Currency Risk Management-Arbitrage opportunity ?

@lakshya25 I gotta agree with @jimmyg.

Day 0: Investor invests in EUR at spot rate (Spot rate = 1.2888)
Day 90: Investment grows to EUR 1.05M, investor decides to hedge (Spot rate = 1.2760)
Unknown amount of time after Day 90: Investor liquidates investment (Spot rate = 1.2763)

np @lakshya25 🙂

I don’t have the book @lakshya – care to include a pic or write it in here? 🙂

@lakshya25, do remember that not everyone has the Schweser reference books here. I agree with @zee’s and @jimmyg’s assessment though, based on your original written question.

It’s best to take an image or replicate the question exactly here for us so that we can help properly. Sometimes rewriting the question as per your own interpretation, some important information may be missed or some misinterpretation may occur. Check out @vincentt’s Level 2 questions for best practices.

Sorry @lakshya25. I’m feeling quite thick today, not sure what the question is in detail. Perhaps you have an example question you want to go through, which you could write (or show a picture) here?

@lakshya25, if i read the question correctly, the Euro futures were sold (on day 90) for a future time frame, not with a maturity on day 90 itself (which doesn’t make sense).

The question says ‘at time the investment is liquidated’ – it’s at a future day beyond day 90, which is irrelevant detail for this question. I hope this makes sense?

That’s odd. I read it that if the investment grows to E1,050,000 on day 90. Then he decides to hedge. It doesn’t make sense to hedge a contract on day 90 and liquidate on day 90?

Thanks for posting the question @layskha25.

It’s true that prices will converge as the contract approaches expiry, however it’s not necessarily guaranteed to be exact. As you say, there will be quite a few parties at the exact time of expiration trying to make a quick profit from differences to the underlying, as well as a flurry of traders trying to roll over to the next contract, so you’ll see the price of futures fluctuate in a fairly volatile manner (but centred around the spot price).

For exam purposes I would say that you can safely assume they will converge (i.e. be close together) but I wouldn’t automatically assume they’re exact. Usually the exam question will specify the spot and futures, or state the assumptions you have to make.

Hope that helps.

As what @zee said. Plus in real life, they usually won’t converge exactly as there’s transaction costs. Hope this helps @Lakshya25. Thanks for putting up the question!

You’re welcome @lakshya25!

@lakshya25, would you mind attaching pictures through http://imgur.com/? I think the previous one doesn’t work.

Ok, I will attach it as an image here