Volume 5, reading 39: 1) In the EOC problems why do they borrow cash in the cash & carry for problem #1 but not in problem #2? 2) Why do they calculate the forward price in example 1 on page 167 as (1.01)^3 instead of a continuous rate? Any help would be greatly appreciated!
jennygirl Wrote: ------------------------------------------------------- > Volume 5, reading 39: > > 1) In the EOC problems why do they borrow cash in > the cash & carry for problem #1 but not in problem > #2? > > 2) Why do they calculate the forward price in > example 1 on page 167 as (1.01)^3 instead of a > continuous rate? > > Any help would be greatly appreciated! #2 - generally when they EFFECTIVE interest, then you would not use the continuously compounded. So just look for key words to determine how to calculate. (also, they are not using this to calculate the forward price, but the FV of storage costs.)
eriqnoodle Wrote: ------------------------------------------------------- > #2 - generally when they EFFECTIVE interest, then > you would not use the continuously compounded. So > just look for key words to determine how to > calculate. (also, they are not using this to > calculate the forward price, but the FV of storage > costs.) They are using that to calculate the forward price…they calculate the storage costs that way as well. But if I understand correctly, if they use effective rates then don’t continuously compound. If they give you a “continuous rate” you would use that throughout the problem. This pisses me off. I mean, if they’re going to test us on this $hit there should be more problems in the EOC!! There’s only ONE reverse cash and carry and that was tested last year. Grrrr!!!
speaking of that… is there ever a time when in an arbitrage (cash and carry or reverse cash and carry) where we receive the storage cost? i think i see how we could not ever receive the lease rate because that includes convenience yield and that cannot be given to anyone other than a commodity user. do i have this all f’ed up?
sorry about that, you are right, about example 1.
What is a reverse cash-and-carry? Why and how do you do it?
phBOOM Wrote: ------------------------------------------------------- > What is a reverse cash-and-carry? Why and how do > you do it? have you looked at 2008 CFI AM actual? its an arbitrage between spot and fwd. in a reverse cash and carry, you go long fwd, short the spot and lend the proceeds. so given you are shorting the spot, you are saying that the spot is over valued and the fwd is under valued. in a cash and carry its the opposite. you short the fwd and buy the spot, and borrow (to buy spot). here you view the spot as under valued and fwd as over valued.
I do not understand cary and carry arbitrage. I understand that Forward prices take into account the Risk-Free Rate (pos), storage costs (pos), the lease rate (neg), and the convenience yield (neg) - and that’s all I really know from Reading 39. I find it incredibly difficult to follow and read, especially using the pencil example and the notations seem backwards. I just had a panic attack. I said to myself if I enter a long forward I make $ when the price of the asset increases since I agree to pay a fixed price for an asset in the future. On page 161 in Table 3 under the “Long fwd @ 0.20 at T =1” the entry is $0.20 - F (0,1) Isn’t this backwards. Shouldn’t a long forward position be written as S(0,T) - F(0,T), where is this $0.20 coming in? I hate CFA!!! HAAAAATE AHHHH BREAKDOWN
eriqnoodle Wrote: ------------------------------------------------------- > speaking of that… > > > is there ever a time when in an arbitrage (cash > and carry or reverse cash and carry) where we > receive the storage cost? i think i see how we > could not ever receive the lease rate because that > includes convenience yield and that cannot be > given to anyone other than a commodity user. > > do i have this all f’ed up? Yes, you receive the storage cost on a reverse cash & carry.
… but on the CFAI 2008 exam, they show the lease rate as being paid, not received. so doesnt that mean you are paying the storage costs?
i noticed a few practice questions where it wasn’t zero investment at the start… seemed completely inconsistent with the general concept and there were no textbook examples that did it that way.
ValueAddict Wrote: ------------------------------------------------------- > I do not understand cary and carry arbitrage. > > I understand that Forward prices take into account > the Risk-Free Rate (pos), storage costs (pos), the > lease rate (neg), and the convenience yield (neg) > - and that’s all I really know from Reading 39. > > I find it incredibly difficult to follow and read, > especially using the pencil example and the > notations seem backwards. I just had a panic > attack. > > I said to myself if I enter a long forward I make > $ when the price of the asset increases since I > agree to pay a fixed price for an asset in the > future. On page 161 in Table 3 under the > > “Long fwd @ 0.20 at T =1” the entry is $0.20 - F > (0,1) > > Isn’t this backwards. Shouldn’t a long forward > position be written as S(0,T) - F(0,T), where is > this $0.20 coming in? I hate CFA!!! HAAAAATE > AHHHH BREAKDOWN You’re right. But in this problem they are assuming they know the SPOT price, and are trying to figure out what the FORWARD price should be.
eriqnoodle Wrote: ------------------------------------------------------- > … but on the CFAI 2008 exam, they show the lease > rate as being paid, not received. so doesnt that > mean you are paying the storage costs? Oh, sorry I haven’t done the exam yet. I just know there was a reverse cash & carry problem in the book and the storage costs were received.
Okay went out for a nice run. Blood pressure is down quite a bit. I vow by the end of the day to OWN cash and carry arbitrage. OWNAGE… And then once I own it, I will help you all own it too!!! (yeah i don’t sound crazy do i? )
it doesn’t help that CFAI text is light on EOC problems. i’m about to go run myself, im about to lose my mind. thank god i have to work for the next two days.
the answer to 2C on page 187 v5 says that it doesn’t make sense to have a negative annual return, but it may be pre-mature to say that reverse cash and carry makes sense. so, lets assume risk free rate is 5%. I calculated the lease rate to be 5.116. (5% - (1/(9/12)) x ln(2.75/3) then you would go through with reverse cash and carry long sep fwd -2.75 short dec spot +3.00 pay lease rate (-.1173) calculated as 3e^(.05116(9/12)) - 3 lend @ 6% and receive 3.1381 at t=9/12 (calculated as 3e^(.05(.75)) profit at t is .2708 does this make sense?
EUREKA! Okay this trick worked for me, so maybe it will help you guys out. Take the general form of the futures price F(0,T) and determine which side of the equation is not justified. Scenario #1: F(0,T) > So(e)^(Rf+ storage cost symbol - lease symbol) SHORT LONG F(0,T) side of the equation is overvalued based upon the left hand side of the equation. To remedy this: T = 0 Short F(0,T) Long So (where do you get the money for this you ask?!) by Borrowing @ Rf T = 1 Deliver the underlying (ST) to satisfy the Short forward position Repay the Loan @ Rf Congrats you made money via CASH-AND-CARRY ARBITRAGE Scenario #2: F(0,T) < So(e)^(Rf+ storage cost symbol - lease symbol) LONG SHORT T = 0 Long F(0,T) Short So (now we have some cash lying around) Lend @ Rf T = 1 Accept delivery of the underlying Cover your short by paying the lease rate Get repaid the loan made at the Rf Reverse cash-and-carry arbitrage
Ok that’s great. But why do they sometimes borrow cash in a C&C and sometimes not? Problem #1 they borrow cash. Problem #2 they DON’T borrow cash, and they calculate the annualized ROR based upon the difference between what was paid & what was earned. Problem #3 they borrow cash. And, if you calculated the annualized ROR based on NOT borrowing cash (like the previous example) it’s not the same as the arbitrage profit of .07 per dollar. F!!! I’m so confused.
i made reference to it earlier but i think “cash & carry” means transaction “self finances”. i think that’s what “cash and carry” actually means. i too was very confused on the annualized return, as was my study buddy. has anyone mentioned the “tailed” cash and carry? where i think the tiny arbitrage profit is kicked out at start, not the end. technically not zero cash at start but close enough… not really sure about this except there was a “tailed” reference and the spot was discounted immediately or am i confused and we are talking about the “tailed” transaction??
For the loaned gold question, I think the following steps occur: 1. Enter into short gold forward contract with maturity of one year 2. Enter into prepaid forward contract for delivery of an ounce of gold in one year. You’ll pay $295.533 at t=0 3. Borrow $295.533 Step two confused me until I realized that $295.533 continuously compounded at the rfr is equal to the futures price. At maturity in t=1 the following happens: 1. Take delivery of the prepaid gold 2. Deliver gold to counter party of short futures contract and get paid 3. Repay bank So basically, when you’re going to lease out the gold, you pay someone to hold your ounce gold for a year. They get to use it and give it back to you. Situations like this would occur with mining operations. You pay them now for future production and at the same time, you enter into a futures contract to sell the metal. All this is financed by a loan. If the markets are efficient, this is no profit. If there is a mispricing (e.g. can enter into prepay position for cheaper (earn higher lease rate) or the futures price is too high) then you can profit.