Mock Question 45 -- ANOTHER CFAI ERROR?

The guideline answer for #45 assumes that the duration of “synthetic cash” created by selling equity futures is 0.25 yrs. So the answer has you buy fewer bond contracts that you would otherwise. I know that we can create cash with a duration of 0.25 but not by directly selling equity futures. I thought that cash created thusly would always have a duration of zero In fact, on the pages in curriculum referenced by the guideline answer, they specifically use ZERO (see V5 very first line of p 336: “Because no movement of actual cash is involved in these futures market transactions, the modified duration of cash is effectively equal to zero”. I think this another goof up by CFAI (like dropping the yield beta issue on question Q51) Any thoughts?

good catch, actually last night i spent 30 min to understand why why why…there’s a good discussion about this thread… search “duration cash”…but i don’t think they reached a conclusion on this. maybe i’m wrong, i was too tired the example in the CFAI book (when 0.25 used) and harrison’s case is totally different. Book example specifically states liquidity needs of the client. This dude only changing allocations. I don’t get it, so many inconsistencies.

They have mentioned the duration in the table. The last column, US treasury bills, equivalent to cash. We have to keep our eyes wide open while reading the questions. CFAI plays a lot with words and information.

Guaravku… That’s completely irrelevant. Sorry. This is why I got bogged down in the other thread. Too much disinformation. Tell me why, just because a column is there, that it should matter to my answer. In fact, I would argue that the T bill column is there simply to distract you and lead you to the wrong answer (which seems to have worked too well in this case) No part of the answer has anything to do with the Tbill contract so it is completely irrelevant. We are not using the T bill contract to create synthetic cash. Please tell me why you think it matters.

duration mentioned doesn’t mean you “must” use it somewhere. case1->>the client is changing portfolio allocation (no liquidity need mentioned)–>>CFAI doesn’t use duration of cash case2->>the client is changing portfolio allocation (short term liquidity need for the client)–>>CFAI uses cash duration (0.25) mock1->>the client is changing portfolio allocation (no liquidity need mentioned)–>>CFAI uses cash duration (0.25) WTF i need to go back and find related questions from CFAI books, but i don’t have my books with me. Later

I would like to politely put my views here. @itstoohot - I am not saying that all the information which is provided should be used. @pylon - The T bill contracts are not relevant, but, many a times T bills (short term instruments are taken as proxies for cash, due to their high liquidity), so, the duration of T bill can be taken as a duration for cash in this case.

guaravku, there’s a inconsistency here, i think this is another yield beta case but only worse… Find Exhibit 6 (GAAG case) and 7 (FIMA case). Exhibit 6 is the same as Harrison’s. Exhibit 7, which is the one duration of cash is used, clearly states that "to increase liquidity, it would like to move $10 million into cash but adjust the duration on the remaining $20 million to 7.5). Actually this Exhibit was labeled as “Adjusting the allocation between One Bond class and Another” Now I’ll email CFAI about this, if they reply fine… if they don’t, i’ll just take this as a “new information” and use cash duration

gauravku Wrote: ------------------------------------------------------- > @pylon - The T bill contracts are not relevant, > but, many a times T bills (short term instruments > are taken as proxies for cash, due to their high > liquidity), so, the duration of T bill can be > taken as a duration for cash in this case. I completely agree with you. But the question remains: WHY DO I CARE ABOUT THE DURATION OF TBILL?? The answer is I don’t, really. Quoting directly from the curriculum: (V5 very first line of p 336: "Because no movement of actual cash is involved in these futures market transactions, the modified duration of cash is effectively equal to zero). Therefore, the fact that a T bill contract doesn’t have a zero duration is a trivial and irrelevant piece of information to our answer.

Its good idea to contact cfai, lets see if they respond. For exam, as you said, we should go ahead with using the cash duration, for longer term, we should get it clarified.

I have contacted them and below I pasted their response. I still disagree, and the response doesn’t make much sense to me. “Thank you for the inquiry. Indeed, if there were no movement of actual cash, the duration of the synthetic cash would have been zero. In this question, however, the relevant paragraph on Harrison’s portfolio states that the change in portfolio mix is to take place over the next three months; hence the use of 0.25 as duration of the cash instrument. Thanks.”

fantastic dude! it doesn’t make sense to me too but still… We have to use cash duration when: a) liquidity needs mentioned b) if a time period is given (or the reallocation is temporary) Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you. Thank you.

thx my head hurts, was just going over this too.

itstoohot: what is this case 2 you mention where liquidity needs drive the need for 0.25? do you have a page reference? thanks

what a f’d up question. going through the mock answers now.

i am using 2008 books and the 2009s are not with me, i’m studying at work now. I’ll post it as soon as I get home actually case2 is FIMA case (Exhibit 7)

myheadhurts Wrote: > > “Thank you for the inquiry. Indeed, if there were > no movement of actual cash, the duration of the > synthetic cash would have been zero. In this > question, however, the relevant paragraph on > Harrison’s portfolio states that the change in > portfolio mix is to take place over the next three > months; hence the use of 0.25 as duration of the > cash instrument. Thanks.” Sorry. I call bullshit on whoever at the CFA was trying to cover their butt with that response. Makes absolutely no sense. If you have an email address you used, please give it to me so I can ask for someone to give a real response. That answer is completely without basis. First of all, the question stated that “Harrison want to change her portfolio … for the next three months,” not OVER the next three months. Now, let’s assume I wanted to make the change for only six months instead of three months. OK… So in that case we’d use a duration of 0.5. So far so good. How about she wanted the change to last for the next year? OK – use 1.0 for duration. What if she wanted to make the change for, oh, I dunno, 5.9 years. Well, sure, let’s use 5.9 years. In which case we don’t need to sell any bond futures whatsoever. Anyone following me so far? Or you could think of the problem this way… Let’s assume she only wanted to make the change for one day. Allright… now at least the CFAI would agree we can use zero. And assume that right after we make this change the equity markets rally 20% and the bond markets fall off by 20%. So we would see a huge change in our portfolio value. And the change in our synthetically altered portfolio would be very different depending on whether we were going to make this change last for one day or three months?? Nope. I don’t buy it. The correct number of contracts to transact has nothing to do with how long you intend to leave the position in place for. Not only does this make no sense if you think about it, it is also never mentioned in the text.

I agree with plyon. Harrison is not moving debt to cash, he is creating synthetic cash from selling equities to buy the bond futures. Therefore NO cash transaction = 0 duration. Time has nothing to do with this question.

plyon Wrote: ------------------------------------------------------- > myheadhurts Wrote: > > > > > “Thank you for the inquiry. Indeed, if there > were > > no movement of actual cash, the duration of the > > synthetic cash would have been zero. In this > > question, however, the relevant paragraph on > > Harrison’s portfolio states that the change in > > portfolio mix is to take place over the next > three > > months; hence the use of 0.25 as duration of > the > > cash instrument. Thanks.” > > Sorry. I call bullshit on whoever at the CFA was > trying to cover their butt with that response. > Makes absolutely no sense. If you have an email > address you used, please give it to me so I can > ask for someone to give a real response. That > answer is completely without basis. > > First of all, the question stated that “Harrison > want to change her portfolio … for the next three > months,” not OVER the next three months. Now, > let’s assume I wanted to make the change for only > six months instead of three months. OK… So in > that case we’d use a duration of 0.5. So far so > good. How about she wanted the change to last for > the next year? OK – use 1.0 for duration. What > if she wanted to make the change for, oh, I dunno, > 5.9 years. Well, sure, let’s use 5.9 years. In > which case we don’t need to sell any bond futures > whatsoever. Anyone following me so far? > > Or you could think of the problem this way… > Let’s assume she only wanted to make the change > for one day. Allright… now at least the CFAI > would agree we can use zero. And assume that > right after we make this change the equity markets > rally 20% and the bond markets fall off by 20%. > So we would see a huge change in our portfolio > value. And the change in our synthetically > altered portfolio would be very different > depending on whether we were going to make this > change last for one day or three months?? Nope. I > don’t buy it. > > The correct number of contracts to transact has > nothing to do with how long you intend to leave > the position in place for. Not only does this > make no sense if you think about it, it is also > never mentioned in the text. And plyon strikes back ha ha

CFA - always managing to explain their way out of things. Still confused on this question and the yield beta. Seems as if there is not definitive answer with respect to the duration of cash and yield beta.

It’s hard for CFAI to admit their errors.