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Derivatives EOC Answer Explanation Makes No Sense

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    • Avatar of ykilsteinykilstein
      Participant
        25 Sep 2017 at 6:48 am
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        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!

      • Avatar of vincenttvincentt
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          • CFA Level 3
          25 Sep 2017 at 7:21 am
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          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.

        • Avatar of ykilsteinykilstein
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            25 Sep 2017 at 7:16 am
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            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

          • Avatar of vincenttvincentt
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              • CFA Level 3
              25 Sep 2017 at 7:04 am
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              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.

            • Avatar of ykilsteinykilstein
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                25 Sep 2017 at 10:57 am
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                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.

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