Practice Assessment - Derivatives - Whitney

First – I feel like if someone gets question 4, they have a pretty good shot with any swap question.

This question is a monster, and I just have a specific part that I don’t get. I think the only person who can answer is someone who has been through this question before.

How do they get this part of their answer:

“Present value of euro fixed payments in HK$ = 0.08649 × 9.96 = 0.8615.”

I don’t know where they get any of those numbers?!

Well, it looks stars aligned properly for this one and only vignette. I scored 6/6. I’m printing it now and hopefully will have an answer for you shortly, provided that I can come up w/ the same guesses (LOL). Hand on…

lol…dude(or dudette) if I got a 6/6 on any of these right now I would be ecstatic. These currency swaps are ridonk.

i’m too exhausted, maxed, spent, fried to work on these curreny swaps tonight. I printed them out and then read the first paragraph, read the first question, flipped back to the reading, and had completely forgotten the question. Is manana okay?

Not too worry. I slaved on derivatives this year since I did not get them at all during Level 1. To spend time of derivatives, I had to punt quant, econ & PM so I’m pretty much screwed. I’ll maybe be able to get 2-3 on those vignettes. If I’m super lucky I’ll score in the 70’s on the other sections. More like handwriting’s on the wall.

lol, you and me both.

Check out this one, it’s gotten me a little bit closer to understanding:

That’s their way of accounting for the initial exchange rate… this took me a while to figure out too, as it’s not exactly how I do my calculations

The .08649 is .9878 (PV of the fixed EUR payments, using the new PV factors) multiplied by .08757 (EUR/HKD rate at initiation)

And then its converted right back to HKD using the current exchange rate of HKD/EUR 9.96

Present value of euro fixed payments in HK$ = 0.08649 × 9.96 = 0.8615.

Personally, I prefer to calculate the value of the interest rate swap in principal terms first and then apply the change in exchange rate. Either way should get you the correct answer if you are (very) careful with your calculations.

Oh thanks. I’m confused by the part where you multiply by the .08757 EUR/HKD.

If .9878 is the PV of the fixed EUR payments, and the rate is 11.42 HKD/EUR. Shouldn’t I multiply by 11.42 to get HKD (If going from EUR to HKD here, you multiply)?

It was a tricky question, but a good one.

essentially what you’re doing is coverting the discount rate back to euro from HKD at the old rate (11.42) and converting it to HKD at the new rate 9.96. Since the answers are in HKD, we start with HKD at 11.42 HKD to a euro, but the rate changes and this conversion takes the effect into consideration.

hope that helped!

11.42 HKD/EUR = .08757 EUR/HKD

pmond, are you set with this one?

Sometimes I look at the CFAI answers and think they’re so elegant but other times I look at them and they just make my head hurt.

I easily get confused with currencies so I find it a lot easier to convert to the relevant currencies and work with actual loan and interest amounts than work with present value factors - although, I readily agree that working w/ factors is quicker (assuming I don’t get confused). However, you’ve got it straight in your head now is what’s important.

Here’s how I approached the question:

  1. I figured out how many HK$ I would need to convert to get 25,000,000 euros. You know how to do this, it’s simply 25,000,000E x 11.42HK/E (the exchange rate at inception) = 285,500,000 HK.

  2. Then I figured out what the quarterly interest payments would be in each currency. In euros, it’s 25,000,000E x 2.32%/4 = 145,000E per quarter In HKD, its’ 285,500,000 HK x 1.84%/4 = 1,313,300 per quarter.

  3. Then I calculated the PV factors for Euribor & Hibor based on the rates in Exhibit 2.

  4. Then I figured out the PV of the interest & principal in euros (the euro loan), and the PV of the interest & principal in HK$ (the Hong Kong dollar loan)

  5. Then I converted the PV of the euro loan back into HK$ given the exchange rate 45 days later and compared it to the PV of the HK loan I calculated in step 4)

I didn’t come up with exact answer of HK$35,402,000 but it was pretty darn close.

I still see it as a double conversion of the same rate.

The .9878 is in EUR right? So we are multiplying by .08757 to get the EUR rate again?

Then after that we get it back to HKD by muliplying by 9.96. I understand that part.

Oh the .9878 is in HKD? But we used Euribor to get it?

I agree that the currency swaps (and really all swaps) are easier to value if you work with each cash flow rather than using the discount factor only like Schweser suggests.

.9878 is based on Euribor, since that is the applicable rate structure for the Euro payer

Here’s a better way to look at it

.9878/ 11.42 = .08649

.08649\ *9.96 = .8615

.8615= the new value of the EURO swap payments per $1 of HKD principal

Sorry for being stubborn.

But if .9879 is based on Euro and 11.42 HKD/EUR is our exchange rate. You divide if you are going from the numerator currency to the denominator currency, right?

dividing by 11.42 means going from HKD to EUR right? Which implies that .9879 is in HKD? That is why my intuition is to multiply by 11.42 because since .9879 comes from our EUR calculations, we are starting at EUR.

What currency is .9879?

check out financialexamhp123 and look at currency swaps. You’ll find it very helpful. It went a long way in helping me set these problems up correctly.