Choosing the correct synthetic derivatives formula

rbarrow1030 · February 12, 2018, 5:07pm

I’m having trouble with questions associated with synthetic cash in reading 28. Specifically, deciding which formula to use.

In the blue box on page 237, they use this formula to determine the number of futures contracts needed convert equity into cash:

[(Value_cash)(1+R_f)] / [(P_f)(multiplier)]

In EOC question 8 on page 267, they use a different formula, but the questions seem to be stated in the same way:

There’s no mention of needing to change the beta in the question. Is there some kind of phrase/keyword I should be looking for in order to determine which formula to use?

AlternativeQ · February 28, 2018, 10:15am

I was going to post asking the same thing. I can’t see why it wouldn’t include (1+rf). Surely the equation they’ve done is to reduce beta to 0 but that isn’t the same as synthetically creating cash (which should generate risk-free rate).

Anyone else?

Redwood_State_Park · February 28, 2018, 11:17am

If you are given the risk free rate in the problem statement, that is the tip off to go with formula 1.

Flashback · February 28, 2018, 5:09pm

When you convert to Cash and from Cash You should use discounting (1+Rf). For conversions other than Cash You should use not discounted Vp value.