CFA CFA Level 2 Buying a forward rate

Buying a forward rate

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  • vincentt
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    @sophie just a quick one as i’m a little confused here (don’t think it’s mentioned clearly anywhere in schweser)
    when you are buying a 1-year forward rate of $1.5/gbp, are you:

    1. securing the rate of $1.5/gbp in 1 year’s time to sell gbp or buy gbp.
    or
    2. securing the rate of $1.5/gbp in 1 year’s time to buy gbp with USD in hand.

    Sarah
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    If you are long position wouldn’t you be on the receiving end (as the short position delivers) so you would be obligated to buy gbp because you are short the dollar and long the gbp…
    ….
    I think. I was looking for this online and found NOTHING.

    vincentt
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    @diya well for FRA there’s only 1 rate for the contract. For example, if you long FRA @ 8% so at maturity if the rate gets above 8% you’ll gain.

    However, for FX there’s USD & GBP (for USD/GBP) so it could be that either unless we are always referring to the base currency, long $1.50/gbp would means to buy GBP and sell USD at maturity.
    So i’m not too sure about this.

    Sarah
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    @vincentt I think I am just going to wait for @Sophie because now I’m just confusing myself. Maybe there is a rule that if you are long a contract it means you are short dollar. It might always be in reference to the dollar? Since currency forwards are relatively new.

    vincentt
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    @diya i’m betting that @sophie is gonna say when you long a fx contract it’s always referring to the base currency.

    So:
    – long forward USD/GBP = buy GBP (equivalent to sell USD).
    – short forward USD/GBP = sell GBP (equivalent to buy USD).

    we’ll see…

    Sophie Macon
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    Sorry guys, a little late to the party! @vincentt yes, you always go long (or short) the currency in the denominator (base currency) – that’s my understanding. But I must admit this section constantly confuses me too at that time!

    harshit_tahiliani
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    The Trick: always treat what is in the denominator as a commodity.. So look at “$1.5/gbp” as “$1.5 per potato” (potato being the commodity)..

    Answer 1:  If you take a long position on a 1yr contract.. you will BUY  one gbp or one potato at $1.5 each (you buy the item in the denominator of the quote)…. Similarly, if you take a short position, you will sell one gbp or one potato at $1.5 each.

    Answer 2: Yes, “you are securing the rate of $1.5/gbp in 1 year’s time to buy gbp with USD in hand.”

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