A Note On Currency And Index Futures
 <<Previous
TRADING USING CURRENCY FUTURES Contd..Futures market
To offset the position, exporter will be required to go long on four March
Euro futures contract. Let the futures rate be 0.82269. This gives the
exporter the notional right to buy Euro 800,000 by paying $658,152 (Euro
800,000 X 0.82269). Profit on the futures contract is
= $659,440 – $658,152 = $1288
The loss resulting in the spot market from the appreciation of dollar is
offset by the profit in the futures market. In the above illustration, the
exporter received the same amount of US$ as if he had sold Euro in the
market on January 27, 2003. This is because the change in the spot rate of
Euro during the period and the change in the price of futures during the
same period are equal.
|
Spot Price (t0) – Spot Price (t1)
= 0.8208 – 0.81919 = 0.00161
Futures Price (t0) – Future Price (t1)
= 0.8243 – 0.82269 = 0.00161
Also, in the above illustration, the basis (the difference between the
spot price and futures price) at time t0 and at time t1 is the same i.e.
0.0035.
Thus, when the basis remains unchanged, the gain/loss in both markets,
that is, spot and futures, is equal and, hence the amounts are exactly
offset. However, it is unlikely that the basis will remain the same
throughout the period.
|
|
This is what gives rise to basis risk. To understand basis risk, let:
St0 be the spot price at time t0
St1 be the spot price at time t1
Ft0 be the futures price at time to
Ft1 be the futures price at time t1
St0 – Ft0 = Basis at time t0
St1 – Ft1 = Basis at time t1
In the above example, the US exporter hedged Euro receivables by taking
a short position on Euro futures. Assume that the hedge was created at time
t0 and the position closed out at time t1. Profits made in the future
markets by closing out position at time t1 = Ft0 – Ft1 (loss if Ft0 < Ft1).
Consider a situation where a hedger knows that the asset will be sold at
time t1 and takes a short future position at time t0. The price realized for
the asset while selling in the spot market = St1, which implies the
effective price at which the US exporter sold the Euro, is
= St1 + (Ft0 – Ft1)
= Ft0 + (St1 – Ft1)
= Ft0 + b1
Where b1 represents basis at time t1.
Since b1 is unknown, the futures transaction is exposed to basis risk. If b1
= b0, then the effective price at which Euro is sold will be Ft0 + St0 – Ft0
= St0.
TRADING USING INDEX FUTURES
CONCLUSION
EXHIBIT I DIFFERENCE BETWEEN FUTURES AND FORWARDS CONTRACTS
EXHIBIT II A NOTE ON ANALYZING FUTURES PRICES
ADDITIONAL READINGS AND REFERENCES
2010, ICMR (IBS Center for Management Research).All rights reserved. No part of this publication may be
reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted
in any form or by any means - electronic or mechanical, without permission.
To order copies, call +91- 8417- 236667 or write to ICMR,
Survey No. 156/157, Dontanapalli Village, Shankerpalli Mandal,
Ranga Reddy District,
Hyderabad-501504.
Andhra Pradesh, INDIA.
Mob: +91- 9640901313, Ph: +91- 8417- 236667,
Fax: +91- 8417- 236668
E-mail: info@icmrindia.org
Website: www.icmrindia.org
|
More Classifications...