# CFAI mock 1 question

I’ve been trying to figure out the answer to # 53 with the equity swap for like an hour now, which is dumb. Anyway, I see the formula in the CFAI text and plugging everything in I get the same answer. However it doesn’t make any sense to me. The long party is receiving the return on the index and paying a fixed rate. The index has gone down, so it seems like the receive side should be negative. However, according to the answer/formula, it’s positive. I don’t understand. Anyone?

Fixed rate on swap = 4.99% (Given in vignette) Market value of a swap: =((723.86 / 757.09) - 0.9209 - 0.0499 x (0.9691+ 0.9209)) x 100,000,000 = -\$5,910,000 The value to the long party is negative because they are paying out the fixed rate AND they are paying an additional amount since the equity index (which they receive) is negative. The value to the short party is positive because they are receiving the fixed rate AND the amount that they pay (return on the equity index) is negative.

why do you have to use 0.9209, discounting it 620 days? Isn’t there 260 days left to maturation?

It’s a 2-year swap annual pay swap. 260 days until the first payment, 620 days until the final payment.

My thinking is it’s a 2 year swap, so they owe two fixed payments of nearly \$5 million each, discounted back to present. On top of that, their index is losing value, so they’d be in the hole even more. It seems like the value would be even more negative than 5.9mm.

When you think about it, the value makes sense: Value of Fixed 4.99% payment after 100 days (payable to short) 0.0499*100/360) = 0.013861 Value of the negative index return - ln(723.86/757.09) = 0.044884 Total value to Short 0.044884 + 0.013861 = 0.058747 * 100,000,000 = 5,874,513

yeah that does make more sense. it seems like i need to look at the value as that which has accrued, instead of the present value of the outstanding payments.

I can…it’s a ratio…current index/old index…it came out to be like .95xx or something like that. Then because you are receiving that, we say…receiving result - paying result = amount to be multiplied by notional principal. OK? I think that the answer was A but I’m dying to get my hands on the PDFs for mock 1 and 2. Can you help me? I totally overlooked that option when I took the exams.

If you log back into testtrac you can view your results to the exams, and click back on the link to the pdfs.

But why do we have to minus 0.9209 in the equation. I thought the equation should be like this: ( - (757.09 - 723.86) / 723.86 - 0.0499 X (0.9691 +0.9209) ) * 100 million But of course it’s not correct. But what’s wrong with my assumption. In fact, I am looking at Page 291 Book 5 in schweser notes. It seems that IF the index is HIGHER (instead of lower in the CFAI Mock exam question), then the equation will be like : 100 million * 996/985 (+ve return of index) - 0.993993 * 100 million (pay fixed) Now… if it’s -ve return of index, shouldn’t I be using the equation I outlined at the top ?

It’s not the return of the index that you are looking for, it’s 1 + the return on the index. Since the factor (723/757) is really (1+Re), the factor will always be positive. So the return on the stock is -4.49% or so, add that to one and you have (723/757).

Thanks McLeod81. But I still can’t get the correct answer. As you said, the return of the stock is -4.49% So, -4.99% * 100million - 0.0499 * (0.9691 + 0.9209) * 100 million is not equal to -5910000 Do you know why?

You have to add 1 to each side to represent the return of principal, since we are working on a per notional principle basis. [[1+(-0.04389)] - (0.0499 \*0.9691) - (1.0499\*0.9209) ] \* 100,000,000 The first part is the return of principal + the negative equity return The second part is the first annual coupon (per notional principal) The third part is the return of principal + the second annual coupon Multiply the differential per dollar notional principal (-0.059101) by the notional principal to get -\$5.9 million

McLeod81… YOU ROCK !!! Thanks a billion !!!

No prob

Could sb help with my confusion? I can’t figure out FSA question 17, reclassification from consolidation to available for sale will decrease BVPS (!!!) CFA says “If De Soto is then classified under available-for-sale, book value per share could decrease because equity will not be increased by ACI’s share of De Soto’s income in excess of dividends.” Many thanks

Mcleod - can you explain what each section of the equation represents? (1+return from index) - (fixed rate * which disc rate??) - (1+fixed rate * which disc rate?) There are 3 parts to this - what does each represent? I’m trying to memorize just trying to see the concept…I’m thinking about jabbing my eye with my pencil as I write this. McLeod81 Wrote: ------------------------------------------------------- > You have to add 1 to each side to represent the > return of principal, since we are working on a per > notional principle basis. \> \> [[1+(-0.04389)] - (0.0499 \*0.9691) - \> (1.0499\*0.9209) ] \* 100,000,000 \> \> The first part is the return of principal + the \> negative equity return \> \> The second part is the first annual coupon (per > notional principal) > > The third part is the return of principal + the > second annual coupon > > Multiply the differential per dollar notional > principal (-0.059101) by the notional principal to > get -\$5.9 million

3_l, the first part is the negative return on the stock index. the 2nd and 3rd parts are the two fixed payments owed at the end of each year.

For the first part, I would recommend using (Equity Index t / Equity Index t=0) to come up with the receive equity portion. I was just breaking it down further in that example to illustrate where the calculation comes from.

I dont get the solution on this question. My calculations looks like this: The fixed rate payer pays 0,0499 in 260 and 620 days. These payments need to be discounted back to present. He also recieves/pays the return on the index wich is -0,04389 in 260 days. this need to be discounted back as well. There is no expected payment for the equity return for the second year, since the expected return is 0. after…days 260 620 return equity -0,04389 0 fixed payment -0,0499 -0,0499 discountfactor 0,9691 0,9209 present value equity -0,042533799 0 present value fixed -0,0483580 -0,04595291 value to fixed rate payer:-0,136844799 *100Mio=13,6 Mio I cannot remember the exchange of principal in the vignette, but if there was one, it is repaid in 620 days and needs to be discounted at 0,9209. That would be an additional value of 7.91 Mio wich leads me to a value of 5.69-very near to the correct number, and enough to make the right mark, but I still have a mistake.