Dear all
In schweser vol 4 p 137 blue box I don’t understand why we use the risk-free rate to calculate the value of the portfolio when we create synthetic stock exposure .
Let me give you the question
Manager A holds $25 Mio market value 3 month T bills yielding 1% and wishes to create $20mio synthetic s&p stock exposure for three months. The s&p contract is priced at 1750 the dollar multiplier is 250 and underlying stock dividend yield is 2.5%. calculate the number of contracts to buy/sell and the zero coupon to take.
Reply
Purchase 46 contracts because
(20mio x 1.01^3/12 )/(1750×250)…
Why are we taking 1% when dividend yield is 2.5%?
the 1st thing is to understand what a synthetic position is, which is basically taking cash / cash equivalent as collateral to gain exposure to i.e. equity market via futures.
that cash is invested in lets say risk free short term investments so you can earn a little something something. so basically your equity exposure needs to be at least = to what you would get if it was invested in a short-term risk free vehicle…
With that in mind, if you re-read that section Schweser does it a pretty good job explaining why you use the risk free rate then use the dividend rate. Also next part is reverse going from equity to cash.
Thanks you’re right it comes afterwards … I was just stuck !