ASET April_'09 qus 3

The question explains flattening the profile as removing both the upside and the downside. I thought of this as making L = 0 in the approach taken by ASET. However there is no unique solution for the amount of forwards to trade! Can someone convince me that I was wrong to set L = 0 in the first place and that a negative value of L (-3.33 million) as shown by the Examiner's report and ASET is not downside.

**P.s, upside-downside is a common 'term' in economics meaning 'profits and losses', the examiner could have easily won by sticking to his 'flatten this profile' alone!

 

Hi Edwin,
I don't think I understand what you are saying. Do you mean you set the payoff as a straight line to 0 instead of plotting the scatter points, and there is no unique solution for the scattered points?

 

ASET sets out the equation;-

X*payoffofforward + y*payoffofput/call +current portfolio value= L.

Payoff of forward = FTSE - Forward price

Forward price = 4000, since the question does not give values for r.

This is then solved by setting simultaneous equations at the points (FTSE, current portfolio value) for;-

(0, 10 mill) , (3000, 0) , (10000, -5 mill)