Not going to write out the full question but can someone please explain how they are getting A instead of B on the practice test Schweser book 2 exam 1 pm #116? They are asking for the value of the FRA in 3 months but then they discount back to the present…does not make sense to me why they would have this step…also the CFAI formula in reading 60 pg 37 does not show this.
draw out a timeline. Can you get to that 7.08% point? Then get that $2,295. That is the amount we will get at the end of the contract. But we want to know what it’s worth today, so discount back 150 days. Let me know if that helps or not.
Thanks for the response Andrew…Can you let me know if the formula on CFAI book 6 pg. 37 is only part of what I need to answer this question? That is where I am having trouble. From the formula for Value of FRA on day g I get the $2,295 and the question ask for the value for 90 days after inception which would be day g no? Do not see why I would need to then discount back Still a little confused on this
I would stick to the schweser formula which i think is the price (top) one looking at pg 37. This is a 3x5 FRA, which just means it’s a 2 month loan that starts in 90 days. So draw out a line, mark days 90, 180 and 240. Now above that draw a line from 90-240 and call that the 150-day rate of 5.96% (and then you unannualize this). Draw another line between that and the original line from day 90 to day 180, call that the 90-day rate of 5.12%. Now draw “x” which is the difference of those and goes from day 180 to day 240, which is just the length of the loan. We find that value to be 7.08% annualized. Now notice how that’s greater than the 6% we “locked in” paying at inception, so because we are long we wanted the rate to go up, which happened, so that’s great, so we calculate the payment we get of 0.0708-0.06…but that’s the payoff at the end of the loan. We want the PV of that, so just discount it back all the way back to day 90, which is where we are at right now, so you discount it back using the 150-day rate. Does that help?
This makes sense but still a little frustrated that the CFAI books do not make this clear…all the examples in the EOC seem to show the Value at day g without the last step Schweser shows…Do you know when you would use the Value Formula shown on pg 37 if it does not apply to this problem? Thanks for the help
For example on CFAI reading 60 EOC #9 C it is the kind of question but it does not show the final step to discount. Sorry to keep coming back to this (I;m wasting way too much time on one problem) but for the answer to have both options and both books steps to give you a separate answer I just want to make sure I understand the difference for test day. thanks again
Auto, CFAI formula does the same thing - does discount the value back to valuation date. However, the formula is messy. The difference you are getting is due to rounding.