This is regarding the question on Tanaka Global, Question 11 on the 2008 AM exam.
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The answer to part is 9000 contracts for USD, and 7000 contracts for JPY
My doubts / questions are related to part B:
To calculate unhedged return, let’s say for the USD investment first, I would use RDC = (1+RFC)(1+RFX)-1.
RFC is 945/900-1 = 5%. RFX is spot (1 July) to spot (1 Sep), so 110.9/115.9-1 = -4.34%, and hence RDC = (1+5%) (1±4.34%)-1 = 0.47%. This is the same as the solution provided by CFAI. Is this method correct, or am I just getting the same answer by coincidence?
To calculate hedged return, again for the USD investment first, I would use the same RDC formula again, however this time around, the RFX would change because the currency would be assumed as hedged.
o If the hedge were to be lifted in between, then I would compare the futures prices as of 1 Jul (115.7) and on the assumed date of the lifting of the hedge i.e. 1 Sep (110.77), i.e. 115.7/110.77-1= 4.45%, because I have locked in a price to sell of 115.7, whereas today the price to sell has fallen to 110.77, so it is favorable to me, and hence RDC = (1+5%) (1+4.45%)-1 = 9.67%.
o This is NOT the same as the solution provided by CFAI. According to CFAI, the correct answer is a return of 4.72%.
What is the error in my approach above? Can someone kindly clarify please? Grateful for your time.
o If the hedge were to be lifted in between, then I would compare the futures prices as of 1 Jul (115.7) and on the assumed date of the lifting of the hedge i.e. 1 Sep (110.77), i.e. 115.7/110.77-1= 4.45%, because I have locked in a price to sell of 115.7, whereas today the price to sell has fallen to 110.77, so it is favorable to me, and hence RDC = (1+5%) (1+4.45%)-1 = 9.67%.
o This is NOT the same as the solution provided by CFAI. According to CFAI, the correct answer is a return of 4.72%.
What is the error in my approach above? Can someone kindly clarify please? Grateful for your time.
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Thats because you’re missing a step. You incorporated the Rfc return and the lifting of the hedge but you still haven’t exchanged your Rfx back to the domestic currency.
And you do need to know these calculations for this year.
You have your asset return, you sold in july so to lift it you need to buy in july. But then you still need to sell in the spot.
o If the hedge were to be lifted in between, then I would compare the futures prices as of 1 Jul (115.7) and on the assumed date of the lifting of the hedge i.e. 1 Sep (110.77), i.e. 115.7/110.77-1= 4.45%, because I have locked in a price to sell of 115.7, whereas today the price to sell has fallen to 110.77, so it is favorable to me, and hence RDC = (1+5%) (1+4.45%)-1 = 9.67%.
o This is NOT the same as the solution provided by CFAI. According to CFAI, the correct answer is a return of 4.72%.
What is the error in my approach above? Can someone kindly clarify please? Grateful for your time.
[/quote]
Thats because you’re missing a step. You incorporated the Rfc return and the lifting of the hedge but you still haven’t exchanged your Rfx back to the domestic currency.
And you do need to know these calculations for this year.
You have your asset return, you sold in july so to lift it you need to buy in july. But then you still need to sell in the spot.
[/quote]
Googs - this Q was from 2 years ago.
I was asking another Q - is the question still relevant any more, as per the 2nd comment?
It appears not directly linked to CFAI material, based off old reading.