ACCA AFM Currency Future Hedge

welcome so another external hatching techniques to hedge against that risks related to the foreign transaction is just going to use the currency futures contract so for a currency futures contract so first of all for the Cosa fetus contract is quite similar to their forward contracts that we've seen before but a difference is the default contract is the over-the-counter contract which means it's the negotiation between you and the bank and of course you can use the full contract to create the perfect hedge against the amounts that you will like to hedge against with but for the currency futures contract on the other hand this is not the OTC contract and that means it needs to be traded on to the recognised exchange so the exchange in London is caliph ik it's the London international financial futures options exchange you can change your physics contracts on that that'll be no problem so that means for example if you like to hedge let's say a hundred and twenty and fifty dollars using forward contract surely again hex that amounts that'll be no problem in full but using a futures contour on the other hand perhaps you can only hedge against a hundred and twenty thousand dollars as a maximum because we're rounding in the number of contracts that you've purchased because for the currency futures contract trailing a Liffey it's the spot which is the exchange so the contract size are standardized so you got the standarized contract size here so you'll explain that in a second so before we move in the further I assume that this is the first time that you hear feature ok this terminology sir me explain what do I mean by future first of all so you are trading your business in the cash market or we can call us the spot market so if I'm gonna say okay we're going to buys the up pole so if we're to buys the output at some point in the future the current price of the Apple is four dollars per kilo because we like to bite the Apple at some points to future you're afraid that the price would increase think for example from $4 to $5 because if the price increases you will have to spend extra $1 to purchase the apples so from that perspective then okay where you need to do if we've out the Apple futures contract and there's no visas contractor you can the hedge against the catch market for example if the price in the future of the output has increased up to $5 per kilo that means if you buy 10 kilos for each killer of the apples you will lose $1 to put it simply at some point in the future you'll have to spend $50 so by the ten kilos of Apple rather than $40 in total so without entering into any of his futures contract or you need to those to kind of spend $50 but what save I'm gonna intervene so the Apple futures contract in the futures market traded in Liffey so for a futures contracts day idea behind it is to focus on what you need okay so that's absolutely important so in this case you need the Apple sort you need to do then is because you buy the Apple you need to the Apple yeah so you're going to buy the Apple futures contract so what you need is you want to bite the Apple in the cash markets are going to buys the future buys the output futures contracts into the futures market is one okay so if you want to save the output in the catch market surely in the futures market you're gonna sell the outpour features call Chuck this one so that's focus on what you need so you can do that it's gonna agree I mean to buy the futures contract at a low price so that's what you need because you want to buy it at the low price which is $4 yeah so you can do for example your greased abides the Apple at some point in the future so that's what I mean by Apple futures contract at $4 per kilo so that's the case down the price where we are setting the contract at some points the future has increased up to 5 so from that perspective then what you can do is this is the exchange or Liffey and this is you buyer and this is the seller I can cuss the dealer the way that the future market operates is this if you see the quoting price of $4 that you can buy that that means there must be another party who agrees to sell the app would sue you at $4 at some points the future per kilo so that means when you close that contract at some points in the future there must be a party that wins and there must be another party who will lose so in this case of course we're going to buys the output futures culture are four dollars at some points in the future and surely we can immediately serve it at five so that means it's still a we're gonna buy the Apple fetus contract from the seller and then we're gonna close it by selling dates so then at $5 so that we can earn one bolus of gang so it's simple words that $5.00 it's the closing price - four dollars that we've bolt so we end up with $1 of game because for 10 kilos of apples so we'll have a gain of 10 dollars in total and that means if we're to pass the Apple on the left hand side which is in a catch market or the spot market we'll spend $50 and then we're going to net off with the game with $10 so the net amount that we spend it's just to be $40 so that means by using a fetus contract on the right-hand side as you can say we can make sure that even though the price fluctuates at some point of future but we still use that $4 to purchase the Apple so by using a fetus contract the first use for the futures contract is for hedging purpose I'm sure that you heard of that term when you're studying are the papers so that means hatch and purpose is smoking they use their gaze so loss in the futures market to set off against the gain so loss in the cash market so that's the furthest first of our use for the futures contract so in this example we use the gain the futures markets to set off against the total costs that we've Spain's their cash market so we end up with $40 that we originally planned to spend in buy the apples the second use for the futures contract is for speculation purpose so what that means is we only perform the transactions in the futures markets we are not performing any of his transaction in a cash market at all we only perform the chance actually in the futures market so that means we are not going to advise the up post-interview life but rather is for speculating purposes so we can earn the net gain of $10 from performing our transactions only in a futures market so that's all you need to know again when entering into the futures market deciding buy or sell something like that is to going to decide where not you need this okay so what you need that will be absolutely important so before we talk about I mean the currency futures contract and just a little bit's extra bits they need to know related to the futures market is for the fetus market although you agrees to buys the futures contract at $4 per kilo but you're not required to inputs that long sum of money right now so that means you agreed to buy a signed contract this is a binding contract to - this party's which needs to be closed out as the settlement they'd agreed in the contract so normally there'll be four days a year so there would be 31st March 30th June 30th September and 31st December so for example you like to bite the Apple for something the previous example in let's say 15th March so what you can do is to enter into a 31st March contract for it to bite the Apple features column chart you're gonna choose that conjunct that's quite near to base that you set to the transaction because you want to buys the app pull on 15th March so what you can do is going to buy the futures contract for the 31st March futures contract and that's all you need to know and also as I said we don't have two inputs that lump sum of money right now but rather we are going to input a small amount of money so that's cause the margin that's caused the initial margin so for example under the inputs $1 in though and of course the price of the apples will fluctuate each and every day of example the decrease in price by not point so so end up with not point a dollars of margin in this particular account and pass according to the exchange itself you may say - okay if the margin is below not point 5 you will have to deposit money up to $1 so for example if the price of Apple continues to decrease for example now decrease down to not point free so you need to do that this exchange is so we'll ask you to inputs the margin is caused a variable margin right now so bigoted biggest the initial margin is one and then you're required so inputs the variable the variable Margie in this case for example you need to make up to one dollar so that means you need to input by another naught point seven dollars at the margin itself would become one dollar that's how it works unsere o'clock it is closed out at they sector mandates okay so that means of course from the accountings perspective how we're gonna I mean how we're gonna account for this I mean that'll be a very difficult to be perfectly honest with you and also it will be depending upon we're not this will be a cash flow hedge or their fair value H and so on so these are the things they need to talk about need to understand related to the margin of how it works okay of how it works so that will be absolutely important so there's my we're going to introduce the Margie system here is simply because we like to prevents the situation where the parties would default on the payments so that's the reason why we have the margin system over here so so you can see that's for the features college I hope you're absolutely happy with it but it's related to the the currency future so that would be slightly difference here and the best way to go through this from my perspective is first of all to go through until next to next three pages for the question call front POC I'm going to come by all these bits and pieces into this / - cost j'en to make sure that you're out there you're absolutely happy with it so first of all let me explain the question itself so requirements is to calculate what's the result of the hatch it's expected to me and cow close the hedging efficiency discuss the reasons why this might not be a perfect hedge of course we are going to be reversed in a second but first of all let's look at the question so says now is furtive June 2014 and the front POC so complete load case in the USA so that means surely if the company's locating the USA the currency is the US dollars and that's what they need in most of the circumstances so subsequently if you are told that we're going to receive a foreign currency what we can do is gonna save that foreign currency to convert that into the US dollars and that's all you need to do so here the fonz POC has a contract to purchase their goods from to Japan in two months time or 1st September 2014 because we are required to purchase taggart so that means we need to spend the japanese yen to purchase that if we're displays the japanese yen all you need to do is step one is we're going to buys the game first before you can pay for it yeah but how are we going to buys the yen surely your are gonna sail the US dollars in order to get that yen so you sailed about it get that yen and use that yen to pay off the goods so that's the idea behind it but what about for the future because we're looking at the currency future here we are afraid studies future exchange rates will move so we're not we're going to buys the future or going to save the future and in this case I so you can say below we are close to contract size is 12.5 million yen so that in yen it's caused a contract currency and in this case I so you can say we've got two steps in there first we're going to buy yen and sick they were going to save a dollar so that means because the contract currency I can Christ ICICI it's the normal eight in yen and hence biggest we buy yen that means we're gonna buy the future on the other hand if your equality for example the current contract currency is the US dollars or you can do because you say that dollars so you save the future if the contract currencies in dollars I mean if you buy the future that means it's going long just the alternative name selling future that means it's going short but in this case surely because the contract currency denominated in yen so that we are gonna buy the future in this case so as I said for example let me give you another example before I move any further or by your side the future that's absolutely important is to focus on what you need so in this case for example your base in USA so let's say you will receive the UK pound because focus on what you need you're in the USA you want to purchase the hamburger in the USA what you need is a hamburger so you've gotta pay for the US dollars so you receive the UK pound starts not used for to you so you need to do it's gonna say that UK pound okay you're gonna say without UK pounds in order to get the dollars and said by the dollar so that means okay if that's the case then I'm gonna say if related to future that's the reason one of your hedge against the foreign exchange rate risk so related to future is so the contract currency if it is in the US dollars so that means we're going to buy the US dollar so that means we're going to buy to the future because that's what you need right if the contract currency is the new UK pounds on the other hand in the second circumstance because we're going to Saudi UK pound so gonna save the future of course buying something which means going long selling something that means going short alternatively so that's the first circumstance in the second circumstance if you're required to pay the UK pound so all you need to do is step one before you pay for it you need to have that UK parent in place right so what you need to do is to buy the UK pound how we're going to bite the UK pound is going to sell you're assisting dollars to buy it so making sure you're going to show this process I mean that's more complicated by the Apple because for the a poor futures contract output is one of the commodities other commodities were like the pears like the peach likes the gold like silver so those would be I mean conforming to the commodity futures contract as well but here it's different from the Apple futures contract because for the Apple you know what you need to directly which means the Apple itself but in this particular case you've received a foreign currency or you're gonna pay for the foreign currency but related to the future itself if you received a foreign currency is to convert that into your home currency that's what you need so that's the reason why we have the first circumstance there if you wanna pay for the foreign currency on the other hand so you need to buy it before you can pay for it so you're gonna sell your home currency so that's not exactly the same that's what we've seen the app pull features contract but the idea would be exact is to say is to focus on what you need and in this case if I said the contract currency is in US dollars so you're gonna save the futures contract alternatively if you were to buys the UK pounds okay if I said the contract currency is in the UK parent because you buy the UK pounds we buy the future in this particular case so that's all you need to know in any circumstances in the exam okay so I hope you're absolutely happy with this idea so let's move on right so we can establish that in this case we are going to buy the future but it starts the same the contract currency the payments to be made in yen and the total is to be a hundred forty me again of course that's in the cash markets that we argue look at the market and the margin director of the fonz POC wishes to protect the contract against any atlas movements in the Forex rate changes and is considering the use of currency futures the following data is available first of all we are given the spot price for days of course we are going to use that in the markets place that means I mean the catch market place is so and also yen currency futures contract on Singapore monetary exchange state contracts IC states and the contract prices would be this as well so the next question is is which column chart that we are going to choose so in this case because we are going to make the payments on first September so which date is very close to the first a temper of course it's the September contract because we are obliged to set to that contact not until 30 September right so we're going to choose this a temper culture here and also we are assumed that features come Sharma choose at the end of each month so that means September contract would be 30 September December corn shall be 31st December so it can close out the contract before that date or we assumed that these spots exchange rate is a hundred and twenty yen per one dollar on the day that we set to the payment okay so we're going to use that rate at this sentiment mate for the cash market and the basis risks be increasing steadily in a linear manner so what do I mean by that then so we're going to explain that the seconds don't worry so don't worry we're gonna tack coat these type of questions in the example is I'm going to use my own be mod X for this it's called CPA so the steps it's going to use the CPA approach so see for consider the situation so in this case because it's dealing with the Forex rate changes related to the receipts or the payments that you are going to make at some points in the future and in this case is related to payment by how much you're going to pay for them because you're gonna pay for a home to meeting yen sorry a hundred forty million yen and the spot rates at that particulate on first at ember that it makes the payment is to be a hundred twenty yen so convert into dollars so it can give you the total amounts of dollars that you are gonna pay for in the catch market we Fowler hedge Inc is 1 million one sixty six six six seven okay that's four C so the pay for poor fear loss from the future market so we are going to start the working one for this in most of the circumstances in the exam and then a stands for the actual so either be actual payments or receipts and in this case the actual payments after netting off the gains losses from the futures market with the catch market so that starts working one for this day it's going to consider piano from the futures market so personally I will use this table to show that or you can climb up the payoff table something line up so this is going to show now and also on assets mandate and also we've got step off for loss see in this case what we're going to do first of all is we're going to show two spots and thence the future so the difference between these two is called the difference but in technical terms it's called basis basis is just to be a difference between the spot price with the future price so now as you can see is on furtive June the spot price now if you look at the spots foreign exchange rate on 30th June today as you can see the future price has been quoted as dollars to Yen so we are going to commerce that spot price yen so dollars into dollars to Yen for sake of arguments that will be easier for us to calculate the basis later on so if that's the case then if we're to quote it using a futures markets futures prices to be dollars to yen so for the spot price all we need to do is we take one divided by a huntin quantify 128 point 15 so that would give me one yen or equals naught point zero seven eight oh three dollar so we're going to take that in circulation there so two spot price today not point 0:07 803 and the future price that we intervene so is to be not point oh oh 79 85 so the difference between so that will cause difference or in technical terms it's called spaces so one - another that would give me negative not points Shapiro 180 - and of course now we agree to buy that price here's what we want is because we have to pay for so you want to pay less so we want to have a low price so we buy that price up today is to be not point 0:07 that 85s enter the into this a temper contract so in the exam you'll always be required to predict what would be the future price up they set from 1/8 because when you're going to set to that contract is on first September they're going to make the payment not the 30th of September so first at ember will be your settlement date but the question is how we're going to estimate the future contracts price about per ticket settlement made them so of course the exchange will tell you about that but in this example we are required to search show the whole process to the examiner so we are told they are the examiner that assumes always in the exam that's the basis will be eliminated or we reduced in a linear manner so if that's the case then so that means we can predict on the sex mandates what's the basis we'll bake because we assume that this not point shipper or 182 would be reduced on the linear basis it's like the depreciation on too long current asset so let's see how we're going to deal with this them so in order to predict that we use not point Shapiro 182 and we're gonna divide by the total ones that we've got so a total months from now up to the end of a contract will be from 30 of jump up to 30 of September so that would be three months here and because we're going to sex in that cold cut be for furtive to we sets that on first September it's still one month left right so the basis will still be one month value so it times one month for that's because one month is from first September up to 30th September in this case we plot that into a calculator but should give you not point four owes 61 so all we can do in order to predict the future value was the future price at the settlement date because we are told on the first attempt oh is the spot price then so the spot price on first attempt but if you look at in the final paragraph is a hundred point a yen for one dollar we're going to take 1 divided by Hongshan 20 so that would give me not point cheaper well I sorry bubble ro8 cheap or free so not point double well aid cheap or free so we simply use the spot price minus the basis which will gives us the feature price on the settlement date that's the bouncing figure is to be not point 0 83 and 94 ok dollars per yen so that means okay at that particular site Mondays we agreed to buy at 9.00 7.85 or we can immediately serve it at 9.00 83 94 so a service oats of it will end up with a game of not point Chippewa 409 and of course the difference between the I mean for the small price now and at the settlement days would be - not point cheaper well 53 negative so that means we use the gain the futures contracts to set off against the price in the spot market but so you can see first of all this is not the same as you can see yeah one is not point zero 50 three one is not point ship around 409 so why this is the case then so first of all but I mean these two figures are not the same so that's cause the basis risks that's different from the basis biggest basis would just be the difference between the spot price and the future price but the basis risks is the changes in the spot price would not be equal to the changes in the future price so first of all why this is the case day is simply because in estimating the future price here we are assuming that's the basis will be decreased in in linear manner such as the depreciation that we've done for not for the non-current asset for example we simply time apportion that so of course our estimation or our assumption may not be the same as the assumptions that has been made by the Masters in the marketplace to be reflected in the spot price and the changes in those would not be the same okay so that's the first we marching like you to know the second thing I'd like you to know is for example at the date that the future contract matures in this case is to be third safe September the spot price at that particular would be equals to a future price so the spot price will be equals to future price on thirds of September because standing up 30 September that particular day there'll be no future price anymore any prices that would be today's price and pays about Pacheco day when they feature contract matures the spot price would equals to the future price so that's the thing though you need to know so because we've got that gay from the future now all we need to do then is we need to work out the total gain for the path loss for the futures contract so the total pier now from the working one we used two ways to calculate this so dissuade number one is the total gain or loss will be equal to the path loss / future contract and we times the number of contract and width times the contract size and in this case the path loss / futures contracts that we've just calculated before is to be not point cheaper or following night so it's not that there how about for numbers of of culture then so numbers of column charts we are going to use the amounts that we're going to hedge against wave is the homes in the 14 million yen so it use the amount divided by the contract contract size in this case the contract size is denominated in a Japanese yen so you have to make sure that they are mouths wh against wave would be in the Japanese yen this one and in this case surely we are cold we're gonna pay 440 me in yen and the contract size for days is to be twelve point five meaning yen so it can work out the number of contracts in there so the number of columns hats if you plot that into a calculator that would give you 11 point so contract so eleven point two column chart I mean we have no eleven point two contracts in the stay in that exchange so all we can do is to round this up to eleven contract that we're going to entered into so it knows that piano player fetus contract with no eleven contacts in total so what about for the contract sized a so for the total contract size all we can do is we're going to times twelve point five million yen for days oops so in total the total gain is to be 56 238 okay so that's how we do it and before I'm moving if I like let's lock this into the CPA formally 56 238 so we end up with the total or net payments in this case it's just to be median one 110 for twenty nine US dollars okay so that's the first way that we can work out the path loss a total Pavlos from the futures market you think the right number once the total gain is broken detected a peer now perkins out x number of kolchak's and times the contract size the second way that we are going to do is we're going to use the CTN so normally when we are trading the futures contact we use the terminology called ticks rather balance is calculating I mean showing this path loss per features contact here so all we can do is the number of contract would be the same as before which is 11 contracts that we've discount cloudy in the year away number 1 but what do I mean by ticks and what do I mean by take value then so in this case because it's associated with the Japanese yen contract so let me bring you back to the few pages before if you turn back to the at the start of his page at the start of his topic related to their currency futures contract you will see the tick in the bottom of this page so here's the pro forma that we can calculate the tick a tick value equals to the size of the futures contract times the tick size except for the Japanese yen the tick size normally to be not point O one so for example for the UK pound for example the size of a fetus contour would normally be 60 to 500 UK pounds and the tick size is to be not point oh one percent so the tick value would then become 6.25 UK pound so that means I mean if you buy one contract and if there's not point oh one percent of changes in the I mean the price of the commodity so that means you will end up with a change in the gaze loss of 6.25 UK pound starts warn me but if value is the piano for you and the tick size is the change in the commodity price based upon the size of a Kong shop though so ours in this case because we are calculating this using the number of ticks and then times the tick value okay and times the number of Kong charts there so it takes how we're going to do that then so for example if the exchange RACI receipt in the next of our paragraph if the exchange rate moves by not point oh four dollars and then we can convert that into 40 ticks because we take that not point zero four divided by they tick size is to be not point oh one percent so that would give me 40 ticks so that means if this is related to the UK pound all related to US dollars we can buy right you take this not point oh-o-oh for nine divided by the tick size which is not point O one so it can gives us that particular figure for a number of ticks there well the question is this is related to Japanese yen if it turned back to your next page you can see that for the Japanese yen the tick size will Beit not point shipper or one percent so that means in order to convert that into the number of ticks we're going to type not point cheaper well fold and I divided by not point Chippewa 1% ants the tick value is to be twelve point five so these the information if you were to use the tick approach these information will be given by your examiner directly so plot that into a calculator so first of all for own itix start me if there's any not point over one percent of changes in their foreign currency they'll be I mean a change in the value that you can get of twelve point five dollars that's the tick value that you can get in this case is for now takes their so each is twelve point five but forward night six so at times twelve point five start we've been total for eleven contract that should give me fifty six thousand two hundred and thirty eight dollars which is same as before so I mean you can use the way number one to calculate this alternatively you can use the second way I mean if you'll requires to use second weight of course that's not point oh-o-oh one percent and twelve point five would be given you can use the mere monix for this is called the T T M biggest by expressing in a number of ticks we don't have to say okay it's not point oh oh oh four oh nine so that's too many O's in there right so via direct experts that's us they tix the number of ticks here so okay so thus ansis are requirements for the number one okay we tick tick for that the requirement number two sturckow close the hedging efficiency and discuss the reasons why this may not be a perfect hedge so hedging efficiency all we're going to do is we're going to take the profits divided by the loss so in this case that the profits that we've made to from the futures contract are so you can see the total profit that we can make is to be 56 to 38 if we were to estimate the losses that we have already made of course that will be related to 140 million yen that we are about to pay and the losses in this spot price is to be not point oh-o-oh 53 dollars per yen so that means we've got of 140 million yen in total it times the loss per yen that we've made is to be not point oh oh oh 53 convert that into dollars so that should give me 74 200 so that means that so you can say we've lost 74 200 we only have got the gain of 56 238 to cover this to cover up the lot C stock we've made and that means the hedging efficiency will be less than a hundred percent so if it is equal to a hundred percent so that would be the perfect hedge you should expect to see that in the forward contract for example but for the futures market on the other hand of course yes sometimes it will be less than hundred percent always for that or sometimes will be more than a hundred percent for that so before we move any further let's see on to your previous page ease for the hedging efficiency so uh so you can say if it's more than a hundred percent so that means the profit is greater than the loss so we can make again less than hundred percent we make loss because the pop is less than the loss equals two hundred percent we've made no gays no loss that's cause the perfect hedge it should expect to see that when using the OTC forward concept but let's question is why the perfect that's not equal to a losses there when using a fetus contract I mean there'll be two reasons for that I mean this will be required to comment on if it's comes up in the exam ok so first of all because of the number of contract because for a number of contracts in this example we use 11 points who writes the 11 but we round this up to 11 contract and that's the reason why the profit is not equals to a losses and secondly basis risks so that means that changes in a spot price it's not equals to changes in the future price and that's the results of a basis risk assists it simply because for a boat for the future price you've made that assumption that's the the difference between the spots and future would be decreased in a linear manner but in the real life this may not be the case because your assumption may not be equal to the assumptions that has been made by the people in a society so that's the reason why it create imperfect hedge okay so in this particular circumstance so that's it's for the coaster future I hope you're absolutely happy about a certainly bring you back to the notes to go through that again first of all we've talked about the similarity between the four contracts and the currency futures contract so the forward contract you know that is the OTC contact would be agreed between two parties over the counter so that would create the perfect hedge the settlement base for the features column chart would be four days so you can set to that column chats always before each of these settlement date and they'll be spanned the rice culture as well so that means this will create imperfect hedge is simply because for the number of contracts we always round it up and of course you can use the tick approach to calculate the total profit or loss for the future contract of course that will be an alternative way that you can do surely you can use the first way to peer know from the futures markets times the number of contract times they call chat size so we are showing you the tick size and tick value etc I mean this will be given by your example as directly insert question and we use the fetus contract there will be two reasons why we're going to use it first of all is for hedging purposes and secondly it's more speculation purpose that means we only performed the transaction in two futures market and the step seen the currency feature we used the CPA approach and such is what we've done before yeah we introduced the concept called buy or so so the key is to focus on the what you need okay so that's absolutely important though and also we talked about the hatching efficiency as well there will be two reasons why there will be imperfect hedge first of all related to the number of contract and secondly the basis risk assists so that means the changes in the spot price may not be the changes in may not be the same as the changes in the futures price okay so that's the idea behind it I'll also we talked about the margin is how it works in order to make sure that the parties will not default onto the pavement okay so we've gotten through the questioning core funds POC it's 1 for the currency future I mean from my perspective that's all you need to know from the exams perspective so well done so in the next section onwards we'll be starting to cover the currency options this one which would be another key example area in the exam what hard I'll see you in the next section a PC accounting for your future

Channel: Steve ACCA/CIMA/CMA/MCSI

Views: 12,895

Rating: 4.7894735 out of 5

Keywords: accaapc, acca, apcacca, apc acca, acca apc, acca p4, acca p4 online, acca p4 course, acca p4 material, acca p4 video, acca p4 online course, acca online course, currency hedge, acca p4 currency future hedge, future hedge, hedging instrument, acca p4 derivative

Id: Fuc_0uQ3b0g

Length: 57min 17sec (3437 seconds)

Published: Sun Jan 10 2016