CFA CFA Level 2 Derivatives EOC Answer Explanation Makes No Sense

# Derivatives EOC Answer Explanation Makes No Sense

• Author
Posts
• 0

EOC Futures Mkts

“The Following…to Q’s 9-14”

Uda…is CFO at Axia…HQ in Germany, reports in EUR.

[skip]

Exhibit 2
UK Rate = 4.17%*
EUR Rate = 3.28%*
Spot Exchange Rate (GBP per EUR) = .6892
*244-day int. rates, discrete and annualized

#12:

Based on Ex. 2, the arbitrage-free 244-day forward exchange rate (GBP per EUR) is closest to:
A. 0.6932
B. 0.6851
C. 0.7083

The answer is A and gives F=S*[(1+RFdomestic)^T/(1+RFforeign)^T]. They put .6892[1.0417^(244/365)/1.0328^(244/365). That makes no sense bc 4.17% is the foreign rate and 3.28% is domestic as they say GBP per EUR, they’re based in EUR, report in EUR…

To quote Walter in The Big Lebowski, “Has the whole world gone CRAZY?”

I saw this same Q on Analyst Forum but they didn’t do a good job of explaining it.

Thanks!

• vincentt
Participant
• CFA Level 3
5

It’s up to you which ever method that works for you, personally I don’t really use the fixed f/d method as long as your answers are in the same order (numerator and denominator) before multiply the answers in #1 and #2 you will be fine.

The only exception is when there’s bid and ask, you can’t just switch it around with 1/x. For example when you switch from buy EUR to sell EUR, you would have to use the relevant rate and not just with the 1/x.

• 4

I believe what you’re saying is ignore notation (f/d) and “go down” the direction they want you to. (GBP/EUR) This relates to Econ exchange rates and I see from here that could use some work!

Thx @vincentt

• vincentt
Participant
• CFA Level 3
2

Don’t get distracted by domestic or foreign as it doesn’t really matter in this case.

1. Look at the answer, what rate is it presented in? GBP/EUR which is the same numerator/denominator as the question (e.g. GBP per EUR = .6892 )

2. Now convert both the exchange rate to a 244 days forward:

GBP
1.0417 ^ (244/365) = 1.027687
EUR
1.0328 ^ (244/365) = 1.021809

In the same order as the rate give GBP / EUR = 1.027687 / 1.021809 = 1.005752

3. Now multiply the spot rate with the answer in 2 (1.005752), which will give you 0.693165

Unless the answer is asking for EUR / GBP you can easily get that with the [1/x ] button on your BA II calculator.

• 0

Even tho the #’s are right, the book’s formula still makes no sense.

I hear what you’re saying. Better to think abt it as Price/Base. If you’re in Australia and you’re dealing GBP for EUR’s, who gives a rat’s behind what country everyone’s in.

With all that bid-ask inverse stuff, my econ is glaringly lacking.