures, that the reason the overall result of converting at spot together with the profit/loss on futures is different from converting at the current spot is simply because of the change in the basis. Since we can ‘predict’ how the basis will change in the normal way, we can therefore ‘predict’ the net result from using futures and this is what the lock-in rate gives us)
If you are using the lock-in rate, then this is the best rate to use for calculating the number of contracts (although don’t worry too much about this – it usually ends up with the same number anyway (because of rounding) and even if you end up with 1 more or less contract, (and therefore a slightly different answer) you will still get the marks.C: If you understand what I have written, then don’t go working through all of the questions again. Most of the marks in the exam are for proving that you know how the different things (futures, options etc) work. The markers for P4 are very good, and if it is clear that you basically understand the way things work (and your workings are clear enough for them to follow) then you will still get most of the marks, even if your answer looks completely different from the examiners answer 🙂
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