Mark to Market Forward Positions

CFA Level II Economics
#1

For the question below, I cannot figure out whether I should use the bid or ask numbers. I do not understand when one currency is long or short. Thanks for your help in advance.

Question:

A few months ago, a company hedged a long exposure to the USD by selling USD 20 million forward against the JPY. The all-in forward price was 89.35 (JPY/USD). Six months prior to the setlement date, the company wants to mark this forward position to market. The following is available:

  1. Spot rate: 88.24/88.31

  2. 6 month points: -13.4/-11.8

  3. 6 month libor (usd): 2.58%

  4. 6 month libor (jpy): 0.42%

part I: The mark to market for the company’s forward position is:

JPY 20.78 million - this is based on using the “ask” prices, 88.31 and -11.8/10000.

Part 2: if the company hedged a long exposure to the JPY by selling JPY 20 million against the USD, and the all in forward price was 89.35 (jpy/usd), the mark to market for the company’s forward position is:

USD: 2,783.28million - this is based on using the “bid” prices, 88.24 and -13.4/10000

#2

Use whichever price will give you less money.

#3

I cannot tell whether I should use the “ask” or “bid” price for part I vs. part II based on the wording of the question.

I am confused by selling ____ against the ____. When that language is used, I cannot tell if the currency strategy is to go long or short.

Thank you.

#4

The company is long (i.e., due to receive) USD, but they don’t want USD; they want JPY. So they’re selling USD forward: they’ll deliver USD and receive JPY.

To mark this position to market, they have to undo it: sell JPY and buy USD. As I wrote above, you _use the value that will give you less money _: because the quotes are in JPY/USD, and you’re paying JPY to get USD, you have to pay the high price, the ask: 88.202 (= 88.31 – 0.118). (Note: it’s not -11.8/10,000; it’s -11.8/100, because the smallest digit on the quote is 1/100 JPY.)

The company is long (i.e., due to receive) JPY, but they don’t want JPY; they want USD. So they’re selling JPY forward: they’ll deliver JPY and receive USD.

To mark this position to market, they have to undo it: sell USD and buy JPY. As I wrote above, you _use the value that will give you less money _: because the quotes are in JPY/USD, and you’re paying USD to get JPY, you will receive the low price, the bid: 88.106 (= 88.24 – 0.134). (Note again: it’s not -13.4/10,000; it’s -13.4/100, because the smallest digit on the quote is 1/100 JPY.)

When I wrote initially:

I wasn’t being flippant; I was giving you the simple, general rule that always works in these situations: use whichever price gives you less money. It’s always the correct price.

I want youse always to remember – and don’t youse never forget – one simple fact: currency dealers are cheapskates. (More generally: all dealers are cheapskates.)

#5

sorry S2000magician, in this scenario, which 6-month LIBOR should I use to discount the offsetting contract? Japan or US? I saw in the recent 2016 mock that the price currency, which in this case - JPY will be used but I don’t get why.

#6

Just remember - When you are -

= buying the base currency - use the ask price (Higher rate when you are buying)

=selling the base currency - use the bid price (cheaper rate when you are selling)

In your example, initally he SOLD USD (the base currency). To mark to market this position he will have to BUY USD. (buying the base- so use the ask price)

#7

Thanks Boca641 for your answers.

How about which country’s interest rate to use when discounting the mark-to-market position 6 months back to the current state?

#8

THe currency that you did not offset’s rate is used.

Also, I memorized going down the quote = Ask, going up the quote = Bid.

#9

Thanks Jsnazz,

Thus, in this example:

A few months ago, a company hedged a long exposure to the USD by selling USD 20 million forward against the JPY. The all-in forward price was 89.35 (JPY/USD). Six months prior to the setlement date, the company wants to mark this forward position to market. The following is available:

As I sell USD, and buy back USD (in the offsetting contract), JPY did not come into picture. Thus, I should use JPY to discount the mark-to-market position to present?

If I’m correct, may I know why is JPY used please?

#10

Hey thanks all. I think I gained a better understanding after reading Example 3 Page 517 of CFA Book 1 material. Since AUD is being netted off, you are left with USD only.

#11

The trick the I am using is the base currency always in the denominatior (for the rates) and the dealer always earn money for you (you always lose)

#12

What I learnt.

This questions may be like following “…XYZ invested in foreign currency X and his broker hedged position by taking short in X. Few months after, broker checked mark to market of FX forward 30 days before contract expiration”

For mark to market relevant is final position, thus it was short in X, so we have to check long in X to calculate mark to market.

The rule is buy base on ask and sell base on bid. The IR in denominator is price currency IR based on add on yield with days to contract expiration.