For Question 6, part D - 2 components of synthetic commodity position in this arbitrage, I understand that the maturity of the zero-coupon bonds should be 3 months, same as forward expiration date, but is the face value equal to the forward price at the BOND’s maturity or the FORWARD’s maturity? I’m leaning towards BOND’s maturity. What’s your take? Thanks!
I got 2.21 Assumed it was some day-count issue - didnt look into it further. Its hard to see that it would be a mistake. If enough people were getting 2.21 vs their answer they would have looked into it in more detail at the time of grading?
rounding, try extending out the decimal places on your calculator. I got the exam answer when I made that adjustment.
the important issue here is the figure in the left of the box-316-this has not been discounted at the lease rate-see again page 165-166 , Volume 5, CFAI Readings -in particualr boxes -for a clear explanation of how/why/when a tailed position is used.
bump, bump, bump it up!
Anyone have an idea about this?
Hi All
I wrote to CFA and asked for an explanation of the above -these are the :
A)Thanks for your patience. A representative from exam development reviewed your queries and the 2008 Level III guideline answers. We do appreciate your comments, but believe the guideline answers are appropriate as they are currently written. The guideline answers are simply answers that would have been awarded full credit. The guideline answers are not comprehensive; there are often alternative answers that are awarded full or partial credit
I pushed them for clarification and got this:
B) Your inquiry concerned Question 6.B. There were several ways candidates received full or partial credit in computing the profit on the reverse cash-and-carry arbitrage. Candidates may take different approaches based on assumptions they make; in this case, one source of variation in valid answers was whether the lease payment was assumed to be made in cash or commodity (copper).
Now-what I cannot understand-I thought the no-arbitrage rule means that regardless of whether obligations are settled for cash or physicals-you will still get the same result.If not you can arbitrage between the physical and cash market-yes?
Nice work checking w/ them. It is annoying because they don’t use the correct formulas in the EOC questions either. Instead they break it out so you can see each seperate cash flow, but the answer is less accurate…
Apparently there are two approaches. Both answers r close 2.19 (given in guideline answer) vs 2.21 (calculated from No arbitrage equation)
But there cannot be two approaches-again, the no arbitrage rule.
To clarify-you can have different approaches to calculation, but can have only one value-in this case 2.21 .
Otherwise it would be possible to arbitrage between structures-despite the transaction involving the same commodity. See the CFA explanation again -it implies that you can get two different answers depending on whether you repay the commodity loan with either cash or the commodity concerned (in this case copper).
That has to be wrong-given the no arbitrage rule.Put in another way, if CFAI is correct-then we have a money machine -an absolute no-no.
As to how to set-up the arbitrage-that would simply be a matter of writing up suitable contracts.
bump.
I think I understand the source of the incongruity. If you make the lease payment in “cash”, they assume you net that out of the short spot, so it is added to the short cost at T,0 … if you make it in “commodity” it is paid at T,1 … so there is a slight TVM variation.
This is speculation, but I think that is what the diff is… I remember when I was going over this section it was confusing to me that in cash and carry they were removing the lease cost from the spot purchase up front, rather than having them receive the lease rate at Time T when the actual position closed out.
Again-no arbitrage -if you are right-congratulations,you have discovered a chronic anomaly .
That difference between 2.19 and 2.21 is enough for me!
good luck exploiting a 2 cent anomoly after transaction costs.
ok-but keep in mind-no arbitrage assumptions that we deal with in the CFA course assume no transaction cost.
real world-who knows? comes down to how much bargaining power i have-and what systems i can access -yes?
I don’t think CFAI’s explanation is acceptable. Many approaches can be used to calculate, but the only correct answer shall be 2.21.