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Study Session 14: Derivative Investments: Valuation and Strategies

Understanding Risk-Free Rate Frequencies

How can “a one-month risk-free rate of 1%, quoted on an annual compounding basis” be understood in simple terms? 

Along similar lines, how can one explain “a five-month risk-free rate of 2.5, quoted on a semi-annual compounding basis” or “a nine-month risk-free rate, quoted on a quarterly compounding basis”?

The frequencies make these statements very abstruse. Please help me understand how it works.

Derivatives from CFAI Books

I’m about 60 pages in and feel like CFAI really complicates what we need to know. Anyone recommend ditching the CFAI readings, going with Schweser, and doing the EOCs from the CFAI books? 

Derivatives, R39 Practice Problem 1

I am trying to do this fixed income futures question by calculating the QF for the underlying bond, then comparing it with the QF of the futures contract.

Quoted futures price
Quoted bond price

Conversion factor
Accrued interest since last coupon payment

Time remaining to contract expiration
Three months
Accrued interest at futures contract expiration


is the notional exchanged in the a equity swap.

current value of the swap

If Pvs are:

Ex 1:

1 0.990099

2 0.977876

3 0.965136

Ex 2:

na = 50M

Term 3 year annual

Fixed Rate 3%

Johnson also uses the present value factors in Exhibit 1 to value an interest rate swap that the bank entered into one year ago as the receive-floating party. Selected data for the swap are presented in Exhibit 2. Johnson notes that the current equilibrium two-year fixed swap rate is 1.12%.

the answer is : 

Value of Forward contract

The CFA book explanation says that value of currency forward contract is:

Vt(T)=Present value of the difference in forward prices=PV£,t,T[Ft(£/€,T)−F0(£/€,T)]

But in the example:

Q) [question removed by moderator]

The value of the foreign exchange forward contract at Time t will be closest to?

Cheapest to deliver bond

In the cfa book it is mentioned that:

Second, fixed-income futures contracts often have more than one bond that can be delivered by the seller. Because bonds trade at different prices based on maturity and stated coupon, an adjustment known as the conversion factor is used in an effort to make all deliverable bonds roughly equal in price.

Does this mean that Govt bonds with different maturities and coupon have similar prices? Should they have diferent prices so the associated risk of # year of maturity, liquidity etc.


FRA contract expiring and Maturing

What does FRA contract expiring and maturing mean?. if FRA(0,30,90) . It expires in 30 days but matures in 90 days. It is expiring before maturing. Not able to understand this part.


Forward contract value at time t when you sell it

Why is the value of Forward Contract Zero if you sell it at time t: why not Vt(T)

1. Buy Forward contract 0 at F0(T) 

  • cash flow at time 0  =0
  • value at time t  = Vt(T)
  • Cash flow at time T  = ST - F0(T) 

2 Sell Forward contract at t at Ft (T) 

  • cash flow at time 0  = NA
  • value at time t  = 0
  • Cash flow at time T  = Ft(T) -  S


Arbitrage Profit on a Bond Futures Contract Under Carry Arbitrage

Quoted Futures Price 125

Conversion Factor 0.9

Time Remaining to Contract Expiration - 3 months

Accrued Interest over life of contract 0

Underlying Bond:

Quoted Bond Price 112

Accrued Int. since last coupon 0.08

Accrued Int. at Futures expiration 0.20

Based on Exhibit 1 and assuming annual compounding, the arbitrage profit on
the bond futures contract is closest to:

Answer is 0.5356.