CFAI morning exam Q2011 Q 8

[derswap07]

Part C

P/L of forwards - how can that be any different then contract rate of .87?

[summerside182]

IM confused also, I calculated the return of the total portfolio exposed to the currency. The way its written i understand that 35million is hedge at the initial rate is 0.8.

So i only exposed the return to the currency fluctuation. anyone has an explnation?

thanks

[S2000magician]

The profit from the forward isn’t the difference between the initial spot rate and the forward rate; it’s the difference between the forward rate and the spot rate at expiry: without the hedge they would have received 0.80 PLN for each LHS, but with the hedge they receive 0.87 PLN for each LHS; that’s a profit of 0.07 PLN per LHS.

(Note, too, that bullet point 4 in the question is incorrect: it reads that “Both the spot and forward exchange rates are 0.87 PLN = 1 LHS at the beginning of month 0”; they meant that those rates existed _ at time t = 0 _, which is _at the beginning of month 1 _; _the beginnng of month 0 is at time t = -1 _.)

[summerside182]

@S2000magician

The profit from the forward isn’t the difference between the initial spot rate and the forward rate; it’s the difference between the forward rate and the spot rate at expiry: without the hedge they would have received 0.80 PLN for each LHS, but with the hedge they receive 0.87 PLN for each LHS; that’s a profit of 0.07 PLN per LHS.

(Note, too, that bullet point 4 in the question is incorrect: it reads that “Both the spot and forward exchange rates are 0.87 PLN = 1 LHS at the beginning of month 0”; they meant that those rates existed _ at time t = 0 _, which is _at the beginning of month 1 _; _the beginnng of month 0 is at time t = -1 _.)

thanks S2000. That bullet point sentence was above confusing for a french guy like me.

[S2000magician]

@summerside182

@S2000magician

The profit from the forward isn’t the difference between the initial spot rate and the forward rate; it’s the difference between the forward rate and the spot rate at expiry: without the hedge they would have received 0.80 PLN for each LHS, but with the hedge they receive 0.87 PLN for each LHS; that’s a profit of 0.07 PLN per LHS.

(Note, too, that bullet point 4 in the question is incorrect: it reads that “Both the spot and forward exchange rates are 0.87 PLN = 1 LHS at the beginning of month 0”; they meant that those rates existed _ at time t = 0 _, which is _at the beginning of month 1 _; _the beginnng of month 0 is at time t = -1 _.)

thanks S2000.

My pleasure.

@summerside182

That bullet point sentence was above confusing for a french guy like me.

Not surprising.

My hat’s off to anyone taking this exam for whom English is not their native language. It’s hard enough when there’s no language difficulty; with that added to it, it seems insurmountable to me.

[james2015]

@S2000magician

The profit from the forward isn’t the difference between the initial spot rate and the forward rate; it’s the difference between the forward rate and the spot rate at expiry: without the hedge they would have received 0.80 PLN for each LHS, but with the hedge they receive 0.87 PLN for each LHS; that’s a profit of 0.07 PLN per LHS.

(Note, too, that bullet point 4 in the question is incorrect: it reads that “Both the spot and forward exchange rates are 0.87 PLN = 1 LHS at the beginning of month 0”; they meant that those rates existed _ at time t = 0 _, which is _at the beginning of month 1 _; _the beginnng of month 0 is at time t = -1 _.)

But the bullet point 3 reads that “The principal value of the portfolio is currency-hedged using a three-month forward contract”. Shouldn’t we be using the forward rather than the spot exchange rate at the end of month 3?

Thank you for the additional help.