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New kids on the block: Currency Futures, Islamic Banking and Spot-to-Futures Arbitrage


TheEconomist

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As I promised to my readers, I am returning with an article about the "new" currency futures contracts introduced by the non-NFA regulated brokers. Together with arbitrageable commodities, currency futures prove to be some of the most valuable contracts to be found in a broker's datafeed.

 

1. Basics of Currency Futures

======================

 

Currency futures are the standardized, transferrable version of currency forwards. Currency forward contracts lock in the price at which an entity can buy or sell a currency on a future date. But how is a currency futures priced?

 

A spot forex rate is the rate at which two currency amounts are equal : for example, 10000 USD are (at a moment, "spot") equal to 1.230.000 JPY at 123 JPY/USD rate. Since the time value of a currency is given by the interest, the currency futures rate which equalizes them incorporates the differential rate.

 

Suppose we have two currencies, A and B, both equal now, as A/B = 1 spot rate.

 

A interest in 20%, while B interest is 5%

 

so there is a rate which equalizes 1.20 with 1.05 , and that rate is 0.875 , as 1.20 x 0.875 = 1.05

 

Hence the futures formula:

 

http://img514.imageshack.us/img514/6458/futuresformulaax8.jpg

 

In our case, the spot rate didn't had any effect, since it was 1.

 

We must know 2 elements:

 

1. The interest rates

2. Futures expiry dates

 

1. The interest rates

 

That's an easy one. A reliable source for this can be found here on FXStreet .

 

2. Futures expiry dates

 

This can be done in a few ways:

a. Download WHC's MetaTrader. Then point to Market Watch, right click, (Show All if they are not already) , Show All, then Properties, then expand the Currencies top folder.

b. Directly from CME website (see below)

 

Of course, when you use the formula you must calculate the time to expiry as precise as possible , because it influences the interests put inside the formula.

For example, if we have 90 days to expiry, that 1+C2 Interest Rate % from the formula transforms in 1 + (0.5/100) / 365 x 90 = 1.001232876

 

Almost forgot: depending on the strategy you'll decide to use, it may be useful to check when the next meetings of the central banks officials will take place and also what's the expectation about the interest rates.

 

 

2. Spot-to-Futures Arbitrage

=====================

 

Since the futures are linked to the spot by the interest to expiry, and futures at expiry equalizes the spot (this equalization is a feature of all futures contracts that have a spot counterpart) there are two possible spot-to-futures arbitrages:

 

http://img128.imageshack.us/img128/4825/eurusdarbitragebigfa2.jpg

 

a. exploiting the difference between spot and futures (often called basis) and cashing it in while paying interest on spot position (the "Covered Interest Arbitrage" in finance books) ; or, depending on the broker's feed , the reverse : paying the basis and getting interest on spot position (which is ockward and not likely to happen for real, but never say never)

b. exploiting missalignments of the converted futures to the spot (or of the real futures to the calculated futures , which is the same thing) using interest rates.

 

However, type b. arbitrage is not as seldom as that picture lets to be understood. You don't have to be a genius to see that a misprice happens not only when futures is on the wrong side, but also when futures is not where it should be: We could also discount (let's call it like that the conversion of futures to spot, even if some futures are discounted, e.g. USDJPY) the futures and see how far is from the real spot. We should also have a neat time conversion on hand to have a continuous time, not a jumpy one (e.g. not the time that decreases by one day when a day passes, but a time in real number format). The discounted futures is calculated using the reversed upper formula (get the spot from the equation to find it out).

 

Discounted futures to spot basis fluctuation

http://img517.imageshack.us/img517/2136/eurusdarbitrage2te3.jpg

The overlay indicator : DiscountedFutures

The window indicator : DiscountedBasis

 

As you can see, with 5-6 pips in magnitude of arbitrage windows, you could cover the 4 pip costs of arbitrage (2 pips on EURUSD, 2 pips 6E equivalent commission in pips). But is MetaTrader fast enough? However, with a pretty superior account trading at 1 pip spread it might work smoothly... With a regular case of EURUSD - 6E you could, for example, when DiscountedBasis has a higher value, sell the futures and buy the spot, and close when it reaches a lower than regular value...

 

Now let's return to the a. arbitrage type ("Covered Interest Arbitrage")

The picture below depicts the basis and swaps consuming reciprocally (in the normal swap rate regime), while the new, swap-free accounts based on brokers arrangements with islamic banks provide new, outstanding arbitrage opportunities:

 

Parameters : Account equity about 450 USD; Account leverage about 200 ; Margin usage = 90% ;

 

http://img524.imageshack.us/img524/7725/spottofuturesarbitrageme1.jpg

from Futures.mq4 script

 

This example was run on WHC (although WHC doesn't offer swap free accounts).

 

How are the calculations done?

 

Below is a picture with the implementation made by Beaverhea Financial. Although it's an untrustable broker, the implementation is useful for calculus and demo.

 

http://img166.imageshack.us/img166/9504/beaverheadfuturesyf1.jpg

 

The real currency futures implementations on CME

 

The ones that can be found with brokers are:

 

CME Euro FX

CME Australian Dollar

CME Canadian Dollar

CME British Pound

CME Japanese Yen

CME Swiss Franc

 

WHC comes also with these two, but they don't seem to work properly:

CME EC/JY Cross Rate

CME EC/SF Cross Rate

 

Now the arbitrage is pretty simple to understand if it's about EURUSD and 6E. Provided that EURUSD's lotsize is 100K and 6E's lotsize is 125K, the ratio : EURUSD traded lots / 6E traded lots = 5/4, as 5 x 100K = 4 x 125K to equalize pip movements.

 

But what if it's a reversed futures, such as USDJPY to 6J ?

 

This is a calculus example, using the Impeccable Hedge algorithm that powers FPI, Intercross Arbitrage and Swap Arbitrage

 

We consider:

 

USD - 5.25%

JPY - 0.25%

 

USDJPY right before old futures expiry: 123.00

6J right before old futures expiry = 100/123.00 = 0.8130

 

New futures, in the first moments, with expiry in 3 months:

 

http://img64.imageshack.us/img64/6761/futurescalculation6jcd5.jpg

 

Actually tested the formula on june 15 data and it was accurate on a range of 6 pips

(of course I used 92 days period instead of dividing to 4)

 

 

Prepairing the hedge : USDJPY spot > transformed USDJPY futures : Sell USDJPY, Sell 6J

 

Sold 100000 (1 lot) USDJPY @ 123

Sold 100000 USD

Bought 12300000 JPY

 

Sold 12300000 (0.98 lots) JPYUSD (6J) @ 0.8232 (/100)

Sold 12300000 JPY

Bought = 101253.6 USD

 

That 1253.6 must be the embedded interest in the futures.

 

 

Supposing now USDJPY=127 on expiry ; 6J is right reversed = 0.7874

 

Sell 100000 USDJPY @ 123 -> (1 pip = 10*100/127 = 7.87 USD) : -400 pips x 7.87 = -3148 USD

Sell 1230000 6J @ 0.8232 -> (1 pip = 12.3 USD) : 358 pips x 12.3 = 4403.40 USD

 

Result = 1255.40

 

Supposing now USDJPY=119 on expiry ; 6J is right reversed = 0.8403

 

Sell 100000 USDJPY @ 123 -> (1 pip = 10*100/119 = 8.40 USD) : 400 pips x 8.40 = 3360 USD

Sell 1230000 6J @ 0.8232 -> (1 pip = 12.3 USD) : -171 pips x 12.3 = -2103.30 USD

 

Result = 1256.70

 

As you see, arbitrage holds no matter the direction. And if the regime is swap free, pocket all of it... about 200K USD in traded volume, this would be tradable with a 500 USD account at about 450 leverage! This means more than double!

 

Of course it is advisable to review articles on central banks monetary policies especially if their meetings happen close to the beginning of futures. Create scenarios about what might happen if interest differential enlarges. Calculate the damage done to the equity, add 20-30 pips or more of market "missalignments" and see at what leverage it is sustainable (also include here the issues about not trading microlots - see the Intercross Arbitrage article). If you're heavy leveraged and faint hearted, better close positions before central bank meetings, and , most important, don't EVER forget to close positions before expiry or your account will likely be blown up due to violent futures shift on expiry change (or hopefully you'll just lose the profit!) . You could even test broker's vigilance by reversing positions with a day before expiry in order to make the entire profit on the expiry shift moment... Whatever, the method is a great progress from leaving the forex madness for a slow paced and profitable trading with controllable risks!

 

3. Warnings about Attachments

========================

 

Be very careful about how you set up DiscountedFutures and DiscountedBasis, especially with the interest rates and the expiries!

Look close at the SwapFree parameter when running Futures.mq4 script!

And be extremely careful when running on real accounts! Measure ten times and cut once! The script supposes all margin requirements are the same, however with some brokers margins for futures are bigger. Experiment first on demo.

33 Comentarii


Comentarii Recomandate



Hi Bog.

 

Very good article and good sourcecode. I'm going to have a deeper look in it, as currently I'm working on the same thing, as you know.

 

Keep in touch, Andi.

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Are you planning an trading EA for the so called "Type B" Arb? Would be nice to see, if its possible to catch such ppportunities.

 

Andi

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Are you planning an trading EA for the so called "Type B" Arb? Would be nice to see, if its possible to catch such ppportunities.

 

Andi

 

Matt did a similar thing but with correlations (picked a common point and displayed movements of spot and futures from that one).

He made cash.... now they put him on manual execution.

I'd think about an EA if I'd have a pip spread. I'd be confortable with that.

 

I see there is this lure... that passive trading gives the impression money are not really used, while active trading gets the full consideration.

However, I'd consider a combinated strategy, with a long hedge to generate interest, both trades being hedged by another pair of hedges (when basis gets big), in order to get the b. type arbitrages (of course this pair of trades is closed when arbitrage window closes).

 

Bogdan

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I repaired and placed back for download the DiscountedBasis and DiscountedFutures indicators, because 6C wasn't treated as a reversed futures of USDCAD (also modified expiries and interest rates). However USDCHF - 6S is not displaying right and I don't have a clue where the mistake is.

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I would really like someone to explain me why there is a difference between the discounted futures and the spot... I don't see why it exists, why the discounted futures isn't 90% of the time 2-3 pips around the spot...

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Bog,

I do not understand well your question.

Are you asking why futures have a discount or premium of spot?

juan

 

No, I am asking why the discounted futures already is distant from the spot...(as if it's not completely discounted).

 

 

P.S.

If you have trouble running futures.mq4 , slide the MarginUsage to 85.

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I'm with you Bog. Cannot understand, why there is a gap between the calculated future from real spot and the real spot.

Just checked some brokers - everywhere the same...

 

Andi.

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Hi Juan.

 

Sample from yesterday:

 

EURUSD spot is BID 1.3862

Interest EUR=4.0%

Interest USD=5.25%

6E Future expires 17.12.2007 = 90 days

 

6E Future BID = EURUSD spot BID x (1+(USD Interest/100)/365 x days)) / (1+(EUR Interest/100)/365 x days))

 

6E = 1.3862 x (1+(5.25/100)/365 x 90)) / (1+(4/100)/365 x 90)) = 1.3904

 

The REAL 6E Future at that time was 1.3893 -> about 10 pips differ to our calculation. And this gap holds on...

 

Andi

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Guys, Fed has lowered fed rates from 5.25% to 4.75% yesterday.

 

So 1.3862*(1+(4.75/100)/365*90)/(1+(4/100)/365*90) = 1.3887

 

very near to the 1.3893, only 5 pips difference

 

But remember that Central bank rates are a proxy of the real cost of building a synthetic future. I will post a comment on this later today.

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Hi guys, one way to create a synthetic currency Future is using swaps. You can also do it with put and calls. Let?s stick to swaps...

 

If you look at this link

http://www.saxobank.com/Default.aspx?id=1572

You will get the interests rates for EUR and USD. The swap charge or credit are based on the LIBOR/LIBID interest rates of the two traded currencies with an added a markup of +/- 0.25%.

So if we adjust the rates given

 

EUR LIBID:3.8%+0.25%

USD LIBOR:5.2%-0.25%

 

We recalculate

 

1.3862*(1+(4.95/100)/365*90)/(1+(4.05/100)/365*90)= 1.3892

 

So there is one pip difference... 1.3892 vs 1.3893

 

Enjoy

Juan

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Hi guys, one way to create a synthetic currency Future is using swaps. You can also do it with put and calls. Let?s stick to swaps...

 

If you look at this link

http://www.saxobank.com/Default.aspx?id=1572

You will get the interests rates for EUR and USD. The swap charge or credit are based on the LIBOR/LIBID interest rates of the two traded currencies with an added a markup of +/- 0.25%.

So if we adjust the rates given

 

EUR LIBID:3.8%+0.25%

USD LIBOR:5.2%-0.25%

 

We recalculate

 

1.3862*(1+(4.95/100)/365*90)/(1+(4.05/100)/365*90)= 1.3892

 

So there is one pip difference... 1.3892 vs 1.3893

 

Enjoy

Juan

 

Very smart =D> So we could just modify the parameters area of the indicators.

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Hi Juan.

 

You got it. I also thought about a "flat fee" beeing charge from the broker, near the global interest rate.

We now can rearrange the calculations and use brokers swap.

 

Andi.

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Vizitator Mr. H

Postat

Hi Everyone,

 

Has anybody noticed any broker providing NZD/USD Futures and Spot on the same account?

Is it allowed to hedge Forex Spot with Forex Futures with non interest brokers?

 

Best wishes.

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Hi Everyone,

 

Has anybody noticed any broker providing NZD/USD Futures and Spot on the same account?

Is it allowed to hedge Forex Spot with Forex Futures with non interest brokers?

 

Best wishes.

 

Hi there Mr. H,

 

I didn't see a broker that offers NZD/USD, at least for the MT brokers area that I know.

Now I won't put the problem as "if it would be allowed to hedge". You have the spot, you have the futures, you can trade both simultaneously, why not?

I'm putting the problem like this : "Is it allowed to keep trades for a long period of time ?"

This is a thing to ask your broker before starting up this strategy.

 

Regards,

Bogdan

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Vizitator Mr. H

Postat

Bog,

 

Thanks for your answer.

Windsor Brokers Ltd. told me a non interest forex spot position is allowed for 10

days then they charge a daily fixed fee until the position is closed.

I don't know this fixed daily charge yet.

 

Regarding placing 2 or 3 orders together on MetaTrader, do you use a script or EA or do it manually one after the other?

 

Thanks,

 

Mr. H

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Bog,

 

Thanks for your answer.

Windsor Brokers Ltd. told me a non interest forex spot position is allowed for 10

days then they charge a daily fixed fee until the position is closed.

I don't know this fixed daily charge yet.

 

Regarding placing 2 or 3 orders together on MetaTrader, do you use a script or EA or do it manually one after the other?

 

Thanks,

 

Mr. H

 

Well, it could work, or it may not be enough. I see that sometimes it takes a lot of time to push forward, then jumps instantly, so the growth is not necesarilly day-by-day. You can use my futures.mq4 to place the trades (supposing the symbols are the same), or you could learn the calculations and place them yourself. If you do by futures.mq4, test how it works first on a demo. However, it would be interesting to find out how much that fixed fee is. Because, if it's fixed, may be a way around it.

 

Regards,

Bogdan

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Vizitator Mr. H

Postat

Well, it could work, or it may not be enough. I see that sometimes it takes a lot of time to push forward, then jumps instantly, so the growth is not necesarilly day-by-day. You can use my futures.mq4 to place the trades (supposing the symbols are the same), or you could learn the calculations and place them yourself. If you do by futures.mq4, test how it works first on a demo. However, it would be interesting to find out how much that fixed fee is. Because, if it's fixed, may be a way around it.

 

Regards,

Bogdan

 

Bogdan,

 

Thanks for your answers.

Yes, I noticed that the growth is not consistent day-by-day but by the Futures expiry, profit can be realized.

I have not looked at Futures.MQ4 yet but my idea is for example:

Do the Calculation manually then

Set up the following in a script / EA:

Sell X lots of USD/CHF Spot at Market BID and

Sell Y Lots of CHF/USD Futures at Market BID

Once all orders filled then

Close all open positions at a specific exit date and time.

 

Sorry Bogdan, I don't know what you mean by

"However, it would be interesting to find out how much that fixed fee is. Because, if it's fixed, may be a way around it."

 

Regards,

 

Mr. H

Link spre comentariu
Well, it could work, or it may not be enough. I see that sometimes it takes a lot of time to push forward, then jumps instantly, so the growth is not necesarilly day-by-day. You can use my futures.mq4 to place the trades (supposing the symbols are the same), or you could learn the calculations and place them yourself. If you do by futures.mq4, test how it works first on a demo. However, it would be interesting to find out how much that fixed fee is. Because, if it's fixed, may be a way around it.

 

Regards,

Bogdan

 

Bogdan,

 

Thanks for your answers.

Yes, I noticed that the growth is not consistent day-by-day but by the Futures expiry, profit can be realized.

I have not looked at Futures.MQ4 yet but my idea is for example:

Do the Calculation manually then

Set up the following in a script / EA:

Sell X lots of USD/CHF Spot at Market BID and

Sell Y Lots of CHF/USD Futures at Market BID

Once all orders filled then

Close all open positions at a specific exit date and time.

 

Sorry Bogdan, I don't know what you mean by

"However, it would be interesting to find out how much that fixed fee is. Because, if it's fixed, may be a way around it."

 

Regards,

 

Mr. H

 

 

You're right. If you want to trade using similar risk parameters like me, consider a margin usage of 50%. Suppose your broker allows max leverage of 200,

calculus would follow this:

X = ( Account equity * 200 * 50% )/100.000

Z units of bought CHF = X*100.000*(USD/CHF bid);

Y=Z/125.000

 

As for the closing moment, that one should be on december 13. The day before the one you can see in WHC's MetaTrader (don't know, perhaps you have it on Windsor Brokers Metatrader too).

 

Now let's settle out that daily fee problem.

If the daily fee is fixed, it means that the cost of maintaining the position is for the entire period to expiry, no matter which forex/futures pair you use, be it the best or the least profitable, and also, no matter how the interests rate change until that time. Now, what "flat" exactly means, is something I can just suppose. Say this would behappening to me:

My strategy should make, in average , $16 a day, as you see, I sold 1.6 lots of USDJPY, and, at that time, there were aproximately 70 pips left to go (after cutting a few pips as error and a few pips for the commission and spread) for about 70 days left to expiry. So, one pip a day.

Suppose I'd have to pay $5 a day, fixed fee. I should stand up to it pretty easily. Even if I'd trade double, and make $32 a day, it would be no difference, the "fixed" thing would still be $5 a day. I've traded the best thing I had available. Supposed I would have chosen to trade EURUSD/6E, with, let's roll the dice, 40 pips to win / 92 days to expiry. At the same 1.6 lots EURUSD, it would have meant 40/92 x $16 = $6.88 a day. Dangerously closed to the $5 daily costs. Almost nothing, but the profit would help me get a bit farther from these costs for the next cycle. Now, what if those $5 a day would be "per lot" ?. For my trading, it would mean $5 * 1.6 = $8. This would have wiped out the EURUSD/6E strategy and would have eaten 50% of the USDJPY/6J strategy output. Even more, the $8 cost would double in the next trading cyle, so it would be at a rate of 50% of the average profit, whereas by being absolutely flat, the $5 cost would become insignifiant over time. You have to find out all the terms linked to the flat fee if you want to use this trategy.

 

Regards,

Bogdan

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Vizitator Mr. H

Postat

Bogdan,

 

Thanks for your reply.

I guess this fixed daily charge is per lot, so let us wait and see.

Is your broker FX India related to FX Open ?

Your margin rate is about 4-5 times lower than Windsor Brokers Ltd.

I will keep you updated for any news about any potential brokers.

 

Regards,

 

Mr. H

Link spre comentariu
Bogdan,

 

Thanks for your reply.

I guess this fixed daily charge is per lot, so let us wait and see.

Is your broker FX India related to FX Open ?

Your margin rate is about 4-5 times lower than Windsor Brokers Ltd.

I will keep you updated for any news about any potential brokers.

 

Regards,

 

Mr. H

 

Well, I don't even wanna talk about this subject too much.

FXIndia is just an IB. The operating center is Masterforex , owned by BeaverheadFinancial

Now, FXOpen says they don't have any connection with Beaverhead, although , if you look on their website, a past note says that the company has been renamed from Beaverhead to Poltek, and also warn customers of a scam email originating from Beaverhead. What is Beaverhead then ?....Gee, I don't wanna know. I just wanna make money and that's all. A friend had an account there, made cash and withdrew. Doesn't look too normal, but it seems to behave so. As long as they respect me as customer, I don't have any problem with them.

 

Other brokers to check up may be AFX (I just heard about) and SpaceVision.

SpaceVision seems similar to Crown, displays itself as swiss, but I heard it's middle east based.

 

Regards,

Bogdan

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Vizitator Mr. H

Postat

Other brokers to check up may be AFX (I just heard about) and SpaceVision.

SpaceVision seems similar to Crown, displays itself as swiss, but I heard it's middle east based.

 

Regards,

Bogdan

 

Bogdan,

 

Thanks for your answer.

AFX uses different Futures contracts set up with no expiry date so it is hard to calculate

how close they converge with the Spot prices.

Have a look at this Post #890

 

As far as I know, SpaceVision has only standard lot sizes of 100 k.

 

Regards,

 

Mr. H

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I have mistaken my calculations...considered a JPY pip of 10, and a day result of $16, but the real pip is more than 8, so the output is about $12-$14 .

 

Other brokers to check up may be AFX (I just heard about) and SpaceVision.

SpaceVision seems similar to Crown, displays itself as swiss, but I heard it's middle east based.

 

Regards,

Bogdan

 

Bogdan,

 

Thanks for your answer.

AFX uses different Futures contracts set up with no expiry date so it is hard to calculate

how close they converge with the Spot prices.

Have a look at this Post #890

 

As far as I know, SpaceVision has only standard lot sizes of 100 k.

 

Regards,

 

Mr. H

 

 

Slightly different...probably it includes a premium (later edit: I heard they have variable spread on futures, and the broker is libanese). It doesn't mean it won't expire. It copies the real futures, even if slightly different. If the broker doesn't closes the futures at expiry, it can be doublecrossed big time. For example you could open the trades reversed a few minutes before Globex futures expiry, the futures jump, and double the money after an hour. I don't recommend this to anyone, the broker would automatically shut this down, because his real futures are closed.

 

Regards,

Bogdan

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Vizitator Mr. H

Postat

Bogdan,

 

I understand your point.

However, I don't feel comfortable about not fixing the expiry date of those CFD/Futures contracts.

The liquidity provider could switch to the new contracts anytime without closing the old contracts

leading to wiping out any profits on short positions.

 

Regards,

 

Mr. H

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