When you switch from Bonds to Equity in this example, you don’t actually convert to cash at any point. You convert to a cash equivalent (U.S. T-Bill) that is listed in Exhibit 2. The cash equivalent has a duration of 0.25. In the example in the book, they used cash instead of a cash equivalent. Since they gave you the cash equivalent in the vignette, the best answer is A.
That still does not make sense. It’s not like we are really converting anything to cash or cash equivalents. If i go and sell XXX equity future contracts to create “cash” and immediately purchase yyy bond future contracts, why would I have any duration of cash if actual cash is not used? This transaction is assumed to happen all at the same time. I agree with plyon on this one. If he wanted to change his allocations slowly (OVER the next 3 months) then I can see how a duration of cash is used. But if we buy and sell the futures contracts immediately, I don’t see how the duration of cash is relevant at all.
SanFranMatt Wrote: ------------------------------------------------------- > When you switch from Bonds to Equity in this > example, you don’t actually convert to cash at any > point. You convert to a cash equivalent (U.S. > T-Bill) that is listed in Exhibit 2. The cash > equivalent has a duration of 0.25. > > In the example in the book, they used cash instead > of a cash equivalent. Since they gave you the > cash equivalent in the vignette, the best answer > is A. Why do you convert to a cash equivalent in this case but not in the book??? Just because they list a T bill future? Does it say anywhere in the problem that we have to use the cash equivalent? What if they had listed a pork belly future? Should we have used that instead? Give me a reason why or how this problem is different from the one in the book and why we should ignore what the text says on page 336. First of all, from an investment standpoint I can tell you that assuming the synthetic cash has a duration of .25 will get you the wrong answer in terms of how your assets subsequently perform. We can simply calculate the dollar duration of the new portfolio using the CFA answer and compare to what the dollar duration would be if we really did re-allocate the portfolio (without using futures). Dollar duration of futures using CFA answer would be 1,264 bond futures X 6.5 (duration) x $110,000 contract price = $903,760,000. That would have to be added to the dollar duration of the existing and unaltered fixed income portfolio, which is 40% X $400MM X 5.9 (DURATION) = $944,000,000 Anyone notice something funny yet? How can we have implemented Harrison’s reallocation (which was to increase the fixed income allocation from 40% to 80%), if we have NOT doubled the dollar duration? Maybe 'cause the CFA is wrong. Now let’s try the “alternate” answer… which is using 1,320 contracts 1,320 bond futures X 6.5 (duration) x $110,000 contract price = $943,800,000 Looks like the alternate answer will nearly exactly double the dollar duration of the portfolio. And the guideline answer won’t. Seems pretty easy to me.
The one in the book wasn’t a problem, it was an example. In the example they used cash as the basis, with a duration of 0. They could have done it either way (cash or cash equivalent), but they decided to us cash as an example. Since they give you the cash equivalent in the mock problem, that’s what you should use. pork belly futures are not cash equivalents. if it was an A.M. question and you used a duration of 0 and specified it’s the duration of cash, you would probably get full credit. but in this case, the ‘best’ answer would be to use the information given in the item set (i.e. the cash equivalent).
SanFranMatt Wrote: ------------------------------------------------------- > The one in the book wasn’t a problem, it was an > example. In the example they used cash as the > basis, with a duration of 0. They could have done > it either way (cash or cash equivalent), but they > decided to us cash as an example. Since they give > you the cash equivalent in the mock problem, > that’s what you should use. pork belly futures > are not cash equivalents. And cash equivalents are not cash. My point being that using anything other than zero actually gets you a demonstrably WRONG answer. In the book they used zero because that’s the only way you will get the correct answer, as I showed above. Not because someone forgot to include the T bill duration. You are somehow assuming that using 0 or 0.25 doesn’t matter here – but it really does! This is not the same situation as someone not caring whether their cash is measured as 0 duration or 0.25 duration. It actually impacts the construction of their long term bond portfolio.
Would you rather get the correct answer in a post on analystforum or would you rather get the correct answer on the test next saturday? What I’ve stated above will help on the test. Real life situations are irrelevant. If, however, they change their mind and post an errata stating that you should use a duration of 0 then that’s what I’d recommend doing on the test.
SanFranMatt Wrote: ------------------------------------------------------- > Would you rather get the correct answer in a post > on analystforum or would you rather get the > correct answer on the test next saturday? What > I’ve stated above will help on the test. Real > life situations are irrelevant. > > If, however, they change their mind and post an > errata stating that you should use a duration of 0 > then that’s what I’d recommend doing on the test. I agree with SanFran. I encountered the same problem while doing the Qbank and Schweser end of session Qs. I learned that if they give you duration for cash, we have to use it. If it is not given, assume it is 0.
SanFranMatt Wrote: ------------------------------------------------------- > Would you rather get the correct answer in a post > on analystforum or would you rather get the > correct answer on the test next saturday? What > I’ve stated above will help on the test. Real > life situations are irrelevant. > > If, however, they change their mind and post an > errata stating that you should use a duration of 0 > then that’s what I’d recommend doing on the test. Honestly? I’m going to pass next week either way, or I wouldn’t be wasting my time with this. So I’d definitely rather be right in the real world. However, I don’t think I have to make that choice because I don’t think that looking for the CFA to make the same mistake twice is a very useful standard to use on the test. As far as I’m concerned a lot of people have a hard time making the distinction between this question, wherein we are moving from one asset class to the other (via synthetic cash with a duration of 0) and those questions wherein we are actually taking a position in synthetic cash (and we would expect to be given the duration). Sleepybird and SanFran, I think you are both pulling out Schweser’s standard advice about how to remember the difference between those two problems – and that is to use the duration of cash if they give it to you. Unfortunately, that advice breaks down in this example, which is why it’s such a clever question. Even more unfortunately, it seems to have caught up the person who wrote the guideline answer.
I’m unsure what you mean by “Unfortunately, that advice breaks down in this example…”. I haven’t seen examples where they give you a duration of cash and it’s not used.
SanFranMatt Wrote: ------------------------------------------------------- > I’m unsure what you mean by “Unfortunately, that > advice breaks down in this example…”. I haven’t > seen examples where they give you a duration of > cash and it’s not used. I’m contending that they should NOT use a duration of 0.25 in this example (or problem, if you prefer). So let this be the first, right?
i chose B wrong too. it makes sense with the 3month rule i guess…but he could do the entire thing right away, so that is why i was confused.
plyon Wrote: ------------------------------------------------------- > SanFranMatt Wrote: > -------------------------------------------------- > ----- > > I’m unsure what you mean by “Unfortunately, > that > > advice breaks down in this example…”. I > haven’t > > seen examples where they give you a duration of > > cash and it’s not used. > > I’m contending that they should NOT use a > duration of 0.25 in this example (or problem, if > you prefer). So let this be the first, right? We have discuss this before. The book clearly state that cash and cash equivalent duratin could be different from zero.
plyon Wrote: > > And cash equivalents are not cash. My point being > that using anything other than zero actually gets > you a demonstrably WRONG answer. > I agree. It would make you end up with a stock position that actually has both duration and beta. I do agree however with others, that if at exam there is given cash eq. dur=0,25, then I’ll use although I think it’s wrong.
tibwa Wrote: > > We have discuss this before. The book clearly > state that cash and cash equivalent duratin could > be different from zero. I do not believe those discussions were clear about this particular issue. You are making the same mistake I cited that others have made here – you are confusing the issue by ASSUMING THERE IS CASH INVOLVED IN THIS PROBLEM. When we do have cash, we might assume duration of 0.25 for instance, when given. However… and let’s quote page 336 of volume 5, wherein the curriculum executes this same exact adjustment, as I already noted, “BECAUSE NO MOVEMENT OF ACTUAL CASH IS INVOLVED IN THESE FUTURES MARKET TRANSACTIONS, THE MODIFIED DURATION OF CASH IS EFFECTIVELY EQUAL TO ZERO” There IS NO CASH. So who cares about the duration of cash that they give us. I mean… I just don’t know how to make it any clearer. There is one example in the curriculum that addresses this exact situation and only one – and it uses a duration of zero. There is, by the way, an example in the book on page 337 wherein the investor wants to actually allocate money to cash. In this example they appropriately use 0.25 for the duration. But for the problem we are dealing with, the investor has no interest in any allocation to cash.
I concur with Plyon. MH
i got this question wrong also. i dont think we should use cash duration. we are simply re-allocating the portfolio. but if thats what cfa wants, lets just do it. so now do we only use this cash duration for the fixed income allocation? we would not use it w/ the equity side right?
… so is there consensus for the exam, that if duration of cash or cash equivalent is given, use it, if not assume 0?
Here is a response from CFAI I got on the question: ******* Thank you for the feedback. The vignette states that the temporary reallocation will be accomplished over three months so the duration of the cash is three months. Yes, you are right in saying that if the cash is instantaneous, then its duration is zero. Thanks. ******* I am still waiting for a second response because I said that if the above is true, then the paragraph in the vignette should state: “…wants to change her portfolio mix to 80 percent bonds and 20 percent equity OVER the next three months…” I’ll let you guys know.
AF 2 - CFAI 0
wanderingcfa Wrote: ------------------------------------------------------- > Here is a response from CFAI I got on the > question: > > ******* > Thank you for the feedback. The vignette states > that the temporary reallocation will be > accomplished over three months so the duration of > the cash is three months. Yes, you are right in > saying that if the cash is instantaneous, then its > duration is zero. Thanks. > ******* > > I am still waiting for a second response because I > said that if the above is true, then the paragraph > in the vignette should state: > > “…wants to change her portfolio mix to 80 > percent bonds and 20 percent equity OVER the next > three months…” > > I’ll let you guys know. After the CFa answer…I am even more confussed