# CFAI derivatives pg 42

CFAI volume 6 derivatives pg 42 example 5, solution to A, I don’t understand what that first step involves. Do we have the PV of \$1.76 or \$1.6573 and then turn that into pounds at what exchange rate? Why 1/1.062? I understand that we are going long the pound. Thanks, Andrew

If I remember correctly, 1/1.062 is the PV to buy 1 unit of foreign currency, discounted at foreign interest rate. So, \$1.76 discounted at the same interest rate (.062) is used to buy this foreign currency. When you have an overpriced forward contract, you want to sell the contract and buy the currency. Does this make sense?

Thanks Iginla. Yes, you just find what the forward price should be (\$1.7418), compare it to what it’s selling at (\$1.75), realize it’s overpriced, so short the contract and buy the pound, but why do you buy the pound- do you think it will appreciate? I can’t seem to visualize shorting a forward contract for some reason…we deliver 1 pound in one year at the price of \$1.75 per pound? So we want to lock in selling it at that high overvalued price of \$1.75 per pound?

You need to buy Pounds because you are short on the forward contract. You need to deliver pounds at the expiry. So, you buy it now cheaper, earn interest on it and deliver it (to the buyer of the forward contract) at expiry for the contract price. Hence, today (t=0) you are using USD (from your pocket, because it is the domestic curr.) to convert to pounds (discounted at the Foreign Curr. rate) which means you’re buying pounds. This is how I explained it to myself when I was doing that reading. Hope this helps.

Awesome explanation thanks!!! Just by reading some of your posts it seems like you’ve covered all the material- what’s your strategy going forward?

CFA texts all the way! I’m becoming a fan of CFAI texts.

yeah me too. Can I send you an EOC accounting problem in PDF and ask you a question? Thanks, Andrew

Just tell me page #, no?

Well I make a bunch of written comments on it and scan it to PDF, but pg 327, #19, can you put this in your own words for me? I have: -if Singapore dollar is used, then current rate method is used -if USD used, then temporal method is used -monetary assets (like sales) are translated at average rate under both methods -Inventory & fixed assets were bought when USD was stronger (the USD has depreciated), and under temporal method we translate those at old historic rates, so when we translate those into SGD would we get more SGDs than if we translated at current rates where the USD is weaker & buys fewer SGDs? -Sales/fixed assets is higher because fixed assets are LOWER under temporal method? -Inventories will be higher under temporal method because ______________? Thanks, Andrew

I don’t know why you think “sales” is a monetary asset?? 1) inventories WILL NOT be higher under temporal. We are using USD as functional, temporal method to translate Vs. current rate, if SGD was functional. Acceltron uses FIFO. It means the inventory balance is made up of more recent purchases when SGD appreciated (USD depreciated). So, using temporal or current rate, inventories will have the same value because we are using the same exchange rate (31 Dec 2007). 2) receivables turnover (sales/AR) WILL NOT be lower We use the same exchange rate under both translation methods, so the numerator and the denominator are the same for both. 3) fixed asset turnover WILL be higher Under temporal, fixed assets are reported using historic rates, that under current rate using current exchange rate. The SGD has appreciated, so the translated value for fixed assets under current rate has increased (\$1,100) Vs. under temporal [(\$1,000*0.568)+(\$640*0.606) = \$956]. So, the denominator is lower under temporal and the ratio is higher. We are not translating assets from USD to SGD but vice versa. I think you are getting confused. Hope this helps.

Thanks very much Iginla, I think this makes sense, I will revisit this