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April 2021

1

1495_sc

Ton up Member
Hello,

Can someone help in clarifying these questions from April 2021 session?

Q4- part v)

The term of risk free rates given isn't very clear to me. For calculating forward price for 2 year forward, are we assuming that risk free rate is for 2 year period and not as at given date? In the accumulation factor, I was assuming 1.2% for year 1, 1.3% for year 2 and so on until I looked at the solution.

Also, when calculating total profit/loss on each forward, the final step is giving me a different answer. For example, for 1 year forward, total profit=

2.76 (same as Examiners report) *1500000 (number of forward contracts purchases, assuming 1 metric tonne per contract)= 4140000
but the solution in the report is 4134940. Am I missing something?

Similar concern with 2 year and 3 year contracts.

Thank you!
 
Q2.

part iv)

The formula quoted in Core Reading for xd adjustment is

xdi,t = (Di,t * N i,t )/B(t-1)

I could not follow the definition of B(t-1).

This part of the question is a direct application of core reading but why is B(t-1)= (2050/1000) here? Why would we consider the whole market capitalisation (2050 vs only 450 for company 2 and 5) when we are calculating xd adjustment only for 2 companies? Understanding the meaning of B(t-1) should answer this I suppose. Please help.
 
Hi, The second of the queries above is easier. The B(t) divisor is simply there to adjust the monetary value of the dividends received on a certain day to be consistent with the capital value of the index components. So if B(t) is 5m, and the market cap on the top line is 500m, then the index stands at 500/5 = 100. If there are 2.5m dividends on a day, then that is 2.5/5 = 0.5, which is on a consistent basis with the index value. Why use the day before divisor? (B(t-1) )? I think that is just because most dividends are declared in the market before the market opens, so the index imagines that they were paid at close of market on the day before.

The first query is just a rounding issue. You say that the profit is 2.76 as in the examiners report. But if you look closely it is 2.75662 .... If you use the full spreadsheet accuracy you get the examiners results.
 
Following on from 4v) I have another question:
So I understand what has been done in the ASET and mark scheme.

My interpretation of the question asking for Profit/Loss was that we needed to account for only 75% of the Fuel needed being hedged. Therefore we would still need to purchase 25% of the fuel at the spot price. So for Profit - loss I did Spot Price - (0.75*forward price + 0.25* spot price). I'm a bit confused as to why this wasn't the answer? Would I have dropped marks as a result?
 
I dont think your interpretation is valid here. They will indeed have to buy the remaining 25% in the spot market. (In fat they will probably buy 100% of requirements on the spot market and just unwind the future.) But those spot purchases will be the same if they hedged 0% of their fuel requirement, so in terms of the profit/loss, it adds nothing to the strategy. The only profit or loss will come from the 75% that you hedged. ie, whether it was good or bad to hedge what you did hedge.
 
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