# Questions on Curriculum book (derivatives)

I am reading Curriculum book from CFAI and I am really confused the table they gave us to show those steps.

I am really wondering why would you go through such steps when net cash flows came down to ‘0’.
When you want to buy underlying you borrow it, so you don’t put your own money but to make arbitrage profit (steps1 and steps 3).
Any cash flow received while carrying the underlying, you reinvest in the available rf rate in the market (that is reasonable and logical->step 2).
You sell the forward contract in order not to take any price risk (Step 4).

Until here, your Cash Flow at time T will be 12 or -8. (i started wondering why would you do such transactions),and my question gets bigger at step 5. Borrow arbitrage profit. (why? what if loss?)

Net cash flow came down to ‘0’ at the end. (What did we just do for?)

This is what happens when people discourage you from studying FRM and justify the all pervasive nature of CFA. Don’t get me wrong. In no way, am I being sarcastic. I also underwent this sort of confusion.

The core to this problem lies in NOT understanding the real purpose of Derivatives , which are mainly two: 1. To speculate ( Even with Jim Simmons, Peter Lynch, Bill Gross,CFA or Mark Howard,CFA) and if you do it enough number of times over an elongated period especially with uncovered naked position - you would lose. I can underwrite a bond on this.

The second (and the most apt) purpose is to HEDGE. Hedging is essentially a SHORT TERM tool.

So the real purpose of doing the above exercise of borrowing, investing, re investing, shorting is to hedge the underlying for a LIMITED time frame.
Discard the notation and the formulas presented and apply your logic to it. You would see the risk manager has perfectly hedged his position irrespective of the underlying’ movement over the horizon. Earning rf for a LIMITED time frame on your investment asset is much better than selling (and thus incurring brokerages, t.c., taxes) and re investing (incurring brokerage, t.c., taxes) ESPECIALLY when your short term prospect of the asset is not encouraging. So you don’t wanna sell yet you wanna hedge.

Another aspect to consider is even if you seek today and buy after the bleak period is over your anticipation might have been wrong and the stock appreciates . So you end selling cheap today just to recapture the same at a higher price. Loss, is not it.

I hope you like the above explanation and your doubts are rested to peace.

Do consider studying FRM. Having done both , I can perhaps say wit some degree of confidence, FRM is in its limited scope ( It is not all pervasive) is a much better if not advanced course than any other financial certification or charter.

FRM appears to be more focused on risk management, while CFA is more broad in scope and is the “jack of all trades, master of none”. In the CFA program you have to learn several topics, but only at a very superficial level. For example, you only need to know statistics and probability at a high-school level, and there appears to be no Calculus in any of the 3 levels. Depending on a person’s career path, this broad scope offered by the CFA program might be preferable. One limitation, of course, is that there is a greater emphasis on memorization rather than understanding. This means that candidates are quick at using the formula to solve very similar problems, but they have trouble solving more complex questions because they did not really understand the fundamental concepts. To be fair, the candidates don’t have much time or incentive to cover things in much depth, and it’s far easier to memorize a few formulas listed in a CFA prep book. There are exceptions, of course, such as portfolio theory, which is among CFA program’s strongest point.

Not amongst my candidates, there isn’t.

(But you’re certainly correct in general.)

1 Like

Respectfully disagree. No that is not the case at all. You won’t succeed solely relying on your memory cell. But the focus is certainly to “somehow pass and be done with the program…because summer is too short to enjoy”. Add to it the swift marketing of the prep providers that talk of “efficient passing and laid down byte sized secret sauce” … and this is what you will get. I literally laugh my heart out when I see people beaming with confidence just because he/she has passed all three levels at one go and is a Charterholder at 25. There was a reason why the Institute had 4 years requirement before earning the Charter. Alas that is now shortened to 3 years. Either we were wrong or the next generation of Charterholders would be. This program was meant for working pros. not kids out of college yet that is what it has boiled down to. But who am I to complain ?

Magician is a Good Samaritan. He strives to explain the often intricate concepts in a lucid manner possible. Even I benefitted.

Now, why my vote goes for FRM is because of the course structure and the actual rigours of the exam. No matter which provider you hire … you will face at least 40-50% odd ball( especially in part 2). That cannot be gamed if one relies on memorisation without having a profound understanding.

And quite rightly so… but for Bionic Turtle there is not a single credible prep provider across both parts of the FRM program.

Anyway, our discussion revolves around memorisation vs. concept building. I hope CFAI does take all measures possible to not let the program be gamed, diluted and commoditised.

1 Like