Roll Yield

If the six month forward rate is higher than the current spot rate does this alway give rise to a positive roll yield

spot 6 months forward

KRW/ EUR 1483.99 1499.23

KRW/ EUR 1108.78 1112.56

Please calculate the roll yield using the above. I am really struggling with this so any help/ clarification would be greately appreciated

6 month forward rate is higher than the spot rate. so the forward rate will “roll down” to the spot. This will mean that when you settle the forward in 6 months - you would pay a lower price to settle the spot and then buy the forward at the higher price. So you will have a loss - a negative roll yield.

For the first case - roll yield = 1499.23 / 1483.89 -1 = 1.03% (-ve)

2nd case: 1112.56 / 1108.78 - 1 = .34% (also negative).

i should clarify that whether it is a positive or a negative roll yield also depends on whether you are long the initial contract or short the contract.

if you are long the contract - you get into a forward contract - will sell at the spot at the forward date, and then buy a new forward contract. You sell low, buy high - get into a negative roll yield.

If you are short the contract - you will buy low spot, sell high forward - and this will be a positive roll yield.

hope this explains…

CPK thanks for taking the time to explain this concept. The calculations give a positive value yet your response indicate the roll yield is negative. can you further explain this aspect. Additionally this is a case where the investment is long the base currency so my understanding is that the hedge will involve shorting that currency.Is this correct and howw does this impact the answer? I also dont understand what takes takes place when the hedge matures and how this affects the roll yield.

Would the higher forward rate always roll down to the lower spot rate meaning that the roll yield in this instance is always positive?

Grateful for your further clarification.

if you went long the futures contract initially

at the hedge maturity - the contract would be sold. Since futures price is higher than the spot price - you are NOW selling at a lower price.

then you have to buy the contract again - a Futures price again - which is again higher.

So you lost money during the process - a negative roll yield.

the futures curve is ABOVE the Spot Curve (a contango situation).

In a contango situation - if you buy a futures contract - you would experience negative roll yield.

however - take the exact same scenario - and say you had to sell a futures contract initially.

when the contract matures - you buy at the spot - buy Low. and sell a futures again - sell High. You experience a profit - a positive roll yield.

so it is both the “shape of the curve” (contango/backwardation) + the nature of your contract (buy/sell) that ultimately decides whether you experience positive or negative roll yield.

I still dont get roll yield after reading this. In a long futures contract you are going to lock in a futures price, and current spot price is lower than futures price (contango) but isnt your profit depend on what the spot price is at expiration? so lets say at expiration of the futures contract the spot price is above the locked in futures price you make a profit?

I am not understanding the rolling part i guess?

Let me try to simply it:

If you are long on MXN, and MXN is trading at premium, then this is + roll yield because in order for you to hedge, you should sell (opposite of long) MXN and since MXN appreciated, then you are selling at higher thus (sell high buy low) = + roll yield. I hope it makes sense now…

ok that actually painted a much better picture for me, ok so roll yeild only applies if you hold the underlying, in the case you presented I am a US investor with a MXN foreign asset and i am hedging MXN by shorting MXN futures and if MXN is in contango I have positive roll yeild, that makes sense in that aspect. (let me know if im wrong)

But if I dont hold the underlying(have no MXN assets) and I am taking a speculative position in a short futures on MXN contract will there still be a roll yeild?

if you are speculating then you’re not heding.

I believe you are right in the first paragraph you wrote.

I will try as well

in both cases above, the euro is trading at a forward premium. Since you have entered a forward contract to buy euros that are at a premium in the forward market compared to the spot market, you would experience negative roll yield, since you are in a contract to purchase a currency that is cheaper to purchase in the spot market

Nah… If you are long forward contract to purchase a currency that is trading at premium you are basically buying it cheaper than on the market thus you have positie roll yield.

Thinking i just memorize your explanation. So far makes sense ;/

Kobi, I think jeff sick is correct, Long futures in cotango = negative roll yield. confirm please if he isnt right then i dont know whats going on

I have entered a contract to buy an asset that is cheaper if I did not enter the contract and bought it spot ,that’s negative. If i was short the forward contract and the currency in was short was trading at a premium that would be positive roll yield since I am selling high

from my understanding that is correct, also there is a formula for this

Roll Yeild = (Ft-F0)-(St-S0)

F0 and S0 bring initial futures price and spot price

and Ft and St being the price at expiration.

But when you are long in a position and you want to hedge, you “sell” so you are short; if its selling at premium which as u said would be a positive roll yield.

does roll yield only apply to currency? or can it be equity futures as well? the only way a contract would have a positive roll yield in backwardation would be if i was short the underlying (lets say S&p500), and hedging by going long futures on S&P500 ?

if MXN is in contango then you would have negative roll yield but referring to the example above:

if the asset you are holding is euro denominated (you’re long this asset)

if you are long in EUR and euro appreciated … to hedge you need to sell. So you sell what has appreciated (EUR) … + roll yield.

if you are long in MXN (asset is MXN denom) and euro appreciated, to hedge you need to sell MXN, so you are selling at low and buying at high, thus its a negative roll yield.

Lets get this straight.

I am holding european assets and I am a mexican investor, I need to convert my euro assets back to mxn so i need to enter a SHORT forward contract to sell euros and buy MXN.

If the euro appreciates that is the euro now buys more MXN in the spot market than the forward market then I would receive more MXN through the forward contract than if I was unhedged and was buying MXN in the spot market.

This i have benefited from hedging and this lead to a positive roll yield.

yea now i am confused as well maybe instead of selling euros, you are buying MXN forward and selling EUR forward (its the same transaction) you are exchanging currencies, if MXN forward is > spot, MXN is in contango there for were are paying a higher price in fwd market so negative roll yield from a MXN investor.

Now the other way around, im a EUR investor with MXN assets and need to sell MXN forward and buy EUR forward (opposite of the above) but the difference now is that if that I am on the otherside of the transaction therefore futures EUR is in backwardation (F

Am i right?

I was reviewing this today with a friend and I think it simplifies to 3 things. First figure out what your hedge position is based on your current position. Then figure out if you are long/selling or short/buying. Then figure out if the forward is selling at a discount or premium. If premium, then you are selling for more/positive or buying for more/negatvie. If discount, you are buying for discount/positive, or selling for discount/negative.