"U.S. investor have 1m euros to invest. the current spot rate is $1.2888/euro. Investor then hedges the principal of 1m euros by selling 1m in euro futures at $1.2891/euro.
time passes and its time to lift the hedge. Current spot exchange rate is 1.2760/euro and futures exchangerate is 1.2763/euro."
in the book, the examples uses the rate of 1.2891/euro (for the initial selling of futures) and 1.2763/euro for the subsequent covering. my question is…can the investor use the spot rate of 1.2760 instead to cover the short future? using another future will lengthen the time of translating back to USD, no?
is it just a case of matching futures with futures and spot with spot? in the example, if the investor decided not to hedge, the calculation is doen with spot rate at the initial and at the end of the investment period
ok i m officially freaking out. i thought i knew how does futures work until today
lets say i take a LONG position in a eurodollar future denominated in USD. the price today is $1/euro. the term of the futures contract is for 1 yr. after 1 yr, the spot exchange rate is $2/euro.
my gain is 2-1 = $1/euro. Correct?
thats why i do not know why the examples in the study session are using the futures exchange rate. is it because there are 2 spot rates? one is the conventional market spot rate and the other is the spot rate in the futures market? (HUH how is that even possible?! i mean come on, is there is a difference and there is no barrier to trading, the traders would have traded the hell out of it for arbitrage profits!)
I think you are confusing terms. Futures price is the price of a contract traded on a futures exchange , while spot is the price prevalent on spot market ( usually brokered by big banks ).
The futures price will converge close to the spot at expiration and probably at no other time . If the vignette doesn’t tell you that hedge is lifted at expiration of futures contract ( or even if it did , but listed the futures price seperately ) , do NOT calculate the P&L on the Futures hedge using the spot exchange rate .
Use Futures price for sell and for lift also.
Lifting the hedge means closing out your Futures position so you buy equivalent number of futures contracts to offset your short position . The price of the futures contract is relevant and not the spot price
i checked the applicable section (hedging with futures), the examples have futures expiring at a certain date but evaluating the hedge before that date (so no hedge lifting here).
the problem uses futures price on the date of hedge evaluation (rather than the spot rate on that date) to compute the gain or loss on the futures contract on that date, which makes sense because there is still some time left to run on the future contract.
hedged return = unhedged return minus futures return
the bolded part helps in the understanding. may i ask where did u get this info from?
ok my understanding is like this.
I took a SHORT futures position of 1m euros at lets say $1.1/euro for 90 days. at the end of the 90 days, i have to deliver 1m euros to the LONG which is a clearinghouse. now i think that the LONG simply would not care how i came up with this 1m euros. so i can then buy 1m worth of euros in the spot market and fulfill my end of the deal. why do i have to just close out my futures position with another futures position?
one more thing, the futures price will converge to the spot at expiration. so that also confused me
please realize that the futures price on the day to day basis is all that matters - since you are NOT going to end up paying the entire 1 Mill or whatever you owe each day. Remember that futures are marked to market - so the difference in the futures price between 2 consecutive days * notional would be settled. Hence the futures price is all that matters.
That the futures price should move towards the Spot price on the day is a mechanism that ensures an arbitrage condition does not occur.