Yes, but I am still not tracking what you are saying.I think the points are added or subtracted based on the difference in interest rates for the two currencies at the point on the yield curve corresponding to the length of the contract.
Lets say that that a 1 year US Treasury is yielding 5% and a German Bund is at 4%. I don’t know if that is a + or - 1% price in futures because I work with forwards or swaps.
The FX Interest Parity Formula shows how to construct a zero cost zero risk hedge. I could buy a 1 year Treasury. Or I could could convert my USD into Euros, buy a German Bund, and by a FX Forward. The points are telling me that the correct forward FX rate for USD will be 1% lower in 1 year. Thus I will earn 4% on the German Bund and 1% due to FX movements, thus earning 5% - exactly the same as if I bought a US Treasury.
i.e. there is no cost. i.e. No Arbitrage Pricing.
If the math doesn’t work out perfectly that means there is a arbitrage opportunity, a chance to make riskless profit. The real world mirrors theory pretty closely.
I could go out today and load up on a couple of billion 5-year USD/Euro swaps. Such a small amount wouldn’t move the market. I would initially have to post next to no margin collateral.
Statistics: Posted by alex_686 — Fri Jun 28, 2024 11:05 am