Future Contracts

April 8, 2018, 5:04 am

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Position 2 (Euro/JGB Forward Contract):

One month ago, Troubadour purchased euro/yen forward contracts with three months to expiration at a quoted price of 100.20 (quoted as a percentage of par). The contract notional amount is ¥100,000,000. The current forward price is 100.05.

The value of Position 2 is closest to:

1. –¥149,925.

2. –¥150,000.

3. –¥150,075.

A is correct. The value of Troubadour’s euro/JGB forward position is calculated as

V_t(T) = PV_t,T[F_t(T) – F₀(T)]

V_t(T) = (100.05 – 100.20)/(1 + 0.0030)^2/12 = –0.149925 (per ¥100 par value)

Why are we discounting the 100.05 by two month since it was only one month ago the initiation of the contract?

The other question, is why are we discounting the 100.2 since it is the quoted price at T=0?

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multicollinearity and overestimates standard errors

April 8, 2018, 9:36 am

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Does anyone know why this tends to be the case in regression models that have multicollinearity?

Kaplan Schweser Mock Exams and Q-Bank vs. Wiley Mock Exams and Test Bank

April 8, 2018, 10:58 am

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I already purchased the 6 mock exams and Q-bank through Kaplan but was thinking about buying the Wiley mock exams too.

The wiley mock exams come with only 2 and is $195 but also includes 1200+ Practice Questions.  It doesn’t seem like a lot of mock exams for that price at all.  However, if the 1200 practice questions are good then it may be worth it.

My question is for anyone who has used BOTH the Kaplan Q-bank and the 1200 practice questions on Wiley… are they similar?  In my opinion the Kaplan Q-Bank is not very hard and the questions are pretty much just useful for quickly reviewing the material.  They really are nothing like taking an actual mock exam and seeing those types of questions.  Is this similar to the 1200+ Practice Questions that come with the Wiley mock exams?  If that is the case then it seems like it may not be worth spending $200 for 2 mock exams and another bunch of questions that aren’t really what I’m looking for.

Does anyone have any insight?  Thank you.

trend model vs AR model

April 8, 2018, 6:56 pm

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I understand the differences in the structure/inputs to each model.

But in the context of what we need to know for the exam, should we just know that we would use the AR model when the trend model (even after it has been linearized via natual logs - if applicable) still contains serial correlation within its residuals?

Question about Ethics

April 8, 2018, 9:13 pm

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Is it assumed that everyone mentioned in a question are supposed to obey CFA standards? I mean if someone does something unethical but is not a CFA charterholder nor candidate then it’s not really a violation isn’t it? However a lot of questions (especially third-party books/mocks) seem to have the assumption.

Long CDS vs Short CDS

April 8, 2018, 11:33 pm

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I am very confused with going Long CDS and going short CDS positions.

I have been doing some curriculum EOC questions and got incorrect answer. As I understand, protection buyers going Long on CDS position to transfer credit risk to protection seller, who going Short on CDS. However, the curriculum said something like this in its EOC solution: “shorting (buying protection) a long-term (20-year) CDX and going long (selling protection) a short-term (2-year) CDX”. Please correct my misunderstanding. I have spent hours on this.

Help - Future libor rate?

April 9, 2018, 6:20 am

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I need help here.

Peter will present the hypothetical rates and LIBORs shown in Exhibit 1 (https://ibb.co/cPLShH)to illustrate the result of using an FRA. Current 2x5 FRA price is 3.8%. All rates are annualized. Using the price and predicted LIBOR rates in exhibit 1, which of the following is closest to the predicted value of the FRA at the year end?

When I working on the question to calculate forward rate base on Libor rate, the questions gives me this table. The answer is the first column (in 30 days) to calculate 1X4 forward rate (I assume the first column is the spot libor rate, but why they mention in 30-day?). Also what is the second and afterwards’s columns mean here? Do they represent future libor rate? Thanks.

Fixed income

April 9, 2018, 7:31 am

≫ Next: [S2000Magician or Tickersu] Help: Doubt related Hypothesis Testing

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Hi,

looking at page 61, Reading 35 The term structure and interest rate dynamics, do you see somewhere in the question 39 the “annual return” been in question:

In presenting Investment 2, Smith should show a total return closest to:

1. 4.31%.

2. 5.42%.

3. 6.53%.

Additionally, in the following question it is said “lower quality, 2-year corporate bond” and I was thinking that we should add the swap spread and the Z-spread to the government spot rate, but no, only the Z-spread is added. I am probably mislead by the “lower quality” wording here. Do you have the same problems or I am missing something? Frankly, sometimes the wording of the problems to solve is not explicit. Do you have the same thoughts?

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[S2000Magician or Tickersu] Help: Doubt related Hypothesis Testing

April 9, 2018, 10:19 am

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For a past few days I have been struggling to understand this concept. I would really appreciate if you could help me out with this. I’ll try to explain my query through an illustration.

Illn: Let our sample mean be 5%, standard error being 0.75%. We are hypothesizing our population mean to be equal to 6.25% . Let’s assume the level of significance to be 5%. Further assuming that z distribution is being followed, since the test is a two tailed test, the z value would be 1.96. Now suppose we are required to solve the question using confidence interval. 

The value we will add or less to fit the level of significance is (Std err * z value) ie (1.96*0.75%) ie our add or subtract value would be 1.47.

Now to make a conclusion if null hypothesis is true or not amongst the following which logical reasoning do we make

Option 1. Build confidence intervals around hypothesized population mean.

We will build confidence intervals around hypothesized population mean and check if the sample mean rests within that range. So in the given question we would create a confidence interval around 6.25. Ie range within which sample mean should rest to prove null hypothesis is 6.25-1.47 & 6.25+1.47 ie if sample mean rests between 4.78  & 7.72. In the given case, since the sample mean of 5% does actually rest between 4.78 & 7.72 we fail to reject null.

Option 2. Build confidence intervals around sample mean.

We will build confidence intervals around sample mean and check if the hypothesized population mean rests within that range. So in the given question we would create a confidence interval around 5. Ie range within which hypothesized population mean should rest to prove null hypothesis is 5-1.47 & 5+1.47 ie if hypothesized mean rests between 3.53 & 6.47. In the given case, since the hypothesized mean of 6.25% does actually rest between 3.53 & 6.47 we fail to reject null.

Which of the above is the actual reasoning on basis we accept or reject hypothesis ?. I would also really appreciate if you could assist me on how to build confidence intervals in one tailed tests in following both cases where

1. H₀: μ₀>=6.25%  2. μ₀<=6.25%

 Thank you for your help.

how to tell on a graph a trend model vs. an autoregressive model?

April 9, 2018, 10:23 am

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Fixed Income

April 9, 2018, 11:47 am

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Please help explain why

z spread > nominal spread => upward sloping yield curve

z spread < nominal spread => downward sloping yield curve

Thank you very much

Poorly worded derivative question?

April 9, 2018, 4:14 pm

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This is EOC, LOS40, Schweser question #11 
A bank entered into a $5,000,000, 1-year equity swap with quarterly payments 300 days ago. The bank agreed to pay an annual fixed rate of 4% and receive the return on an international equity index. The index was trading at 3,000 at the end of the third quarter, 30 days ago. The current 60-day LIBOR rate is 3.6%, the discount factor is 0.9940, and the index is now at 3,150. The value of the swap to the bank is closest to:

Is this a poorly worded questions? The part with fixed rate payments confuses me. Not sure Why it says “with quarterly payments 300 days ago.” Why can’t they just say quarterly payment was made 30 days ago, and another one will be made in 60 days? 

What are your thoughts? Also lets talk about how crappy the derivative section is on L2. This section isn’t easy to read at all. 

z spread and nominal spread

April 9, 2018, 11:27 pm

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Please help explain why

z spread > nominal spread => upward sloping yield curve

z spread < nominal spread => downward sloping yield curve

Thank you very much

Forward Contracts

April 10, 2018, 1:35 am

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My question regarding the answer of the below problem, should not the short experience loss when the value of the contract increase (i.e interest decrease) because the contract will be exercised?

Troubadour next considers an equity forward contract for Texas Steel, Inc. (TSI). Information regarding TSI common shares and a TSI equity forward contract is presented in Exhibit 2.

Exhibit 2. Selected Information for TSI

• The price per share of TSI’s common shares is $250.

• The forward price per share for a nine-month TSI equity forward contract is $250.562289.

• Assume annual compounding.

Troubadour takes a short position in the TSI equity forward contract. His supervisor asks, “Under which scenario would our position experience a loss?”

Three months after contract initiation, Troubadour gathers information on TSI and the risk-free rate, which is presented in Exhibit 3.

Exhibit 3. Selected Data on TSI and the Risk-Free Rate

• The price per share of TSI’s common shares is $245.

• The risk-free rate is 0.325% (quoted on an annual compounding basis).

• TSI recently announced its regular semiannual dividend of $1.50 per share that will be paid exactly three months before contract expiration.

• The market price of the TSI equity forward contract is equal to the no-arbitrage forward price.

The most appropriate response to Troubadour’s supervisor’s question regarding the TSI forward contract is:

1. a decrease in TSI’s share price, all else equal.

2. an increase in the risk-free rate, all else equal

3. a decrease in the market price of the forward contract, all else equal.

B is correct. From the perspective of the long position, the forward value is equal to the present value of the difference in forward prices:

V_t(T) = PV_t,T[F_t(T) – F₀(T)],

where F_t(T) = FV_t,T(S_t + θ_t – γ_t).

All else equal, an increase in the risk-free rate before contract expiration would cause the forward price, F_t(T), to increase. This increase in the forward price would cause the value of the TSI forward contract, from the perspective of the short, to decrease. Therefore, an increase in the risk-free rate would lead to a loss on the short position in the TSI forward contract.

Translation methods

April 10, 2018, 8:36 am

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Hi guys,

Hope you are doing well in your studies.

I reached to the translation methods of financial statements. Well, the official curriculum says the following:
“Which method is appropriate for an individual foreign entity depends on that entity’s functional currency.”
and then no explanation which method (current rate vs temporal) is appropriate for an individual foreign entity. At least I didn’t find/grasp.

Could someone be kind to shade some light here?
Thanks beforehand.

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Currency Exchange Rates EOC

April 10, 2018, 12:18 pm

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I came across this EOC and was wondering if someone could explain. its a simple concept but i have one question on it…

statement: “Assume an emerging market country has restrictive monetary and fiscal policies under low capital mobility conditions. Are these policies likely to lead to currency appreciation, depreciation, or have no impact?”

Answer is currency appreciation. My question is why is it this and not “no impact”? wont restrictive monetary policy raise rates, and restrictive fiscal policy lower rates, thus canceling each other out? any explanation is appreciated, thanks

Reading 37 EOC question 27

April 10, 2018, 12:58 pm

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The correct answer is B but in my opinion it should be both B and C. How can a lower rated bond be more expensive than an identical higher rated bond, which is what they imply?

B is correct. A bond with a larger option-adjusted spread (OAS) than that of a bond with similar characteristics and credit quality means that the bond is likely underpriced (cheap). Bond 7 (OAS 85 bps) is relatively cheaper than Bond 6 (OAS 65 bps).

C is incorrect because Bond 8 (CCC) has a lower credit rating than Bond 7 (B) and the OAS alone cannot be used for the relative value comparison. The larger OAS (105 bps) incorporates compensation for the difference between the B and CCC bond credit ratings. Therefore, there is not enough information to draw a conclusion about relative value.

(Institute 199)

Institute, CFA. 2018 CFA Program Level II Volume 5 Fixed Income and Derivatives. CFA Institute, 07/2017. VitalBook file.

Forward contract with future spot rate

April 10, 2018, 10:36 pm

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Hi all,

I have just encountered a question in blue box in curriculum as follows:

4. A forward contract price will increase if:

1. future spot rates evolve as predicted by current forward rates.

2. future spot rates are lower than what is predicted by current forward rates.

3. future spot rates are higher than what is predicted by current forward rate

3. B is correct. The forward rate model can be used to show that a change in the forward contract price requires a deviation of the spot curve from that predicted by today’s forward curve. If the future spot rate is lower than what is predicted by the prevailing forward rate, the forward contract price will increase because it is discounted at an interest rate that is lower than the originally anticipated rate.

3. However, I thought that forward contract price would increase if rate increase (F0= S0*(1+r1)(1+r2)…) . I also confused between some terminologies: future spot rates, interest rate  is predicted by current forward rate

Some fixed income terminology

April 11, 2018, 12:52 am

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Dear all,

I am confused with some terminologies as follows:

Ex: we have 1 year spot rate = R₁ and 2 year spot rate = R₂, then calculate 1 year forward rate 1 year from today = ₁F₁

We have the following terms:

Expected spot rate = future spot rate = 1 year- spot rate in 1 years = ₁F₁

Please advise if i am wrong

Thanks all

Value of interest rate call option

April 11, 2018, 3:13 pm

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I’ve run into several questions that give you a binomial tree of interest rates and asks to calculate the interest rate call option value and provides a notion amount.

Let’s assume a 5% strike with a notion of $2M two year euro call option. The binomial tree is

4% 5.31% 8.3%

3.22% 5.04%

3.06%

So option strike hits at 8.3% and 5.04% with values of $66K and $800. Then I start working it through the tree. However, in the past I’ve had to discount these values by 8.3% and 5.04% respectively.. However, this problem I ran into skipped those nodes and discounted it by T1 interest rates (5.31/3.22/3.06) rather than starting at T2 interest rates.  So it seems inconsistent.

Q :Is the reason because the problem has to state “payments are made in arrears” to start discounting at T2 rather than T1?