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Study Session 15: Risk Management Applications of Derivatives

Synthetic Index Fund and Dividends

The CFAI’s curriculum states that since the index is a price index only and does not include dividends, the synthetic replication strategy can capture only the index performance without the dividends. It also states that the dividend yield is important in the calculations, but the fund does not earn these dividends. Why is that?

Book 5, Reading 34, EOC question 3


I’m stuggling with the EOC question #3 from reading 34. 

In the question, they say :

[question removed by moderator]

My question is, where does this “2,5” come from? As per my understanding, the terms of the swap were 1. fixed leg with 6% 2. floating leg with LIBOR. 

synthetic cash from equity

From Schweser, example on page 144 of book 4.

Manager B has a large position in UK stocks that are similar to a major UK stock index. She wishes to create GBP 15,000,000 of synthetic cash earning 2.0% for a six-month period. The futures index contract is priced at 3,700 with a multiplier of 10. The stock have a dividend yield of 3.0%.

FRA vs. Interest Rate Options

Hi Level III-ers!

Can someone please explain why when calculating the effective rate on an FRA (Ch. 28 – blue box example 1), you annualize at the end of the calculation by subtracting 1 then MULTIPLYING by 360/# of days, but when calculating effective rate on interest rate options (Ch. 29 – blue box example 11), you annualize by RAISING to 365/# of days, then subtract 1. I understand that you use the 360 convention for FRAs, but don’t understand why the calculation is different.

Thanks so much in advance and good luck to everyone out there studying!

Future Value: Why relevant for equitizing / synthectic positions but not adjusting asset allocation or modifying portfolio beta?

Hey all,

why do we not need to calculate future of the investment value when we adjust the asset allocation (or do any of the other forward tricks)?

If we want to create a synthetic position, bond or equity, we need to use the FV of the amount to modifiy:

Nf = 1*cash*(1+RFR)t / (Pf * multiplier)

And I think I understand why we need to do this to create the exact dollar amount of equity or cash that we want.

Credit risk from OTC dealer - 2018 AM Mock Q38

Hi guys - Confused with this question re the Apollo Bank Case Scenario.

Item says investment portfolio includes large and small cap domestic stocks and global bonds. Bonds denominated in various currencies and have fixed and floating rates. Fund uses OTC derivatives to hedge risks related to interest rates, FX, adverse security price movements, and payment default.

Q: portfolio most likely has greatest net exposure to which source of risk? 

A) Credit Risk

B) Market Risk

C) Liquidity Risk 

Interest Rate Option Payoff/EAR

Does anyone have any advice or logic which can help me understand this better? It’s really challenging me and I just can’t seem to get it. Militant repetition until exam day? 

Creating cash out of equity and alter portfolio mix

When altering the portfolio mix with futures, say 20mil out of 100mil equity will be reallocate to fixed income. We use equity futures to adjust Beta to 0 to resemble that I first convert the position to cash and then that portion of “cash” will be convert to fixed income with certain duration.

Synthetic Stock Position

We say that being Long T-Bills + Equity Futures is the same as owning the underlying stock (I think?), but wouldn’t you need different initial cash outlays depending on whether you went down the synthetic route or the outright ownership route?


Futures: The amount of cash I need to enter the forward contract is my desired investment amount * (1+RFR), e.g. 100mio. I will invest this today and grow it at the risk-free rate and will then have enough cash to pay for the stock at contract maturity.