CFAI Book 4, pg. 429 problems 1 and 2. How do we know whether we are supposed to borrow money to cover the short position or just use the money we have? In problem 1, we borrow the $300 to buy gold, but in problem 2, we do not borrow. Can someone please explain?
If you buy the spot you are borrowing the $300 to buy the spot. If you are doing a reverse cash and carry arb then you are selling the spot and those dont need to borrow money… Sorry dont have book with me.
They are both cash and carry problems. Just in one we borrow to cover the long asset spot price, and in the second problem there is no borrowing component.
OK I think I get it now…in problem 2 we are buying the FORWARD long not the actual asset, hence why we are also paying the storage cost. It doesn’t make sense to borrow $3 to buy a forward long. Am I missing anything else?
Step 1: Decide whether you are going to be buying or selling the future (buy underpriced, sell overpriced). Step 2: Do the opposite transaction in the spot market (completes the hedge at the theoretical futures price). Step 3: If you are buying in the spot market, you’ll borrow money to do it, because arbitrage always has a net cash outlay of zero (other than transaction costs).
I just remember that in a arb (true arb), don’t risk any of your own money. That is how I know if I should borrow or not.
Yeah, I posted this awhile ago too… is that the question where they ask you to calculate return on cash-and-carry?
Yeah, Question 2 asks for the return on two different cash-and-carry scenarios. I still don’t understand why we don’t borrow to buy the spot. Can someone please explain it further? Thanks!
you need to borrow so you have the money to buy spot. you assume that you don’t have any money to being with.
Is this even on this year’s exam curriculum? Did I totally miss it? Now I’m screwed.
Right, I initially assumed you need to borrow to buy spot…but in problem 2, they *don’t* borrow to buy spot, so that the total cash flow at time 0 is *not* zero. Other than the fact that having a non-zero cash flow at Time 0 allows you to calculate the annualized return on the cash-and-carry, how else were we supposed to know not to borrow? I feel like I must be completely missing some obvious piece of information on this problem.
i’m really confused by this as well…
My advice - if they ask for dollar return, do borrow as in previous problem. If they ask for % return, you cannot borrow. Why - because this is the way it is.
I think I’ll follow your advice. It’s probably better to just go by this and spend my time worrying about stuff I can substantiate.