I don’t understand their calculations for this one: “Betty owns 5 million pounds in stock. She sells 5 million pounds forward for Canadian Dollars at a futures rate of 1.75 dollars/pounds. The spot rate is 1.8 dollars/pounds. One month later, the stock is worth 5100000 pounds, the spot rate is 1.75 dollars/pounds, and the futures rate is 1.70 dollars/pounds. Calculate her profit/loss on her hedged UK stock position.” Answer: Profit/loss = VtSt – V0S0 – V0(Ft – F0) = 5,100,000 × 1.75 – 5,000,000 × 1.80 – 5,000,000 (1.70 – 1.75) = 8,925,000 – 9,000,000 + 250,000 = $175,000 Her stock is worth 8,925,000 Canadian dollars; I get that. But how are they getting the rest of this equation? When you sell pounds forward for dollars, you are agreeing to pay at the futures rate and receive at the spot rate, right?
I think you have it backwards…when you sell forward, you are agreeing to sell at the futures rate…therefore, her profit on the futures position would be: (1.75 - 1.7)*5000000 = 250000 Hope this helps, TheChad
this whole set terminology is confusing and i am reading it again today… But, in this case, think you possess two things today; stocks in pounds and a future. You have planned to sell them both. Stocks you will sell in 6 months at the spot rate.Future you have sold now at a given rate ($1.75)… IN six months, you give pound in the market and get dollars worth 8925000. Since earlier you had 9000000 worth of value (1.8X5000000), you have lost $75000 value here. Now you also had futures which you sold for $1.75… Now you need to get it back, but you can only get it back at $1.7… so here you made money… sell higher, buy cheaper… worth $0.05X5000000 = 250000… so you lost $75K, made $250 K and hence net net you made $175K… I killed myslef thinking from selling future, getting money angel, but it was worthless… Think of this as two transactions… One in underlying on spot… other as a transaction in futures… The same issue stumped me in the 2008 essay question # 9… BTW, is this the sample question from CFAI that you need to buy?
Yeah - agree that best way to look at these problems is 2 separate transactions. And before you do any calcs just look at the futures px chg and figure out whether it was a winning or losing position, it helps to keep things straight. i.e. I sold pound futures short and pound depreciated - so I made money in my futures position. Sample exam is available on CFAI website - 30 questions mult choice, 40 bucks
financial_novice Wrote: ------------------------------------------------------- > I killed myslef thinking from selling future, > getting money angel, but it was worthless… Think > of this as two transactions… One in underlying > on spot… other as a transaction in futures… The > same issue stumped me in the 2008 essay question # > 9… > I had the same pain before. actually, this is the real way of hedge, use derivative’s gain cover the assets’ loss.