Now that I am done the SS, I have a better grasp on this concept. iossif is correct, naren_ has got it backwards. Here is what I’ve learned in my studies:

If a currency is trading at a forward discount (which I will call B for Base currency), and you go LONG on that forward contract, that means F P/B < S P/B, which is consistent with my example. I had F = 1.50, and S = 2.00. In the book, it says price movements tend to not appreciate/depreciate up/down to the forward prices - and I say TEND to because it’s a skewed distribution, meaning that when shit gets out of hand, it gets really out of hand (ie market stress). For that reason, if you buy a forward contract at a discount, you should have POSITIVE roll yield, because the expectation is that the price depreciation from the current spot rate will not be as extreme as the forward price. So if F = 1.50 and S = 2.00, and I go LONG on S, that means I commit to buying this foreign currency for 1.50 units of my own domestic currency. If the spot price stays the same until maturity, that means my profit will be .50 P because I will pay 1.50 P and receive 1.00 B, which I will then be able to immediately sell back on the spot market at a price of 2.00 P.

The simple roll yield formula here ignores interest rates, however, which is wrong, but it gets the basic idea of the abvoe right. Also, VERY IMPORTANT: The formula is if you go LONG on the S, and SHORT on the F, and I incorrectly assumed it was for the other way around.

So I still used this overly simple formula correctly when I did this:

roll yield = (1.50 - 2)/2 = -.25 or -25%

The roll yield is indeed -25% for this scenario, except that this is the roll yield if you SHORTL the F and LONG the S. The roll yield for LONG the F and SHORT the S is +25% (you just use the same formula and reverse the sign). This is consistent with the book’s repeated concept that if you Buy a Futures contract that is selling at a discount, you have a positive expected roll yield.

Remember, it is an EXPECTED roll yield, not a guarantee. The text describes chasing roll yield as picking up quarters off a railway track, or something like that. I think the analogy is more valid if Helen Keller is the one picking up the quarters, but whatever.

Another thing: this formula, (F - S)/S, is an over simplified one that ignores interest rates and assumes the spot price will stay the same, so if you are provided with interest rates, here is the formula you should use:

unannualized Roll yield = [(ip - ib)*t]/(1+ib*t)]

where ip and ib are the interest rates for the price and base currencies, respectively, and it is the roll yield if you SELL the forward contract. Just switch the sign for if you’re going long on it instead.

Also, in the formula (F - S)/S, I think the S in the bracket is the EXPECTED spot price, and the S in the denominator is the current one. Can someone confirm that for me please?

Thanks