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Collar expiration

April 25, 2019, 11:56 am
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Hi

Could someone explain to me the answer?

Why does the first collar expiration  occur on February 1 for payment on August 1?

Why is there  no collar payment on the first February 1?

Thank you.

Qn:

On August 1, a bank enters a 2-year, zero-cost collar for a $20 million portfolio of floating-rate loans by buying the floor and selling the cap. The floor strike is 2.5%, the cap strike is 4.7%, and the reference rate is LIBOR. The interest payments on the loan assets are LIBOR plus 240 basis points. The collar’s semiannual settlement dates exactly match the dates when the floating-rate payments are made: August 1 and February 1 over the next two years. Payments made August 1 cover 181 days and payments made February 1 cover 184 days. Current LIBOR is 4.1%. The values of LIBOR on the next three settlement dates are 2.4%, 5%, and 5%. Calculate the actual interest rate payments (to the bank), settlements, and effective interest payments.

Ans:

The first collar expiration will occur on February 1 for payment on August 1.

There will be no collar payment on the first February 1. The payoffs on the derivatives are:

Floorlets:

Year 1 payoff on Feb. 1 = N/A 

payoff on Aug. 1 = $10,056 = $20,000,000[max(0, 0.025 − 0.024)(181 / 360)] Year 2 payoff on Feb. 1 = $0 = $20,000,000[max(0, 0.025 − 0.050)(184 / 360)]

payoff on Aug. 1 = $0 = $20,000,000[max(0, 0.025 − 0.050)(181 / 360)] 

Caplets:

Year 1 payoff on Feb. 1 = N/A 

payoff on Aug. 1 = $0 = $20,000,000[max(0, 0.024 − 0.047)(181 / 360)] Year 2 payoff on Feb. 1 = $30,667 = $20,000,000[max(0, 0.050 − 0.047)(184 / 360)] payoff on Aug. 1 = $30,167 = $20,000,000[max(0, 0.050 − 0.047)(181 / 360)] The interest payments are:

pmt. on Feb. 1 = $664,444 = $20,000,000(0.041 + 0.024)(184 / 360) pmt. on Aug. 1 = $482,667 = $20,000,000(0.024 + 0.024)(181 / 360) pmt. on Feb. 1 = $756,444 = $20,000,000(0.050 + 0.024)(184 / 360) pmt. on Aug. 1 = $744,111 = $20,000,000(0.050 + 0.024)(181 / 360)

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Delta hedging

April 25, 2019, 12:10 pm
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Hi

1) The increase in volatility makes both call and put more valuable. The increase in value is a loss to the dealer’s short option position ans is not offset by immediate change in value of the shares used for the hedge. There is an immediate loss on the net hedged position.

Why immediate loss?

2) Why is time premium the largest for ATM options and it diminishes as the option moves OTM or ITM?

Thank  you

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Currency Forward

April 25, 2019, 12:45 pm
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I understand that the value of a 1 year forward contract to buy a stock at a strike of $50 will be as follows 3 months into the contract:

current market price of stock minus $50/(1+rfr)0.75…correct?

Now if we change this to a currency forward- to buy USD forward in 1 yr at a strike of $1.2/EUR…to value this contract 3 months in:

1) take opposite position- so calculate new forward rate, which is now a 9 month forward rate (I do know how this is done)

2) value of contract is the difference between these two forward contract rates, but then discounted back 9 months?

My Qs are- am I correct in all of the above & also- are these 2 methods consistent or am I missing something? I keep forgetting how to value a forward contract when currencies are involved, want to make sure I have done the above correctly…

Thx!

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Exam 1 AM session / Mark Meldrum /Question 38

April 25, 2019, 2:25 pm
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Why is it considered long position in swap when trying to reduce duration of portfolio in the question ?

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AM Exam

April 25, 2019, 6:41 pm
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Well, I just finished a grueling - and I mean grueling, mock of the 2018 AM.

This was my first go at an AM mock. And man the time crunch is real. I kept track of time as I went and literally had 30 seconds left to circle the last answer - which I got wrong. My head is spinning. I scored 62%. Meh. Honestly thought I did better but just bombed a few answers and made some silly mistakes on others. Forgot to circle an answer, added something wrong, etc. It’s easy to make these mistakes when the clock is on. I was pretty hard on myself with the grading but given how I have no idea how they actually do it, I thought I might as well. 

Anyhow, just throwing this out there to see where everybody else is. I think I’m going to keep putting myself through this torture from here on out. Its a great way to check your weaknesses. I’m writing down my tank areas and will try to put a focus on those. 

Don’t go gentle into that long dark night……

Godspeed my friends. 

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EOC only

April 25, 2019, 9:17 pm
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For level 1 and 2, the consensus is that you should focus on the EOC and you are good if you understand the EOC.

What about level 3? There are quite a bit of essay style questions in the EOC.

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CFAI Derivatives practice problem - Anna Lehigh case

April 25, 2019, 11:01 pm
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In Q2, it asked for the notional principal of the IRS.

My question is, how do you know which swap to use? 3 were provided, with maturity at 2y, 3y and 3.5y. I dunno which one to choose, so I thought with a target duration of 3, I went with the 3y one, but the answer went for the 3.5y one. Why is that?

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Capital Market Expectations (Doubt)

April 26, 2019, 3:34 am
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Hi

‘I cant understand how did they calculate the 1 year trend in consumer spending and inflation to be 4% and 10% respectively?

Please help me with the question (I have posted the question as well as the solution below)

Question 11 Pg 122 Reading 16

Plim Ltd. is a manufacturing company in Finland that is a defined-benefit pension plan sponsor. Plim intends to increase its overall plan diversification by making an investment in Country X. The table below provides data for Country X indexes representing various economic variables.

Based only on the data presented, from the perspective of year-end 2011, indicate whether the 1-year trend for each of the economic variables is stronger than, weaker than, or the same as its 3-year and 20-year data trend growth rates.

Economic Index Data for Country X

Variable
Year-End
2008
Year-End
2009
Year-End
2010
Year-End
2011
20-Yr. L/T Average Annual % Increase

GDP
118.3
121.3
124.3
127.4
4.2

Consumer spending
1,569.2
1,596.2
1,584.3
1,647.7
2.5

Business spending
650.1
632.0
707.8
726.9
2.6

Inflation
2,749.8
2,901.1
3,133.1
3,446.4
14.3

Government spending 
(% of GDP)
16.2
16.5
16.0
15.8
3.6

 

Solution in book 

To address the question, we first convert the data from the table into trend information (1-year, 3-year, and long-term 20-year trend information). The time periods are from the perspective of the end of 2011.

Trend Comparisons
1-Year Trend
3-Year Trend
20-Year Trend

GDP
2.5%
7.7%
(2.5% compound average annual growth)
4.2%

Consumer spending
4.0
5.0
(1.6% compound average annual growth)
2.5

Business spending
2.7
11.8
(3.8% compound average annual growth)
2.6

Inflation
10.0
25.3
(7.8% compound average annual growth)
14.3

Gov’t. spending (% of GDP)
−1.25
−2.5
(−0.8% compound average annual growth)
3.6

 

Based on the above comparisons, our conclusions about current trends witnessed over the past year for the economy of Country X relative tolonger-term 3-year and 20-year trends are reflected in the table below.

Trend Analysis
1-Year Trend
3-Year Trend
20-Year Trend

GDP
2.5%
1-year trend is the same as the average annual GDP growth 3-year trend of 2.5%.
1-year trend of GDP growth is weaker than the 20-year trends.

Consumer spending
4.0
1-year trend is stronger than average annual consumer spending growth 3-year trend of 1.6%.
1-year trend is stronger than the average annual consumer spending growth 20-year trend of 2.5%.

Business spending
2.7
1-year trend is weaker than the average annual business spending growth 3-year trend of 3.8%.
1-year trend is stronger than the average annual business spending growth 20-year trend of 2.6%.

Inflation
10.0
1-year trend is weaker (higher inflation) than theaverage annual inflation growth 3-year trend of 7.8%.
1-year trend is stronger (lower inflation) than theaverage annual inflation growth 20-year trend of 14.3%.

Gov’t. spending (% of GDP)
−1.25
1-year trend is weaker than the average annual govt spending growth 3-year trend of −0.8%.
1-year trend is weaker than the average annual govt spending growth 20-year trend of 3.6%.

 

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CFAI Web practice questions - Equity Portfolio Management

April 26, 2019, 3:57 am
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Hi all,

Just wondering if someone can justify the answer on Question no.3

I don’t understand why “Manager B’s excess return is more a matter of luck than skill”?

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AM Mocks

April 26, 2019, 8:00 am
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When publishing mocks on their official website does CFAI give new questions in place of topics no longer relevant to the syllabus or are the papers posted as is.

Am asking because I know that the 2018 AM was revised as per the current syllabus has the same been done for 2017 and 2016.

Cheers.

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Predicted change using partials

April 26, 2019, 8:12 am
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Hello everyone,

There is a formula I do not understand and it is driving me crazy:

Predicted change = Portfolio par amount x Partial PVBP x (-Curve shift)

Why do we multiply Curve shift by BOTH portfolio par amount AND PVBP  since both metrics already contain the portfolio value (PVBP = modified duration x Portfolio value x 0.0001). Doesn’t it result in squaring portfolio value ?

Thank you much guys!

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Exam Day Strategy (AM & PM)

April 26, 2019, 8:48 am
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guys, i’m curious how’s everyone formulating the exam day strategy ?  

I practiced and did Lv. 2 by reading the entire case then answer the multiple choices questions. But when practicing Lv 3 AM sessions, i found it quite efficient to read questions first and then go back to case paragraphs to get the context. Is this a economical strategy for the real exam? what’s the real exam book look like, single-sided or double sided? 

Some of the tips says that it’s important to use watch wisely on exam day, to track the time lapse on each question, eg from 10:00 - 10:05 answer Q2 Question B. I found it quite difficult to practice. Is there an alternative?

For the PM sessions, I noticed that CFA website qbank is structured in a way that each case paragraph discusses one question, so usually 6 questions in total. But I think the CFAI sent out email saying that 2019 exam structure will be altered, that each case question will have unequal number of questions. So what’s a good strategy for PM session ?

Thanks

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2017 AM Question 6A

April 26, 2019, 2:09 pm
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Past AM Exams

April 26, 2019, 7:27 pm
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I have the 2015/16/17/18 AM papers - and I’m wondering if you guys have any trustworthy resources on knowing exactly which questions from thos past papers translate into still being relevant for 2019?? 

Tanks in advance

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Callable Bond - Convexity

April 27, 2019, 9:07 am
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If callable bonds exhibit negative convexity, why does the textbook say buy callable bonds = buy convexity on p.147 R24? 

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R24 P163: "Partial PVBP" Epiphany

April 27, 2019, 4:40 pm
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This formula from Reading 24, page 163 (underneath Exhibit 33) seems to be giving everyone fits:

Predicted change = Portfolio par amount × Partial PVBP × (–Curve shift)

First off, the confusion surrounding this topic is (as are most things) directly related to poor wording on the part of the CFA curriculum writers.

I came across the partial PVBV topic and didn’t fully understand its calculation or the logic behind the formula. After working through it, I could never get the decimal places to line up with the answers in the books either. After searching AF, it seems that there are only unanswered questions, nothing helpful. Meaning I’m not going crazy and others don’t understand this either (which makes me feel a little more sane haha).

So here goes: two issues seem to keep popping up:

  1. Do you scale the Partial PVBP calculation by 100 to get the right answer? 
  2. If “PVBP” (and therefore Partial PVBP) is a $ figure & Portfolio Par Amount is a $ figure, aren’t you essentially squaring $s?

Here’s what made sense to me- if it makes sense to others, please respond and/or critique.

1. The issue is not with the Partial PVBP number. On an earlier post, S2000 Magician guessed that it might be that Partial PVBP was supposed to be stated in % terms, but he was waiting for clarification from CFAI. Let’s take Exhibit 33 for example. The 2Y Maturity bond experiences an 18.3 Key Rate Curve Shift (bps) on a Portfolio par amount of 60,000 ($ thousands) and has a Partial PVBP of 0.0056. If you multiply those #s out as per the equation below the exhibit (Predicted change = Portfolio par amount × Partial PVBP × (–Curve shift)), you get a number that is supposed to be in “$ thousands:” “-6,148.” However, Exhibit 33’s answer is “-61.5.” So why the difference of a factor of 100? Here’s the disgusting answer: You have to convert the “Key Rate Curve Shift” from bps to %. Look at the difference in wording of the formula in the Reading vs the formula in the End Of Chapter Solution to Q20. “Predicted change = Portfolio par amount × Partial PVBP × (–Curve shift)” VERSUS  ”Predicted change = Portfolio par amount × partial PVBP × (curve shift in bps)/100” (Forget the fact that the EOC Solution formula forgot to include a “negative” symbol for the curve shift portion). Once you convert the Key Rate Curve Shift to % from bps- i.e. divide by 100- all of the calculations will work.

2. Portfolio Amount is a $ figure. But PVBP (and Partial PVBP by extension) is not actually a “$ figure.” It is a scaling number that you multiply by every $1 of par value to get the change in price. Expand the calculations for the “PVBP” part of “Partial PVBP” to understand why you’re not squaring $s. PVBP is Money Duration / 100. Money Duration is Modified (or Effective) Duration times the Portfolio Value per $1 of Par divided by 100. Which means that the actual notation is “Portfolio Value in $s divided by 1 unit of Par Value in $s.” So the $s cancel each other out. Put another way, if you rearrange the above equation to Partial PVBP = Predicted change / (Portfolio par amount × (–Curve shift)  and substitute ”0.0001 x (Effective duration x (Portfolio value / Portfolio par amount)” for PVBP, the “Portfolio par amount” expressions cancel each other out and you are left with only 1 “$ figure” in the equation. Hence you are not squaring $s.

I hope this helps and if anyone see anything wrong with mmy explanation / conclusions, please comment away!

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Are you memorizing these equations in Capital Market Exp?

April 27, 2019, 9:02 pm
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The formulas for market variance and covariance (equations 3a and 3b on page 29 of the cap market exp book) are pretty long and uninteresting. I found several questions on these in the CFAI online practice questions, but there are no book examples or EOCs on these, and they’re not explicitly mentioned in the learning outcomes.

Are you guys memorizing these?

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Example 4 - External constraints and asset allocation (reading 20)

April 27, 2019, 9:56 pm
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Under example 4 - external constraints and asset allocation, the insurance company plans would like to limit risk to the plan’s funded status. The pension assets are 95% invested in high-quality intermediate duration bonds and 5% in global equities. The duration of pension liabilities is approximately 25 years. 
(Institute 341)

Institute, CFA. 2019 CFA Program Curriculum Level III Volume 3. CFA Institute, 5/2018. VitalBook file.

One of the proposals suggests retaining the same asset allocation but it was criticized that given the intermediate duration bond allocation, the proposal fails to consider the mismatch between pension assets and liabilities and risks a reduction in the funded status and increased contributions if bond yields decline. (If yields decline across the curve, the shorter duration bond portfolio will fail to hedge the increase in liabilities.). It was also criticized that the proposal does not reduce balance sheet and surplus risk relative to the pension liabilities.

Why is that so? I thought if the liabilities are now immunized, investing in a different duration may introduce a basis mismatch? 

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Surplus Optimisation vs Two Portfolio Approach

April 28, 2019, 2:18 am
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CD someone please explain how these two approaches differ on reading they both sound very similar 

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L3 2010 Essay Mock Q6 vs 2018 Essay Mock Q7B on money duration

April 28, 2019, 5:28 am
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In the 2018 question, it stated money duration = modified duration × market value.

but in the 2010 question, it is instead stated money duration = modified duration × market value /100 which is inline with the text book 3.2.1.1 in reading 24, it states “Money duration is market value multiplied by modified duration, divided by 100”

anyone knows why the 2018 question is the exception?

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