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Sep 19 Q4 and Apr 09 Q3

M

mgh

Member
Hi

I was hoping someone could assist with my understanding for the Sep 19 Q4 and Apr 09 Q3iv.

September 2019 Q4

The main query for this question is around figuring out if the investor should buy or sell the future which I'm struggling to get my head around. I am happy with the derivation of the Future rate of 1.1614 dollars per euro.

Any help on why they would buy or sell the future at this stage would be appreciated!

April 09 Q3iv

It is a smaller query for this question. I have worked through it and am fairly comfortable with the answer as we need to make sure we use the number of days rather than assume half a year. My main question is for the discount factor derivation. The discount rate is set as:

1 / (1+annual forward rate * number of days in period / 360)

In year 1 for example, I am wondering why it is set as this rather than setting it as:

1 / (1+ annual forward rate)^(number of days in period / 360)



Many thanks in advance



 
September 2019 Q4
So the manager expects the spot rate to be 1:1.16 but forward rate is 1:1.1614 Euro to US dollars. So the investor gets a better conversion from euro to US if they buy the forward. They can buy the forward convert 1 euro into 1.1614 dollars, and then convert those dollars back into euros at 1:1.16 and they will make a profit. (Assuming of course that spot rates do turn out to be 1:1.16.)

April 2009 Q3iv
It's convention in ST5/SP5 to treat these interest rates as convertible. So when swaps are half-yearly the interest rate given is i(2) and so to get the half-yearly effective rate we divide by 2 (because the year can be split into 2). When the basis is actual/360 rather than dividing by 2 or multiplying by 0.5 we instead multiply by (no of days/360)

Your question is a fair one because we often think of compound interest in the real world. However, after you run through a number of past paper questions like this you'll probably become quite thankful that the examiners typically present interest rates to you in a way that is quite simple to handle (mathematically).

Hope this helps. If it generates follow up questions don't hesitate to ask.
Joe
 
Last edited:
Hi Joe,

I just want to check my understanding of September 2019 Q4 - have you got the dollars/euros mixed up?

My thought:
The investor gets a better deal converting euros to US if they buy the forward.
Say we start with EUR1 we can buy the forward to convert this to 1.1614 at delivery.
If the spot price does turn out to be 1.16, we can convert 1.16 back to give us the original EUR1 leaving $0.0014 profit.
So to get $100,000 profit, we need to convert 100,000/0.0014= EUR71,428,571.43
Which, at the forward rate of 1.1614, is asking for delivery of $82.957m
Is my understanding correct?

Thanks
 
Hi Orchard,

You are quite right, thanks for pointing this out. I've amended my post above swapping around the dollars and euros.

Joe
 
Hi Joe, Orchard

Thank you both very much for your comments and explanations! They make sense and are very helpful
 
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