# Mock 2 question I don't get

Someone please take pity on me and explain this answer to me. You are going to create synthetic European call option with a strike price of .84 by using: 1) a long position in a put option with same strike price 2) a position in a 90 day forward contract (the price of the forward will be higher than the .84 strike price 3) a position in a zero coupon bond that matures in 90 days The positions that should be used for forward and the bnd are: Forward: Short or long? Bond: Short or long? I just can’t get this.

never mind… T/G

But that’s the formula for put call parity, not put call parity with forwards, which is c+(x-f)/(1+r)t=P I can’t rearrange that formula in a way that results in a c = long forward and LONG bond Sorry- I mistyped. The answer is that both froward and bond should be LONG, which is why I’m so confused.

To create the synthetic call using the formula C= S-X/(1+r)+P, so long the forward and short the bond, I think

anybody?

The formula is C0+X-F(T)/(1+r)t=P0, which shows the price to create this portfolio. The actual portfolio is C0+X-FT/(1+r)t=P0 + F(T). The reason the term F(T) is not added in the above is that we don’t pay anything to enter into a forward contract. So to create synthetic C0, C0=P0+F(T)-(X-F(T)/(1+R)T. Again we should compare X and F(T). If X>F(T), we should long the bond. It’s confusing, and took me 1 hour to figure it out. Hope it helps.

smarshy, i’m trying to figure this out too… the cfa books did not really do a good job on this. they are really hesitant on saying long or short the bond… it’s really vague! hope i will have a clear mind about this concept in a couple.

tom18606 Wrote: ------------------------------------------------------- > The formula is C0+X-F(T)/(1+r)t=P0, which shows > the price to create this portfolio. > > The actual portfolio is C0+X-FT/(1+r)t=P0 + F(T). > The reason the term F(T) is not added in the above > is that we don’t pay anything to enter into a > forward contract. > > So to create synthetic C0, > C0=P0+F(T)-(X-F(T)/(1+R)T. Again we should compare > X and F(T). If X>F(T), we should long the bond. > > It’s confusing, and took me 1 hour to figure it > out. Hope it helps. Bless you my son.

nice stuff T/G

from c+(x-F)/(1+r)=p, u know the bond is x-F, not x

hey tom, your post seems to contradict CFAI. the answer to # 50 says since F(0,T) >X we should be long the zero-coupon bond…isn’t that vice versa of what you said? although, explanation could be wrong b/c i put short and got 100% on derivs, whereas answer key says long.

aeolusloo Wrote: ------------------------------------------------------- > from c+(x-F)/(1+r)=p, u know the bond is x-F, not > x insightful! Many thanks!

So you are saying: C0=P0+F(T)-(X-F(T))/(1+R)T And since F(T) > X, then C0=P0+F(T) + (F(T) - X) /(1+R)T So it’s LONG the forward (which is F(T)) and LONG the bond (which is F(T) - X ) ?? Confused…

AVNX, you and I think the same way. I am not an expert but I could figure it out that much. Hope it makes sense. NG, please see AVNX comment. Somebody please help me on LIFO reserve. Why shoud we reduce COGS by the LIFO reserve (hence incerase NI by LIFO reserve (1-tax) when we restate the innventory LIFO+LIFO reserve?

tom18606 Wrote: > Somebody please help me on LIFO reserve. Why shoud > we reduce COGS by the LIFO reserve (hence incerase > NI by LIFO reserve (1-tax) when we restate the > innventory LIFO+LIFO reserve? Because of inflation: FIFO - first in, first out…we sell the old, cheap stuff first, less cost to offset against sales/revenue, thus NI is higher and taxes payable are higher LIFO, Last in, First out…we sell the expensive stuff first which increases COGS (cost of goods sold) and as a result increases the tax shield (less income to tax) and reduces NI to adjust for FIFO we remove the LIFO reserve: we’re taking away the “benefit” of inflation and the associated tax benefit

i just looked at this in Schweser----how can you be long bond? seems short bond, long forward aligns the equation C + X/1+r^t = P + F/1+r^t ??

nice analysis tom

Other one covered well by CFAI, book 6 205. Of course, I only read it after I got this wrong.

tough problem…from CFAI, basically you are short the bond in the beginning equation if x

can someone shed some light on this pls… cfa text if X>F(0.T) we are long the bond, if X X, then this would be a long position in the zero-coupon bond… is it just too late or why am i not getting this straight? mock answer annotates: face value of “F(0,T) - X” while cfa considers a zero face value of X-F(0,T)… hmmm