Chapter 13: Arbitrage and Forward Contracts

[Gbob1]

I've just finished reading through all the different cases of calculating the forward price and the forward contract. I've been able to understand the logic and the workings (although being a bit confused at times) and how to derive all the formulae. However I am aware that there are questions asking us to deduce the formulae and I find this tricky because I can't describe the portfolios offhand. Is it just a case of memorizing the different portfolio situations? Or is it a case of becoming really familiar with the scenarios and then everything will be much easier to remember? I just have trouble remembering for example what to invest and what to borrow for each case.

Anything after the portfolios I'm alright with because it's all quite straight-forward and methodical. Any tips would be appreciated!

Thank you.

 

[didster]

I suppose there are a limited number of contracts that would be examined and you could learn them off.

My approach was to think of the replicating portfolio on the spot. The method is to consider the cashflows and try to find items which provide them, eg a fixed £x amount in n years is the discounted amount of x at a known fixed rate, and an amount equal to the price of an asset can be reproduced by selling/buying the asset in future. If you want to pay the amount equal to the price, you buy it now and keep it. If something gives you extra cashflows, you try to find something else to cancel it.

This is a good technique to develop for the more complex questions you may eventually find in CT8 and ST6 etc.

 

[John Lee]

However I am aware that there are questions asking us to deduce the formulae

Not in the CT1 exam. Yes it's in the Core Reading and so could be asked - but the syllabus objective states "calculate the forward price" and exam questions have all (so far) fallen into this category.

 

[Gbob1]

Not in the CT1 exam. Yes it's in the Core Reading and so could be asked - but the syllabus objective states "calculate the forward price" and exam questions have all (so far) fallen into this category.

Really? That's great news then. It's just there were a couple of questions within the chapter that asked me to deduce the formulae and I was like So I figured that they could be in the real exam too. But seeing as there's never been a question on it *fingers crossed*

 

[John Lee]

*fingers crossed*

John

 

[Calum]

Not in the CT1 exam. Yes it's in the Core Reading and so could be asked - but the syllabus objective states "calculate the forward price" and exam questions have all (so far) fallen into this category.

Interesting. A lot of the stuff we do at Heriot Watt is a bit lightweight compared to the CT exams (at least so far), but certainly for our CT1 equivalent we're expected to produce replicating portfolios for more or less arbitrary scenarios. As didster says, though, it's actually easier than you think once you get the hang of how to assign the numbers.

 

[John Lee]

Interesting. A lot of the stuff we do at Heriot Watt is a bit lightweight compared to the CT exams (at least so far), but certainly for our CT1 equivalent we're expected to produce replicating portfolios for more or less arbitrary scenarios.

From conversations with lots of students - it seems that the Unis do a far more proof based approach to the syllabuses (syllabi?) - which is consistent with the higher education establishment. Whereas the Profession's approach is much more understanding and applying the results as that's what we'll actually need in the workplace.