Question

A foreign exchange trader working for a bank enters into a long position in a forward contract to buy one million pounds of sterling at an exchange rate of 1.6500 in three-months. At the same time, another trader on the next desk takes a long position in 16 three-month futures contracts on sterling. The futures price is 1.6500, and a futures contract is at £62,500. The forward and the futures prices both increase to 1.6560 at the end of the day the trades being executed. Both traders claim the same profit, but the bank’s accounting system shows that the forward trader has made a smaller profit than the futures trader has made. The forward trader immediately picks up the phone to complain to the accounting department. If you work in the accounting department, answers to the following questions are the explanations you need to give to the forward trader. (Assume that the interest rate is 6%.)

(a)What are the value of the futures and the value of the forward when the futures price and the forward price both increase to 1.6560?

(b)Why are the two values different?

(c)If the forward price and futures price both go down by 0.0060, instead of going up, what will be the profit (or loss) of the two traders in their positions and which trader’s profit(or loss) is bigger?

Answer 1

ANS 1 ;a) TO BE EXPLAINED ; Both trader might have entry the same contracts but their lot size and quaantity may be different and which can make their changes in buying price too.

b) TO BE EXPLAINED ; Because one is the buying price and other is the selling price.

c) TO BE EXPLAINED ; If the price goes down it will incurred a loss and the loss value is totally depending upon the quantity or the units they are holding.

PART SECOND

And those who hold higher units might face more losses than the other trader.