Mark-to-market forward **when to use (Bid & Ask)**

Does any one have a good logical way to always get these problems right? I’m having issues thinking through when to use the bid or offer.

Example 1:

  • At origination, you sold $6M AUD to be deliver against the GBP @ 1.0256 (AUD/GBP). They ask you how to Mark-to-market with 1 month remaining? They give you the bid-offer 1.0468 - 1.0470.
  • My logic here is: if I want to cancel the contract, I need to buy AUD (which is equivalent to selling GBP).
  • Since the rate is already in AUD, then you buy at the bid!

Example 2:

  • You purchase $20M GBP for deliverly against USD @ 1.0078 (USD/GBP)
  • They give you the Bid-offer spot rate 1.0102 - 1.035
  • My logic: to MTM or cancel the contract you will need to sell $20M GBP (selling the base). This is equivalent to buying dollars.
  • Trick: thinking that I need to buy dollars at the offer rate (highest rate) is wrong. I think it is because the base is the currency being quoted. So buying USD is = to selling GBP (which is the original fx trade per say). so you would use the BID???

SO FREAKING CONFUSING!

Do you have a better way to think abou this?

EDIT:

Sorry, I just realized that my previous answer is not very relevant to your question. I edited it as follow.

Example 2:

First we purchased $20M GBP (i.e. selling USD) under the original Forward contract.

To close out our long position in GBP, we will need to sell $20M GBP forward contract to the same settlement date, alternatively buy USD.

At the settlement, we purchase $20M GBP under the original contract and sell $20 GBP under the offsetting foward contract. So:

  1. The GBP will net to zero

  2. However, USD is not net to zero because the forward contract has changed since the contract initiation.

At the settlement we will :

  1. Receive $20M GBP and pay out X amout of USD under the original forward contract. (you do the maths for X, i don’t have a calculator with me here)

  2. Sell $20M GBP and receive Y amount of USD under the new contract. As you noticed, the USD has become the base currency. The OFFER of GBP/USD = 1/THE BID of USD/GBP. I think that’s why we use the BID.

Thanks man!

I get all of that! the only problem i’m struggling with is when to use the BID rate and when to use the offer rates!

As you see! in both examples, they use the bid!

To cancel the contrcat or mark-to-market… I will need to sell GBP. Given the quotation USD/GBP, they use the bid rate to cancel. However, selling GBP = buying USD… Right now the quotation is USD per 1 unit of GBP. So if i were to buy GBP with my dollars i would use the OFFER. However, i’m buying USD the numerator.

I guess this is why we use the bid? AAAAAAAAAAH i hate this :slight_smile:

In the CFAi Books the author says this “To summarize, the process for marking to market a forward position is relatively straightforward”

hahahaha

You have to use the base currency as the benchmark. If you initally went short on a forward contract to hedge a long position in USD for example, to mark to market you need to offset the initial position. You offset your initial position by buying the USD notional you initially shorted. If you have a spot rate USD/AUD for example, you need to sell the AUD to buy the USD, hence you use the bid rate. If you had AUD/USD, you would’ve simply bought the USD by using the ask price.

To get the cash inflows/outflows, you simply compute the difference of initial forward rates and rates at time t times notional, and divide the whole thing by the current libor (the rate has to match the notional currency calculated!)

What I do is to get clear what I’m doing, (1) buying or selling a given currency; (2) watch carefully how the exchange rate is nominated, for example USD/AUD or AUD/USD; and (3) always remember that you (as a market participant, client) you buy expensive and sell cheap, thats the dealer income.

The problems can tell you BUY 20 MM USD with a USD/AUD exchange rate, so the base currency is AUD, but you buying USD lol (confusing). This means that you are already selling AUD, so when you sell AUD you use the bid (you selling at the cheaper quotation). If they tell you SELL 20 MM USD, you are buying AUD and use the offer (you buying at the more expensive quotation).

Therefore, a good reference to pick well the bid or offer is to use the base currency and looking what you doing, buying (accept the offer) and selling (hit the bid).

I laughed too when the book said MTM calculation is “strighforward” lmao

Hope this helps!

Hi,

As others already said, you need to use the base currency as a bench mark.

For myself, I read “USD/GBP” as “Selling USD to buy GBP” and “GBP/USD” as “Selling GBP to buy USD”.

After identify which one is the base currency as above, you can use the trick “Up the bid and multiply, Down the ask and divide” to determine the approriate exchange rate (i.e the bid or the offer)

In your example 2:

  1. You purchase GPB (the base currency) ==> “Down the ask and divide” ==> you use the ASK

  2. You offset the contract by selling GBP (alternatively buy USD) ==> USD is the base currency ==> “Down the ask and divide”. However, they don’t give us the ASK rate of GBP/USD. But we can still get it because we know that THE ASK of GBP/USD = 1/THE BID of USD/GBP . That’s why we use the BID here.

Hope it helps

P/s: I think besides determining the bid or the offer, more importantly we have to know these quotes are for USD/GBP or GBP/USD.

Guys! This is some tricky a** ish! Check this out! The problems below ALWAYS USE THE BID whether you are selling the base or not!

I agree with the comment by Harrogath, i will always buy/sell at the worst possible rate.

Ex1: hedged a long exposure to the New Zealand dollar by selling NZD 10 million forward against the USD; the all-in forward price was 0.7900 (USD/NZD). Spot rate (USD/NZD) 0.7825/0.7830

Logic: To cancel contract, i need to buy NZD (base) = sell USD at worst possible rate (lowest) rate used: Bid Ex2: Selling USD 10 million forward against the NZD at an all-in forward rate of 0.7900 (USD/NZD). Logic: to cancel the contract i need to buy USD (Not the base). Buying USD = selling NZD at the worst possible rate (lowest rate) rate used: Bid** Ex3:**you sold $6M AUD to be deliver against the GBP @ 1.0256 (AUD/GBP). Logic: to cancel the contract i need to buy AUD = selling GBP at the worst possible rate (lowest rate)**rate used: Bid **** Ex4:**You purchase $20M GBP for deliverly against USD @ 1.0078 (USD/GBP) Logic: to cancel the contract i need to sell GBP = buying USD at the worst possible rate (lowest rate)**Rate used: Bid **WHEN THE H*** DO WE USE THE OFFER RATE???

As I said in the earlier post, it’s not only about the bid or the offer; you have to determine the bid/offer rates for A/B or B/A

In the example 2 above, the rate used is BID but this is the BID for USD/NZD.

Although USD is not the base currency, you can get the bid-offer rates for NZD/USD given you know that :

  • The bid for NZD/USD = 1/the OFFER for USD/NZD

  • The offer for NZD/USD = 1/the BID for USD/NZD

After doing the conversion, you buy the USD at the OFFER rate which is equal to 1/the BID for USD/NZD.

This is tricky for me as well. It’s even trickier if there are 3 currencies and you have to use the cross rates.

The currency you are buying in the forward is the long currency and the currency you are selling the short.

The currency quotations must have the long currency as the base currency and the short currency as the quoted.

The rate you use to enter the contract is therefore the ask rate (you are converting price currency to base currency) and hence the “down the ask rule” applies.

When closing out in effect we are pretending to do the opposite i.e sell the base currency and buy the quoted so you must use the bid rate.

It then follows that becuase your profit is in units of the short currency (priced) you must discount back from contract expiry to the valuation date using the priced (short) currencies interest rate.

What would you use here?

Sold GBP to hedge exposure and now you want to Mark-to-market. You are given USD/GBP

Logic: to cancel the contract I need to buy GBP. would i use the offer?

I think you missing that the pick of bid or offer depends on what is the base currency.

EX1: You buy NZD and since NZD is the base currency you will buy expensive, you pay the OFFER.

EX2: You buy USD which is the same as to sell NZD, since NZD is the base currency, you sell cheap NZD, you use BID (you was correct here)

EX3: You buy AUD which is the same as to sell GBP, since GBP is the base currency, you sell cheap GBP, you use BID (you was correct here too)

EX4: You sell GBP, since GBP is already the base currency, you sell cheap GBP, you use BID (correct too)

Remember always look it from the Base Currency perspective because the quotes are in that way !

Regards

***In E1, they use the bid, not the offer! ***

***E1 is from the CFAi books***

[quote=“Rasec”]

Are you sure? I remember that exersice from Example 3 question #4 , if you go directly to the solution it says that buying NZD you pay the offer. Please check again that exercise. The rule I told you must work always.

I’m sorry! I was wrong! The offer is used!

Harrogath, are you on gchat?

mine is: Perea.cesar@ G M A I L DOT COM

Oh no sorry, but if you want to tell me anything just send me a message here in the forum.

ok! cool!